10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________

FORM 10-K

(Mark One)

x    Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2010

OR

o    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission file number 1-12040

SUN HEALTHCARE GROUP, INC.

(Exact name of registrant as specified in its charter)

Delaware (State of Incorporation) 13-4230695 (I.R.S. Employer Identification No).

18831 Von Karman, Suite 400

Irvine, CA  92612

(949) 255-7100

(Address, including zip code, and telephone number of principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class Common Stock, par value $.01 per share Name of Exchange on Which Registered The NASDAQ Stock Market LLC (Nasdaq Global Select Market)

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. oYes     xNo

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. oYes     xNo

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. xYes     oNo

Indicate by check mark whether the registrant has submitted electronically and posted to 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).   oYes     oNo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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 filero     Accelerated filerx     Non-accelerated filero     Smaller reporting companyo

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). oYes     xNo

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, as reported on the NASDAQ Global Select Market, as of the last business day of the registrant's most recently completed second fiscal quarter was $348.4 million.

     On March 1, 2011, Sun Healthcare Group, Inc. had 24,979,551 outstanding shares of Common Stock.

Documents Incorporated by Reference:  Part III of this Form 10-K incorporates information by reference from the Registrant’s definitive proxy statement for the 2011 Annual Meeting to be filed prior to May 2, 2011.

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

INDEX

		Page
PART I
Item 1.	Business	1
Item 1A.	Risk Factors	8
Item 1B.	Unresolved Staff Comments	16
Item 2.	Properties	17
Item 3.	Legal Proceedings	19
PART II
Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
	Purchases of Equity Securities	19
Item 6.	Selected Financial Data	21
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of
	Operations	24
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	50
Item 8.	Financial Statements and Supplementary Data	50
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial
	Disclosure	50
Item 9A.	Controls and Procedures	51
Item 9B.	Other Information	51
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	52
Item 11.	Executive Compensation	52
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related
	Stockholder Matters	52
Item 13.	Certain Relationships and Related Transactions and Director Independence	52
Item 14.	Principal Accountant Fees and Services	52
PART IV
Item 15.	Exhibits and Financial Statement Schedules	52
Signatures		56

___________________

     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.

    Sun Healthcare Group®, SunBridge®, SunDance®, CareerStaff Unlimited®, SolAmor®, Rehab Recovery Suites® and related names are trademarks of Sun Healthcare Group, Inc. and its subsidiaries.

__________________________________________

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Information provided in this Annual Report on Form 10-K (“Annual Report”) contains “forward-looking” information as that term is defined by the Private Securities Litigation Reform Act of 1995 (the “Act”).  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 outcome and costs of litigation, projected expenses and capital expenditures, growth opportunities and potential acquisitions, competitive position, plans and objectives of management for future operations and compliance with and changes in governmental regulations.  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 are forward-looking statements.  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.  We caution investors that any forward-looking statements made by us herein are not guarantees of future performance and that investors should not place undue reliance on any of such forward-looking statements, which speak only as of the date of this report.  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 should carefully consider the disclosures we make concerning risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements, including those described in this report under Part I, Item 1A – “Risk Factors” and any of those made in our other reports filed with the Securities and Exchange Commission. There may be additional risks of which we are presently unaware or that we currently deem immaterial.  We do not intend, and undertake no obligation, to update our forward-looking statements to reflect future events or circumstances.

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

PART I

Item 1.  Business

Overview

Sun Healthcare Group, Inc. (NASDAQ GS: SUNH) is a healthcare services company, serving principally the senior population, with consolidated annual revenues in excess of $1.9 billion and approximately 30,000 employees in 46 states. Sun’s services are provided through its subsidiaries: as of December 31, 2010, SunBridge Healthcare and its subsidiaries operates 164 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 an aggregate of 23,053 licensed beds in 25 states; SunDance Rehabilitation provides rehabilitation therapy services to affiliated and non-affiliated centers in 36 states; CareerStaff Unlimited provides medical staffing services in 39 states; and SolAmor Hospice provides hospice services in 10 states.

2010 Restructuring

On November 15, 2010, our former parent, Sun Healthcare Group, Inc. (“Old Sun”) completed a restructuring of its business by separating its real estate assets and its operating assets into two separate publicly traded companies.  The restructuring consisted of certain key transactions including the reorganization, through a series of internal corporate restructurings, such that (i) substantially all of Old Sun’s owned real property and related mortgage indebtedness owed to third parties were transferred to or assumed by Sabra Health Care REIT, Inc (“Sabra”), a Maryland corporation and a wholly owned subsidiary of Old Sun, or one or more subsidiaries of Sabra, and (ii) all of Old Sun’s operations and other assets and liabilities were transferred to or assumed by SHG Services, Inc., a Delaware corporation and a wholly owned subsidiary of Old Sun (“New Sun”), or one or more subsidiaries of New Sun.

On November 15, 2010, Old Sun distributed 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 Old Sun’s stockholders aggregating approximately $10 million.  Old Sun then merged with and into Sabra, with Sabra surviving the merger and Old Sun’s stockholders receiving shares of Sabra common stock in exchange for their shares of Old Sun’s common stock (the “REIT Conversion Merger”).  Immediately following the Separation and REIT Conversion Merger, New Sun changed its name to Sun Healthcare Group, Inc.  Pursuant to master lease agreements that were entered into between subsidiaries of Sabra and of New Sun in connection with the Separation, subsidiaries of Sabra lease to subsidiaries of New Sun the properties that Sabra’s subsidiaries own following the REIT Conversion Merger.

In this Annual Report we discuss the business of both Old Sun and of New Sun because New Sun has continued the business of Old Sun and is the successor issuer to Old Sun for purposes of the Securities Exchange of 1934, as amended (the “Exchange Act”).   References to ‘we’, ‘us’ ‘our’ and the ‘Company’ refer to Old Sun and New Sun and their businesses.

Business Segments

During 2010, our subsidiaries engaged in the following three principal business segments:

Ø inpatient services, primarily skilled nursing centers;

Ø rehabilitation therapy services; and

Ø medical staffing services.

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Inpatient services.    As of December 31, 2010, we operate 164 skilled nursing centers, 16 combined skilled nursing, assisted and independent living centers, 10 assisted living centers, two independent living centers and eight mental health centers with an aggregate of 23,053 licensed beds in 25 states through SunBridge Healthcare Corporation (“SunBridge”) and other subsidiaries. Our skilled nursing centers provide services that include daily nursing, therapeutic rehabilitation, social services, housekeeping, nutrition and administrative services for individuals requiring certain assistance for activities in daily living. Rehab Recovery Suites (“RRS”), which specialize in Medicare and managed care patients, are located in 68 of our skilled nursing centers, and 47 of our skilled nursing centers contain wings dedicated to the care of residents afflicted with Alzheimer’s disease. Our assisted living centers provide services that include minimal nursing assistance, housekeeping, nutrition, laundry and administrative services for individuals requiring minimal assistance for activities in daily living. Our independent living centers provide services that include security, housekeeping, nutrition and limited laundry services for individuals requiring no assistance for activities in daily living. Our mental health centers provide a range of inpatient and outpatient behavioral health services for adults and children through specialized treatment programs. We also provide hospice services, including palliative care, social services, pain management and spiritual counseling, through our subsidiary SolAmor Hospice Corporation (“SolAmor”), in 11 states for individuals facing end of life issues. We generated 89.0%, 89.0% and 88.6% of our consolidated net revenues through inpatient services in 2010, 2009 and 2008, respectively.

Rehabilitation therapy services.  We provide rehabilitation therapy services through SunDance Rehabilitation Corporation (“SunDance”). SunDance provides a broad array of rehabilitation therapy services, including speech pathology, physical therapy and occupational therapy. As of December 31, 2010, SunDance provided rehabilitation therapy services to 508 centers in 36 states, 346 of which were operated by nonaffiliated parties and 162 of which were operated by affiliates.  We generated 6.3%, 5.6% and 4.9% of our consolidated net revenues through rehabilitation therapy services in 2010, 2009 and 2008, respectively.

Medical staffing services.  We provide temporary medical staffing in 39 states through CareerStaff Unlimited, Inc. (“CareerStaff”). For the year ended December 31, 2010, CareerStaff derived 50.6% of its revenues from hospitals and other providers, 26.8% from skilled nursing centers,16.4% from schools and 6.2% from prisons. CareerStaff provides (i) licensed therapists skilled in the areas of physical, occupational and speech therapy, (ii) nurses, (iii) pharmacists, pharmacist technicians and medical imaging technicians, (iv) physicians and (v) related medical personnel. We generated 4.7%, 5.4% and 6.5% of our consolidated net revenues through medical staffing services in 2010, 2009 and 2008, respectively.

See Note 13 – “Segment Information” to our consolidated financial statements included in this Annual Report on Form 10-K for additional information regarding our segments.

Competition

Our businesses are competitive. The nature of competition within the inpatient services industry varies by location. We compete with other healthcare centers based on key factors such as the number of centers in the local market, the types of services available, quality of care, reputation, age and appearance of each center and the cost of care in each locality. Increased competition in the future could limit our ability to attract and retain residents or to expand our business.

We also compete with other companies in providing rehabilitation therapy services, medical staffing services and hospice services, and in employing and retaining qualified nurses, therapists and other medical personnel. The primary competitive factors for the ancillary services markets are quality of services, charges for services and responsiveness to customer needs.

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Competitive Strengths

We believe that the following strengths will allow us to improve our operations and profitability:

• High Quality Portfolio. SunBridge operates inpatient services in all of its centers, which, as of December 31, 2010, consisted of 164 skilled nursing centers, 16 combined skilled nursing, assisted and independent living centers, 10 assisted living centers, two independent living centers and eight mental health centers. Our subsidiaries also provide rehabilitation therapy services through SunDance, which, as of December 31, 2010, provided rehabilitation therapy services to 508 centers in 36 states and medical staffing services through CareerStaff, which, as of December 31, 2010, provided medical staffing services in 39 states. Our operations are geographically diversified and characterized by strong operating metrics. The quality of our operations enables SunBridge to manage patients with higher acuity levels (i.e., the condition of patients that determines the level of skilled nursing and rehabilitation therapy services required).  Higher acuity levels help drive operating margins. The size of our operations enables us to realize the benefits of economies of scale, purchasing power and increased operating efficiencies. Furthermore, our geographic diversity helps to mitigate the risk associated with adverse regulatory changes related to Medicaid reimbursement in any one state.

• Core Inpatient Services Business. Our inpatient business has the ability to achieve consistent revenue and earnings growth by expanding services and increasing focus on integrated skilled nursing care and rehabilitation therapy services to attract high-acuity patients to all of our nursing and rehabilitation centers and through targeting specific centers with Rehab Recovery Suites that exclusively specialize in caring for high-acuity patients.

• Quality of Care and Strong Brand Image. SunBridge’s centers maintain initiatives to provide high quality of care to their patients. These initiatives have resulted in third-party recognition for quality of care and clinical services. SunBridge has been able to, and expects to continue to, attract an increased number of high-acuity patients, maintain a high occupancy rate and develop an effective referral network of patients.

• Ancillary Businesses Will Support Inpatient Services and Provide Diversification. SunDance, our rehabilitation therapy business, complements our core inpatient services business. Its services are particularly attractive to high-acuity patients who require more intensive and medically complex care. SunDance has demonstrated the ability to grow organically and partner with non-affiliated skilled and assisted living facilities in delivering efficient and effective rehabilitation services to customers in 36 states. Our SolAmor hospice business, which serves patients in certain of our nursing centers, in-home settings and non-affiliated centers, is an increasingly important contributor to our earnings growth and operating margin.  SolAmor now operates in 11 states and has demonstrated the ability to integrate efficiently the operations of three nonaffiliated hospice companies since 2008. CareerStaff, our medical staffing business, primarily services non-affiliated providers and derives a majority of its revenues from its placement of therapists. CareerStaff also places physicians, nurses and pharmacists. We expect to continue to leverage the core competencies of CareerStaff’s business to benefit the SunBridge and SunDance businesses. These ancillary businesses diversify our revenue base and  provide an opportunity to improve our payor mix.

• Experienced Management Team with a Proven Track Record. We have a strong and committed management team with substantial industry knowledge. Our chief executive officer and chief financial officer together have over 45 years of healthcare experience, as well as a proven track record of operational success in the long-term care industry. Our management team has successfully acquired and integrated numerous businesses, assets and properties, and this experience should position us well to successfully implement our growth and integration strategies.

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Business Strategy

We intend to build on our current competitive strengths and to grow our businesses and strengthen our position as a nationwide provider of senior healthcare services by pursuing the following:

Focus on Inpatient Growth. SunBridge intends to increase its inpatient revenue and profitability by maintaining high occupancy rates and by continuing to focus on attracting more high-acuity and Medicare patients. SunBridge will implement this strategy by focusing on expanding its clinical and case management and by developing additional Rehab Recovery Suites that exclusively specialize in Medicare and managed care patients. SunBridge plans to take advantage of its marketing infrastructure, local community knowledge and brand image to attract new patients and to expand its referral and customer bases.

Grow Ancillary Businesses. SolAmor intends to grow its hospice operations through acquisitions and internal growth. SunDance will focus on its rehabilitation therapy business, which will be a key driver of our Medicare services and revenues, by improving its clinical product offering, labor productivity and operating profitability and increasing the number of third-party contracts. Our hospice and ancillary services businesses should provide us with diversified revenue sources, a favorable payor mix and growth opportunities.

Increase Operational Efficiency and Leverage Our Existing Platform. We will focus on improving operating efficiencies without compromising high quality of care. We plan to reduce costs and enhance efficiencies through various methods, including:

• reducing labor and billing expenses through technological advances and operational improvements that enable management to more efficiently deploy resources;

• reducing overhead through process improvement initiatives and frequent re-examination of costs;

• improving therapist productivity in our rehabilitation services business;

• controlling litigation expenses by focusing on risk management; and

• monitoring and analyzing the operations and profitability of individual business units.

Employees and Labor Relations

As of December 31, 2010, we and our subsidiaries had 29,922 full-time, part-time and per diem employees. Of this total, there were 24,163 employees in our inpatient services operations (including 485 employees in our hospice operations), 3,564 employees in our rehabilitation therapy services operations, 1,895 employees in our medical staffing business and 300 employees at our corporate offices.

As of December 31, 2010, SunBridge operated 35 centers with union employees. Approximately 2,800 of our employees (9.4% of all of our employees) who worked in healthcare centers in Alabama, California, Connecticut, Georgia, Massachusetts, Maryland, Montana, New Jersey, Ohio, Rhode Island, Washington and West Virginia were covered by collective bargaining contracts. Collective bargaining agreements covering approximately 1,600 of these employees (5.3% of all our employees) either are currently in renegotiations or will shortly be in renegotiations due to the expiration of the collective bargaining agreements.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Federal and State Regulatory Oversight

The healthcare industry is extensively regulated. In the ordinary course of business, our operations are continuously subject to federal, state and local regulatory scrutiny, supervision and control. This often includes inquiries, investigations, examinations, audits, site visits and surveys. As more fully described below, various laws, including anti-kickback, anti-fraud and abuse provisions codified under the Social Security Act, prohibit certain business practices and relationships that might affect the provision and cost of healthcare services reimbursable under Medicare and Medicaid. Sanctions for violating these anti-kickback, anti-fraud and abuse provisions include criminal penalties, civil sanctions, fines and possible exclusion from government programs such as Medicare and Medicaid. If a center is decertified as a Medicare or Medicaid provider by the Centers for Medicare and Medicaid Services (“CMS”) or a state, the center will not thereafter be reimbursed for caring for residents that are covered by Medicare and Medicaid, and the center would be forced to care for such residents without being reimbursed or to transfer such residents.

Our skilled nursing centers and mental health centers are currently licensed under applicable state law, and are certified or approved as providers under the Medicare and Medicaid programs. State and local agencies survey all skilled nursing centers on a regular basis to determine whether such centers are in compliance with governmental operating and health standards and conditions for participation in government sponsored third-party payor programs. From time to time, we receive notice of noncompliance with various requirements for Medicare/Medicaid participation or state licensure. We review such notices for factual correctness, and based on such reviews, either take appropriate corrective action or challenge the stated basis for the allegation of noncompliance. Where corrective action is required, we work with the reviewing agency to create mutually agreeable measures to be taken to bring the center or service provider into compliance. Under certain circumstances, the federal and state agencies have the authority to take adverse actions against a center or service provider, including the imposition of a monitor, the imposition of monetary penalties and the decertification of a center or provider from participation in the Medicare and/or Medicaid programs or licensure revocation. When appropriate, we vigorously contest such sanctions. Challenging and appealing notices or allegations of noncompliance can require significant legal expenses and management attention.

Various states in which we operate centers have established minimum staffing requirements or may establish minimum staffing requirements in the future. Our ability to satisfy such staffing requirements depends upon our ability to attract and retain qualified healthcare professionals, including nurses, certified nurse’s assistants and other staff. Failure to comply with such minimum staffing requirements may result in the imposition of fines or other sanctions.

Most states in which we operate have statutes which require that, prior to the addition or construction of new nursing home beds, the addition of new services or certain capital expenditures in excess of defined levels, we first must obtain a certificate of need (“CON”), which certifies that the state has made a determination that a need exists for such new or additional beds, new services or capital expenditures. The certification process is intended to promote quality healthcare at the lowest possible cost and to avoid the unnecessary duplication of services, equipment and centers.

We are subject to federal and state laws that govern financial and other arrangements between healthcare providers. These laws often prohibit certain direct and indirect payments or fee-splitting arrangements between healthcare providers that are designed to induce the referral of patients to, or the recommendation of, a particular provider for medical products and services. These laws include:

– the “anti-kickback” provisions of the Medicare and Medicaid programs, which prohibit, among other things, knowingly and willfully soliciting, receiving, offering or paying any remuneration (including any kickback, bribe or rebate) directly or indirectly in return for or to induce the referral of an

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	individual to a person for the furnishing or arranging for the furnishing of any item or service for which payment may be made in whole or in part under Medicare or Medicaid; and
–	the “Stark laws” which prohibit, with limited exceptions, the referral of patients by physicians for certain services, including physical therapy and occupational therapy, to an entity in which the physician has a financial interest.

False claims are prohibited pursuant to criminal and civil statutes. These provisions prohibit filing false claims or making false statements to receive payment or certification under Medicare or Medicaid or failing to refund overpayments or improper payments. Suits alleging false claims can be brought by individuals, including employees and competitors.  Newly adopted legislation has expanded the scope of the federal False Claims Act and eased some requirements for the filing of a lawsuit under the act.  We believe that our billing practices are compliant with the False Claims Act and similar state laws.  However, if our practices, policies and procedures are found not to comply with the provisions of those laws, we could be subject to civil sanctions.

Commencing January 1, 2010, recovery audit contractors, or RACs, operating under the Medicare Integrity Program, seek to identify alleged Medicare overpayments based on the medical necessity of services provided in nursing centers.  Similar audits are conducted by various state agencies under the Medicaid program.

As of December 31, 2010, we have approximately $4.6 million, or 0.2% of our revenues, of claims that are under various stages of review or appeal with the Medicare Administration Contractors/Fiscal Intermediaries.  We cannot assure you that future recoveries will not be material or that any appeal of a medical review or RAC audit that we are pursuing will be successful.

We are also subject to regulations under the privacy and security provisions of the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”). The privacy rules provide for, among other things, (i) giving consumers the right and control over the release of their medical information, (ii) the establishment of boundaries for the use of medical information and (iii) civil or criminal penalties for violation of an individual’s privacy rights.

These privacy regulations apply to “protected health information,” which is defined generally as individually identifiable health information transmitted or maintained in any form or medium, excluding certain education records and student medical records. The privacy regulations limit a provider’s use and disclosure of most paper, oral and electronic communications regarding a patient’s past, present or future physical or mental health or condition, or relating to the provision of healthcare to the patient or payment for that healthcare.

The security regulations require us to ensure the confidentiality, integrity, and availability of all electronic protected health information that we create, receive, maintain or transmit. We must protect against reasonably anticipated threats or hazards to the security of such information and the unauthorized use or disclosure of such information.

Compliance Process

Our compliance program, referred to as the “Compliance Process,” was initiated in 1996. It has evolved as the requirements of federal and private healthcare programs have changed.  There are seven principal elements to the Compliance Process:

Written Policies, Procedures and Standards of Conduct.    Our business lines have extensive policies and procedures (“P&Ps”) modeled after applicable laws, regulations, government manuals and industry practices

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and customs. The P&Ps govern the clinical, reimbursement, and operational aspects of each subsidiary. To emphasize adherence to our P&Ps, we publish and distribute a Code of Conduct and an employee handbook.   

Designated Compliance Officer and Compliance Committee.    We have a Chief Compliance Officer whose responsibilities include, among other things: (i) overseeing the Compliance Process; (ii) overseeing compliance with judicial and regulatory requirements, and functioning as the liaison with the state agencies and the federal government on matters related to the Compliance Process and such requirements; (iii) reporting to our board of directors, the Compliance Committee of our board of directors, and senior corporate managers on the status of the Compliance Process; and (iv) overseeing the coordination of a comprehensive training program which focuses on the elements of the Compliance Process and employee background screening process. Compliance matters are reported to the Compliance Committee of our board of directors on a regular basis. The Compliance Committee is comprised solely of independent directors.

Effective Training and Education.    Every employee, director and officer is trained on the Compliance Process and Code of Conduct. Training also occurs for appropriate employees in applicable provisions of the Medicare and Medicaid laws, fraud and abuse prevention, clinical standards, and practices, and claim submission and reimbursement P&Ps.

Effective Lines of Communication.    Employees are encouraged to report issues of concern without fear of retaliation using a Four Step Reporting Process, which includes the toll-free “Sun Quality Line.” The Four Step Reporting Process encourages employees to discuss clinical, ethical or financial concerns with supervisors and local management since these individuals will be most familiar with the laws, regulations, and policies that impact their concerns. The Sun Quality Line is an always-available option that may be used for anonymous reporting if the employee so chooses. Reported concerns are internally reviewed and proper follow-up is conducted.

Internal Monitoring and Auditing.    Our Compliance Process puts internal controls in place to meet the following objectives: (i) accuracy of claims, reimbursement submissions, cost reports and source documents; (ii) provision of patient care, services, and supplies as required by applicable standards and laws; (iii) accuracy of clinical assessment and treatment documentation; and (iv) implementation of judicial and regulatory requirements (e.g., background checks, licensing and training). Each business line monitors and audits compliance with P&Ps and other standards to ensure that the objectives listed above are met. Data from these internal monitoring and auditing systems are analyzed and acted upon through a quality improvement process. We have designated the subsidiary presidents and each member of the operations management team as Compliance Liaisons. Each Compliance Liaison is responsible for making certain that all requirements of the Compliance Process are completed at the operational level for which the Compliance Liaison is responsible.

Enforcement of Standards.    Our policies, the Code of Conduct and the employee handbook, as well as all associated training materials, clearly indicate that employees who violate our standards will be subjected to discipline. Sanctions range from oral warnings to suspensions and/or to termination of employment. We have also adopted a proactive approach to offset the need for punitive measures. First, we have implemented employee background review practices that surpass industry standards. Second, as noted above, we devote significant resources to employee training. Finally, we have adopted a performance management program intended to make certain that all employees are aware of what duties are expected of them and understand that compliance with policies, procedures, standards and laws related to job functions is required.

Responses to Detected Offenses and Development of Corrective Actions.    Correction of detected misconduct or a violation of our policies is the responsibility of every manager. As appropriate, a manager is expected to develop and implement corrective action plans and monitor whether such actions are likely to keep a similar violation from occurring in the future.

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Our Compliance Process incorporates the terms of a revised Permanent Injunction and Final Judgment entered on September 14, 2005 (“PIFJ”). The PIFJ, which resulted from investigations by the Bureau of Medi-Cal Fraud and Elder Abuse of the Office of the California Attorney General and applies to our California centers, required compliance with certain clinical practices that are substantially consistent with existing law and our current practices, and imposed staffing requirements and specific training obligations. All California administrators have been trained on the requirements of the PIFJ.  The PIFJ was terminated in January 2011.

General Information

New Sun was incorporated in Delaware in 2002, and continues the business of Old Sun, which was incorporated in Delaware in 1993.  Our principal executive offices are located at 18831 Von Karman, Suite 400, Irvine, CA 92612, and our telephone number is (949) 255-7100.  We maintain a website at www.sunh.com.  Through the “Financial Info” and “SEC Filings” links on our website, we make available free of charge, as soon as reasonably practicable after such information has been filed or furnished to the Securities and Exchange Commission, each of our filings with the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act .

Item 1A. Risk Factors

Our business is dependent on reimbursement rates under federal and state programs, and legislation or regulatory action may reduce or otherwise materially adversely affect the reimbursement rates.

Our revenues are heavily dependent on payments administered under the Medicare and Medicaid programs. The economic downturn has caused many states to institute freezes on or reductions in Medicaid reimbursements to address state budget concerns. Moreover, for the 2010 federal fiscal year (commencing October 1, 2009), the Centers for Medicare and Medicaid Services (“CMS”) effectively reduced our Medicare reimbursement rates (this reduction was not repeated for the 2011 federal fiscal year). In addition, the skilled nursing center exception to the statutory cap on Medicare reimbursements for therapy services is scheduled to expire on December 31, 2011. If the skilled nursing center exception is not extended, reimbursement for therapy services rendered to our residents and patients will be reduced.

In addition to these reductions, there have been numerous initiatives on the federal and state levels for comprehensive reforms affecting the payment for and availability of healthcare services. Aspects of certain of these initiatives, such as further reductions in funding of the Medicare and Medicaid programs, additional changes in reimbursement regulations by CMS, enhanced pressure to contain healthcare costs by Medicare, Medicaid and other payors, and additional operational requirements, could materially adversely affect us.

Healthcare reform may affect our revenues and increase our costs and otherwise materially adversely affect our business.

In March 2010, the Patient Protection and Affordable Care Act 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. In addition, in 2011, federal legislation is being formulated to

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repeal or amend provisions of these new statutes.  We cannot predict the exact effect these newly enacted laws or any future legislation or regulation will have on us, including future reimbursement rates and occupancy in our inpatient facilities.

Our revenue and collections have been adversely affected and may continue to be materially adversely affected by the economic downturn.

In addition to state and federal budgetary actions that have impacted the amount of reimbursements that we receive for services under state and federal programs, the recent economic downturn has resulted in reduced demand for our staffing services that we provide through or to other healthcare providers and has impacted our ability to collect receivables from nongovernmental sources. If economic conditions do not improve or if they worsen, this reduction in demand and impact on our receivables collection could continue. Adverse economic conditions could also result in continued reduced demand for our therapy and staffing services, which could have a material adverse effect on our business, financial position or results of operations.

Delays in collecting or the inability to collect our accounts receivable could materially adversely affect our cash flows and financial position.

Prompt billing and collection are important factors in our liquidity. Billing and collection of our accounts receivable are subject to the complex regulations that govern Medicare and Medicaid reimbursement and rules imposed by nongovernment payors. Our inability to bill and collect on a timely basis pursuant to these regulations and rules could subject us to payment delays that could negatively impact our cash flows and ultimately our financial position in a material manner. In addition, commercial payors and other customers, as well as individual patients, may be unable to make payments to us for which they are responsible. The recent economic downturn has resulted in a decrease in our ability to collect accounts receivable from some of our customers. A continuation or worsening of recent unfavorable economic conditions may result in a further decrease in our ability to collect accounts receivable from some of our customers, in which case we will have to make larger allowances for doubtful accounts or incur bad debt write-offs, each of which could have a material adverse effect on our business, financial position or results of operations.

Our business is subject to reviews, audits and investigations under federal and state programs and by private payors, which could have a material adverse effect on our business, financial position or results of operations.

We are subject to review, audit or investigation by federal and state governmental agencies to verify compliance with the requirements of the Medicare and Medicaid programs and other federal and state programs. Audits under the Medicare and Medicaid programs have intensified in recent years. Private payors also may have a contractual right to review or audit our files. Any review, audit or investigation could result in various actions, including our paying back amounts that we have been paid pursuant to these programs, our paying fines or penalties, the suspension of our ability to collect payment for new residents to a skilled nursing center, exclusion of a skilled nursing center from participation in one or more governmental programs, revocation of a license to operate a skilled nursing center, or loss of a contract with a private payor. Any of these events could have a material adverse effect on our business, financial position or results of operations.

Possible changes in the case mix of residents and patients as well as payor mix and payment methodologies could materially affect our revenue and profitability.

The sources and amount of our revenues are determined by a number of factors, including the licensed bed capacity and occupancy rates of our healthcare centers, the mix of residents and patients and the rates of reimbursement among payors. Likewise, services provided by our ancillary businesses vary based upon payor

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

and payment methodologies. Changes in the case mix of the residents and patients as well as payor mix among private pay, Medicare and Medicaid could materially affect our profitability. In particular, any significant decrease in our population of high-acuity residents and patients or any significant increase in our Medicaid population could have a material adverse effect on our business, financial position or results of operations, especially if states operating Medicaid programs continue to limit, or more aggressively seek limits on, reimbursement rates.

Unfavorable resolution of litigation matters and disputes could have a material adverse effect on our business, financial position or results of operations.

Skilled nursing center operators, including our inpatient services subsidiaries, are from time to time subject to lawsuits seeking to hold them liable for alleged negligent or other wrongful conduct of employees that allegedly result in injury or death to residents of the centers. We currently have numerous patient care lawsuits pending against us, as well as other types of lawsuits. Adverse determinations in legal proceedings, including potential punitive damages, and any adverse publicity arising therefrom could have a material adverse effect on our business, financial position or results of operations.

We rely primarily on self-funded insurance programs for general and professional liability and workers’ compensation claims against us, and any claims not covered by, or in excess of, our insurance coverage limits could have a material adverse effect upon our business, financial position or results of operations.

We self-insure for the majority of our insurable risks, including general and professional liabilities, workers’ compensation liabilities and employee health insurance liabilities, through the use of self-insurance or self-funded insurance policies, which vary by the states in which we operate. We rely upon self-funded insurance programs for general and professional liability claims up to $5.0 million per claim, which amounts we are responsible for funding. We maintain excess insurance for claims above this amount. There is a risk that the amounts funded to our programs of self-insurance and future cash flows may not be sufficient to respond to all claims asserted under those programs.

There is no assurance that a claim in excess of our insurance coverage limits will not arise. A claim against us that is not covered by, or is in excess of, the coverage limits provided by our excess insurance policies could have a material adverse effect upon our business, financial position or results of operations. Furthermore, there is no assurance that we will be able to obtain adequate excess liability insurance in the future or that, if such insurance is available, it will be available on acceptable terms.

Our operations are extensively regulated and adverse determinations against us could result in severe penalties, including loss of licensure and decertification.

In the ordinary course of business, we are subject to a wide variety of federal, state and local laws and regulations and to federal and state regulatory scrutiny and supervision in various areas, including referral of patients, false claims under Medicare and Medicaid, health and safety laws, environmental laws and the protection of health information. Such regulatory scrutiny often includes inquiries, civil and criminal investigations, examinations, audits, site visits and surveys, some of which are non-routine. If we are found to have engaged in improper practices, we could be subject to civil, administrative or criminal fines, penalties or restitutionary relief or corporate settlement agreements with federal, state or local authorities, and reimbursement authorities could also seek our suspension or exclusion from participation in their programs. The exclusion of centers from participating in Medicare or Medicaid could have a material adverse effect on our business, financial position or results of operations. We cannot predict the future course of any laws or regulations to which we are subject, including Medicare and Medicaid statutes and regulations, the intensity of federal and state enforcement actions or the extent and size of any potential sanctions, fines or

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

penalties. Changes in existing laws or regulations, or the enactment of new laws or regulations, could result in changes to our operations requiring significant capital expenditures or additional operating expenses. Evolving interpretations of existing, new or amended laws and regulations or heightened enforcement efforts could have a material adverse effect on our business, financial position or results of operations.

Our hospice business is subject to a cap on the amount paid by Medicare and other Medicare payment limitations, which limitations could materially adversely affect our hospice revenues and earnings.

Payments made by Medicare for hospice services are subject to a cap amount on a per hospice basis. Our ability to comply with this limitation depends on a number of factors, including the number of admissions, average length of stay, acuity level of our patients and patients that transfer into and out of our hospice programs. Our hospice revenue and profitability could be materially reduced if we are unable to comply with this and other Medicare payment limitations.

Our business is dependent on referral sources, which have no obligation to refer residents and patients to our skilled nursing centers, and our failure to maintain our existing referral sources, develop new relationships or achieve or maintain a reputation for providing high quality of care could materially adversely affect us.

We rely on referrals from physicians, hospitals and other healthcare providers to provide our skilled nursing centers with our patient population. These referral sources are not obligated to refer business to us and may refer business to other long-term care providers. If we fail to maintain our existing referral sources, fail to develop new relationships or fail to achieve or maintain a reputation for providing high quality of care, our patient population, payor mix, revenue and profitability could be materially adversely affected.

Providers of commercial insurance and other nongovernmental payors are increasingly seeking to control costs, which efforts could materially adversely impact our revenues.

Private insurers are seeking to control healthcare costs through direct contracts with healthcare providers, and reviews of the propriety of, and charges for, services provided. These private payors are increasingly demanding discounted fee structures. These cost control efforts could have a material adverse effect on our business, financial position or results of operations.

We face national, regional and local competition, which could materially limit our ability to attract and retain residents or to expand our business.

The healthcare industry is highly competitive and subject to continual changes in the methods by which services are provided and the types of companies providing services. Our nursing centers compete primarily on a local and regional basis with many long-term care providers, some of whom may own as few as a single nursing center. Our ability to compete successfully varies from location to location depending on a number of factors, including the number of competing centers in the local market, the types of services available, quality of care, reputation, age and appearance of each center and the cost of care in each locality.  Our rehabilitation, staffing and hospice businesses also face significant competition from local and regional providers.  Increased competition in the future could limit our ability to attract and retain residents or to expand our business.

State efforts to regulate the construction or expansion of healthcare providers could impair our ability to expand our operations or make acquisitions.

Some states require healthcare providers (including skilled nursing centers, hospices and assisted living centers) to obtain prior approval, in the form of a CON, for the purchase, construction or expansion of healthcare

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

centers; capital expenditures exceeding a prescribed amount; or changes in services or bed capacity. To the extent that we are unable to obtain any required CON or other similar approvals, our expansion could be materially adversely affected. We cannot make any assurances that we will be able to obtain a CON or other similar approval for any future projects requiring this approval.

We may be unable to reduce costs to offset completely any decreases in our revenues.

Reduced levels of occupancy in our healthcare centers or reductions in reimbursements from Medicare and Medicaid could materially adversely impact our cash flow and revenues. Fluctuations in occupancy levels may become more common as we increase our emphasis on patients with shorter stays but higher acuities. If we are unable to put in place corresponding adjustments in costs in response to declines in census or other revenue shortfalls, we will be unable to prevent future decreases in earnings. Our centers are able to reduce some of their costs as occupancy decreases, although the decrease in costs will in most cases be less than the decrease in revenues. However, our centers are not able to reduce their costs of providing care to offset a decrease in reimbursement revenues from federal and state programs.

We continue to be adversely affected by an industry-wide shortage of qualified center care-provider personnel and increasing labor costs.

We, like other providers in the long-term care industry, have had and continue to have difficulties in retaining qualified personnel to staff our healthcare centers, particularly nurses, and in such situations we may be required to use temporary employment agencies to provide additional personnel. The labor costs are generally higher for temporary employees than for full-time employees. In addition, many states in which we operate have increased minimum staffing standards. As minimum staffing standards are increased, we may be required to retain additional staffing. In addition, in recent years we have experienced increases in our labor costs primarily due to higher wages and greater benefits required to attract and retain qualified personnel and to increase staffing levels in our centers.

A similar situation exists in the rehabilitation therapy industry. We, like other providers in the long-term care industry, have had and continue to have difficulties in hiring a sufficient number of rehabilitation therapists. Under these circumstances, we, like others in this industry, have been required to offer higher compensation to attract and retain these personnel, and we have been forced to rely on independent contractors, at higher costs, to fulfill our contractual commitments with our customers. Existing contractual commitments, regulatory limitations and the market for these services have made it difficult for us to pass through these increased costs to our customers.

Our business may be adversely impacted by labor union activity.

As of December 31, 2010, we had 29,992 employees, of which 9.4% are represented by unions.  Collective bargaining agreements covering 5.3% of all our employees either are currently in renegotiations or will shortly be in renegotiations due to the expiration of the collective bargaining agreements.  At this time, we are unable to predict the outcome of the negotiations, but increases in salaries, wages and benefits could result from renegotiated agreements. No assurances can be made that we will not in the future experience these and other types of conflicts with labor unions or our employees generally.  We are unable to predict the outcome of future union organizing activities by labor unions and employees.  To the extent a greater portion of our employee base unionizes, our labor costs could increase materially.

If we are unable to meet minimum staffing standards, we may be subject to fines or other sanctions and increased costs, which could materially adversely affect our profitability.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Increased attention to the quality of care provided in skilled nursing centers has caused several states to mandate, and other states to consider mandating, minimum staffing laws that require minimum nursing hours of direct care per resident per day. These minimum staffing requirements further increase the gap between demand for and supply of qualified professionals, and lead to higher labor costs. Failure to comply with minimum staffing requirements can result in lawsuits seeking significant damages, fines and requirements that we provide a plan of correction.

Our ability to satisfy minimum staffing requirements depends upon our ability to attract and retain qualified healthcare professionals, including nurses, certified nurse’s assistants and other personnel. Attracting and retaining these personnel is difficult given existing shortages of these employees in the labor markets in which we operate. Furthermore, if states do not appropriate additional funds (through Medicaid program appropriations or otherwise) sufficient to pay for any additional operating costs resulting from minimum staffing requirements, our profitability could be materially adversely affected.

If we lose our key management personnel, we may not be able to successfully manage our business and achieve our objectives, which could have a material adverse effect on our business, financial position or results of operations.

Our future success depends in large part upon the leadership and performance of our executive management team and key employees at the operating level. If we lose the services of any of our executive officers or any of our key employees at the operating or regional level, we may not be able to replace them with similarly qualified personnel, which could have a material adverse effect on our business, financial position or results of operations.

We could be materially adversely affected by our level of indebtedness.

As of December 31, 2010, we had indebtedness of $156.0 million, a $60.0 million revolving credit facility ($30.0 million of which may be utilized for letters credit, but undrawn at December 31, 2010) and a $75.0 million letter of credit facility ($66.2 million outstanding at December 31, 2010) funded by proceeds of additional term loans. The level of our indebtedness could have adverse consequences to us, such as requiring us to dedicate a substantial portion of our cash flows from operations to payments on our debt, limiting our ability to fund, and potentially increasing the cost of funding, working capital, capital expenditures, acquisitions and other general corporate requirements and making us more vulnerable to general adverse economic and industry conditions. If we fail to comply with the payment requirements or financial covenants contained in our debt agreements, we would be required to seek waivers from our lenders. Seeking these waivers may be difficult or expensive to obtain and, if we fail to obtain any necessary waivers, the resulting default would allow the lenders to accelerate the maturity of the indebtedness, which could have a material adverse effect on our business, financial position or results of operations.

An increase in market interest rates could increase our interest costs on existing and future debt and could adversely affect our stock price.

If interest rates increase, so could our interest costs for any new debt. This increased cost could make the financing of any acquisition more costly. We may incur more variable interest rate indebtedness in the future. Rising interest rates could limit our ability to refinance existing debt when it matures, or cause us to pay higher interest rates upon refinancing and increased interest expense on refinanced indebtedness.

Covenants in our debt agreements may limit our operational flexibility, and a covenant breach could materially adversely affect our business, financial position or results of operations.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

The agreements governing our indebtedness contain customary covenants that include restrictions on our ability to make acquisitions and other investments, pay dividends, incur additional indebtedness and make capital expenditures. These restrictions may limit our operational flexibility or require us to approach our lenders for consent to allow us to implement our business plans.  Such a consent could be difficult or expensive to obtain. Our failure to comply with such restrictions and other covenants could materially adversely affect our business, financial position or results of operations or our ability to incur additional indebtedness or refinance existing indebtedness.

We continue to seek acquisitions and other strategic opportunities, which may result in the use of a significant amount of management resources or significant costs and we may not be able to fully realize the potential benefit of such transactions.

We continue to seek acquisitions and other strategic opportunities. Accordingly, we are often engaged in evaluating potential transactions and other strategic alternatives. In addition, from time to time, we may engage in discussions that may result in one or more transactions. Although there is uncertainty that any of these discussions will result in definitive agreements or the completion of any transaction, we may devote a significant amount of our management resources to such a transaction, which could negatively impact our operations. In addition, we may incur significant costs in connection with seeking acquisitions or other strategic opportunities regardless of whether the transaction is completed and in combining our operations if such a transaction is completed. In the event that we consummate an acquisition or strategic alternative in the future, there is no assurance that we would fully realize the potential benefit of such a transaction.

We lease substantially all of our centers and could experience risks relating to lease termination, lease extensions, and special charges, which could have a material adverse effect on our business, financial position or results of operations.

We face risks because of the number of centers that we lease. We currently lease 195 of the 200 healthcare centers operated by our subsidiaries as of December 31, 2010. Each of our lease agreements provides that the lessor may terminate the lease for a number of reasons, including, subject to applicable cure periods, the default in any payment of rent, taxes or other payment obligations or the breach of any other covenant or agreement in the lease. Termination of any of our lease agreements could result in a default under our debt agreements and could have a material adverse effect on our business, financial position or results of operations. Although we believe that we will be able to renew our lease agreements that we wish to extend, there is no assurance that we will succeed in obtaining extensions in the future at rental rates and on other terms that we believe to be reasonable, or at all. Our high percentage of leased centers limits our ability to exit markets. As a result, if some centers should prove to be unprofitable, we could remain obligated for lease payments even if we decided to withdraw from those locations. We could incur special charges relating to the closing of such centers including lease termination costs, impairment charges and other special charges that would reduce our profits and could have a material adverse effect on our business, financial position or results of operations.

Natural disasters and other adverse events may harm our centers and residents.

Our centers and residents may suffer harm as a result of natural or other causes, such as storms, earthquakes, floods, fires and other conditions. Such events can disrupt our operations, negatively affect our revenues, and increase our costs or result in a future impairment charge. For example, nine of our healthcare centers are in Florida, which is prone to hurricanes, and 16 of our centers and our executive offices are in California, which is prone to earthquakes.

Environmental compliance costs and liabilities associated with our centers may have a material adverse effect on our business, financial position or results of operations.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

We are subject to various federal, state and local environmental and health and safety laws and regulations with respect to our centers. These laws and regulations address various matters, including asbestos, fuel oil management, wastewater discharges, air emissions, medical wastes and hazardous wastes. The costs of complying with these laws and regulations and the penalties for non-compliance can be substantial. For example, with respect to our owned and leased property, we may be held liable for costs relating to the investigation and clean up of any of our owned or leased properties from which there has been a release or threatened release of a regulated material as well as other properties affected by the release. In addition to these costs, which are typically not limited by law or regulation and could exceed the property’s value, we could be liable for certain other costs, including governmental fines and injuries to persons, property or natural resources. Further, some environmental laws create a lien on the contaminated site in favor of the government for damages and the costs it incurs in connection with the contamination. Such environmental compliance costs and liabilities may have a material adverse effect on our business, financial position or results of operations.

Our ability to use our net operating losses (“NOLs”) and other tax attributes to offset future taxable income could be limited by an ownership change and/or decisions by California and other states to suspend the use of NOLs.

We have significant NOLs, tax credits and amortizable goodwill available to offset our future U.S. federal and state taxable income. Our ability to utilize these NOLs and other tax attributes may be subject to significant limitations under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), and applicable state law if we undergo an ownership change. An ownership change occurs for purposes of Section 382 of the Code if certain events occur, including 5% stockholders (i.e., stockholders who own or have owned 5% or more of our stock (with certain groups of less-than-5% stockholders treated as single stockholders for this purpose)) increasing their aggregate percentage ownership of our stock by more than fifty percentage points above the lowest percentage of the stock owned by these stockholders at any time during the relevant testing period. An issuance of shares of our common stock in connection with acquisitions or for any other reason can contribute to or result in an ownership change under Section 382. Stock ownership for purposes of Section 382 of the Code is determined under a complex set of attribution rules, so that a person is treated as owning stock directly, indirectly (i.e., through certain entities) and constructively (through certain related persons and certain unrelated persons acting as a group). In the event of an ownership change, Section 382 imposes an annual limitation (based upon our value at the time of the ownership change, as determined under Section 382 of the Code) on the amount of taxable income and tax liabilities a corporation may offset with NOLs and other tax attributes, such as tax credit carryforwards. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOL and tax credit carryforwards. As a result, our inability to utilize these NOLs or credits as a result of any ownership changes could materially adversely impact our business, financial position or results of operations.

In addition, California and certain states have suspended use of NOLs for certain taxable years, and other states are considering similar measures. As a result, we may incur higher state income tax expense in the future. Depending on our future tax position, continued suspension of our ability to use NOLs in states in which we are subject to income tax could have a material adverse impact on our business, financial position or results of operations.

Failure to maintain effective internal control over financial reporting could have a material adverse effect on our ability to report our financial results on a timely and accurate basis.

We are required to maintain internal control over financial reporting pursuant to Rule 13a-15 under the Exchange Act. Failure to maintain such controls could result in misstatements in our financial statements and potentially subject us to sanctions or investigations by the SEC or other regulatory authorities or could cause us

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to delay the filing of required reports with the SEC and our reporting of financial results. Any of these events could result in a decline in the price of shares of our common stock. Although we have taken steps to maintain our internal control structure as required, we cannot assure you that control deficiencies will not result in a misstatement in the future.

We do not expect to pay any dividends for the foreseeable future, which will affect the extent to which our investors realize any future gains on their investment.

We are currently prohibited by the terms of our senior credit facility from paying dividends to holders of our common stock. We do not anticipate paying any other dividends in the foreseeable future. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment.

Delaware law and provisions in our Restated Certificate of Incorporation, Amended and Restated Bylaws and our stockholder rights plan may delay or prevent takeover attempts by third parties and therefore inhibit our stockholders from realizing a premium on their stock.

We are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law (the “DGCL”). This section prevents any stockholder who owns 15% or more of our outstanding common stock from engaging in certain business combinations with us for a period of three years following the time that the stockholder acquired such stock ownership unless certain approvals were or are obtained from our board of directors or the holders of 66 2/3 % of our outstanding common stock (excluding the shares of our common stock owned by the 15% or more stockholder).

Our Restated Certificate of Incorporation and Amended and Restated Bylaws also contain several other provisions that may make it more difficult for a third party to acquire control of us without the approval of our board of directors. These provisions include (i) advance notice for raising business or making director nominations at meetings, (ii) an affirmative vote of the holders of 66 2/3 % of our outstanding common stock for stockholders to remove directors or amend our Amended and Restated Bylaws or certain provisions of our Restated Certificate of Incorporation and (iii) the ability to issue “blank check” preferred stock, which our board of directors, without stockholder approval, can designate and issue with such dividend, liquidation, conversion, voting or other rights, including the right to issue convertible securities. The issuance of blank check preferred stock may adversely affect the voting and other rights of the holders of our common stock as our board of directors may designate and issue preferred stock with terms that are senior to shares of our common stock.

Our board of directors can use these and other provisions to discourage, delay or prevent a change in the control of the Company or a change in our management.  Any delay or prevention of a change in control transaction or a change in our board of directors or management could deter potential acquirers or prevent the completion of a transaction in which our stockholders could receive a substantial premium over the current market price for their shares.  These provisions could also limit the price that investors might be willing to pay for our common stock.

Item 1B.  Unresolved Staff Comments

None.

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Item 2.  Properties

Inpatient Services

As of December 31, 2010, we operate 164 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. The 200 centers are comprised of 195 properties that are leased and five properties that are owned. We hold options to acquire, at fair value or at a set purchase price, ownership of 21 of the centers that we currently lease, of which options on four centers are exercisable or will become exercisable by December 31, 2011. We generally consider our properties to be in good operating condition and suitable for the purposes for which they are being used. Our leased centers are subject to long-term operating leases or subleases which require us, among other things, to fund all applicable capital expenditures, taxes, insurance and maintenance costs. The annual rent payable under most of the leases generally increases based on a fixed percentage or increases in the U.S. Consumer Price Index. Many of the leases contain extension options.  Administrative office space was also leased for our inpatient segment in 19 locations in twelve states.

On July 1, 2010 we assumed operations of a skilled nursing center in Idaho that we owned 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 and operations of two skilled nursing centers in Oklahoma to outside parties effective January 1, 2011.  During the third quarter of 2010 we disposed 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.  We continue to review our operations to identify centers and operations that do not perform at an appropriate level.

Our aggregate occupancy percentage for all of our nursing and rehabilitation, assisted living, independent living and mental health centers was 87.0% for the year ended December 31, 2010. Our occupancy was 88.5% and 88.9% for the years ended December 31, 2009 and 2008, respectively. The percentages were computed by dividing the average daily number of beds occupied by the total number of available beds for use during the periods indicated (beds of acquired centers are included in the computation following the date of acquisition only). However, we believe that occupancy percentages, either individually or in the aggregate, should not be relied upon alone to determine the performance of a center. Other factors that may impact the performance of a center include, among other things, the sources of payment, terms of reimbursement and the acuity level of the patients.

The following table sets forth certain information concerning the 200 centers in our continuing operations as of December 31, 2010, which consisted of 164 skilled nursing centers, 16 combined skilled nursing, assisted and independent living centers, 10 assisted living centers, two independent living centers and eight mental health centers.

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		Number of Licensed Beds/Units(1)
	Total		Assisted/
	Number of	Skilled	Independent	Mental
State	Centers	Nursing	Living	Health	Total
Ohio	17	2,392	-	-	2,392
Massachusetts	18	1,803	57	-	1,860
Kentucky	20	1,598	235	-	1,833
New Hampshire	15	1,131	474	-	1,605
Connecticut	10	1,327	72	-	1,399
California	15	858	-	473	1,331
Colorado	9	1,203	97	-	1,300
Idaho	11	1,053	141	22	1,216
Oklahoma	7	1,003	83	60	1,146
Florida	9	1,120	-	-	1,120
New Mexico	9	890	180	-	1,070
Georgia	9	1,002	32	-	1,034
North Carolina	8	930	44	-	974
Alabama	7	757	26	-	783
West Virginia	7	739	-	-	739
Tennessee	8	693	22	-	715
Montana	5	538	112	-	650
Washington	5	444	36	-	480
Maryland	3	434	-	-	434
Rhode Island	2	261	-	-	261
Indiana	2	208	-	-	208
New Jersey	1	176	-	-	176
Arizona	1	161	-	-	161
Utah	1	120	-	-	120
Wyoming	1	46	-	-	46
Total	200	20,887	1,611	555	23,053

(1) “Licensed Beds” refers to the number of beds for which a license has been issued, which may vary in  some instances from licensed beds available for use, which is used in the computation of occupancy. Available beds for the 200 centers were 22,400.

Rehabilitation Therapy Services

As of December 31, 2010, we leased offices and patient care delivery sites in 32 locations in 11 states to operate our rehabilitation therapy businesses.

Medical Staffing Services

As of December 31, 2010, we leased offices in 25 locations in 17 states to operate our medical staffing business.

Hospice Services

As of December 31, 2010, we leased offices in 20 locations in 10 states to operate our hospice business.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Corporate

We lease our executive offices in Irvine, California. We also own three corporate office buildings and lease office space in a fourth building in Albuquerque, New Mexico.

Item 3.  Legal Proceedings

For a description of our legal proceedings, see Note 12(a) – “Other Events – Litigation” of our consolidated financial statements included in this Annual Report on Form 10-K, which is incorporated by reference to this item.

PART II

Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

New Sun’s common stock began trading under the symbol “SUNHD” on The NASDAQ Global Select Market on November 16, 2010 and then began trading under the symbol “SUNH” on December 20, 2010.  The following table shows the high and low sale prices for the common stock as reported by The NASDAQ Global Select Market for the periods indicated.  Prior to November 16, 2010, Old Sun’s common stock was traded under the symbol “SUNH” on The NASDAQ Global Select Market.

		High		Low
2010
Fourth Quarter (November 16 to December 31, 2010)	$	12.99	$	9.37

There were approximately 3,265 holders of record of our common stock as of March 1, 2011. Other than in connection with the Separation, we have not paid dividends on our common stock and do not anticipate paying dividends in the foreseeable future. Our senior credit facility prohibits us from paying any dividends or making any distributions to our stockholders. Any future determination to pay dividends will be at the discretion of our board of directors and will be dependent upon our financial condition, results of operations, capital requirements and other factors as our board of directors deems relevant.

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STOCK PRICE PERFORMANCE GRAPH

New Sun separated from Old Sun on November 15, 2010 and began trading on The NASDAQ Global Select Market on November 16, 2010.  The following graph and chart compare the cumulative total stockholder return for the period from November 16, 2010 through December 31, 2010 assuming $100 was invested on November 16, 2010 in (i) our common stock, (ii) the Russell 2000 Stock Index and (iii) the Morningstar Long-Term Care Facilities Index. Cumulative total stockholder return assumes the reinvestment of all dividends. Stock price performances shown in the graph are not necessarily indicative of future price performances.

COMPARISON OF CUMULATIVE TOTAL RETURN

ASSUMES $100 INVESTED ON NOV. 16, 2010

ASSUMES DIVIDEND REINVESTED

FISCAL YEAR ENDING DEC. 31, 2010

	11/16/10		11/22/10		11/29/10		12/6/10		12/13/10		12/20/10		12/27/10		12/31/10
Sun Healthcare Group, Inc.	$	100.00	$	88.39	$	83.82	$	93.14	$	105.63	$	109.85	$	110.29	$	111.35
Russell 2000 Index	$	100.00	$	103.13	$	103.81	$	107.93	$	109.56	$	111.03	$	112.47	$	111.30
Long-Term Care Facilities	$	100.00	$	105.40	$	102.51	$	107.41	$	114.49	$	118.90	$	120.24	$	120.05

The above performance graph shall not be deemed to be soliciting material or to be filed with the Securities and Exchange Commission under the Securities Act of 1933 or the Securities Exchange Act of 1934 or incorporated by reference in any document so filed.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Item 6.  Selected Financial Data

The following selected consolidated financial data for the periods indicated have been derived from our consolidated financial statements.  The financial data set forth below should be read in connection with Item 7 – “Management's Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements and related notes thereto (in thousands, except per share data and percentages):

	At or For the Year Ended December 31,
	2010 (1)			2009 (2)			2008 (3)			2007 (4)			2006 (5)
Total net revenues	$	1,906,861		$	1,880,776		$	1,822,766		$	1,557,463		$	982,658
Income before income taxes
and discontinued operations		248			72,696			67,161			43,367			11,259
(Loss) income from continuing
operations		(2,716	)		43,080			114,509			54,281			11,473
(Loss) income from discontinued
operations		(1,934	)		(4,409	)		(5,222	)		3,229			15,645
Net (loss) income	$	(4,650	)	$	38,671		$	109,287		$	57,510		$	27,118
Basic earnings per common and common equivalent share:
(Loss) income from continuing
operations	$	(0.14	)	$	2.95		$	7.93		$	3.85		$	1.09
(Loss) income from discontinued
operations		(0.10	)		(0.30	)		(0.36	)		0.23			1.48
Net (loss) income	$	(0.24	)	$	2.65		$	7.57		$	4.07		$	2.57
Diluted earnings per common and common equivalent share:
(Loss) income from continuing
operations	$	(0.14	)	$	2.93		$	7.60		$	3.58		$	1.07
(Loss) income from discontinued
operations		(0.10	)		(0.30	)		(0.35	)		0.21			1.47
Net (loss) income	$	(0.24	)	$	2.63		$	7.25		$	3.80		$	2.54
Weighted average number of common and common equivalent shares:
Basic		19,280			14,614			14,444			14,117			10,546
Diluted		19,280			14,714			15,075			15,142			10,696
Working capital	$	172,592		$	175,604		$	172,145		$	83,721		$	96,245
Total assets	$	1,081,758		$	1,571,194		$	1,543,334		$	1,373,826		$	621,423
Long-term debt and capital lease    obligations, including current portion	$	155,980		$	700,548		$	725,841		$	729,268		$	174,165
Stockholders' equity	$	512,443		$	449,064		$	403,709		$	246,257		$	144,133
Dividends per share	$	0.1335		$	-		$	-		$	-		$	-
Dividends	$	9,996		$	-		$	-		$	-		$	-
Supplemental Financial Information:
EBITDA (6)	$	91,320		$	167,476		$	162,112		$	118,930		$	44,013
EBITDA margin (6)		4.8	%		8.9	%		8.9	%		7.6	%		4.5	%
Adjusted EBITDA (6)	$	121,388		$	168,822		$	161,135		$	122,126		$	45,161
Adjusted EBITDA margin (6)		6.4	%		9.0	%		8.8	%		7.8	%		4.6	%
Adjusted EBITDAR (6)	$	205,722		$	241,950		$	234,728		$	192,536		$	96,575
Adjusted EBITDAR margin (6)		10.8	%		12.9	%		12.9	%		12.4	%		9.8	%

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

(1)	Results for the year ended December 31, 2010 include $29.1 million in transaction costs and $29.2 million in loss on extinguishment of debt due to the Separation.  The results also reflect an increase of $13.1 million of reserves for prior period self-insurance and other general liabilities and $0.4 million of transaction costs related to a hospice acquisition.
(2)	Results for the year ended December 31, 2009 include an increase of $8.2 million of self-insurance reserves for general and professional liability and workers’ compensation related to prior years’ continuing operations, $1.3 million of restructuring costs and $0.5 million of transaction costs related to a hospice acquisition.
(3)	Results for the year ended December 31, 2008 include a full year of revenues and expenses of Harborside Healthcare Corporation (“Harborside”), which was acquired on April 1, 2007, a release of $70.5 million of deferred tax valuation allowance, an increase of $0.9 million of self-insurance reserves for general and professional liability and workers’ compensation related to prior years’ continuing operations, and a gain of $0.9 million related to the sale of non-core business assets.
(4)	Results for the year ended December 31, 2007 include the revenues and expenses of the Harborside centers since April 1, 2007, a release of $28.8 million of deferred tax valuation allowance, a reduction of $8.6 million of self-insurance reserves for general and professional liability and workers’ compensation related to prior years’ continuing operations, and a charge of $3.2 million related to the early extinguishment of debt.
(5)	Results for the year ended December 31, 2006 include an $11.7 million release of self-insurance reserves for general and professional liability and workers’ compensation related to prior years’ continuing operations, a $2.5 million non-cash charge to account for certain lease rate escalation clauses, a net loss on sale of assets of $0.2 million and a $1.0 million charge for the termination of a management contract associated with the acquisition of hospice operations.
(6)	We define EBITDA as net income before loss (gain) on discontinued operations, interest expense (net of interest income), income tax expense (benefit), depreciation and amortization.  EBITDA margin is EBITDA as a percentage of revenue.  Adjusted EBITDA is EBITDA adjusted for the following: ·gain (loss) on sale of asset, net ·restructuring costs ·loss on extinguishment of debt, net ·loss on contract termination 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 (“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. 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, depreciation and amortization expense and special charges, 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 determined 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 expected EBITDA returns and establish compensation programs and

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

bonuses for our center-level employees that are based upon the achievement of pre-established EBITDA and 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, investing 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, 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;

·they do not reflect the impact on earnings of charges resulting from certain matters we consider

   not to be indicative of our ongoing operations; 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.

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

		For the Years Ended December 31,
		2010			2009		2008			2007			2006
Net (loss) income	$	(4,650	)	$	38,671	$	109,287		$	57,510		$	27,118
Plus:
Loss (income) from discontinued      operations		1,934			4,409		5,222			(3,229	)		(15,646	)
Interest expense, net of interest      income		43,064			49,327		54,603			44,347			18,179
Income tax expense (benefit)		2,964			29,616		(47,348	)		(10,914	)		(214	)
Depreciation and amortization		48,008			45,453		40,348			31,216			14,576
EBITDA	$	91,320		$	167,476	$	162,112		$	118,930		$	44,013
Plus:
Loss (gain) on sale of assets, net		847			42		(977	)		23			173
Restructuring costs		-			1,304		-			-			-
Loss on extinguishment of debt		29,221			-		-			3,173			-
Loss on contract termination		-			-		-			-			975
Adjusted EBITDA	$	121,388		$	168,822	$	161,135		$	122,126		$	45,161
Plus:
Center rent expense		84,334			73,128		73,593			70,410			51,414
Adjusted EBITDAR	$	205,722		$	241,950	$	234,728		$	192,536		$	96,575

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes, which appear elsewhere in this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report. See Item 1A – “Risk Factors.”

Overview

Our subsidiaries provide long-term, subacute and related specialty healthcare services primarily to the senior population in the United States. We were engaged in the following three principal business segments during 2010:

Ø	inpatient services, primarily skilled nursing centers;
Ø	rehabilitation therapy services; and
Ø	medical staffing services.

Commencing in 2005, we implemented a business strategy to leverage our existing platform, and in December 2005, we acquired an operator of 56 skilled nursing centers and independent and assisted living residences and a small hospice operation.  In 2006, we continued this strategy by purchasing a hospice company now known as SolAmor.  In April 2007, we acquired Harborside, an operator of 73 skilled nursing centers, one assisted living center and one independent living center with approximately 9,000 licensed beds in ten states.

We continually review our operations and portfolio of facilities to determine if any of these operations or assets no longer fit with our business strategies.  This review has resulted in dispositions of certain assets and operations.

During 2008, we reclassified six skilled nursing centers into discontinued operations because they were divested, sold or qualified as assets held for sale. In 2008, we sold two hospitals that were classified as held for sale since 2007; exercised an option to purchase a skilled nursing center that was classified as held for sale since 2007 and simultaneously sold the asset; exercised options to purchase two skilled nursing centers that were classified as held for sale and sold those centers and a third center; transferred operations of two leased skilled nursing centers, and sold a regional provider of adolescent rehabilitation and special education services.

During 2009, we reclassified an assisted living facility into discontinued operations.  We elected not to renew the lease of the assisted living facility and allowed operations to transfer to another operator.  We also closed a leased skilled nursing center and transferred the remaining residents to other centers.

During 2010, we updated our historical financial statements to reflect the reclassification of our nurse practitioner services group of our Inpatient Services segment to discontinued operations during the year ended December 31, 2010.  U.S. generally accepted accounting principles (“GAAP”) require that these operations be reclassified as discontinued operations on a retroactive basis. The financial information in this Annual Report reflects that reclassification for all periods since January 1, 2006.

2010 Restructuring

As discussed in Item 1. Business, in 2010 Old Sun completed a restructuring of its business by separating its real estate assets and its operating assets into two separate publicly traded companies, Sabra and New Sun.  New Sun changed its name to Sun Healthcare Group, Inc. following the merger of Old Sun into Sabra.  Pursuant to master lease agreements that were entered into between subsidiaries of Sabra and of New Sun in connection

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

with the Separation, subsidiaries of Sabra lease to subsidiaries of New Sun the properties that Sabra’s subsidiaries own following the REIT Conversion Merger.

The Separation was accounted for as a reverse spinoff where New Sun was designated as the “accounting” spinnor and Sabra was designated as the “accounting” spinnee.  Accordingly, the assets and liabilities distributed were recorded based on their historical carrying values.

The historical carrying values of assets and liabilities distributed to Sabra in the Separation are as follows (in thousands):

Cash	$$	66,862
Restricted cash		5,527
Property and equipment, net of accumulated depreciation and
amortization of $91,878		484,801
Intangible and other assets, net		16,116
Long-term debt and mortgage notes payable		(386,678	)
Accrued interest on mortgage notes payable		(1,425	)
Other accrued liabilities		(2,326	)
Deferred tax liabilities		(21,821	)
Due to Sun Healthcare Group, Inc.		(5,307	)
Net distribution	$$	155,749

For accounting purposes, the historical consolidated financial statements of Old Sun became the historical consolidated financial statements of New Sun after the distribution on November 15, 2010.

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 recent adverse 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. We cannot at this time predict the extent to which proposals limiting federal or state expenditures will be adopted or, if adopted and implemented, what effect, if any, such proposals will have on us. Efforts to impose reduced coverage, greater discounts and more stringent cost controls by government and other payors are expected to continue.

In addition, due to recent adverse economic conditions, we have experienced reduced demand for the specialty services that we provide to third parties.  If economic conditions do not improve or worsen, we may experience additional reductions in demand for the specialty services we provide.  We are unable at this time to predict the impact or extent of such reduced demand.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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

	For the Years Ended
Sources of Revenues	December 31, 2010				December 31, 2009				December 31, 2008
	(dollars in thousands)
Consolidated:
Medicaid	$	771,128	40.5	%	$	753,393	40.0	%	$	729,014	40.0	%
Medicare		566,874	29.7			554,570	29.5			521,819	28.7
Private pay and other		472,706	24.8			471,218	25.1			480,242	26.3
Managed care and
commercial insurance		96,153	5.0			101,595	5.4			91,691	5.0
Total	$	1,906,861	100.0	%	$	1,880,776	100.0	%	$	1,822,766	100.0	%
Inpatient Only:
Medicaid	$	770,978	45.4	%	$	753,260	45.0	%	$	728,882	45.1	%
Medicare		548,216	32.3			538,316	32.1			509,276	31.6
Private pay and other		283,271	16.7			282,300	16.9			286,025	17.7
Managed care and
commercial insurance		94,979	5.6			100,876	6.0			91,139	5.6
Total	$	1,697,444	100.0	%	$	1,674,752	100.0	%	$	1,615,322	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, hospice 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 subsequent revisions, the most recent of which was effective October 1, 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 prior to October 1, 2010 and 66 RUGs categories after October 1, 2010.  Each RUG level represents the level of services required to treat the patient’s condition or level of acuity.

The new 66 RUG categorization is the result of research performed by CMS that created the Resource Utilization Group version IV (“RUG IV”).   RUG IV is part of CMS’s continuing effort to increase the correlation of the cost of services to the condition of individual patients.  CMS created the system to be budget neutral, but actual results are expected to vary by provider.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Under the RUG III system, CMS considered some services that were delivered in the hospital when determining the payment category, referred to as the “lookback”.  Under the RUG IV system CMS eliminated this consideration.   The RUG III system also reimbursed for therapy service delivered concurrently, in a group or individually at the same rate.  The RUG IV system changes maintain the same reimbursement methodology for group and individual therapy, but will only consider concurrent therapy if it is delivered to two patients and divides the services between the two patients that receive the services.

Changes were also made in the qualifications required to qualify for each RUG level and additional levels were added to provider further refinement.

In order to implement the RUG IV system, it was necessary for CMS to change the way some payment related data was collected and collect additional data.  CMS implemented the Minimum Data Set version 3.0 to accomplish this as well at to gather additional data that will be used to improve the quality of care of patients.

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 years ended December 31 (data includes revenues for acquired centers following the date of acquisition only):

	2010		2009		2008
$	476.59	$	455.02	$	424.23

Under current law, there are limits on reimbursement provided under Medicare Part B for therapy services.  An automatic exception was in place for patients residing in skilled nursing centers.  That exception will continue through December 31, 2011.

Effective January 1, 2011, changes were made in the payment methodology for Medicare Part B services received by patients in a skilled nursing facility setting.   As part of the Physician Fee Schedule, CMS applied a Multi Procedure Payment Reduction (“MPPR”).  CMS previously applied an MPPR to diagnostic services and is now expanding it to include other Part B services.  A portion of the payment for Part B services is related to activities that CMS contends are only delivered one time when multiple units of the same or related services are delivered.  CMS reduced the portion of the rate that contains these services by 25% which equates to a 7.2% reduction in Part B therapy services for us.

The adjustment will impact our rehabilitation therapy services segment by reducing the amount that we are able to charge to external customers.  We estimate the impact to be $6.5 million annually.

We receive Medicare reimbursements for hospice care at daily or hourly rates based on the level of care furnished to the patient.  Our ability to receive Medicare reimbursement for our hospice services is subject to two limitations:

· If inpatient days of care provided to all patients at a hospice exceed 20% of the total days of hospice care provided by that hospice for an annual period, then payment for days in excess of this limit are paid for at the routine home care rate.  None of our hospice programs exceeded the payment limits on inpatient services for 2010 or 2009.

· Overall payments made by Medicare on a per hospice program basis are subject to a cap amount at the end of an annual period.  The cap amount is calculated by multiplying the numberof first time Medicare hospice beneficiaries during the year by the Medicare per beneficiary cap amount, resulting in that hospice’s aggregate cap, which is the allowable amount of total Medicare payments that hospice can receive for that cap year.  If a hospice program exceeds its aggregate cap, then the hospice must repay

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

the excess.  As of December 31, 2010, we had accrued $2.1 million for the repayment of Medicare payments received in excess of the cap limits.

On July 14, 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% decrease resulting from a phase out of the wage index budget neutrality factor.  We estimate that the net impact on our hospice service operations of these two adjustments will be an increase of 2.2% in our reimbursement rates, which we estimate will result in increased revenues of approximately $0.3 million per quarter.

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 recent 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 years ended December 31 (data includes revenues for acquired centers following the date of acquisition only):

	2010		2009		2008
$	173.62	$	171.55	$	166.62

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 years ended December 31 (data includes revenues for acquired centers following the date of acquisition only):

	2010		2009		2008
$	159.79	$	159.51	$	157.08

Managed Care and Insurance

During the year ended December 31, 2010, we received 5.0% 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.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

     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 years ended December 31 (data includes revenues for acquired centers following the date of acquisition only):

	2010		2009		2008
$	374.02	$	372.93	$	351.93

Private Payors, Veterans and Other

During the year ended December 31, 2010, we received 24.8% 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 years ended December 31 (data includes revenues for acquired centers following the date of acquisition only):

	2010		2009		2008
$	188.05	$	179.05	$	172.50

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.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Results of Operations

The following table sets forth our historical consolidated income statements and certain percentage relationships for the years ended December 31 (dollars in thousands):

										As a Percentage of Net Revenues
	2010			2009			2008			2010			2009			2008
Total net revenues	$	1,906,861		$	1,880,776		$	1,822,766			100.0	%		100.0	%		100.0	%
Costs and expenses:
Operating salaries and benefits		1,077,859			1,056,265			1,027,872			56.5			56.2			56.4
Self-insurance for workers’ compensation
and general and professional liabilities		70,806			63,740			59,689			3.7			3.4			3.3
General and administrative expenses		60,842			62,068			62,302			3.2			3.3			3.4
Other operating costs (1)		441,951			435,579			424,143			23.2			23.2			23.3
Center rent expense		84,334			73,128			73,593			4.4			3.9			4.0
Depreciation and amortization		48,008			45,453			40,348			2.5			2.4			2.2
Provision for losses on accounts receivable		20,568			21,174			14,032			1.1			1.1			0.8
Interest, net		43,064			49,327			54,603			2.3			2.6			3.0
Other expenses (income) (2)		59,181			1,346			(977	)		3.1			-			(0.1	)
Income before income taxes and
discontinued operations		248			72,696			67,161			-			3.9			3.7
Income tax expense (benefit)		2,964			29,616			(47,348	)		0.1			1.6			(2.6	)
(Loss) income from continuing operations		(2,716	)		43,080			114,509			(0.1	)		2.3			6.3
Loss from discontinued operations		(1,934	)		(4,409	)		(5,222	)		(0.1	)		(0.2	)		(0.3	)
Net (loss) income	$	(4,650	)	$	38,671		$	109,287			(0.2	)%		2.1	%		6.0	%
Supplemental Financial Information:
EBITDA (3)	$	91,320		$	167,476		$	162,112			4.8	%		8.9	%		8.9	%
Adjusted EBITDA (3)	$	121,388		$	168,822		$	161,135			6.4	%		9.0	%		8.8	%
Adjusted EBITDAR (3)	$	205,722		$	241,950		$	234,728			10.8	%		12.9	%		12.9	%

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

(2)  Other expenses include transaction costs, loss (gain) on sale of assets, loss on extinguishment of debt and restructuring costs.

(3) We define EBITDA as net income before loss (gain) on discontinued operations, interest expense (net of interest income), income tax expense  (benefit), depreciation and amortization.  Adjusted EBITDA is EBITDA adjusted for gain (loss) on sale of assets, net, restructuring costs, loss on extinguishment of debt, net, loss on contract termination and loss on asset impairment. Adjusted EBITDAR is Adjusted EBITDA before center rent expense. See footnote 6 to Item 6 – “Selected Financial Data” of this report for an explanation of EBITDA, Adjusted EBITDA and Adjusted EBITDAR, including a description of our uses of, and the limitations associated with, EBITDA, Adjusted EBITDA and Adjusted EBITDAR, and a reconciliation of EBITDA, Adjusted EBITDA and Adjusted EBITDAR to net income, the most directly comparable GAAP financial measure.

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       The following discussion of the “Year Ended December 31, 2010 Compared to Year Ended December 31, 2009” and “Year Ended December 31, 2009 Compared to Year Ended December 31, 2008” is based on the financial information presented in Note 13 – “Segment Information” of our consolidated financial statements included in this Annual Report on Form 10-K.

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

Total net revenue increased $26.1 million, or 1.4%, to $1,906.9 million for the year ended December 31, 2010 from $1,880.8 million for the year ended December 31, 2009.  Of this increase in revenue, $22.6 million was contributed by our Inpatient Services segment and $14.3 million by our Rehabilitation Therapy segment.  These increases were offset by a $10.8 million decrease in revenue from our Medical Staffing segment.

Operating salaries and benefits expense increased $21.6 million, or 2.0%, to $1,077.9 million (56.5% of net revenues) for the year ended December 31, 2010 from $1,056.3 million (56.2% of net revenues) for the year ended December 31, 2009.  The increase is primarily the result of wage rate increases.

Self insurance for workers’ compensation and general and professional liability insurance increased $7.1 million, or 11.1%, to $70.8 million (3.7% of net revenues) for the year ended December 31, 2010 from $63.7 million (3.4% of net revenues) for the year ended December 31, 2009.  The increase was attributable to increased general and professional liability insurance costs driven by adverse developments in claims incurred in prior years.

General and administrative expenses decreased $1.3 million, or 2.1%, to $60.8 million (3.2% of net revenues) for the year ended December 31, 2010 from $62.1 million (3.3% of net revenues) for the year ended December 31, 2009.  The decrease was due to decreased salaries and bonus costs driven by continued efforts to control costs.

Other operating costs increased $6.4 million, or 1.5%, to $442.0 million (23.2% of net revenues) for the year ended December 31, 2010 from $435.6 million (23.2% of net revenues) for the year ended December 31, 2009.  The increase in other operating costs was principally comprised of cost increases due to increased provider taxes, coupled with increases in service contracts for software maintenance.

Center rent expense increased $11.2 million, or 15.3%, to $84.3 million (4.4% of net revenues) for the year ended December 31, 2010 from $73.1 million (3.9% of net revenues) for the year ended December 31, 2009.  The increase was primarily due to increased rent paid to Sabra after the Separation.

Depreciation and amortization increased $2.5 million, or 5.5%, to $48.0 million (2.5% of net revenues) for the year ended December 31, 2010 from $45.5 million (2.4% of net revenues) for the year ended December 31, 2009.  The increase was primarily attributable to additional capital expenditures incurred for information systems improvements in 2010, partially offset by a decrease in depreciation related to buildings as a result of the transfer of substantially all of our real estate to Sabra in the Separation.

The provision for losses on accounts receivable decreased $0.6 million, or 2.8%, to $20.6 million (1.1% of net revenues) for the year ended December 31, 2010 from $21.2 million (1.1% of net revenues) for the year ended December 31, 2009.  The decrease was principally driven by improved cash collections.

Net interest expense decreased $6.2 million, or 12.6%, to $43.1 million (2.3% of net revenues) for the year ended December 31, 2010 from $49.3 million (2.6% of net revenues) for the year ended December 31, 2009, principally due to lower interest rates on variable rate indebtedness coupled with reduced debt balances following the Separation.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

        Income tax expense decreased $26.6 million, or 90.0%, to $3.0 million (0.1% of net revenues) for the year ended December 31, 2010 from $29.6 million (1.6% of net revenues) for the year ended December 31, 2009, principally due to a decrease in income before income taxes and discontinued operations.  Offsetting the decrease is a partial increase because we anticipate that certain of the transaction costs for the Separation will not be deductible for tax purposes, which increases our income tax expense.

Other expenses (income) are comprised of transaction costs, loss (gain) on sale of assets, loss on extinguishment of debt and restructuring costs.  Other expenses increased $57.9 million to $59.2 million for the year ended December 31, 2010 from $1.3 million for the year ended December 31, 2009.  The increase is driven by $29.1 million of transaction costs and $29.2 million of loss on extinguishment of debt, both of which are due to the Separation and REIT Conversion Merger.

Our Adjusted EBITDA decreased $47.4 million, or 28.1%, to $121.4 million (6.4% of net revenues) for the year ended December 31, 2010 from $168.8 million (9.0% of net revenues) for the year ended December 31, 2009.  The decrease was primarily attributable to transaction costs incurred for the Separation ($29.1 million), operating salaries and benefits ($21.6 million), self-insurance for workers’ compensation and general and professional liability insurance ($7.1 million), and other operating costs ($6.4 million), offset by additional revenues of $26.1 million, all discussed above.  For an explanation of Adjusted EBITDA, including a description of our uses of, and the limitations associated with, Adjusted EBITDA, and a reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP financial measure, see footnote 6 to Item 6 – “Selected Financial Data” of this Annual Report on Form 10-K.

Segment information

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.

The following table sets forth the amount and percentage of certain elements of total net revenues for the years ended December 31 (dollars in thousands):

	2010					2009					2008
Inpatient Services	$	1,697,444		89.0	%	$	1,674,752		89.0	%	$	1,615,322		88.6	%
Rehabilitation Therapy Services		206,088		10.8			179,532		9.5			150,475		8.3
Medical Staffing Services		91,801		4.8			102,554		5.5			120,410		6.6
Corporate		40		0.0			34		0.0			37		0.0
Intersegment eliminations		(88,512	)	(4.6	)		(76,096	)	(4.0	)		(63,478	)	(3.5	)
Total net revenues	$	1,906,861		100.0	%	$	1,880,776		100.0	%	$	1,822,766		100.0	%

Inpatient services revenues for long-term care, subacute care and assisted living services include revenues billed to patients or third party payors for therapy and medical staffing services provided by our affiliated operations.  The following table sets forth a summary of the intersegment revenues for the years ended December 31 (in thousands):

	2010		2009		2008
Rehabilitation Therapy Services	$	86,476	$	74,166	$	60,856
Medical Staffing Services		2,036		1,930		2,622
Total affiliated revenues	$	88,512	$	76,096	$	63,478

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

 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 loss (gain) on sale of assets, net, restructuring costs, transaction costs, income tax benefit and discontinued operations. Net segment income for the year ended December 31, 2010 for (1) our inpatient services segment decreased $6.0 million, or 3.8%, to $150.7 million, (2) our rehabilitation therapy services segment increased $3.0 million, or 27.0%, to $14.1 million and (3) our medical staffing services segment decreased $3.0 million, or 34.9%, to $5.6 million 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.  The following table sets forth the amount of net segment income for the years ended December 31 (in thousands):

	2010			2009			2008
Inpatient Services	$	150,744		$	156,685		$	154,866
Rehabilitation Therapy Services		14,073			11,112			8,462
Medical Staffing Services		5,595			8,610			9,690
Net segment income before Corporate		170,412			176,407			173,018
Corporate		(110,983	)	$	(102,365	)	$	(106,834	)
Net segment income	$	59,429			74,042			66,184

Inpatient Services.  Net revenues increased $22.7 million, or 1.4%, to $1,697.4 million for the year ended December 31, 2010 from $1,674.7 million for the year ended December 31, 2009.  The increase in net revenues was primarily the result of:

-	an increase of $19.3 million in Medicaid revenues, driven by increases in customer base and rates, which drove $10.5 million and $8.8 million of the increase, respectively;
-	an increase of $14.6 million in hospice revenues due to an acquisition and internal growth; and
-	an increase of $2.5 million in other revenues including veterans and other various inpatient services;
	offset by
-	a $6.2 million decrease in managed care and commercial insurance revenues due to a lower customer base;
-	a $4.9 million decrease in private revenues also due to a lower customer base; and
-	a $2.6 million decrease in Medicare revenues due to a lower customer base, which was mitigated by  increases in Medicare Part A rates and Medicare Part B revenues, which resulted in increased revenues of $21.1 million and $0.9 million, respectively.

Operating salaries and benefits expenses, excluding workers' compensation insurance costs, increased $4.6 million, or 0.6%, to $838.3 million for the year ended December 31, 2010 from $833.7 million for the year ended December 31, 2009.  The increase was primarily due to:

-	increases in compensation and related benefits and taxes of $7.2 million to remain competitive in local markets;
	offset by

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

- a decrease of $2.6 million in overtime expenses.

        Self-insurance for workers’ compensation and general and professional liability insurance decreased $5.4 million, or 9.0%, to $54.4 million for the year ended December 31, 2010 as compared to $59.8 million for the year ended December 31, 2009.  The decrease was attributable to a $4.2 million decrease in general and professional liability insurance costs and a $1.2 million decrease in workers’ compensation costs.

Other operating costs increased $20.3 million, or 4.8%, to $457.7 million for the year ended December 31, 2010, from $437.4 million for the year ended December 31, 2009.  The increase was primarily due to:

-	a $9.4 million increase in therapy, pharmacy and medical supplies attributable to patient mix as well an increase in the number of new Rehab Recovery Suites coming on line;
-	a $6.7 million increase in taxes (primarily provider taxes and real estate taxes);
-	a $4.4 million increase in purchased services of which a majority of the increase was in service contracts, software maintenance and collection agency expense;
-	a $1.0 million increase in utility costs;
-	a $0.8 million increase in legal fees;
-	a $0.7 million increase in other supplies costs, principally food costs;
-	a $0.7 million increase in rebates and vendor discounts; and
-	a $0.5 million increase in contract nursing labor;
	offset by
-	a $1.4 million decrease in equipment rental;
-	a $1.2 million decrease in training and recruitment costs;
-	a $1.0 million decrease in nursing and ancillary services consultant costs; and
-	a $0.3 million decrease in office lease costs.

Operating administrative expenses were consistent with the prior year at $41.2 million for the years ended December 31, 2010 and 2009.

The provision for losses on accounts receivable decreased $1.2 million, or 5.8%, to $19.4 million for the year ended December 31, 2010, from $20.6 million for the year ended December 31, 2009.  The decrease is due to improved cash collections.

Center rent expense for the year ended December 31, 2010 increased $11.3 million, or 15.8%, to $83.0 million, compared to $71.7 million for the year ended December 31, 2009. The increase was attributable to the new lease agreements signed in conjunction with the Separation and negotiated rent increases.

Depreciation and amortization increased $2.0 million, or 4.8%, to $43.3 million for the year ended

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December 31, 2010, from $41.3 million for the year ended December 31, 2009. Increases in depreciation and amortization related to computer hardware and software, respectively, were partially offset by a decrease in depreciation related to buildings transferred to Sabra in the Separation.

Net interest expense for the year ended December 31, 2010 was $9.5 million as compared to $12.2 million for the year ended December 31, 2009.  The decrease of $2.7 million was a result of lower borrowing costs and lower aggregate borrowings.

Rehabilitation Therapy Services.  Total revenues increased $26.6 million, or 14.8%, to $206.1 million for the year ended December 31, 2010, from $179.5 million for the year ended December 31, 2009.  Of the $26.6 million increase in total revenues, affiliated contract revenues increased $12.3 million; nonaffiliated contract revenues increased $13.2 million and other revenue increased $1.1 million. The addition of 35 affiliated contracts, combined with a rate increase and service volume growth drove the affiliated contract revenue increase. The increase in nonaffiliated contract revenues was due primarily to new contracts (net positive change in contract count), rate increases in existing business and growth in dysphagia and management services business lines.  Affiliated and non-affiliated volume growth was offset by the negative effects of the changes in reimbursement for therapy occasioned by the implementation of RUG IV in October 2010.

Operating salaries and benefits expenses, excluding workers’ compensation insurance costs, increased $21.7 million, or 14.4%, to $172.0 million for the year ended December 31, 2010 from $150.3 million for the year ended December 31, 2009. The increase was primarily due to service volume growth and an average increase of 1.66% in therapy wage rates.

Other operating costs, including contract labor expenses, increased $0.4 million, or 5.3%, to $8.0 million for the year ended December 31, 2010 from $7.6 million for the year ended December 31, 2009. The increase was primarily due to increased contract labor, supplies, administrative and business tax expenses resulting from the increased business volume.

Medical Staffing Services.  Total revenues from Medical Staffing Services decreased $10.8 million, or 10.5%, to $91.8 million for the year ended December 31, 2010 from $102.6 million for the year ended December 31, 2009. The decrease in revenues was primarily the result of:

-	a $8.1 million decrease in staffing other medical professionals due to a decline of 82,600 hours;
-	a decrease in locum tenens (physician placement) business of $3.3 million; and
-	a $0.1 million decrease due to nursing offices permanently closed in 2009;
	offset by
-	a $0.7 million increase in the nurse staffing business.

Operating salaries and benefits expenses, excluding workers’ compensation insurance costs, decreased $4.7 million, or 6.5%, to $67.6 million for the year ended December 31, 2010 from $72.3 million for the year ended December 31, 2009. The $4.7 million decrease was primarily driven by the decline in business volume.

Other operating costs decreased $2.9 million, or 18.5%, to $12.8 million for the year ended December 31, 2010 from $15.7 million for the year ended December 31, 2009. The decrease was primarily attributable to a decline in hours associated with the decline in revenues.

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Corporate.  General and administrative costs not directly attributed to operating segments decreased $1.3 million, or 2.1%, to $60.8 million for the year ended December 31, 2010 from $62.1 million for the year ended December 31, 2009. The decrease was due to decreased salaries and bonus costs driven by continued efforts to control costs.

Interest expense

Net interest expense not directly attributed to operating segments decreased $3.5 million, or 9.4%, to $33.6 million for the year ended December 31, 2010 from $37.1 million for the year ended December 31, 2009. The decrease was principally due to lower interest rates on variable rate indebtedness coupled with reduced debt balances.

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

Total net revenue increased $58.0 million, or 3.2%, to $1,880.8 million for the year ended December 31, 2009 from $1,822.8 million for the year ended December 31, 2008.  Of this increase in revenue $59.4 million was contributed by our Inpatient Services segment and $15.8 million by our Rehabilitation Therapy segment.  These increases were offset by a $17.2 million decrease in revenue from our Medical Staffing segment.

Operating salaries and benefits expense increased $28.4 million, or 2.8%, to $1,056.3 million (56.2% of net revenues) for the year ended December 31, 2009 from $1,027.9 million (56.4% of net revenues) for the year ended December 31, 2008.  The increase is primarily the result of wage rate increases.

Self insurance for workers’ compensation and general and professional liability insurance increased $4.0 million, or 6.7%, to $63.7 million (3.4% of net revenues) for the year ended December 31, 2009 from $59.7 million (3.3% of net revenues) for the year ended December 31, 2008.  The increase was attributable to a $5.7 million increase in general and professional liability insurance costs driven by an increased claims costs related to prior years, partially offset by a $1.7 million decrease in workers’ compensation costs resulting from costs recorded in 2008 related to earlier years.

General and administrative expenses decreased $0.2 million, or 0.3%, to $62.1 million (3.3% of net revenues) for the year ended December 31, 2009 from $62.3 million (3.4% of net revenues) for the year ended December 31, 2008.  The decrease was due to cost reductions in professional and consultant fees and benefits expenses.

Other operating costs increased $11.5 million, or 2.7%, to $435.6 million (23.2% of net revenues) for the year ended December 31, 2009 from $424.1 million (23.3% of net revenues) for the year ended December 31, 2008.  The increase in other operating costs was principally comprised of cost increases relating to pharmaceutical, therapy and other ancillary services, which in turn were driven by increased patient needs, coupled with increases in utilities and provider and real estate taxes.

Center rent expense decreased $0.5 million, or 0.7%, to $73.1 million (3.9% of net revenues) for the year ended December 31, 2009 from $73.6 million (4.0% of net revenues) for the year ended December 31, 2008.  The decrease was due to reduced rent for a previously leased center that was purchased in the first quarter of 2009.

Depreciation and amortization increased $5.2 million, or 12.9%, to $45.5 million (2.4% of net revenues) for the year ended December 31, 2009 from $40.3 million (2.2% of net revenues) for the year ended December 31, 2008.  The increase was primarily attributable to the purchase of previously leased centers and additional capital expenditures incurred for center and information systems improvements in 2009.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

The provision for losses on accounts receivable increased $7.2 million, or 51.4%, to $21.2 million (1.1% of net revenues) for the year ended December 31, 2009 from $14.0 million (0.8% of net revenues) for the year ended December 31, 2008. The increase was principally driven by lower recoveries of inpatient services bad debt and continued deterioration in the aging of uncollected accounts, which are primarily private payor accounts.

Net interest expense decreased $5.3 million, or 9.7%, to $49.3 million (2.6% of net revenues) for the year ended December 31, 2009 from $54.6 million (3.0% of net revenues) for the year ended December 31, 2008, principally due to lower interest rates on variable rate indebtedness coupled with reduced debt balances.

There is a provision for income taxes of $29.6 million for the year ended December 31, 2009, compared to an income tax benefit of $47.3 million for the year ended December 31, 2008.  The 2008 benefit amount included a $70.5 million benefit from the reversal of a portion of the valuation allowance on our net deferred tax assets offset by a provision from operations and other adjustments totaling $23.2 million.  Our valuation allowance on our net deferred tax assets decreased $6.7 million during the year ended December 31, 2009 due to the write-off of deferred tax assets for certain state net operating loss carryforwards that were fully reserved.  No portion of the $6.7 million reduction in our valuation allowance in 2009 affected our provision for income taxes.

Our Adjusted EBITDA increased $7.7 million, or 4.8%, to $168.8 million (9.0% of net revenues) for the year ended December 31, 2009 from $161.1 million (8.8% of net revenues) for the year ended December 31, 2008.  The increase was primarily attributable to additional revenues of $58.0 million, offset by additional expenses, primarily operating salaries and benefits ($28.4 million), other operating costs ($11.5 million), provision for losses on accounts receivable ($7.2 million) and self-insurance for workers’ compensation and general and professional liability insurance ($4.0 million), all discussed above.  For an explanation of Adjusted EBITDA, including a description of our uses of, and the limitations associated with, Adjusted EBITDA, and a reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP financial measure, see footnote 6 to Item 6 – “Selected Financial Data” of this Annual Report on Form 10-K.

Segment information

Net segment income is defined as earnings before loss (gain) on sale of assets, net, restructuring costs, transaction costs, income tax benefit and discontinued operations. Net segment income for the year ended December 31, 2009 for (1) our inpatient services segment increased $1.8 million, or 1.2%, to $156.7 million, (2) our rehabilitation therapy services segment increased $2.6 million, or 30.6%, to $11.1 million and (3) our medical staffing services segment decreased $1.1 million, or 11.3%, to $8.6 million due to the factors discussed below for each segment.

Inpatient Services.  Net revenues increased $59.5 million, or 3.7%, to $1,674.8 million for the year ended December 31, 2009 from $1,615.3 million for the year ended December 31, 2008.  The increase in net revenues was primarily the result of:

- an increase of $35.6 million in Medicare revenues driven by increases in Medicare Part A rates and Medicare Part B revenues, which drove $31.6 million and $4.0 million of the increase, respectively;

- an increase of $24.3 million in Medicaid revenues, driven by increases in rates and customer base, which drove $21.0 million and $3.3 million of the increase, respectively;

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

-	an increase of $15.2 million in hospice revenues due to an acquisition and internal growth; and
-	a $9.5 million increase in managed and commercial insurance revenues driven by a higher customer base and higher rates, which caused $4.2 million and $5.3 million of the increase, respectively;
-	an $8.9 million increase in revenues from private sources due to higher rates;
-	an increase of $0.3 million in other revenue including veterans and other various inpatient services;
	offset by
-	a $20.2 million decrease in Medicare revenues due to a lower customer base; and
-	a $14.1 million decrease in private revenues also due to a lower customer base.

Operating salaries and benefits expenses, excluding workers' compensation insurance costs, increased $17.0 million, or 2.0%, to $833.7 million for the year ended December 31, 2009 from $816.7 million for the year ended December 31, 2008.  The increase was primarily due to:

-	increases in compensation and related benefits and taxes of $24.8 million to remain competitive in local markets;
	offset by
-	a decrease of $7.8 million in overtime expenses.

Self-insurance for workers’ compensation and general and professional liability insurance increased $4.3 million, or 7.7%, to $59.8 million for the year ended December 31, 2009 as compared to $55.5 million for the year ended December 31, 2008.  The increase was attributable to a $6.1 million increase in general and professional liability insurance costs, offset by a $1.8 million decrease in workers’ compensation costs. The increase in general and professional liability costs was a result of increased claims costs related to prior years. The decrease in workers’ compensation costs resulted from costs recorded in 2008 from changes in estimates related to earlier years.

Other operating costs increased $25.6 million, or 6.2%, to $437.4 million for the year ended December 31, 2009, from $411.8 million for the year ended December 31, 2008.  The increase was primarily due to:

- a $15.1 million increase in therapy, pharmacy and medical supplies attributable to patient mix as well an increase in the number of new Rehab Recovery Suites coming on line;

- a $12.0 million increase in taxes (primarily provider taxes and real estate taxes);

- a $4.3 million increase in purchased services of which a majority of the increase was in service contracts and software maintenance;

- a $1.0 million increase in legal fees; and

- a $0.5 million increase in acquisition transaction costs related to an acquisition of a hospice

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

	company;
	Offset by
-	a $2.5 million decrease in contract nursing labor;
-	a $1.2 million decrease in equipment rental;
-	a $1.2 million increase in vendor discounts and rebates;
-	a $1.2 million decrease in help wanted;
-	a $1.1 million decrease in civil monetary penalties; and
-	a $0.1 million decrease in travel and vehicle expenses.

Operating administrative expenses decreased $0.2 million, or 0.5%, to $41.2 million for the year ended December 31, 2009 from $41.4 million for the year ended December 31, 2008.

The provision for losses on accounts receivable increased $7.3 million, or 54.9%, to $20.6 million for the year ended December 31, 2009, from $13.3 million for the year ended December 31, 2008.  The increase is due to increased credit risk associated with slower cash collections.

Center rent expense for the year ended December 31, 2009 decreased $0.5 million, or 0.7%, to $71.7 million, compared to $72.2 million for the year ended December 31, 2008. The decrease was attributable to the purchase of previously leased centers.

Depreciation and amortization increased $5.3 million, or 14.7%, to $41.3 million for the year ended December 31, 2009, from $36.0 million for the year ended December 31, 2008. The increase was attributable to additional depreciation expense due to the purchase of previously leased centers and for property and equipment acquired during the period.

Net interest expense for the year ended December 31, 2009 was $12.2 million as compared to $13.7 million for the year ended December 31, 2008.  The decrease of $1.5 million was a result of lower borrowing costs and lower aggregate borrowings.

Rehabilitation Therapy Services.  Total revenues increased $29.0 million, or 19.3%, to $179.5 million for the year ended December 31, 2009, from $150.5 million for the year ended December 31, 2008.  Of the $29.0 million increase in total revenues, affiliated revenues increased $13.3 million; nonaffiliated revenues increased $14.8 million and other revenue increased $0.9 million. The addition of nine affiliated contracts, coupled by a rate increase and service volume growth in our affiliated book of business, drove the affiliated revenue increase. The increase in nonaffiliated revenues was due primarily to new contracts (net positive change in contract count), rate increases in existing business and growth in dysphagia and management services business lines.

Operating salaries and benefits expenses, excluding workers’ compensation insurance costs, increased $25.5 million, or 20.4%, to $150.3 million for the year ended December 31, 2009 from $124.8 million for the year ended December 31, 2008. The increase was primarily due to service volume growth and an average increase of 4.18% in therapy wage rates. These increases were compounded by an increase in health insurance costs of $1.5 million.

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Other operating costs, including contract labor expenses, increased $0.5 million, or 7.0%, to $7.6 million for the year ended December 31, 2009 from $7.1 million for the year ended December 31, 2008. The increase was primarily due to increased administrative expenses and other direct contract expenses resulting from the increased business volume.

Provision for losses on accounts receivable increased $0.3 million to $0.5 million for the year ended December 31, 2009 from $0.2 million for the year ended December 31, 2008.  The increase was due to the aging of uncollected accounts and a higher reserve percentage for our oldest rehab agency accounts.

Medical Staffing Services.  Total revenues from Medical Staffing Services decreased $17.8 million, or 14.8%, to $102.6 million for the year ended December 31, 2009 from $120.4 million for the year ended December 31, 2008.  The decrease in revenues was primarily the result of:

-	a $11.2 million decrease in the nurse staffing business;
-	a $5.4 million decrease in staffing other medical professionals due to a decline in hours; and
-	a $2.4 million decrease due to nursing offices permanently closed in 2008;
	offset by
-	an increase in locum tenens (physician placement) business of $1.2 million.

Operating salaries and benefits expenses, excluding workers’ compensation insurance costs, decreased $14.0 million, or 16.2%, to $72.3 million for the year ended December 31, 2009 from $86.3 million for the year ended December 31, 2008. The $14.0 million decrease was primarily driven by the decline in revenue.

Other operating costs decreased $1.9 million, or 10.8%, to $15.7 million for the year ended December 31, 2009 from $17.6 million for the year ended December 31, 2008. The decrease was primarily attributable to a decline in hours associated with the decline in revenue.

Provision for losses on accounts receivable decreased $0.5 million, or 83.3%, to $0.1 million for the year ended December 31, 2009 from $0.6 million for the year ended December 31, 2008 due primarily to the recovery of large accounts that were reserved in prior year and strong ongoing collections efforts.

Corporate.  General and administrative costs not directly attributed to operating segments decreased $0.2 million, or 0.3%, to $62.1 million for the year ended December 31, 2009 from $62.3 million for the year ended December 31, 2008.

As we continue to focus on reducing costs and maximizing occupancy, we have evaluated and will continue to evaluate certain restructuring activities in our operations and administrative functions.  During the year ended December 31, 2009, we incurred $1.3 million of restructuring costs.  The costs consisted primarily of severance benefits resulting from reductions of administrative staff.

Interest expense

Net interest expense not directly attributed to operating segments decreased $3.9 million, or 9.5%, to $37.1 million for the year ended December 31, 2009 from $41.0 million for the year ended December 31, 2008. The decrease was principally due to lower interest rates on variable rate indebtedness coupled with reduced debt balances.

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Liquidity and Capital Resources

For the year ended and as of December 31, 2010, our net loss was $4.7 million and our working capital was $172.6 million. As of December 31, 2010, we had cash and cash equivalents of $81.2 million, $60.0 million available on our revolving credit facility and $156.0 million in borrowings.  As of December 31, 2010, we were in compliance with the covenants contained in the credit agreement governing the revolving credit facility.

Based on current levels of operations, we believe that our operating cash flows (which were $79.9 million for the year ended December 31, 2010), existing cash reserves and availability for borrowing under our 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 the table under “Obligations and Commitments” at least through the next twelve months. We believe our long term liquidity needs will be satisfied by these same sources, as well as borrowings as required to refinance indebtedness. Although our credit agreement, which is described under “Loan Agreements”, contains 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.

Since April 2007 we have relied on our cash flows to provide for operational needs and capital expenditures, and have not relied on revolving credit borrowings. 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. While we do not anticipate that any of our lenders will be unable to lend under our revolving credit facility if we determine to borrow funds, no assurance can be given that one or more of our lenders will be able to fulfill their commitments.  We do not depend on cash flows from discontinued operations or sales of assets to provide for future liquidity.

Cash flows

During the year ended December 31, 2010, net cash provided by operating activities decreased by $29.0 million as compared to the prior year.  This decrease was the result of (i) a year-over-year decrease in net income of $43.3 million, which is primarily driven by the transaction costs and loss on extinguishment of debt resulting from the Separation and REIT Conversion Merger, (ii) a year-over-year increase in working capital changes of $25.6 million due to timing differences and (iii) a $11.3 million decrease in non-cash adjustments to net income, principally related to deferred taxes offset by the loss on extinguishment of debt, depreciation and amortization expenses and the provision for losses on accounts receivable.

Net cash used for investing activities of $67.4 million for the year ended December 31, 2010 is comprised of (i) $53.5 million used for capital expenditures and (ii) $13.9 million used for acquisitions net of cash acquired.

Net cash used for financing activities of $35.8 million for the year ended December 31, 2010 is comprised of (i) $590.9 million in principal repayments of long-term debt and capital lease obligations, (ii) $66.9 million distributed to Sabra in connection with the Separation, (iii) $26.8 million in deferred financing costs, (iv) a $10.0 million dividend to stockholders in connection with the Separation, and (v) $2.1 million in payments to a non-controlling interest, offset by (vi) $435.5 million provided by long-term borrowings and (vii) $225.4 million provided by the issuance of common stock.

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        During the year ended December 31, 2009, net cash provided by operating activities increased by $20.7 million as compared to the prior year.  This increase was the result of (i) a year-over-year decrease in net income of $70.6 million, (ii) a year-over-year increase in working capital changes of $5.2 million due to timing differences and (iii) a $86.2 million increase in non-cash adjustments to net income, principally related to depreciation and amortization expenses, the provision for losses on accounts receivable and recognition of deferred taxes.

Loan Agreements

Prior to the completion of financings related to the Separation, Old Sun had issued, and there remained outstanding, $200.0 million aggregate principal amount of 9-1/8% Senior Subordinated Notes due 2015 (the “Notes”), and a senior secured credit facility with a syndicate of financial institutions (the “Old Sun Credit Agreement”).    The Old Sun Credit Agreement, following an amendment entered into in June 2010, provided for $365.0 million of term loans, a $45.0 million letter of credit facility and a $50.0 million revolving credit facility.   Interest on the outstanding unpaid principal amount of loans under the Old Sun Credit Agreement equaled an applicable percentage plus, at Old Sun’s 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 and revolving loans at September 30, 2010 was 2.0% for alternative base rate loans and 3.0% for LIBOR loans.

In October 2010, in connection with the Separation, subsidiaries of Sabra issued $225 million principal amount of senior notes due 2018, the proceeds of which were used, together with cash from Old Sun, to redeem the Notes in December 2010, including accrued interest and a redemption premium.

In October 2010, in connection with the Separation, New Sun entered into a $285.0 million senior secured credit facility (the “Credit Agreement”) with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent.  The Credit Agreement provides for $150.0 million in term loans ($147.5 million was outstanding at December 31, 2010), 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 ($66.2 million was utilized at December 31, 2010).  The revolving credit facility was undrawn on December 31, 2010. In addition to funding the letter of credit facility, the proceeds of the term loans were used to repay outstanding term loans under the Old Sun Credit Agreement, which was concurrently terminated, to pay related fees and expenses and to provide funds for general corporate purposes.  The letter of credit facility replaced the letter of credit facility under the Old Sun 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.

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 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 Credit Agreement). The 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.  The obligations of New Sun under the Credit Agreement are guaranteed by most of New Sun’s subsidiaries and are 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 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 LIBOR, adjusted for statutory reserves or (b) an alternative base

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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 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.  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 Credit Agreement. In addition to paying interest on outstanding loans under the 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.

In August 2010, we refinanced mortgage indebtedness collateralized by four of our health care centers.  The new mortgage indebtedness of $20.5 million bears interest at LIBOR plus 4.5% (with a LIBOR floor of 1.0%).  In October 2010, we refinanced mortgage indebtedness collateralized by nine of our health care centers.  The new mortgage indebtedness of $30.0 million bears interest at LIBOR plus 4.5% (with a LIBOR floor of 1.0%), and was collateralized by seven of our health care centers.  Both mortgage loans were assumed by Sabra in the Separation.

Acquisitions

In December 2010, we completed the purchase of a hospice company that operates in Alabama and Georgia for $13.9 million.  The purchase price included allocations of $6.7 million for intangible assets, $9.7 million for goodwill, and $0.3 million for net working capital and other assets.

In October 2009, we completed the purchase of a hospice company, which operates four hospice programs in three states in the New England area, for $16.1 million.  The purchase price included allocations of $6.3 million for intangible assets, $11.3 million for goodwill, and $1.5 million for net working capital and other assets.

Assets held for sale

We had no assets held for sale as of December 31, 2010 or 2009.

During 2010 we disposed 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.  During October 2009, we transferred operations of an assisted living center in Utah to an outside party.  This center has been classified as a discontinued operation.

Capital expenditures

We incurred capital expenditures, related primarily to improvements in continuing operations, of $53.5 million, $54.3 million, and $42.5 million for the years ended December 31, 2010, 2009, and 2008, respectively, which included capital expenditures for discontinued operations of $0.1 million for the year ended December 31, 2008.  We did not incur any capital expenditures related to discontinued operations in 2010 or 2009.  During the year ended December 31, 2010, we incurred $32.1 million of capital expenditures for ongoing normal operational needs of our centers, plus we expended $16.4 million for major renovations of our centers, including $7.4 million spent on construction of our Rehab Recovery Suites.  Our development and rollout of a new billing platform and labor management system resulted in $2.1 million of expenditures during 2010.  We also incurred capital expenditures of $2.9 million in our Corporate segment for information systems and other needs.

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We had construction commitments as of December 31, 2010 under various contracts of $9.4 million related to improvements at centers.  These commitments, and other expenditures in response to emergency situations at our centers, the amount of which we cannot predict, represent our non-discretionary capital expenditures.  The remaining amount of our 2010 planned capital expenditures is discretionary.  We expect to incur approximately $55 million to $60 million in capital expenditures during 2011, related primarily to improvements at existing centers and information system upgrades.

Obligations and Commitments

The following table provides information about our contractual obligations and commitments in future years as of December 31, 2010 (in thousands):

	Payments Due by Period
													After
	Total		2011		2012		2013		2014		2015		2015
Contractual Obligations:
Debt, including interest
payments (1)	$	249,081	$	28,035	$	27,288	$	26,541	$	25,323	$	24,084	$	117,810
Capital leases (2)		587		336		194		51		6		-		-
Construction commitments		9,387		9,387		-		-		-		-		-
Purchase obligations (3)		373,080		101,880		101,880		79,080		56,280		33,960		-
Operating leases (4)		1,199,645		147,256		143,121		139,600		110,483		108,637		550,548
Other liabilities (5)		6,173		-		6,173		-		-		-		-
Total	$	1,837,953	$	286,894	$	278,656	$	245,272	$	192,092	$	166,681	$	668,358

	Amount of Commitment Expiration Per Period
	Total
	Amounts												After
	Committed		2011		2012		2013		2014		2015		2015
Other Commercial Commitments:
Letters of credit (6)	$	66,169	$	66,169	$	-	$	-	$	-	$	-	$	-
Total	$	66,169	$	66,169	$	-	$	-	$	-	$	-	$	-

(1)	Debt includes principal payments and interest payments through the maturity dates. Total interest on debt, based on contractual rates, is $93.6 million, of which $88.9 million is attributable to variable interest rates determined using the weighted average method.
(2)	Includes interest of $0.1 million.
(3)	Represents our estimated level of purchasing from our main suppliers assuming that we continue to operate the same number of centers in future periods.
(4)	Some of our operating leases also have contingent rentals.
(5)	$6.2 million of liability due to the previous shareholders of Harborside when certain tax benefits associated with that acquisition are realized.  Excludes liabilities for uncertain tax positions that are included in other liabilities at December 31, 2010 for which we are unable to make a reasonably reliable estimate as to when, if at all, cash settlements with taxing authorities will occur.
(6)	Letters of credit expire annually but may be reissued pursuant to a $75.0 million letter of credit facility that terminates in October 2016.

Critical Accounting Estimates

Our discussion and analysis of the financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the use of estimates and judgments that affect the reported amounts and related disclosures of assets and liabilities, the disclosure of contingent assets and

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liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ materially from these estimates. We believe the following are the most significant judgments and estimates affecting the accounting policies we use in the preparation of the consolidated financial statements.

Net revenues.  Net revenues consist of long-term and subacute care revenues, rehabilitation therapy revenues, and medical staffing services revenues. Net revenues are recognized as services are provided and billed. Revenues are recorded net of provisions for discount arrangements with commercial payors and contractual allowances with third-party payors, primarily Medicare and Medicaid. Net revenues realizable under third-party payor agreements are subject to change due to examination and retroactive adjustment. Estimated third-party payor settlements are recorded in the period the related services are rendered. The methods of making such estimates are reviewed periodically, and differences between the net amounts accrued and subsequent settlements or estimates of expected settlements are reflected in current results of operations, when determined.

Accounts receivable and related allowance.  Our accounts receivable relate to services provided by our various operating divisions to a variety of payors and customers. The primary payors for services provided in healthcare centers that we operate are the Medicare program and the various state Medicaid programs. The rehabilitation therapy service operations provide services to patients in nonaffiliated healthcare centers. The billings for those services are submitted to the nonaffiliated centers. Many of the nonaffiliated healthcare centers receive a large majority of their revenues from the Medicare program and the state Medicaid programs.

Estimated provisions for losses on accounts receivable are recorded each period as an expense in the income statement.  In evaluating the collectability of accounts receivable, we consider a number of factors, including the age of the accounts, changes in collection patterns, the financial condition of our customers, the composition of patient accounts by payor type, the status of ongoing disputes with third-party payors and general industry conditions.  Any changes in these factors or in the actual collections of accounts receivable in subsequent periods may require changes in the estimated provision for loss. Changes in these estimates are charged or credited to the results of operations in the period of change.  In addition, a retrospective collection analysis is performed within each operating company to test the adequacy of the reserve on a semi-annual basis.

The allowance for doubtful accounts related to centers that we have divested was based on management’s expectation of collectability at the time of divestiture and was recorded in gain or loss on disposal of discontinued operations, net. As collections are recognized or new information becomes available, the allowance is adjusted as appropriate. As of December 31, 2010, accounts receivable for divested operations were significantly reserved.

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 management 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 there from 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

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 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 loss 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. These functions ensure that the claims are properly administered 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 cases where our historical data are not statistically credible, stable, or mature, we supplement our experience with nursing home 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 limitations is applied when weighting the results of each method.  The results of each of the methods are estimates of ultimate losses which includes the case reserves plus an estimate for future development of these reserves based on past trends, and an estimate for losses incurred but not reported.   These results are compared by accident year and an estimated unpaid loss and allocated loss adjustment expense are determined for the open accident years based on judgment reflecting the range of estimates produced by the methods.

Regarding our estimates for workers’ compensation reserves, there were no large or unusual settlements during the 2010 period.  As of December 31, 2010, the discounting of the policy periods resulted in a reduction to our reserves of $13.4 million.

During 2010 we determined that the previous estimates for general and professional liabilities reserves for matters related to years prior to 2010 were understated by $13.1 million due to adverse developments with respect to a number of claims that arose in prior periods. Accordingly we have recorded a charge in the fourth quarter of 2010 to increase our general and professional liabilities reserves.  Professional liability claims have a reporting tail that exceeds one year.  A significant component of our reserves is estimates for incidents that have been incurred but not reported.

Impairment of assets.

Goodwill and Accounting for Business Combinations

Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies.  Our goodwill included in our consolidated balance sheets as of December 31, 2010 and 2009 was $348.0 and $338.3 million, respectively.  The increase in our goodwill during 2010 was primarily the result of a hospice acquisition in our Inpatient Services segment.

Under GAAP, goodwill and intangible assets with indefinite lives are not amortized; however, they are subject to annual impairment tests. Intangible assets with definite lives continue to be amortized over their estimated useful lives.

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The purchase price of acquisitions is allocated to the assets acquired and liabilities assumed based upon their respective fair values.  We may engage independent third-party valuation firms to assist us in determining the fair values of assets acquired and liabilities assumed for significant acquisitions.  Such valuations require us to make significant estimates and assumptions, including projections of future events and operating performance.

We perform our annual goodwill impairment analysis for our reporting units during the fourth quarter of each year, which timing for 2010 also coincided with the Separation.  A reporting unit is a business for which discrete financial information is produced and reviewed by operating segment management and provides services that are distinct from the other components of the operating segment and are reviewed at the division level.  For our Rehabilitation Therapy Services and Medical Staffing Services segments, the reporting unit for our annual goodwill impairment analysis was determined to be at the segment level.  For our Inpatient Services segment, the reporting unit for our annual goodwill impairment analysis was determined to be at one level below our segment level.  Our goodwill balances by reporting unit as of December 31, 2010 are (in thousands):

Inpatient Services – Healthcare facilities reporting unit	$	314,729
Inpatient Services – Hospice services reporting unit		28,710
Rehabilitation Therapy Services segment		75
Medical Staffing Services segment		4,533
Total goodwill	$	348,047

We determined potential impairment by comparing the net assets of each reporting unit to their respective fair values, which GAAP describes as Step 1 of goodwill impairment testing. We determined the estimated fair value of each reporting unit using a discounted cash flow analysis and other appropriate valuation methodologies. In the event a unit's net assets exceed its fair value, an implied fair value of goodwill must be determined by assigning the unit's fair value to each asset and liability of the unit, which is referred to in GAAP as Step 2 of the impairment analysis. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill.  An impairment loss is measured by the difference between the goodwill carrying value and the implied fair value.

The discounted cash flow model utilizes five years of projected cash flows for each reporting unit. The projected financial results are created from critical assumptions and estimates based upon management’s business plan and historical trends while giving consideration to the overall economic environment. Determining fair value requires the exercise of significant judgments about appropriate discount rates, business growth rates, the amount and timing of expected future cash flows and market information relevant to our overall company value. In addition, to validate the reasonableness of our assumptions, we utilized our discounted cash flow model on a consolidated basis and compared the estimated fair value to our market capitalization as of December 31, 2010.  Key assumptions in the discounted cash flow model are as follows:

Business Growth Assumptions – In determining our projected Inpatient Services revenue growth rates for our discounted cash flow model, we focus on the two primary drivers: average daily census (“ADC”) and reimbursement rates. Key revenue inputs include historical ADC adjusted for known trends and current Medicare and Medicaid rates adjusted for anticipated changes. ADC trends have been reasonably constant within a narrow range and may be influenced over the long run by a number of factors, including demographic changes in the population we serve and our ability to deliver quality service in an attractive environment. Generally long term care reimbursement rates are set annually by the payor. To estimate these rates, we evaluate the current reimbursement climate and adjust historical trends where appropriate. Significant adverse rate changes in any one year would cause us to reevaluate our projected rates.  In recent years we have generated historical revenue growth of 1.4% to 6.2% annually.  Expenses generally vary with ADC and have historically grown by approximately 2.9% to

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5.6% annually.  Labor is the largest component of our expenses.  We consider labor market trends and staffing needs for the projected ADC levels in determining labor growth rates to be used in our projections. The projected growth rates used in our discounted cash flow model took into account the potential adverse effects of the current economic downturn on our projected revenue and expenses.

Terminal Value EBITDAR Multiple – Consistent with commonly accepted valuation techniques, a terminal multiple for the final year’s projected results is applied to estimate our value in the final year of the analysis. That multiple is applied to the final year’s projected EBITDAR from continuing operations.

Discount Rate – Market conditions indicated that a discount rate of 13% was appropriate at December 31, 2010.  This discount rate is consistent with our overall market capitalization comparison. We consistently apply the same discount rate to the evaluation of each reporting unit.

The goodwill impairment analysis is subject to impact from uncertainties arising from such events as changes in economic or competitive conditions, the current general economic environment, material changes in Medicare and Medicaid reimbursement that could positively or negatively impact anticipated future operating conditions and cash flows, and the impact of strategic decisions such as the Separation. The Step 1 results of our fourth quarter 2010 goodwill impairment analysis showed that none of our reporting units exhibited any indications of potential goodwill impairment. Based on the analysis performed, we determined there was no goodwill impairment for the years ended December 31, 2010, 2009 or 2008.

In accordance with the authoritative guidance for goodwill and other intangible assets, we are required to perform an impairment test for goodwill and indefinite lived intangible assets at least annually or more frequently if adverse events or changes in circumstances indicate that the asset may be impaired. During 2010 and 2009, the market value of our common stock was below our book equity value. Management believes that the difference between our market equity value and our book equity during 2010 was generally attributable to uncertainty in equity markets related to certain Medicare regulatory changes that went into effect October 1, 2010 for our Inpatient Services and Rehabilitation Services segments and uncertainty related to the enactment of healthcare reform legislation during 2010. Management believes that the difference between our market equity value and our book equity value during 2009 was generally attributable to uncertainty in the equity markets related to proposed federal healthcare reform legislation and certain Medicare revenue reductions announced by CMS during the year. The difference between the book equity value and the market value of our common stock during 2010 and 2009 was a potential indication that the carrying value of our goodwill may have been impaired but was not viewed as a triggering event.

Although we have determined that there was no goodwill or other indefinite lived intangible asset impairments as of December 31, 2010, adverse changes in the operating environment and related key assumptions used to determine the fair value of our reporting units and indefinite lived intangible assets or declines in the value of our common stock may result in future impairment charges for a portion or all of these assets. Specifically, if the rate of growth of government and commercial revenues earned by our reporting units were to be less than projected or if healthcare reforms were to negatively impact our business, an impairment charge for a portion or all of the assets may be required. An impairment charge could have a material adverse effect on our financial position and results of operations, but would not be expected to have an impact on our cash flows or liquidity.

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Indefinite Lived Intangibles

Our indefinite lived intangibles primarily consist of values assigned to CONs and regulatory licenses obtained through various acquisitions.

We evaluate the recoverability of our indefinite lived intangibles by comparing the asset's respective carrying value to estimates of fair value. We determine the estimated fair value of these intangible assets through an estimate of incremental cash flows with the intangible assets versus cash flows without the intangible assets in place. We determined there was no impairment charge to our indefinite lived intangibles for the years ended December 31, 2010, 2009 or 2008.

Finite Lived Intangibles

Our finite lived intangibles include tradenames, favorable lease intangibles and customer contracts.

We evaluate the recoverability of our finite lived intangibles if an impairment indicator is present.  As there were no such indicators, we determined there was no impairment of our finite lived intangibles for the years ended December 31, 2010, 2009 or 2008.

Long-Lived Assets

GAAP requires impairment losses to be recognized for long-lived assets used in operations when indicators of impairment are present and the estimated undiscounted cash flows are not sufficient to recover the assets' carrying amounts at each center. The impairment loss is measured by comparing the estimated fair value of the asset, usually based on discounted cash flows, to its carrying amount.  We assess the need for an impairment write-down when such indicators of impairment are present.  We determined there was no impairment to our long-lived assets used in continuing operations for the years ended December 31, 2010, 2009, and 2008.

Income Taxes.  Pursuant to GAAP, an asset or liability is recognized for the deferred tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements.  These temporary differences would result in taxable or deductible amounts in future years when the reported amounts of the assets are recovered or liabilities are settled.  Deferred tax assets are also recognized for the future tax benefits from net operating loss, capital loss and tax credit carryforwards.  A valuation allowance is to be provided for the net deferred tax assets if it is more likely than not that some portion or all of the net deferred tax assets will not be realized.

In evaluating the need to record or continue to reflect a valuation allowance, all items of positive evidence (e.g., future sources of taxable income and tax planning strategies) and negative evidence (e.g., history of taxable losses) are considered.  In determining future sources of taxable income, we use management-approved budgets and projections of future operating results for an appropriate number of future periods, taking into consideration our history of operating results, taxable income and losses, etc.  This future taxable income is then used, along with all other items of positive and negative evidence, to determine the amount of valuation allowance that is needed, and whether any amount of such allowance should be reversed.

We are subject to income taxes in the U.S. and numerous state and local jurisdictions.  Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes.  Effective January 1, 2007, we adopted the GAAP guidance for accounting for uncertainty in income tax positions, which contains a two-step approach to recognizing and measuring uncertain tax positions.  The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation

49

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

processes, if any.  The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.  We reserve for our uncertain tax positions, and we adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the expiration of the statute of limitations.

Recent Accounting Pronouncements

Discussion of recent accounting pronouncements can be found in the “Recent Accounting Pronouncements” portion of Note 2 – “Summary of Significant Accounting Policies” to our consolidated financial statements included in this Annual Report on Form 10-K, which is incorporated by reference in response to this item.

Impact of Inflation

CMS implemented market basket increases of 2.3%, 2.2%, and 3.4% to the Medicare reimbursement rates for Federal fiscal years 2011, 2010, and 2009, respectively, which increases were primarily intended to keep track with inflation. The final rule for Federal fiscal year 2010 also had a 0.6% reduction for a forecast error/parity adjustment.  We estimate that the net result of the two 2011 adjustments, based on our current acuity mix, will be an increase of 1.7% in our reimbursement rates, which we estimate will increase our net revenues by approximately $1.9 million per quarter.

Off-Balance Sheet Arrangements

None.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk because we hold 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 for debt.

			Expected Maturity Dates																					Fair Value		Fair Value
																								December 31,	December 31,
			2011				2012			2013			2014			2015			Thereafter			Total		2010 (1)		2009 (1)
			(Dollars in thousands)
Long-term Debt:
Fixed rate debt		$	1,050			$	1,002		$	949		$	517		$	65		$	4,897		$	8,480	$	8,584	$	488,393
Rate			7.5		%		7.3	%		7.0	%		6.8	%		6.7	%		6.7	%
Variable rate debt		$	10,000			$	10,000		$	10,000		$	10,000		$	10,000		$	97,500		$	147,500	$	147,500	$	202,557
Rate			7.5		%		7.5	%		7.5	%		7.5	%		7.5	%		7.5	%
	(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.

Item 8.  Financial Statements and Supplementary Data

Information with respect to Item 8 is contained in our consolidated financial statements and financial statement schedules and is set forth herein beginning on Page F-1 which information is incorporated by reference into this Item 8.

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

50

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Item 9A.  Controls and Procedures

Management's Report on Disclosure Controls and Procedures

We maintain disclosure controls and procedures defined in Rule 13a-15(e) under the Exchange Act, as controls and other procedures that are designed to ensure that information required to be disclosed by the 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 Chief Executive Officer (“CEO”), William A. Mathies, and Chief Financial Officer (“CFO”), L. Bryan Shaul, 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 the CEO and CFO, of the effectiveness of the Company’s disclosure controls and procedures.  Based on that evaluation, our CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2010.

Management's Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act).  Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation and presentation. Therefore, even those systems determined to be effective may not prevent or detect all misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of internal control over financial reporting as of December 31, 2010, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework.  Based on this assessment, our management concluded that our internal control over financial reporting was effective as of December 31, 2010.

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2010 has been audited by PricewaterhouseCoopers LLP (“PwC”), an independent registered public accounting firm, as stated in their report which appears herein.

Changes to Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the fourth quarter of 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B.  Other Information

Not applicable.

51

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

PART III

Item 10.  Directors, Executive Officers and Corporate Governance

The information required under Item 10 is incorporated herein by reference to our definitive proxy statement, which we will file pursuant to Exchange Act Regulation 14A prior to May 2, 2011.

Code of Ethics

     We have adopted a Code of Ethics that applies to our Chief Executive Officer, Chief Financial Officer, and Corporate Controller, and other financial personnel.  The Code of Ethics is designed to deter wrongdoing and to promote, among other things, (i) honest and ethical conduct, (ii) full, fair, accurate, timely and understandable disclosures, and (iii) compliance with applicable governmental laws, rules and regulations.  The Code of Ethics is available on our web site at www.sunh.com by clicking on “Governance” and then “Compliance.”   If we make any substantive amendments to the Code of Ethics or grant any waiver, including any implicit waiver, from a provision of the Code to our Chief Executive Officer, Chief Financial Officer or Corporate Controller, we will disclose the nature of such amendment or waiver on our website.

Item 11.  Executive Compensation

The information required under Item 11 is incorporated herein by reference to our definitive proxy statement, which we will file pursuant to Exchange Act Regulation 14A prior to May 2, 2011.

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required under Item 12 is incorporated herein by reference to our definitive proxy statement, which we will file pursuant to Exchange Act Regulation 14A prior to May 2, 2011.

Item 13.  Certain Relationships and Related Transactions and Director Independence

The information required under Item 13 is incorporated herein by reference to our definitive proxy statement, which we will file pursuant to Exchange Act Regulation 14A prior to May 2, 2011.

Item 14.  Principal Accountant Fees and Services

The information required under Item 14 is incorporated herein by reference to our definitive proxy statement, which we will file pursuant to Exchange Act Regulation 14A prior to May 2, 2011.

PART IV

Item 15.  Exhibits, Financial Statements and Schedules

(a)	(1)	The following consolidated financial statements of Sun Healthcare Group, Inc. and subsidiaries are filed as part of this report under Item 8 – “Financial Statements and Supplementary Data”:
		Report of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm
		Consolidated Balance Sheets as of December 31, 2010 and 2009

52

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

	Consolidated Income Statements for the years ended December 31, 2010, 2009 and 2008
	Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2010, 2009 and 2008
	Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008
	Notes to Consolidated Financial Statements
(2)	Financial schedules required to be filed by Item 8 of this form, and by Item 15(a)(2) below:
	Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2010, 2009 and 2008
	All other financial schedules are not required under the related instructions or are inapplicable and therefore have been omitted.
(3)	Exhibits

Exhibit
Number	Description of Exhibits
2.1(1)	Agreement and Plan of Merger dated October 19, 2006 by and among Sun Healthcare Group, Inc., Horizon Merger, Inc. and Harborside Healthcare Corporation
2.2(8)±	Distribution Agreement, dated November 4, 2010, by and among Sun Healthcare Group, Inc. (Old Sun), Sabra Health Care REIT, Inc. and Sun Healthcare Group, Inc. (formerly SHG Services, Inc.)
3.1*	Amended and Restated Certificate of Incorporation of Sun Healthcare Group, Inc., as amended
3.2*	Amended and Restated Bylaws of Sun Healthcare Group, Inc.
10.1(2)	Credit Agreement, dated as of October 18, 2010, among Sun Healthcare Group, Inc., the Lenders named therein and Credit Suisse, as Administrative Agent and Collateral Agent for the Lenders
10.2*+	Sun Healthcare Group, Inc. 2004 Equity Incentive Plan
10.3*+	Sun Healthcare Group, Inc. 2009 Performance Incentive Plan
10.4*+	Form of Stock Option Agreement
10.5*+	Form of Stock Unit Agreement for employees
10.6*+	Form of Stock Unit Agreement for non-employee directors

53

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

10.7*+	Non-employee Directors Stock-for-Fees Program and Payment Election Form
10.8(3)+	Amended and Restated Employment Agreement by and between Sun Healthcare Group, Inc. and L. Bryan Shaul dated as of December 17, 2008
10.9(4)+	Employment Agreement by and between Sun Healthcare Group, Inc. and William A.  Mathies dated as of November 18, 2010
10.10(3)+	Amended and Restated Employment Agreement by and between Sun Healthcare Group, Inc. and Michael Newman dated as of December 17, 2008
10.11(3)+	Amended and Restated Employment Agreement by and between Sun Healthcare Group, Inc. and Chauncey J. Hunker dated as of December 17, 2008
10.12*+	Non-Employee Director Compensation Policy of Sun Healthcare Group, Inc.
10.13(9)	Tax Allocation Agreement, dated as of September 23, 2010, by and among Sun Healthcare Group, Inc. (Old Sun), Sabra Health Care REIT, Inc. and Sun Healthcare Group, Inc. (formerly SHG Services, Inc.)
10.14(5)	Third Amended and Restated Master Lease Agreement among Sun Healthcare Group, Inc. and certain of its subsidiaries (as Lessees) and Omega Healthcare Investors, Inc. and certain of its subsidiaries (as Lessors) dated November 4, 2010
10.14.1(5)	Guaranty dated November 4, 2010 by Sun Healthcare Group, Inc. in favor of Lessors under the Third Amended and Restated Master Lease Agreement dated November 4, 2010 among Sun Healthcare Group, Inc. and certain of its subsidiaries (as Lessees) and Omega Healthcare Investors, Inc. and certain of its subsidiaries (as Lessors)
10.15(5)	Form of Indemnification Agreement entered into with each of the directors and officers of Sun Healthcare Group, Inc. and certain of its subsidiaries
10.16(10)+	Sun Healthcare Group, Inc. Deferred Compensation Plan
10.17(6)+	Amended and Restated Severance Benefits Agreement dated as of December 17, 2008 by and between Richard L. Peranton and CareerStaff Unlimited, Inc.
10.18(7)+	Amended and Restated Severance Benefits Agreement dated as of December 17, 2008 by and between Sue Gwyn and SunDance Rehabilitation Corporation
10.19(8)	Transition Services Agreement, dated November 4, 2010, by and between Sun Healthcare Group, Inc. (formerly SHG Services, Inc.) and Sabra Health Care REIT, Inc.
10.20(8)	Form of Master Lease Agreement entered into between subsidiaries of Sun Healthcare Group, Inc. (formerly SHG Services, Inc.) and subsidiaries of Sabra Health Care REIT, Inc.

54

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

10.20.1(8)	Form of Guaranty entered into by Sun Healthcare Group, Inc. (formerly SHG Services, Inc.) in favor of subsidiaries of Sabra Health Care REIT, Inc., as landlords under the Master Lease Agreements.
21.1*	Subsidiaries of Sun Healthcare Group, Inc.
23.1*	Consent of PricewaterhouseCoopers LLP
31.1*	Section 302 Sarbanes-Oxley Certifications by Principal Executive Officer
31.2*	Section 302 Sarbanes-Oxley Certifications by Principal Financial and Accounting Officer
32.1*	Section 906 Sarbanes-Oxley Certifications by Principal Executive Officer
32.2*	Section 906 Sarbanes-Oxley Certifications by Principal Financial and Accounting Officer

_______________

*      Filed herewith.

+      Designates a management compensation plan, contract or arrangement

± Schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The registrant hereby agrees to furnish supplementally copies of any of the omitted schedules and exhibits upon request by the Securities and Exchange Commission.

(1)	Incorporated by reference from exhibits to our Form 8-K filed on October 25, 2006
(2)	Incorporated by reference from exhibits to our Form 8-K filed on October 22, 2010
(3)	Incorporated by reference from exhibits to our Form 10-K filed on March 4, 2009
(4)	Incorporated by reference from exhibits to our Form 8-K filed on November 23, 2010
(5)	Incorporated by reference from exhibits to our Form 8-K filed on November 16, 2010
(6)	Incorporated by reference from exhibits to our Form 10-Q filed on August 7, 2009
(7)	Incorporated by reference from exhibits to our Form 10-K filed on March 5, 2010
(8)	Incorporated by reference from exhibits to our Form 8-K filed on November 5, 2010
(9)	Incorporated by reference from exhibits to our Form 8-K filed on September 29, 2010
(10)	Incorporated by reference from exhibits to our Form 10-Q filed on April 29, 2009

55

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

SIGNATURES

Pursuant to the requirements of Section 13or 15(d)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

       Chief Financial Officer

February 28, 2011

56

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant as of dates and in the capacities indicated.

Signatures	Title	Date
	Chairman of the Board and Chief Executive Officer
/s/ William A. Mathies	(Principal Executive Officer)	February 28, 2011
William A. Mathies
	Executive Vice President and Chief Financial Officer (Principal
/s/ L. Bryan Shaul	Financial and Accounting Officer)	February 28, 2011
L. Bryan Shaul
/s/ Gregory S. Anderson	Director	March 2, 2011
Gregory S. Anderson
/s/ Tony M. Astorga	Director	February 25, 2011
Tony M. Astorga
/s/ Christian K. Bement	Director	February 25, 2011
Christian K. Bement
/s/ Michael J. Foster	Director	March 2, 2011
Michael J. Foster
/s/ Barbara B. Kennelly	Director	February 25, 2011
Barbara B. Kennelly
/s/ Milton J. Walters	Director	March 2, 2011
Milton J. Walters

57

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Index to Consolidated Financial Statements

December 31, 2010

	Page
Report of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm	F-2
Consolidated Balance Sheets	F-3– F-4
As of December 31, 2010 and 2009
Consolidated Statements of Operations	F-5
For the years ended December 31, 2010, 2009 and 2008
Consolidated Statements of Stockholders’ Equity and Comprehensive (Loss)	F-6
Income for the years ended December 31, 2010, 2009 and 2008
Consolidated Statements of Cash Flows	F-7 – F-8
For the years ended December 31, 2010, 2009 and 2008
Notes to Consolidated Financial Statements	F-9 – F-45
Supplementary Data (Unaudited) - Quarterly Financial Data	1 – 3
Schedule II – Valuation and Qualifying Accounts	4

F-1

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

Sun Healthcare Group, Inc.

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Sun Healthcare Group, Inc and its subsidiaries at December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.  In addition, in our opinion the financial statement schedule listed in the accompanying index on page F-1 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.  Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed 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.  A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Irvine, California

March 3, 2011

F-2

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

(in thousands)

	December 31, 2010		December 31, 2009
Current assets:
Cash and cash equivalents	$	81,163	$	104,483
Restricted cash		15,329		24,034
Accounts receivable, net of allowance for doubtful accounts of $66,607
and $55,402 at December 31, 2010 and 2009, respectively		218,040		220,319
Prepaid expenses and other assets		16,859		21,757
Deferred tax assets		69,800		68,415
Total current assets		401,191		439,008
Property and equipment, net of accumulated depreciation and amortization
of $102,897 and $153,854 at December 31, 2010 and 2009, respectively		139,860		622,682
Intangible assets, net of accumulated amortization of $12,506 and $9,760 at
December 31, 2010 and 2009, respectively		41,967		38,628
Goodwill		348,047		338,296
Restricted cash, non-current		350		3,317
Deferred tax assets		126,540		108,999
Other assets		23,803		20,264
Total assets	$	1,081,758	$	1,571,194

F-3

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Continued)

LIABILITIES AND STOCKHOLDERS' EQUITY

(in thousands, except share data)

	December 31, 2010			December 31, 2009
Current liabilities:
Accounts payable	$	49,993		$	57,109
Accrued compensation and benefits		61,518			58,953
Accrued self-insurance obligations, current portion		52,093			45,661
Other accrued liabilities		53,945			55,265
Current portion of long-term debt and capital lease obligations		11,050			46,416
Total current liabilities		228,599			263,404
Accrued self-insurance obligations, net of current portion		133,405			121,948
Long-term debt and capital lease obligations, net of current portion		144,930			654,132
Unfavorable lease obligations, net of accumulated amortization of
$19,298 and $16,450 at December 31, 2010 and 2009, respectively		9,815			12,663
Other long-term liabilities		52,566			69,983
Total liabilities		569,315			1,122,130
Commitments and contingencies (Note 8)
Stockholders' equity:
Preferred stock of $.01 par value, authorized 3,333,333
shares, zero shares issued and outstanding as of December 31, 2010
and authorized 10,000,000 shares, zero shares issued and outstanding as of December 31, 2009		-			-
Common stock of $.01 par value, authorized 41,666,667 shares,
24,973,693 shares issued and outstanding as of December 31, 2010
and authorized 125,000,000 shares, 43,764,240 shares issued and
outstanding as of December 31, 2009		250			438
Additional paid-in capital		720,854			655,666
Accumulated deficit		(208,661	)		(204,011	)
Accumulated other comprehensive loss, net		-			(3,029	)
Total stockholders' equity		512,443			449,064
Total liabilities and stockholders' equity	$	1,081,758		$	1,571,194

See accompanying notes.

F-4

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

	For the Years Ended December 31,
	2010			2009			2008
Total net revenues	$	1,906,861		$	1,880,776		$	1,822,766
Costs and expenses:
Operating salaries and benefits		1,077,859			1,056,265			1,027,872
Self-insurance for workers' compensation and general
and professional liability insurance		70,806			63,740			59,689
Operating administrative expenses		51,943			50,924			51,171
Other operating costs		390,008			384,655			372,972
Center rent expense		84,334			73,128			73,593
General and administrative expenses		60,842			62,068			62,302
Depreciation and amortization		48,008			45,453			40,348
Provision for losses on accounts receivable		20,568			21,174			14,032
Interest, net of interest income of $315, $383, and $1,781, respectively		43,064			49,327			54,603
Loss on extinguishment of debt		29,221			-			-
Transaction costs		29,113			-			-
Loss (gain) on sale of assets, net		847			42			(977	)
Restructuring costs		-			1,304			-
Total costs and expenses		1,906,613			1,808,080			1,755,605
Income before income taxes and discontinued operations		248			72,696			67,161
Income tax expense (benefit)		2,964			29,616			(47,348	)
(Loss) income from continuing operations		(2,716	)		43,080			114,509
Discontinued operations:
Loss from discontinued operations, net of related taxes		(1,934	)		(4,076	)		(2,221	)
Loss on disposal of discontinued operations, net of related taxes		-			(333	)		(3,001	)
Loss from discontinued operations		(1,934	)		(4,409	)		(5,222	)
Net (loss) income	$	(4,650	)	$	38,671		$	109,287
Basic earnings per common and common equivalent share:
(Loss) income from continuing operations	$	(0.14	)	$	2.95		$	7.93
Loss from discontinued operations, net		(0.10	)		(0.30	)		(0.36	)
Net (loss) income	$	(0.24	)	$	2.65		$	7.57
Diluted earnings per common and common equivalent share:
(Loss) income from continuing operations	$	(0.14	)	$	2.93		$	7.60
Loss from discontinued operations, net		(0.10	)		(0.30	)		(0.35	)
Net (loss) income	$	(0.24	)	$	2.63		$	7.25
Weighted average number of common and common equivalent
shares outstanding:
Basic		19,280			14,614			14,444
Diluted		19,280			14,714			15,075

See accompanying notes.

F-5

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND

COMPREHENSIVE (LOSS) INCOME

(in thousands)

	For the Years Ended December 31,
	2010						2009					2008
	Shares			Amount			Shares		Amount			Shares		Amount
Common stock:
Issued and outstanding at beginning of period		43,764		$	438			43,545	$	435			43,016	$	430
Issuance of common stock		306			3			219		3			529		5
Issuance of common stock in the equity offering		30,763			307			-		-			-		-
Exchange of shares in the Separation (Note 1)		(49,859	)		(498	)		-		-			-		-
Common stock issued and outstanding at
end of period		24,974			250			43,764		438			43,545		435
Additional paid-in capital:
Balance at beginning of period					655,666					650,542					600,199
Issuance of common stock in excess of par value					494					101					2,488
Stock based compensation expense					6,300					5,810					5,270
Issuance of common stock in excess of par value    from the equity offering, net					224,685					-					-
Exchange of shares in the Separation (Note 1)					498					-					-
Realization of pre-emergence tax benefits					-					-					43,093
Dividend to stockholders (Note 1)					(9,996	)				-					-
Distribution to Sabra (Note 1)					(155,749	)				-					-
Other					(1,044	)				(787	)				(508	)
Additional paid-in capital at end of period					720,854					655,666					650,542
Accumulated deficit:
Balance at beginning of period					(204,011	)				(242,682	)				(351,969	)
Net (loss) income					(4,650	)				38,671					109,287
Accumulated deficit at end of period					(208,661	)				(204,011	)				(242,682	)
Accumulated other comprehensive loss:
Balance at beginning of period					(3,029	)				(4,586	)				(2,403	)
Other comprehensive income (loss) from cash    flow hedge, net of related tax expense (benefit)    of $2,105, $1,038, and ($3,058)					3,029					1,557					(2,183	)
Accumulated other comprehensive loss at
end of period					-					(3,029	)				(4,586	)
Total stockholders' equity				$	512,443				$	449,064				$	403,709
Comprehensive (loss) income:
Net (loss) income				$	(4,650	)			$	38,671				$	109,287
Other comprehensive income (loss) from cash flow    hedge, net of related tax expense (benefit) of    $2,019, $1,038, and ($3,058), respectively					3,029					1,557					(2,183	)
Comprehensive (loss) income				$	(1,621	)			$	40,228				$	107,104

See accompanying notes.

F-6

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	For the Years Ended December 31,
	2010			2009			2008
Cash flows from operating activities:
Net (loss) income	$	(4,650	)	$	38,671		$	109,287
Adjustments to reconcile net (loss) income to net cash provided by
operating activities, including discontinued operations:
Loss on extinguishment of debt		14,126			-			-
Depreciation and amortization		48,023			45,465			40,614
Amortization of favorable and unfavorable lease intangibles		(1,945	)		(1,824	)		(1,879	)
Provision for losses on accounts receivable		21,175			21,196			15,283
Loss on sale of assets, including discontinued operations, net		847			605			2,151
Impairment charge for discontinued operation		-			-			1,800
Stock-based compensation expense		6,300			5,810			5,270
Deferred taxes		(1,590	)		27,003			(51,128	)
Other		-			-			(10	)
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(18,945	)		(33,547	)		(35,136	)
Restricted cash		3,176			10,628			3,215
Prepaid expenses and other assets		5,671			2,940			(4,213	)
Accounts payable		(1,842	)		(8,390	)		4,032
Accrued compensation and benefits		2,519			(2,989	)		(2,367	)
Accrued self-insurance obligations		17,890			7,759			4,773
Income taxes payable		-			-			(1,806	)
Other accrued liabilities		(9,919	)		(3,196	)		(8,719	)
Other long-term liabilities		(928	)		(1,223	)		7,020
Net cash provided by operating activities		79,908			108,908			88,187
Cash flows from investing activities:
Capital expenditures		(53,528	)		(54,312	)		(42,543	)
Purchase of leased real estate		-			(3,275	)		(8,956	)
Proceeds from sale of assets held for sale		-			2,174			18,354
Acquisitions, net of cash acquired		(13,894	)		(14,936	)		(11,734	)
Insurance proceeds received		-			-			628
Net cash used for investing activities		(67,422	)		(70,349	)		(44,251	)
Cash flows from financing activities:
Borrowings of long-term debt		435,500			20,822			20,290
Principal repayments of long-term debt and capital lease obligations		(590,939	)		(46,292	)		(29,627	)
Payment to non-controlling interest		(2,025	)		(311	)		(418	)
Distribution to non-controlling interest		(105	)		(549	)		(353	)
Distribution to Sabra Health Care REIT, Inc.		(66,862	)		-			-
Dividend to stockholders		(9,996	)		-			-
Proceeds from issuance of common stock		225,393			101			2,493
Deferred financing costs		(26,772	)		-			-
Net cash (used for) provided by financing activities		(35,806	)		(26,229	)		(7,615	)
Net (decrease) increase in cash and cash equivalents		(23,320	)		12,330			36,321
Cash and cash equivalents at beginning of period		104,483			92,153			55,832
Cash and cash equivalents at end of period	$	81,163		$	104,483		$	92,153
Supplemental disclosure of cash flow information:
Interest payments	$	47,160		$	48,781		$	52,208
Capitalized interest	$	614		$	523		$	447
Income taxes paid, net	$	103		$	3,484		$	2,231

F-7

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(in thousands)

Supplemental Disclosures of Non-Cash Investing and Financing Activities

For the year ended December 31, 2010, additional paid-in capital decreased dueto thedistribution of net non-cash assets to Sabra in the amount of $88.9 million (see Note 1 – “Nature of Business”).

For the year ended December 31, 2009, capital lease obligations of $79 were incurred in 2009 when we entered into new equipment and vehicle leases.

For the year ended December 31, 2008, stockholders’ equity increased by $43,093 due to a change in the valuation allowance for deferred tax assets and income tax payable attributable to fresh-start accounting and business combinations (see Note 9 – “Income Taxes”).  Capital lease obligations of $575 were incurred in 2008 when we entered into new equipment and vehicle leases.

See accompanying notes

F-8

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2010

(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 Annual 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, subacute and related specialty healthcare in the United States.  We operate through three principal business segments: (i) inpatient services, (ii) rehabilitation therapy services, and (iii) medical staffing services.  Inpatient services represent the most significant portion of our business.  We operated 200 healthcare facilities in 25 states as of December 31, 2010.

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 $224.8 million, net of the underwriter’s discount and other professional fees. The net proceeds and other cash on hand were used to repay $225.0 million of our term loans (see Note 3 – “Long-Term Debt, Capital Lease Obligations and Hedging Arrangements”).

2010 Restructuring

On November 15, 2010, our former parent, Sun Healthcare Group, Inc. ("Old Sun"), completed a restructuring of its business by separating its real estate assets and its operating assets into two separate publicly traded companies.  The restructuring consisted of certain key transactions including the reorganization, through a series of internal corporate restructurings, such that (i) substantially all of Old Sun's owned real property and related mortgage indebtedness owed to third parties were transferred to or assumed by Sabra Health Care REIT, Inc (“Sabra”), a Maryland corporation and a wholly owned subsidiary of Old Sun, or one or more subsidiaries of Sabra, and (ii) all of Old Sun’s operations and other assets and liabilities were transferred to or assumed by SHG Services, Inc., a Delaware corporation and a wholly owned subsidiary of Old Sun (“New Sun”), or one or more subsidiaries of New Sun.

On November 15, 2010, Old Sun distributed 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 Old Sun’s stockholders aggregating approximately $10 million.  Old Sun then merged with and into Sabra, with Sabra surviving the merger and Old Sun’s stockholders receiving shares of Sabra common stock in exchange for their shares of Old Sun’s common stock (the “REIT Conversion Merger”).  Immediately following the Separation and REIT Conversion Merger, New Sun changed its name to Sun Healthcare Group, Inc.  Pursuant to master lease agreements that were entered into between subsidiaries of Sabra and of New Sun in connection with the Separation, subsidiaries of Sabra lease to subsidiaries of New Sun the properties that Sabra’s subsidiaries own following the REIT Conversion Merger.

The Separation was accounted for as a reverse spinoff where New Sun was designated as the “accounting” spinnor and Sabra was designated as the “accounting” spinnee.  Accordingly, the assets and liabilities distributed were recorded based on their historical carrying values.

F-9

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

 The historical carrying values of assets and liabilities distributed to Sabra in the Separation are as follows (in thousands):

Cash	$	66,862
Restricted cash		5,527
Property and equipment, net of accumulated depreciation and
amortization of $91,878		484,801
Intangible and other assets, net		16,116
Long-term debt and mortgage notes payable		(386,678	)
Accrued interest on mortgage notes payable		(1,425	)
Other accrued liabilities		(2,326	)
Deferred tax liabilities		(21,821	)
Due to Sun Healthcare Group, Inc.		(5,307	)
Net distribution	$	155,749

For accounting purposes, the historical consolidated financial statements of Old Sun became the historical consolidated financial statements of New Sun after the distribution on November 15, 2010.

Exchange of Shares in the Separation

In connection with the Separation on November 15, 2010, stockholders of Old Sun received one share of New Sun in exchange for every three shares of Old Sun.  All prior period share amounts have been adjusted to give retroactive effect to the exchange of shares in the Separation.

Transaction Costs

Our results of operations for 2010 include $29.1 million of transaction costs related to the Separation and REIT Conversion Merger, which consist primarily of fees for professional services such as investment banker, legal and accounting fees.

Restructuring Costs

As we continue to focus on reducing costs and maximizing occupancy, we have evaluated and will continue to evaluate certain restructuring activities in our operations and administrative functions.  During the year ended December 31, 2009, we incurred $1.3 million of restructuring costs, of which $1.0 million was paid during 2009 and the remainder paid in 2010.  The costs consisted primarily of severance benefits resulting from reductions of administrative staff and costs related to closure of a center in Massachusetts.

Comparability of Financial Information

Generally accepted accounting principles in the U.S. (“GAAP”) requires reclassification of the results of operations of subsequent divestitures that qualify as discontinued operations for all periods presented.

F-10

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

(2)  Summary of Significant Accounting Policies

(a)  Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include determination of net revenues, allowances for doubtful accounts, self-insurance obligations, goodwill and other intangible assets (including impairments), and allowances for deferred tax assets.  Actual results could differ from those estimates.

(b)  Principles of Consolidation

Our consolidated financial statements include the accounts of our subsidiaries in which we own more than 50% of the voting interest. Investments of companies in which we own between 20% - 50% of the voting interests and have significant influence were accounted for using the equity method, which records as income an ownership percentage of the reported income of the subsidiary.  Investments in companies in which we own less than 20% of the voting interests and do not have significant influence are carried at lower of cost or fair value. All significant intersegment accounts and transactions have been eliminated in consolidation.

(c)  Cash and Cash Equivalents

We consider all highly liquid, unrestricted investments with original maturities of three months or less when purchased to be cash equivalents. Cash equivalents are stated at fair value.

(d)  Restricted Cash

Certain of our cash balances are restricted for specific purposes such as funding of self-insurance reserves, mortgage escrow requirements and capital expenditures on HUD-insured buildings (see Note 8 – “Commitments and Contingencies”).  These balances are presented separately from cash and cash equivalents on our consolidated balance sheets and are classified as a current asset when expected to be utilized within the next year.  Restricted cash balances are stated at cost, which approximates fair value.

(e)  Net Revenues

Net revenues consist of long-term and subacute care revenues, rehabilitation therapy services revenues, temporary medical staffing services revenues and other ancillary services revenues. Net revenues are recognized as services are provided and billed. Revenues are recorded net of provisions for discount arrangements with commercial payors and contractual allowances with third-party payors, primarily Medicare and Medicaid. Net revenues realizable under third-party payor agreements are subject to change due to examination and retroactive adjustment. Estimated third-party payor settlements are recorded in the period the related services are rendered. The methods of making such estimates are reviewed periodically, and differences between the net amounts accrued and subsequent settlements or estimates of expected settlements are reflected in the current period results of operations. Laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation.

F-11

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

       Revenues from Medicaid accounted for 40.5%, 40.0%, and 40.0% of our net revenue for the years ended December 31, 2010, 2009 and 2008, respectively.  Revenues from Medicare comprised 29.7%, 29.5%, and 28.7% of our net revenues for the years ended December 31, 2010, 2009 and 2008, respectively.

(f)  Accounts Receivable

Our accounts receivable relate to services provided by our various operating divisions to a variety of payors and customers. The primary payors for services provided in healthcare centers that we operate are the Medicare program and the various state Medicaid programs. Our rehabilitation therapy service operations provide services to patients in unaffiliated healthcare centers. The billings for those services are submitted to the unaffiliated centers. Many of the unaffiliated healthcare centers receive a large majority of their revenues from the Medicare program and the state Medicaid programs.

Estimated provisions for losses on accounts receivable are recorded each period as an expense in the income statement.  In evaluating the collectability of accounts receivable, we consider a number of factors, including the age of the accounts, changes in collection patterns, the financial condition of our customers, the composition of patient accounts by payor type, the status of ongoing disputes with third-party payors and general industry and economic conditions.  Any changes in these factors or in the actual collections of accounts receivable in subsequent periods may require changes in the estimated provision for loss. Changes in these estimates are charged or credited to the results of operations in the period of change.  In addition, a retrospective collection analysis is performed within each operating company to test the adequacy of the reserve.

The allowance for doubtful accounts related to centers that we have divested was based on management’s expectation of collectability at the time of divestiture and is recorded with the gain or loss on disposal of discontinued operations.  As collections are realized or if new information becomes available, the allowance is adjusted as appropriate.  As of December 31, 2010 and 2009, accounts receivable for divested operations were significantly reserved.

(g)  Property and Equipment

Property and equipment are stated at historical cost. Property and equipment held under capital lease are stated at the net present value of future minimum lease payments and their amortization is included in depreciation expense.  Major renewals or improvements are capitalized whereas ordinary maintenance and repairs are expensed as incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows: buildings and improvements – five to forty years; leasehold improvements - the shorter of the estimated useful lives of the assets or the life of the lease; and equipment - three to twenty years.  We subject our long-lived assets to an impairment test if an indicator of potential impairment is present. (See Note 6 – “Goodwill, Intangible Assets and Long-Lived Assets.”)

(h)  Intangible Assets

Consistent with GAAP, we do not amortize goodwill and intangible assets with indefinite lives. Consequently, we subject them at a minimum to annual impairment tests. Intangible assets with definite lives are amortized over their estimated useful lives. (See Note 6 – “Goodwill, Intangible Assets and Long-Lived Assets.”)

F-12

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

(i) 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. Provisions for estimated reserves, including incurred but not reported losses, are provided in the period of the related loss and then updated through the coverage period. These provisions are based on actuarial analyses, internal evaluations of the merits of individual claims, and industry loss development factors or lag analyses. The methods of making such estimates and establishing the resulting reserves are reviewed periodically and are based on historical paid claims information and nationwide nursing home trends. Any resulting adjustments are reflected in current earnings. Claims are paid over varying periods, and future payments may differ materially than the estimated reserves.  (See Note 8 – “Commitments and Contingencies.”)

(j)  Stock-Based Compensation

We follow the fair value recognition provisions of GAAP, which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values.  (See Note 11 – “Capital Stock.”)

(k)  Income Taxes

Pursuant to GAAP, an asset or liability is recognized for the deferred tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements.  These temporary differences would result in taxable or deductible amounts in future years when the reported amounts of the assets are recovered or liabilities are settled.  Deferred tax assets are also recognized for the future tax benefits from net operating loss, capital loss and tax credit carryforwards.  A valuation allowance is to be provided for the net deferred tax assets if it is more likely than not that some portion or all of the net deferred tax assets will not be realized.

In evaluating the need to record or continue to reflect a valuation allowance, all items of positive evidence (e.g., future sources of taxable income and tax planning strategies) and negative evidence (e.g., history of taxable losses) are considered.  In determining future sources of taxable income, we use management-approved budgets and projections of future operating results for an appropriate number of future periods, taking into consideration our history of operating results, taxable income and losses, etc.  This future taxable income is then used, along with all other items of positive and negative evidence, to determine the amount of valuation allowance that is needed, and whether any amount of such allowance should be reversed.

We are subject to income taxes in the U.S. and numerous state and local jurisdictions.  Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes.  GAAP guidance for accounting for uncertainty in income tax positions contains a two-step approach to recognizing and measuring uncertain tax positions.  The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any.  The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.  We reserve for our uncertain tax positions, and we adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate.  (See Note 9 – “Income Taxes.”)

F-13

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

(l)  Net (Loss) Income Per Share

Basic net (loss) income per share is based upon the weighted average number of common shares outstanding during the period.  The weighted average number of common shares for the years ended December 31, 2010, 2009 and 2008 includes all the common shares that are presently outstanding and the common shares issued as common stock awards and exclude non-vested restricted stock.  (See Note 11 – “Capital Stock.”)

The diluted calculation of income per common share includes the dilutive effect of warrants, stock options and non-vested restricted stock, using the treasury stock method (see Note 11 – “Capital Stock”). However, in periods of losses from continuing operations, diluted net income per common share is based upon the weighted average number of basic shares outstanding.

(m)  Discontinued Operations and Assets Held for Sale

GAAP requires that long-lived assets to be disposed of be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations.  GAAP also requires the reporting of discontinued operations which includes all components of an entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. Depreciation is discontinued once an asset is classified as held for sale.  (See Note 7 – “Sale of Assets, Discontinued Operations and Assets and Liabilities Held for Sale.”)

(n)  Reclassifications

Certain reclassifications have been made to the prior period financial statements to conform to the 2010 financial statement presentation.  Specifically, we have reclassified the results of operations of material divestitures subsequent to December 31, 2009 (see Note 7 – “Sale of Assets, Discontinued Operations and Assets and Liabilities Held for Sale”) for all periods presented to discontinued operations within the income statement, in accordance with GAAP.

(o)  Interest Rate Swap Agreements

We manage interest expense using a mix of fixed and variable rate debt, and to help manage borrowing costs, we have entered 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 such arrangements that qualify for hedge accounting treatment.  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 recognized through other comprehensive income.  Ineffectiveness, if any, would be recognized in earnings.  (See Note 3 – “Long-Term Debt, Capital Lease Obligations and Hedging Arrangements.”)

(p)  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.

F-14

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

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.

(3)  Long-Term Debt, Capital Lease Obligations and Hedging Arrangements

Prior to the completion of financings related to the Separation, Old Sun had issued, and there remained outstanding, $200.0 million aggregate principal amount of 9-1/8% Senior Subordinated Notes due 2015 (the “Notes”), and a senior secured credit facility with a syndicate of financial institutions (the “Old Sun Credit Agreement”).  The Old Sun Credit Agreement, following an amendment entered into in June 2010, provided for $365.0 million of term loans, a $45.0 million letter of credit facility and a $50.0 million revolving credit facility.   Interest on the outstanding unpaid principal amount of loans under the Old Sun Credit Agreement equaled an applicable percentage plus, at Old Sun’s 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 and revolving loans at September 30, 2010 was 2.0% for alternative base rate loans and 3.0% for LIBOR loans.

In October 2010, in connection with the Separation, subsidiaries of Sabra issued $225 million principal amount of senior notes due 2018, the proceeds of which were used, together with cash from Old Sun, to redeem the Notes in December 2010, including accrued interest and a redemption premium.

In October 2010, in connection with the Separation, New Sun entered into a $285.0 million senior secured credit facility (the “Credit Agreement”) with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent.  The Credit Agreement provides for $150.0 million in term loans ($147.5 million was outstanding at December 31, 2010), 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 ($66.2 million was utilized at December 31, 2010).  The revolving credit facility was undrawn on December 31, 2010. In addition to funding the letter of credit facility, the proceeds of the term loans were used to repay outstanding term loans under the Old Sun Credit Agreement, which was concurrently terminated, to pay related fees and expenses and to provide funds for general corporate purposes.  The letter of credit facility replaced the letter of credit facility under the Old Sun 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.

Availability of amounts under the revolving credit facility is subject to compliance with financial covenants, including an interest coverage test and a leverage covenant. As of December 31, 2010, we were in compliance with the covenants contained in the Credit Agreement governing the revolving credit facility. The Credit Agreement also contains customary events of default, such as a failure by us to make payment of amounts due, defaults under other agreements evidencing indebtedness, certain bankruptcy events and a change of control (as defined in the Credit

F-15

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

Agreement). The 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.  The obligations of New Sun under the Credit Agreement are guaranteed by most of New Sun’s subsidiaries and are 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 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 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 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.  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 Credit Agreement. In addition to paying interest on outstanding loans under the 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.

In August 2010, we refinanced mortgage indebtedness collateralized by four of our health care centers.  The new mortgage indebtedness of $20.5 million bears interest at LIBOR plus 4.5% (with a LIBOR floor of 1.0%).  In October 2010, we refinanced mortgage indebtedness collateralized by nine of our health care centers.  The new mortgage indebtedness of $30.0 million bears interest at LIBOR plus 4.5% (with a LIBOR floor of 1.0%), and was collateralized by seven of our health care centers.  Both mortgage loans were assumed by Sabra in the Separation.

Our long-term debt and capital lease obligations consisted of the following as of December 31 (in thousands):

	2010			2009
Revolving loans	$	-		$	-
Mortgage notes payable due at various dates through 2042, interest at
rates from 6.7% to 8.5%, collateralized by the carrying values of
various centers totaling approximately $6.7 million		7,979			170,608
Term loans		147,492			329,107
Senior subordinated notes		-			200,000
Capital leases		509			833
Total long-term obligations		155,980			700,548
Less amounts due within one year		(11,050	)		(46,416	)
Long-term obligations, net of current portion	$	144,930		$	654,132

F-16

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

        The scheduled or expected maturities of long-term obligations as of December 31, 2010 were as follows (in thousands):

2011	$	11,050
2012		11,002
2013		10,949
2014		10,517
2015		10,065
Thereafter		102,397
	$	155,980

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 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 recognized through other comprehensive loss.  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 at December 31 are as follows (in thousands):

	Liability Derivatives
	2010			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

F-17

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

The effect of the interest rate swap agreements on our consolidated comprehensive income, net of related taxes, for the year ended December 31 is as follows (in thousands):

									Gain Reclassified from
		Amount of Income/(Loss)							Accumulated Other Comprehensive
		In Other Comprehensive							Loss to Net Income
		Income/(Loss)							(ineffective portion)
		2010		2009		2008			2010		2009		2008
Derivatives designated as cash
flow hedges:
Interest rate swap agreements	$	3,029	$	1,557	$	(2,183	)	$	-	$	-	$	-

The Credit Agreement requires that 50% of our term loans be subject to at least a 3-year hedging arrangement.  We executed two hedging instruments on January 18, 2011 to satisfy this requirement.  A two-year interest rate cap limits our exposure to increases in interest rates for $82.5 million of debt through December 31, 2012.  The cap is effective when LIBOR rises above 1.75%, effectively fixing $82.5 million of the debt at 7.5% for two years.  The fee for this interest rate cap arrangement was $0.3 million, which will be amortized to interest expense over the life of the arrangement.  A two-year “forward starting” interest rate swap effectively converts $82.5 million of debt to fixed rate from January 1, 2013 through December 31, 2014.  LIBOR is fixed at 3.185%, making the all-in rate effectively a fixed 8.935%.  There was no fee for this swap agreement.

Both arrangements qualify for hedge accounting treatment and necessary disclosures will be made in our interim financial statements beginning with the first quarter 2011.

(4)  Property and Equipment

Property and equipment consisted of the following as of December 31 (in thousands):

	2010			2009
Land	$	2,936		$	78,848
Buildings and improvements		21,235			464,136
Equipment		116,468			128,939
Leasehold improvements		93,680			83,751
Construction in process(1)		8,438			20,862
Total		242,757			776,536
Less accumulated depreciation and amortization		(102,897	)		(153,854	)
Property and equipment, net	$	139,860		$	622,682

(1) Capitalized interest associated with construction in process is $0.6 million and $0.4 million at December 31, 2010 and 2009, respectively.

(5)  Acquisitions

On December 29, 2010 we completed the purchase of a hospice company that operates in Alabama and Georgia for $13.9 million.  The purchase price excludes $0.5 million of transaction costs, which consisted primarily of investment banker success fees that were expensed in the accompanying statements of operations in accordance with GAAP.  The hospice company's results of operations will be included in our consolidated financial statements beginning January 1, 2011.  Pro forma information related to this acquisition is not provided because the impact on

F-18

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

our consolidated financial position and results of operations is not significant.  The purchase price was funded through cash on-hand at the time of the acquisition and allocated to the following fair values of assets acquired and liabilities assumed at the date of acquisition (in thousands):

Net working capital	$	67
Property and equipment		177
Licensing intangible asset		6,652
Goodwill(1)		9,683
Other long-term assets		47
Total assets acquired		16,626
Liabilities assumed		(2,732	)
Net assets acquired	$	13,894

(1) Tax-deductible goodwill has not yet been determined.

On October 1, 2009 we acquired a hospice company that provides services to patients in Maine, Massachusetts and New Hampshire, for $16.1 million in cash, excluding transaction costs.  The purchase price excludes $0.5 million of transaction costs, which consisted primarily of investment banker success fees that were expensed in the accompanying income statement in accordance with GAAP.  The hospice company's results of operations have been included in our consolidated financial statements since October 1, 2009.  Pro forma information related to this acquisition is not provided because the impact on our consolidated financial position and results of operations is not significant.  The purchase price was funded through cash on-hand at the time of the acquisition and allocated to the following fair values of assets acquired and liabilities assumed at the date of acquisition (in thousands):

Net working capital	$	564
Property and equipment		264
Licensing intangible asset		6,271
Goodwill(1)		11,344
Other long-term assets		24
Total assets acquired		18,467
Liabilities assumed		(2,322	)
Net assets acquired	$	16,145

(1) Tax-deductible goodwill is $3.6 million.

We paid a premium (i.e., goodwill) over the fair value of the net tangible and identified intangible assets acquired because we believed the acquisitions of the hospice companies would create the following benefits:  (1) increase the scale of our operations, thus leveraging our corporate and regional infrastructure and (2) expand our hospice operations into a state in which we did not previously have a presence due to limitations with regulatory licensing.

F-19

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

(6)  Goodwill, Intangible Assets and Long-Lived Assets

(a)  Goodwill

The following table provides information regarding our goodwill, which is included in the accompanying consolidated balance sheets at December 31 (in thousands):

			Rehabilitation		Medical
	Inpatient		Therapy		Staffing
	Services		Services		Services		Consolidated
Balance as of January 1, 2009	$	322,200	$	75	$	4,533	$	326,808
Goodwill acquired		11,276		-		-		11,276
Purchase price adjustments for prior
year acquisition		212		-		-		212
Balance as of December 31, 2009	$	333,688	$	75	$	4,533	$	338,296
Goodwill acquired		9,683		-		-		9,683
Purchase price adjustments for prior
year acquisition		68		-		-		68
Balance as of December 31, 2010	$	343,439	$	75	$	4,533	$	348,047

(b)  Intangible Assets

The following table provides information regarding our intangible assets, which are included in the accompanying consolidated balance sheets at December 31 (in thousands):

	Gross
	Carrying		Accumulated		Net
	Amount		Amortization		Total
Finite-lived Intangibles:
Favorable lease intangibles:
2010	$	10,100	$	3,831	$	6,269
2009		10,311		3,140		7,171
Management and customer contracts:
2010	$	3,334	$	2,500	$	834
2009		3,334		2,024		1,310
Tradenames:
2010	$	13,109	$	6,175	$	6,934
2009		13,121		4,535		8,586
Other intangible assets:
2010	$	-	$	-	$	-
2009		189		61		189
Indefinite-lived Intangibles:
Certificates of need/licenses:
2010	$	27,930	$	-	$	27,930
2009		21,433		-		21,433

F-20

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

Total Intangible Assets:
2010	$	54,473	$	12,506	$	41,967
2009		48,388		9,760		38,628
Unfavorable Lease Obligations:
2010	$	29,113	$	19,298	$	9,815
2009		29,113		16,450		12,663

A net credit to rent expense was a result of the amortization of favorable and unfavorable lease intangibles, recognized as adjustments in rent expense in connection with fair market valuations performed on our center lease agreements associated with fresh-start accounting and our acquisitions.

The net amount recorded to amortization was as follows for the years ended December 31 (in thousands):

	2010			2009			2008
Amortization expense	$	7,558	)	$	7,359		$	7,410
Amortization of unfavorable
and favorable lease intangibles, net
included in rent expense		(1,945	)		(1,824	)		(1,878	)
	$	5,613		$	5,535		$	5,532

Total estimated amortization expense (credit) for our intangible assets for the next five years is as follows (in thousands):

	Expense		Credit			Net
2011	$	2,838	$	(2,705	)	$	133
2012		2,718		(2,436	)		282
2013		2,346		(2,115	)		231
2014		2,201		(904	)		1,297
2015		2,195		(898	)		1,297

The weighted-average amortization period for lease intangibles is approximately six years at December 31, 2010.

(c)  Impairment of Intangible Assets

Goodwill

We perform our annual goodwill impairment analysis for our reporting units during the fourth quarter of each year, which timing for 2010 also coincided with the Separation.  A reporting unit is a business for which discrete financial information is produced and reviewed by operating segment management and provides services that are distinct from the other components of the operating segment and are reviewed at the division level.  For our Rehabilitation Therapy Services and Medical Staffing Services segments, the reporting unit for our annual goodwill impairment analysis was determined to be at the segment level.  For our Inpatient Services segment, the reporting unit for our annual goodwill impairment analysis was determined to be at one level below our segment level.

F-21

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

        We determined potential impairment by comparing the net assets of each reporting unit to their respective fair values, which GAAP describes as Step 1 of goodwill impairment testing. We determined the estimated fair value of each reporting unit using a discounted cash flow analysis and other appropriate valuation methodologies. In the event a unit's net assets exceed its fair value, an implied fair value of goodwill must be determined by assigning the unit's fair value to each asset and liability of the unit, which is referred to in GAAP as Step 2 of the impairment analysis. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill.  An impairment loss is measured by the difference between the goodwill carrying value and the implied fair value.

The goodwill impairment analysis is subject to impact from uncertainties arising from such events as changes in economic or competitive conditions, the current general economic environment, material changes in Medicare and Medicaid reimbursement that could positively or negatively impact anticipated future operating conditions and cash flows, and the impact of strategic decisions such as the Separation. The Step 1 results of our fourth quarter 2010 goodwill impairment analysis showed that none of our reporting units exhibited any indications of potential goodwill impairment.  Based on the analysis performed, we determined there was no goodwill impairment for the years ended December 31, 2010, 2009 or 2008.

Indefinite Lived Intangibles

Our indefinite lived intangibles consist primarily of values assigned to CONs and regulatory licenses obtained through our acquisitions.

We evaluate the recoverability of our indefinite lived intangibles by comparing the asset's respective carrying value to estimates of fair value. We determine the estimated fair value of these intangible assets through an estimate of incremental cash flows with the intangible assets versus cash flows without the intangible assets in place. We determined there was no impairment of our indefinite lived intangibles for the years ended December 31, 2010, 2009 or 2008.

Finite Lived Intangibles

Our finite lived intangibles include tradenames, favorable lease intangibles and customer contracts.

We evaluate the recoverability of our finite lived intangibles if an impairment indicator is present.  As there were no such indicators, we determined there was no impairment of our finite lived intangibles for the years ended December 31, 2010, 2009 or 2008.

(d)  Impairment of Long-Lived Assets

GAAP requires impairment losses to be recognized for long-lived assets used in operations when indicators of impairment are present and the estimated undiscounted cash flows are not sufficient to recover the assets' carrying amounts. In estimating the undiscounted cash flows for our impairment assessment, we primarily use our internally prepared budgets and forecast information including adjustments for the following items: Medicare and Medicaid funding; overhead costs; capital expenditures; and patient care liability costs.  We assess the need for an impairment write-down when such indicators of impairment are present.  We determined there was no impairment of long-lived assets used in continuing operations for the years ended December 31, 2010, 2009 or 2008.

F-22

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

(e)  Long Lived Assets to be Disposed Of

GAAP requires that long-lived assets to be disposed of be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations.  GAAP defines the reporting of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. Depreciation is discontinued once an asset is classified as held for sale.

(7)  Sale of Assets, Discontinued Operations and Assets and Liabilities Held for Sale

(a)  Gain (Loss) on Disposal of Discontinued Operations, net of related taxes

We did not incur a gain or loss on disposal of discontinued operations in 2010.  We reported a $0.3 million net loss and a $3.0 million net loss for the years ended December 31, 2009 and 2008, respectively, primarily related to the disposals of assets associated with discontinued operations.

(b)  Discontinued Operations

In accordance with GAAP, 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.

Inpatient Services: During 2010 we disposed 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.

During 2009, we reclassified one assisted living center into discontinued operations as we elected to not renew that center’s lease and allowed operations to transfer to another operator.

(c)  Assets and Liabilities Held for Sale

We had no assets held for sale as of December 31, 2010 or 2009.

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

F-23

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

 A summary of the discontinued operations for the years ended December 31 is as follows (in thousands):

	2010
	Inpatient
	Services			Other			Total
Net operating revenues	$	855		$	-		$	855
Loss from discontinued operations, net (1)	$	(1,861	)	$	(73	)	$	(1,934	)
Loss on disposal of discontinued operations, net (2)		-			-			-
Loss from discontinued operations, net	$	(1,861	)	$	(73	)	$	(1,934	)

(1)  Net of related tax benefit of $1,031

(2)  Net of related tax expense of $0

	2009
	Inpatient
	Services			Other			Total
Net operating revenues	$	1,544		$	-		$	1,544
Loss from discontinued operations, net (1)	$	(4,043	)	$	(33	)	$	(4,076	)
Loss on disposal of discontinued operations, net (2)		(317	)		(16	)		(333	)
Loss from discontinued operations, net	$	(4,360	)	$	(49	)	$	(4,409	)

(1)  Net of related tax benefit of $2,416

(2)  Net of related tax benefit of $231

	2008
	Inpatient
	Services			Other			Total
Net operating revenues	$	43,024		$	17,888		$	60,912
Loss from discontinued operations, net (1)	$	(2,008	)	$	(213	)	$	(2,221	)
Loss on disposal of discontinued operations, net (2)		(2,246	)		(755	)		(3,001	)
Loss from discontinued operations, net	$	(4,254	)	$	(968	)	$	(5,222	)

(1)  Net of related tax benefit of $1,125

(2)  Net of related tax benefit of $1,949

F-24

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

(8)  Commitments and Contingencies

(a)  Lease Commitments

We lease real estate and equipment under cancelable and noncancelable agreements. Most of our operating leases have original terms from seven to twelve years and contain at least one renewal option (which could extend the terms of the leases by five to ten years), escalation clauses (primarily related to inflation) and provisions for payments by us of real estate taxes, insurance and maintenance costs. Leases with a fixed escalation are accounted for on a straight-line basis. Future minimum operating lease payments as of December 31, 2010 under real estate leases are as follows (in thousands):

2011	$	147,256
2012		143,121
2013		139,600
2014		110,483
2015		108,637
Thereafter		550,548
Total minimum lease payments	$	1,199,645

Center rent expense for continuing operations totaled $84.3 million, $73.1 million, and $73.6 million for the years ended December 31, 2010, 2009, and 2008, respectively. Center rent expense for discontinued operations for the years ended December 31, 2010, 2009 and 2008 was $0.1 million, $0.2 million, and $3.6 million, respectively.  The increase in future center lease payments is primarily due to the leases our subsidiaries entered into with subsidiaries of Sabra.

(b)  Purchase Commitments

We have an agreement establishing Medline Industries, Inc. (“Medline”) as the primary medical supply vendor through December 31, 2014 for all of the healthcare centers that we operate.  The agreement provides that the long-term care division of the Inpatient Services segment shall purchase at least 90% of its medical supply products from Medline.

We have an agreement establishing SYSCO Corporation (“SYSCO”) as our primary foodservice supply vendor through June 30, 2015 for all of our healthcare centers.  The agreement provides that the long-term care division of the Inpatient Services segment shall purchase at least 80% of its foodservice supply products from SYSCO.

We have an agreement establishing Omnicare Pharmacy Services as the primary pharmacy services vendor through July 15, 2013 for substantially all of the healthcare centers that we currently operate.

(c)  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

F-25

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

are made in the period of the related coverage.  An independent actuarial analysis is prepared twice a year to assist management 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 there from 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 loss 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. These functions ensure that the claims are properly administered 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 cases where our historical data are not statistically credible, stable, or mature, we supplement our experience with nursing home 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 limitations is applied when weighting the results of each method.  The results of each of the methods are estimates of ultimate losses which includes the case reserves plus an estimate for future development of these reserves based on past trends, and an estimate for losses incurred but not reported.   These results are compared by accident year and an estimated unpaid loss and allocated loss adjustment expense are determined for the open accident years based on judgment reflecting the range of estimates produced by the methods.

Regarding our estimates for workers’ compensation reserves, there were no large or unusual settlements during the 2010 period.  As of December 31, 2010, the discounting of the policy periods resulted in a reduction to our reserves of $13.4 million.

During 2010 we determined that the previous estimates for general and professional liabilities reserves for matters related to years prior to 2010 were understated by $13.1 million due to adverse developments with respect to a number of claims that arose in prior periods. Accordingly we have recorded a charge in the fourth quarter of 2010 to increase our general and professional liabilities reserves. Professional liability claims have a reporting tail that exceeds one year.  A significant component of our reserves is estimates for incidents that have been incurred but not reported.

F-26

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

        Activity in our insurance reserves as of and for the years ended December 31, 2010, 2009 and 2008 is as follows (in thousands):

	Professional Liability			Workers’ Compensation			Total
Balance as of January 1, 2008	$	86,291		$	61,439		$	147,730
Current year provision, continuing operations		29,454			29,335			58,789
Current year provision, discontinued operations		790			852			1,642
Prior year reserve adjustments, continuing operations		(1,700	)		2,600			900
Prior year reserve adjustments, discontinued operations		(20	)		400			380
Claims paid, continuing operations		(20,343	)		(18,499	)		(38,842	)
Claims paid, discontinued operations		(3,755	)		(3,674	)		(7,429	)
Amounts paid for administrative services and other		(3,435	)		(5,865	)		(9,300	)
Balance as of December 31, 2008	$	87,282		$	66,588		$	153,870
Current year provision, continuing operations		27,152			28,368			55,520
Current year provision, discontinued operations		1,512			644			2,156
Prior year reserve adjustments, continuing operations		6,500			1,720			8,220
Prior year reserve adjustments, discontinued operations		890			230			1,120
Claims paid, continuing operations		(20,394	)		(20,165	)		(40,559	)
Claims paid, discontinued operations		(3,699	)		(2,530	)		(6,229	)
Amounts paid for administrative services and other		(4,313	)		(7,349	)		(11,662	)
Balance as of December 31, 2009	$	94,930		$	67,506		$	162,436
Current year provision, continuing operations		29,620			28,086			57,706
Current year provision, discontinued operations		10			21			31
Prior year reserve adjustments, continuing operations		13,100			-			13,100
Claims paid, continuing operations		(19,636	)		(18,948	)		(38,584	)
Claims paid, discontinued operations		(3,422	)		(2,059	)		(5,481	)
Amounts paid for administrative services and other		(2,731	)		(6,121	)		(8,852	)
Balance as of December 31, 2010	$	111,871		$	68,485		$	180,356

F-27

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

 A summary of the assets and liabilities related to insurance risks at December 31 is as indicated below (in thousands):

		2010					|		2009
		Professional		Workers'			|		Professional		Workers'
		Liability		Compensation		Total	|		Liability		Compensation		Total
Assets (1):							|
Restricted cash							|
Current	$	3,659	$	10,864	$	14,523	|	$	3,406	$	12,013	$	15,419
Non-current		-		-		-	|		-		-		-
Total	$	3,659	$	10,864	$	14,523	|	$	3,406	$	12,013	$	15,419
							|
Liabilities (2)(3):							|
Self-insurance							|
liabilities							|
Current	$	25,942	$	21,009	$	46,951	|	$	20,369	$	20,119	$	40,488
Non-current		85,929		47,476		133,405	|		74,561		47,387		121,948
Total	$	111,871	$	68,485	$	180,356	|	$	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 excluded $1,156 and $11,932 at December 31, 2010 and 2009, respectively, held for bank collateral, various mortgages, bond payments and capital expenditures on HUD-insured buildings.
(2)	Total self-insurance liabilities excluded $5,142 and $5,173 at December 31, 2010 and 2009, respectively, related to our health insurance liabilities.
(3)	Total self-insurance liabilities are collateralized, in addition to the restricted cash, by letters of credit of $59,066 for workers' compensation as of December 31, 2010 and $250 and $53,191 for general and professional liability insurance and workers' compensation, respectively, as of December 31, 2009.

(d)  Construction Commitments

As of December 31, 2010, we had construction commitments under various contracts of approximately $9.4 million. These items consisted primarily of contractual commitments to improve existing centers.

(e)  Labor Relations

As of December 31, 2010, SunBridge operated 35 centers with union employees. Approximately 2,800 of our employees (9.4% of all of our employees) who worked in healthcare centers in Alabama, California, Connecticut, Georgia, Massachusetts, Maryland, Montana, New Jersey, Ohio, Rhode Island, Washington and West Virginia were covered by collective bargaining contracts. Collective bargaining agreements covering approximately 1,600 of these employees (5.3% of all our employees) either are currently in renegotiations or will shortly be in renegotiations due to the expiration of the collective bargaining agreements.

F-28

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

(9)  Income Taxes

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

Income tax expense (benefit) on income attributable to continuing operations consisted of the following for the years ended December 31 (in thousands):

	2010		2009		2008
Current:
Federal	$	-	$	-	$	941
State		1,772		2,300		1,417
		1,772		2,300		2,358
Deferred:
Federal		963		24,829		(40,150	)
State		229		2,487		(9,556	)
		1,192		27,316		(49,706	)
Total	$	2,964	$	29,616	$	(47,348	)

Actual tax expense (benefit) differed from the expected tax expense, which was computed by applying the U.S. Federal corporate income tax rate of 35% to our profit before income taxes for the years ended December 31 as follows (in thousands):

	2010			2009			2008
Computed expected tax expense	$	87		$	25,234		$	23,302
Adjustments in income taxes resulting from:
Change in valuation allowance		(111	)		-			(70,465	)
State income tax expense, net of Federal
income tax effect		694			3,814			3,568
Reduction in unrecognized tax benefits		(264	)		(56	)		(2,202	)
Nondeductible transaction costs		3,771			-			-
Tax credits		(1,612	)		(1,339	)		(1,114	)
Nondeductible compensation		31			53			137
Other nondeductible expenses		439			728			964
Other		(71	)		1,182			(1,538	)
Total	$	2,964		$	29,616		$	(47,348	)

F-29

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

        Deferred tax assets (liabilities) at December 31 consisted of the following (in thousands):

	2010			2009
Deferred tax assets:
Accounts and notes receivable	$	26,945		$	22,722
Accrued liabilities		89,865			82,018
Intangible assets		9,936			19,555
Property and equipment		5,400			-
Write-down of assets held for sale		888			1,016
Partnership investments		2,165			4,274
Minimum tax and other credit carryforwards		6,457			8,794
State net operating loss carryforwards		16,120			25,035
Federal net operating loss carryforwards		56,690			79,122
Other		-			37
		214,466			242,573
Less valuation allowance		(18,126	)		(27,572	)
Total deferred tax assets		196,340			215,001
Deferred tax liabilities:
Property and equipment		-			(37,587	)
Deferred tax assets, net	$	196,340		$	177,414

In connection with the Separation, certain deferred tax assets (e.g., net operating loss carryforwards and tax credit carryforwards) and certain deferred tax liabilities (primarily related to property and equipment) were transferred to or assumed by Sabra.  In the case of net operating loss (“NOL”) carryforwards, regulations under the Internal Revenue Code and similar state rules require the NOLs to be allocated to the two companies based on their relative contributions (including the contributions of their subsidiaries) to the NOLs for each tax period.  Similar rules are applied for the allocation of tax credits.  In the case of other deferred balances (e.g., property and equipment), the deferred tax asset (liability) transferred was based upon the difference between the net book basis and net tax basis transferred to Sabra.  The net amount of deferred tax assets (liabilities) assumed by Sabra was approximately $21.8 million.

The $9.4 million total decrease in the valuation allowance resulted from the expiration or loss of certain state NOL carryforwards which were fully reserved ($0.9 million), the amount of valuation allowance related to deferred tax assets transferred to Sabra ($8.4 million), and an adjustment to our tax provision ($0.1 million).  The deferred tax asset for the expired state NOLs and the corresponding valuation allowance were reduced accordingly.  In evaluating the need to maintain a valuation allowance on our net deferred tax assets, all items of positive evidence (e.g., future sources of taxable income and tax planning strategies) and negative evidence (e.g., history of taxable losses) were considered.  This assessment required significant judgment.  Based upon our estimates of future taxable income, we believe that we will more likely than not realize a significant portion of our net deferred tax assets.  If any future reversals of the remaining valuation allowance of $18.1 million as of December 31, 2010, should occur, then such reversal would reduce the provision for income taxes.

F-30

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

        Internal Revenue Code Section 382 imposes a limitation on the use of a company’s NOL carryforwards and other losses when the company has an ownership change.  In general, an ownership change occurs when shareholders owning 5% or more of a “loss corporation” (a corporation entitled to use NOL or other loss carryovers) have increased their ownership of stock in such corporation by more than 50 percentage points during any 3-year testing period beginning on the first day following the change date for an earlier ownership change.  The annual base Section 382 limitation is calculated by multiplying the loss corporation's value at the time of the ownership change times the greater of the long-term tax-exempt rate determined by the IRS in the month of the ownership change or the two preceding months.

The issuance of our common stock in connection with an acquisition in 2005 resulted in an ownership change under Section 382.  The annual base Section 382 limitation to be applied to our tax attribute carryforwards as a result of this ownership change is approximately $10.3 million.  Accordingly, our NOL, capital loss, and tax credit carryforwards have been reduced to take into account this limitation and the respective carryforward periods for these tax attributes.  In addition, a separate annual base Section 382 limitation of approximately $14.6 million is to be applied to the tax attribute carryforwards of Harborside as a result of the Harborside acquisition.  Per the Tax Allocation Agreement between New Sun and Sabra (see Note 14 – “Transactions with Sabra”), New Sun and Sabra have agreed to allocate all Section 382 limitations to New Sun unless New Sun decides that a portion of the Section 382 limitation should be allocated to Sabra.

After considering the reduction in tax attributes resulting from the allocation to Sabra and the Section 382 limitation discussed above, we have Federal NOL carryforwards of approximately $162.0 million with expiration dates from 2019 through 2027.  Various subsidiaries have state NOL carryforwards totaling approximately $322.7 million with expiration dates beginning in 2011 through the year 2029.Our application of the rules under Section 382 is subject to challenge upon IRS review.  A successful challenge could significantly impact our ability to utilize tax attribute carryforwards from periods prior to the ownership change dates.

We are subject to income taxes in the U.S. and numerous state and local jurisdictions.  Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes.  Effective January 1, 2007, we adopted the guidance for accounting for uncertain tax positions, which contains a two-step approach to recognizing and measuring uncertain tax positions.  The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any.  The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.

Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different.  We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the expiration of the statute of limitations.  To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made.  The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest.

F-31

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

        A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

	2010			2009			2008
Balance at the beginning of the period	$	26,316		$	25,654		$	5,417
Additions for tax positions of prior years		248			730			-
Reductions for tax positions of prior years		-			-			(1,501	)
Additions based on tax positions related to the current year		-			-			23,497
Lapsing of statutes of limitations		(318	)		(68	)		(1,759	)
Balance at the end of the period	$	26,246		$	26,316		$	25,654

All of the gross unrecognized tax benefits would affect the effective tax rate if recognized.  Unrecognized tax benefits are adjusted in the period in which new information about a tax position becomes available or the final outcome differs from the amount recorded.  Unrecognized tax benefits are not expected to change significantly over the next twelve months.

We recognize potential accrued interest related to unrecognized tax benefits in income tax expense.  Penalties, if incurred, would also be recognized as a component of income tax expense.  The amount of accrued interest related to unrecognized tax benefits as of December 31, 2010, 2009, and 2008 was $0.3 million, $0.2 million, and $0.1 million, respectively.

We file numerous consolidated and separate state and local income tax returns in addition to our consolidated U.S. federal income tax return.  With few exceptions, we are no longer subject to U.S. federal, state or local income tax examinations for years before 2007.  These jurisdictions can, however, adjust NOL carryforwards from earlier years.

(10)  Fair Value of Financial Instruments

The estimated fair values of our financial instruments as of December 31 were as follows (in thousands):

	2010				2009
	Carrying				Carrying
	Amount		Fair Value		Amount		Fair Value
Cash and cash equivalents	$	81,163	$	81,163	$	104,483	$	104,483
Restricted cash	$	15,679	$	15,679	$	27,351	$	27,351
Long-term debt and capital lease obligations,
including current portion	$	155,980	$	156,084	$	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 December 31, 2010 and 2009, the fair value of our long-term debt, including current maturities, and our interest rate swap agreement 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.

F-32

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

The FASB accounting guidance establishes a hierarchy for ranking the quality and reliability of the information used to determine fair values.  This 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.

We endeavor to utilize the best available information in measuring fair value.  The following table summarizes the valuation of our financial instruments by the above pricing levels as of December 31 (in thousands):

		December 31, 2010
				Unadjusted Quoted		Significant Other
				Market Prices		Observable Inputs
		Total		(Level 1)		(Level 2)
Restricted cash – money market funds	$	1,465	$	1,465	$	-

		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 agreement – liability	$	5,048	$	-	$	5,048

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

(11)  Capital Stock

(a)  Basic and Diluted Shares

Basic net income per common share is calculated by dividing net income applicable to common stock by the weighted average number of common shares outstanding during the period. The calculation of diluted net income per common share is similar to that of basic net income per common share, except the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally those issuable upon the exercise of stock options and warrants and the vesting of stock units, were issued during the period.

F-33

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

The following table summarizes the calculation of basic and diluted net income per common share for each period (in thousands except per share data):

		2010			2009		2008
Numerator:
Net (loss) income	$	(4,650	)	$	38,671	$	109,287
Denominator:
Weighted average shares for basic net
income per common share		19,280			14,614		14,444
Add dilutive effect of assumed exercise of
stock options and warrants and vesting
of restricted stock units using the
treasury stock method		-			100		524
Weighted average shares for diluted net
income per common share		19,280			14,714		14,968
Basic net income per common share	$	(0.24	)	$	2.65	$	7.57
Diluted net income per common share	$	(0.24	)	$	2.63	$	7.30

(b)  Equity Incentive Plans

Pursuant to our 2004 Equity Incentive Plan (the “2004 Plan”), as of December 31, 2010 our employees and directors held options to purchase 913,530 shares of common stock and 176,867 unvested restricted stock units. No additional awards can be made under the 2004 Plan.

As of December 31, 2010, our directors held options to purchase 16,604 shares under our 2002 Non-employee Director Equity Incentive Plan (the “Director Plan”). No additional awards can be made under the Director Plan.

Our 2009 Performance Incentive Plan (the “2009 Plan”) allows for the issuance of shares of common stock equal to the sum of:  (i) 4.0 million shares, plus (ii) the number of any shares subject to stock options granted under the 2004 Plan or the Director Plan  which expire, or for any reason are canceled or terminated, without being exercised, plus (3) the number of any shares subject to restricted stock units under the 2004 Plan which are forfeited, terminated or cancelled without having become vested.  As of December 31, 2010 our employees and directors held options to purchase 628,981 shares of common stock and 656,121 unvested restricted stock units.

Option awards are granted with an exercise price equal to the market price of our stock at the date of grant; those option awards generally vest based on four years of continuous service and have seven-year contractual terms.  Share awards generally vest over four years and no dividends are paid on unexercised options or unvested share awards.  Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the applicable plan).

During the year ended December 31, 2010, we issued 306,602 shares of common stock upon the vesting of restricted stock shares and restricted stock units and the exercise of stock options.

In connection with the Separation on November 15, 2010, vested and unvested option awards and unvested restricted stock unit awards of Old Sun were converted into awards with respect to shares of New Sun common

F-34

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

stock.  The number of shares subject to and the exercise price of each converted option, and the number of shares subject to each unvested or vested and deferred restricted stock unit, were adjusted to preserve the same intrinsic value of the awards that existed immediately prior to the Separation and REIT Conversion Merger.  Awards held by our former Chief Executive Officer were assumed by Sabra upon Separation and converted to awards with respect to Sabra common stock in a manner similar to the conversion of Old Sun to New Sun shares.

A summary of option activity under the 2004 Plan, the 2009 Plan and the Director Plan during the year ended December 31, 2010 is presented below:

					Weighted-
					Average		Aggregate
				Weighted-	Remaining		Intrinsic
Options	Shares			Average	Contractual		Value
(Prior to the Separation)	(in thousands)			Exercise Price	Term (in years)		(in thousands)
Outstanding at January 1, 2010	2,310		$	10.05
Granted	496			9.81
Exercised	(185	)		7.10
Assumed by Sabra	(788	)		10.08
Forfeited	(53	)		11.99
Outstanding at November 15, 2010	1,780		$	10.22	4	$	-

					Weighted-
					Average		Aggregate
				Weighted-	Remaining		Intrinsic
Options	Shares			Average	Contractual		Value
(Subsequent to the Separation)	(in thousands)			Exercise Price	Term (in years)		(in thousands)
Outstanding at November 16, 2010	1,478		$	12.30
Granted	88			10.55
Forfeited	(7	)		10.89
Outstanding at December 31, 2010	1,559		$	10.52	4	$	526
Exercisable at December 31, 2010	794		$	11.99	4	$	529

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table.  Expected volatility is based on the historical volatility of our stock.  The expected term of options granted is derived using a temporary “shortcut approach” of our “plain vanilla” employee stock options as we do not have sufficient data to develop a more precise estimate. Under this approach, the expected term would be presumed to be the mid-point between the vesting date and the end of the contractual term.  The risk-free rate for the period within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The weighted-average grant-date fair value of stock options granted during the year ended December 31, 2010, 2009 and 2008 was $9.92, $9.86 and $5.78, respectively.

F-35

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

 The significant assumptions in the valuation model for the years ended December 31 are as follows:

	2010	2009	2008
Expected volatility	49.6 %- 51.9%	51.2% - 51.9%	50.7% - 80.6%
Weighted-average volatility	60.4%	51.6%	61.3%
Expected term (in years)	4.75	4.75	4.75
Risk-free rate	1.3% - 2.5%	1.8% - 2.6%	1.6% - 5.0%

In connection with the restricted stock units granted to employees we recognized the full fair value of the shares of nonvested restricted stock awards.  A summary of restricted stock activity with our share-based compensation plans during the year ended December 31, 2010 is as follows:

				Weighted-
				Average
Nonvested Shares	Shares			Grant-Date
(Prior to the Separation)	(in thousands)			Fair Value
Nonvested at January 1, 2010	999		$	10.93
Granted	623			9.75
Vested	(457	)		10.65
Assumed by Sabra	(130	)		10.52
Forfeited	(35	)		11.61
Nonvested at November 15, 2010	1,000			10.33

				Weighted-
				Average
Nonvested Shares	Shares			Grant-Date
(Subsequent to the Separation)	(in thousands)			Fair Value
Nonvested at November 16, 2010	831		$	10.69
Granted	19			10.59
Vested	(6	)		8.82
Forfeited	(7	)		10.99
Nonvested at December 31, 2010	837			10.72

The total fair value of restricted shares vested was $4.9 million for the year ended December 31, 2010 and $4.0 million for the year ended December 31, 2009.

We recognized stock compensation expense of $6.3 million, $5.8 million and $5.3 million for the years ended December 31, 2010, 2009 and 2008 respectively.

F-36

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

(12)  Other Events

(a)  Litigation

We are a party to various legal actions and administrative proceedings and are subject to various claims arising in the ordinary course of our business, including claims that our services have resulted in injury or death to the residents of our centers 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.  In certain states in which we have operations, insurance coverage for the risk of punitive damages arising from general and professional liability litigation may not be available due to state law public policy prohibitions.  There can be no assurance that we will not be liable for punitive damages awarded in litigation arising in states for which punitive damage insurance coverage is not available.

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

In September 2010, a lawsuit was filed 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.  We deny all of the allegations in the employee’s complaint.  The lawsuit, which was filed as a purported class action on behalf of the former employee and all those similarly situated, has been settled. The terms of the settlement are confidential pending court approval.   We believe our reserves are adequate for this matter.

In November 2010, a jury verdict was rendered in a Kentucky state court against us for $2.75 million in compensatory damages and $40 million in punitive damages. On February 25, 2011, the trial court judge reduced the punitive damage award to $24.75 million.  The case involves claims for professional negligence resulting in wrongful death.  We disagree with the jury’s verdict and believe that it is not supported by the facts of the case or applicable law.  We are in the process of preparing our appeal of this judgment.  We believe our reserves are adequate for this matter.

(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.

F-37

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

(c)  Legislation, Regulations and Market Conditions

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

(13)  Segment Information

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

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

Inpatient Services:  This segment provides, among other services, inpatient skilled nursing and custodial services as well as rehabilitative, restorative and transitional medical services. We provide 24-hour nursing care in these centers by registered nurses, licensed practical nurses and certified nursing aids.  At December 31, 2010, we operated 200 healthcare centers (consisting of 164 skilled nursing centers, 16 combined skilled nursing, assisted and independent living centers, 10 assisted living centers, two independent living centers and eight mental health centers with an aggregate of 23,053 licensed beds) as compared with 205 healthcare centers (consisting of 183 skilled nursing centers, 14 assisted living and independent living centers and eight mental health centers) with 23,205 licensed beds at December 31, 2009.

Rehabilitation Therapy Services:  This segment provides, among other services, physical, occupational, speech and respiratory therapy supplies and services to affiliated and nonaffiliated skilled nursing centers. At December 31, 2010, this segment provided services in 36 states via 508 contracts, 346 nonaffiliated and 162 affiliated, as compared to 464 contracts at December 31, 2009, of which 337 were nonaffiliated and 127 were affiliated.

Medical Staffing Services:  For the year ended December 31, 2010, this segment provided services in 39 states and derived 50.6% of its revenues from hospitals and other providers, 26.8% from skilled nursing centers, 16.4% from schools and 6.2% from prisons. We provide (i) licensed therapists skilled in the areas of physical, occupational and speech therapy, (ii) nurses, (iii) pharmacists, pharmacist technicians and medical imaging technicians, (iv) physicians, and (v) related medical personnel.  As of December 31, 2010, this segment had 25 branch offices, which provided temporary therapy, nursing, pharmacy and physician staffing services in major metropolitan areas and one office servicing locum tenens.  As of December 31, 2008, this segment had 30 branch offices, which provided temporary therapy, nursing, pharmacy and physician staffing services in major metropolitan areas and one division office, which specializes in the placement of temporary traveling therapists, and one office servicing locum tenens.

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

F-38

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

        The accounting policies of the segments are the same as those described in Note 2 – “Summary of Significant Accounting Policies.” We primarily evaluate segment performance based on profit or loss from operations before reorganization and restructuring items, income taxes and extraordinary items. Gains or losses on sales of assets and certain items including impairment of assets recorded in connection with annual impairment testing and restructuring costs are not considered in the evaluation of segment performance. Interest expense is recorded in the segment carrying the obligation to which the interest relates.

Our reportable segments are strategic business units that provide different products and services.  They are managed separately because each business has different marketing strategies due to differences in types of customers, distribution channels and capital resource needs.  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 loss (gain) on sale of assets, net, restructuring costs, income tax benefit and discontinued operations. Net segment income for the year ended December 31, 2010 for (1) our inpatient services segment decreased $6.0 million, or 3.8%, to $150.7 million, (2) our rehabilitation therapy services segment increased $3.0 million, or 27.0%, to $14.1 million and (3) our medical staffing services segment decreased $5.2 million, or 34.9%, to $5.6 million. We use the measure of net segment income to help identify opportunities for improvement and assist in allocating resources to each segment. 

F-39

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

As of and for the
Year Ended
December 31, 2010				Segment Information (in thousands):
				Rehabilitation		Medical
		Inpatient		Therapy		Staffing						Intersegment
		Services		Services		Services			Corporate			Eliminations			Consolidated
Revenues from external customers	$	1,697,444	$	119,612	$	89,765		$	40		$	-		$	1,906,861
Intersegment revenues		-		86,476		2,036			-			(88,512	)		-
Total revenues		1,697,444		206,088		91,801			40			(88,512	)		1,906,861
Operating salaries and benefits		838,251		171,970		67,638			-			-			1,077,859
Self insurance for workers'
compensation and general and
professional liability insurance		54,379		1,774		1,309			13,344			-			70,806
Other operating costs		457,693		8,008		12,819			-			(88,512	)		390,008
General and administrative expenses		41,195		8,160		2,588			60,842			-			112,785
Provision for losses on
accounts receivable		19,362		929		277			-			-			20,568
Segment operating income (loss)	$	286,564	$	15,247	$	7,170		$	(74,146	)	$	-		$	234,835
Center rent expense		82,994		496		844			-			-			84,334
Depreciation and amortization		43,333		678		732			3,265			-			48,008
Interest, net		9,493		-		(1	)		33,572			-			43,064
Net segment income (loss)	$	150,744	$	14,073	$	5,595		$	(110,983	)	$	-		$	59,429
Identifiable segment assets	$	708,227	$	16,492	$	20,933		$	313,536		$	20,879		$	1,080,067
Goodwill	$	343,439	$	75	$	4,533		$	-		$	-		$	348,047
Segment capital expenditures	$	49,003	$	1,061	$	203		$	3,261		$	-		$	53,528

_____________________________________

General and administrative expenses include operating administrative expenses.

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

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

F-40

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

As of and for the
Year Ended
December 31, 2009				Segment Information (in thousands):
				Rehabilitation			Medical
		Inpatient		Therapy			Staffing						Intersegment
		Services		Services			Services			Corporate			Eliminations			Consolidated
Revenues from external customers	$	1,674,752	$	105,366		$	100,624		$	34		$	-		$	1,880,776
Intersegment revenues		-		74,166			1,930			-			(76,096	)		-
Total revenues		1,674,752		179,532			102,554			34			(76,096	)		1,880,776
Operating salaries and benefits		833,658		150,271			72,336			-			-			1,056,265
Self insurance for workers'
compensation and general and
professional liability insurance		59,830		2,161			1,331			418			-			63,740
Other operating costs		437,418		7,620			15,713			-			(76,096	)		384,655
General and administrative expenses		41,245		6,868			2,811			62,068			-			112,992
Provision for losses on
accounts receivable		20,637		482			55			-			-			21,174
Segment operating income (loss)	$	281,964	$	12,130		$	10,308		$	(62,452	)	$	-		$	241,950
Center rent expense		71,728		480			920			-			-			73,128
Depreciation and amortization		41,325		540			780			2,808			-			45,453
Interest, net		12,226		(2	)		(2	)		37,105			-			49,327
Net segment income (loss)	$	156,685	$	11,112		$	8,610		$	(102,365	)	$	-		$	74,042
Identifiable segment assets	$	1,190,638	$	16,011		$	25,143		$	863,505		$	(528,456	)	$	1,566,841
Goodwill	$	333,688	$	75		$	4,533		$	-		$	-		$	338,296
Segment capital expenditures	$	50,418	$	650		$	74		$	3,170		$	-		$	54,312

_____________________________________

General and administrative expenses include operating administrative expenses.

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

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

F-41

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

As of and for the
Year Ended
December 31, 2008				Segment Information (in thousands):
				Rehabilitation			Medical
		Inpatient		Therapy			Staffing						Intersegment
		Services		Services			Services			Corporate			Eliminations			Consolidated
Revenues from external customers	$	1,615,322	$	89,619		$	117,788		$	37		$	-		$	1,822,766
Intersegment revenues		-		60,856			2,622			-			(63,478	)		-
Total revenues		1,615,322		150,475			120,410			37			(63,478	)		1,822,766
Operating salaries and benefits		816,710		124,817			86,345			-			-			1,027,872
Self insurance for workers'
compensation and general and
professional liability insurance		55,480		2,138			1,514			557			-			59,689
Other operating costs		411,784		7,113			17,553			-			(63,478	)		372,972
General and administrative expenses		41,382		6,806			2,983			62,302			-			113,473
Provision for losses on
accounts receivable		13,256		213			563			-			-			14,032
Segment operating income (loss)	$	276,710	$	9,388		$	11,452		$	(62,822	)	$	-		$	234,728
Center rent expense		72,223		394			976			-			-			73,593
Depreciation and amortization		35,951		533			806			3,058			-			40,348
Interest, net		13,670		(1	)		(20	)		40,954			-			54,603
Net segment income (loss)	$	154,866	$	8,462		$	9,690		$	(106,834	)	$	-		$	66,184
Identifiable segment assets	$	1,145,106	$	12,489		$	28,262		$	880,428		$	(528,449	)	$	1,537,836
Goodwill	$	322,200	$	75		$	4,533		$	-		$	-		$	326,808
Segment capital expenditures	$	39,976	$	286		$	188		$	1,962		$	-		$	42,412

_____________________________________

General and administrative expenses include operating administrative expenses.

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

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

F-42

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

Measurement of Segment Income or Loss

The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies (See Note 2 – “Summary of Significant Accounting Policies”).  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 for the years ended December 31 (in thousands):

		2010			2009			2008
Net segment income	$	59,429		$	74,042		$	66,184
Transaction costs		(29,113	)		-			-
Restructuring costs, net		-			(1,304	)		-
Loss on extinguishment of debt		(29,221	)		-			-
(Loss) gain on sale of assets, net		(847	)		(42	)		977
Income before income taxes and
discontinued operations	$	248		$	72,696		$	67,161

(14)  Transactions with Sabra

For the purpose of governing certain of the ongoing relationships between us and Sabra after the Separation and to provide mechanisms for an orderly transition, we and Sabra entered into various agreements. The most significant agreements are as follows:

Distribution Agreement

The Distribution Agreement provides for the various actions taken in connection with the Separation,the conditions to the Separation and the relationship between the parties subsequent to the Separation.Pursuant to the Distribution Agreement, any liability arising from or relating to legal proceedings involving Old Sun’s healthcare business prior to the Separation will be assumed by New Sun, and New Sun will indemnifySabra against any losses arising from or relating to such legal proceedings. The Distribution Agreement provides that any liability arising from or relating to legalproceedings involving Old Sun’s real property assets now owned by Sabra are assumed by Sabra. Any liability arising from or relating to legal proceedings prior to the Separation,other than those arising from or relating to legal proceedings involving Old Sun’s healthcare business or such realproperty assets, are assumed by New Sun.

In addition, the Distribution Agreement provides for cross-indemnities that require (i) Sabra to indemnifyNew Sun (and its subsidiaries, directors, officers, employees and agents and certain other related parties) againstall losses arising from or relating to the liabilities being assumed by Sabra or the breach of the DistributionAgreement by Sabra and (ii) New Sun to indemnify Sabra (and its subsidiaries, directors, officers, employees andagents and certain other related parties) against all losses arising from or relating to the liabilities being assumedor retained by New Sun or the breach of the Distribution Agreement by New Sun.

New Sun and Sabra have agreed in the Distribution Agreement that New Sun will pay all costs associated with theSeparation and REIT Conversion Merger that are incurred prior to the Separation. All costs relating to

F-43

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

the Separation orREIT Conversion Merger incurred after the Separation will be borne by the party incurring such costs.

Master Lease Agreements
 

Sabra received substantially all of Old Sun’s owned real property in the Separation and leases such real property to New Sun under eighteen master lease agreements which set forth the terms governing each of the leased properties (the "Lease Agreements").
 

Subsidiaries of New Sun (each a “Tenant”) entered into the Lease Agreements with subsidiaries of Sabra (each a “Lessor”) pursuant to which the Tenants lease the 86 healthcare properties owned by subsidiaries of Sabra following the Separation (consisting of 67 skilled nursing facilities, ten combined skilled nursing, assisted and independent living facilities, five assisted living facilities, two mental health facilities, one independent living facility and one continuing care retirement community). The obligations of the Tenants under the Lease Agreements are guaranteed by New Sun.

The Lease Agreements provide for the lease of land, buildings, structures and other improvements on the land, easements and similar appurtenances to the land and improvements, and equipment relating to the operation of the leased properties. There are multiple bundles of leased properties under each Lease Agreement with each bundle containing one to fourteen leased properties. The Lease Agreements provide for an initial term of between 10 and 15 years and no purchase options. At the option of the Tenant, the Lease Agreements may be extended for up to two five-year renewal terms beyond the initial term at the then currently in place rental rate plus an annual rent escalator equal to the lesser of the percentage change in the Consumer Price Index or 2.50% (but not less than zero). If the Tenant elects to renew the term of one or more expiring Lease Agreements, the renewal will be effective as to all, but not less than all, of the leased property then subject to the applicable Lease Agreements.

The Lease Agreements are commonly known as triple-net leases. Accordingly, in addition to rent, the Tenant will be required to pay the following: (1) all facility maintenance, (2) all insurance required in connection with the leased properties and the business conducted on the leased properties, (3) taxes levied on or with respect to the leased properties (other than taxes on the income of the Lessor) and (4) all utilities and other services necessary or appropriate for the leased properties and the business conducted on the leased properties.

Under the Lease Agreements, the initial annual aggregate base rent payable by subsidiaries of New Sun is $70.2 million. The Lease Agreements provide for an annual rent escalator equal to the lesser of the percentage change in the Consumer Price Index or 2.50% (but not less than zero).

Tax Allocation Agreement

Under the Tax Allocation Agreement, New Sun is responsible for and will indemnify Sabra against (i) allfederal income taxes, including any taxes resulting from the restructuring of Old Sun’s business and the distributionof shares of New Sun common stock to Old Sun’s stockholders, that are reportable on any tax return for periods priorto and including the Separation that includes Sabra or one of its subsidiaries, on the one hand, and New Sun orone of its subsidiaries, on the other hand, (ii) all state and local income taxes in jurisdictions in which it isexpected that net operating losses or other tax attributes will be sufficient to offset tax liability for such returns in such periods, and (iii) all transfer taxes resulting from the restructuring of Old Sun’s business and the distribution of shares of New Sun common stock to Old Sun’s stockholders. With respect to non-income

F-44

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2010

taxes (other than transfer taxes) and income taxes in state and local jurisdictions in which it is not expected that net operating losses orother tax attributes will be sufficient to offset tax liability, tax liability will be allocated between New Sun andSabra using a closing of the books method on the date of Separation.

After the 2010 tax year, Sabra and New Sun have agreed, to the extent allowable by applicable law, to allocate all limitations to utilizenet operating loss carryforwards to New Sun. New Sun will prepare, at its own cost, all taxreturns and elections for periods prior to and including the date of the Separation. In addition, New Sun willgenerally have the right to control the conduct and disposition of any audits or other proceeding with regard tosuch periods. In addition, from and after the distribution date of the Separation, New Sun will be entitled to anyrefund or credit for such periods.

New Sun included in the cash allocation made to Sabra pursuant to the Distribution Agreement, an amount equal to an estimate of such unpaid taxes described above for the 2010 taxable year. New Sun will only indemnify Sabra against such taxes if, and to the extent, such taxes exceed such estimate. With respect to any period in which Sabra has made or will make an election to be taxed as a real estate investment trust (“REIT”), New Sun will not make any indemnity payments to Sabra in an amount that could cause Sabra to fail to qualify as a REIT. The unpaid amount, if any, of such indemnity will be placed in escrow and will be paid to Sabra only upon the satisfaction of certain conditions related to the REIT income requirements under the Code. Any such amount held in escrow after five years will be released back to New Sun.

The Tax Allocation Agreement is not binding on the IRS or any other governmental entity and does not affect the liability of each of New Sun, Sabra, and their respective subsidiaries and affiliates, to the IRS or any other governmental authority for all U.S. federal, state or local or non-U.S. taxes of the Old Sun consolidated group relating to periods through the distribution date for the Separation. Accordingly, although the Tax Allocation Agreement will allocate tax liabilities between New Sun and Sabra, either Sabra and its subsidiaries or New Sun and its subsidiaries could be liable for tax liabilities not allocated to them under the Tax Allocation Agreement in the event that any tax liability is not discharged by the other party.

Transition Services Agreement

To the extent requested by Sabra, New Sun will provide Sabra with administrative and support services on a transitional basis pursuant to the Transition Services Agreement, including finance and accounting, human resources, legal support, and information systems support (the “Transition Services”) for a period of up to one year, subject to any permitted extensions contained therein.  The Transition Services Agreement provides for Sabra to pay New Sun a rate per labor hour of actual services rendered. The Transition Services Agreement provides that Sabra has the right to terminate a Transition Service after an agreed notice period. The Transition Services Agreement also contains provisions whereby Sabra  generally agrees to indemnify New Sun for all claims, losses, damages, liabilities and other costs incurred by New Sun to a third party which arise in connection with the provision of a Transition Service, other than those costs resulting from New Sun’s gross negligence or willful misconduct.

F-45

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

SUPPLEMENTARY DATA (UNAUDITED)

QUARTERLY FINANCIAL DATA

The following tables reflect unaudited quarterly financial data for fiscal years 2010 and 2009 (in thousands, except per share data):

	For the Year Ended
	December 31, 2010
	Fourth			Third			Second			First
	Quarter (a)			Quarter			Quarter			Quarter			Total
Total net revenues	$	483,418		$	475,997		$	474,394		$	473,052		$	1,906,861
(Loss) income from continuing operations	$	(31,930	)	$	7,998		$	10,499		$	10,717		$	(2,716	)
Loss from discontinued operations	$	(446	)	$	(442	)	$	(526	)	$	(520	)	$	(1,934	)
Net (loss) income	$	(32,376	)	$	7,556		$	9,973		$	10,197		$	(4,650	)
Basic earnings per common and
common equivalent share:
(Loss) income from continuing operations	$	(1.24	)	$	0.40		$	0.71		$	0.73		$	(0.14	)
Loss from discontinued operations		(0.02	)		(0.02	)		(0.03	)		(0.04	)		(0.10	)
Net (loss) income	$	(1.26	)	$	0.38		$	0.68		$	0.69		$	(0.24	)
Diluted earnings per common and
common equivalent share:
(Loss) income from continuing operations	$	(1.24	)	$	0.40		$	0.71		$	0.72		$	(0.14	)
Loss from discontinued operations		(0.02	)		(0.02	)		(0.04	)		(0.03	)		(0.10	)
Net (loss) income	$	(1.26	)	$	0.38		$	0.67		$	0.69		$	(0.24	)
Weighted average number of
common and common equivalent
shares outstanding:
Basic		25,791			19,839			14,744			14,677			19,280
Diluted		25,791			19,857			14,843			14,802			19,280

 (a)  Includes certain pretax amounts related to year-end charges due to the Separation, consisting primarily of $29.1 million of transaction costs and $29.2 million of loss on extinguishment of debt.

1

	For the Year Ended
	December 31, 2009 (1)
	Fourth			Third			Second			First
	Quarter			Quarter			Quarter			Quarter			Total
Total net revenues	$	473,827		$	470,644		$	468,444		$	467,861		$	1,880,776
Income from continuing  operations	$	9,810		$	10,539		$	10,974		$	11,757		$	43,080
(Loss) income from discontinued operations	$	(1,135	)	$	(881	)	$	(878	)	$	(1,515	)	$	(4,409	)
Net income	$	8,675		$	9,658		$	10,096		$	10,242		$	38,671
Basic earnings per common and
common equivalent share:
Income from continuing operations	$	0.67		$	0.72		$	0.75		$	0.81		$	2.95
(Loss) income from discontinued operations		(0.08	)		(0.06	)		(0.06	)		(0.11	)		(0.30	)
Net income	$	0.59		$	0.66		$	0.69		$	0.70		$	2.65
Diluted earnings per common and
common equivalent share:
Income from continuing operations	$	0.67		$	0.72		$	0.75		$	0.80		$	2.93
(Loss) income from discontinued operations		(0.08	)		(0.06	)		(0.06	)		(0.11	)		(0.30	)
Net income	$	0.59		$	0.66		$	0.69		$	0.69		$	2.63
Weighted average number of
common and common equivalent
shares outstanding:
Basic		14,648			14,641			14,617			14,548			14,614
Diluted		14,746			14,717			14,707			14,738			14,714

(1) We have reclassified all activity related to entities whose operations were divested or identified for disposal for the years ended December 31, 2010 and 2009 to discontinued operations.  Therefore, the quarterly financial data presented above including revenues, income (loss) before income taxes and discontinued operations and income (loss) on discontinued operations will not reflect the amounts reported previously in our Quarterly Reports on Form 10-Q filed with the SEC.  However, net income remains the same.

2

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

SUPPLEMENTARY DATA (UNAUDITED)

INSURANCE RESERVES

Activity in our insurance reserves as of and for the three months ending December 31, 2010 and 2009 is as follows (in thousands):

	Professional Liability			Workers’ Compensation			Total
Balance as of September 30, 2009	$	90,007		$	65,554		$	155,561
Current year provision, continuing operations		6,942			7,260			14,202
Current year provision, discontinued operations		434			161			595
Prior year reserve adjustments, continuing operations		2,200			1,720			3,920
Prior year reserve adjustments, discontinued operations		300			230			530
Claims paid, continuing operations		(4,045	)		(4,901	)		(8,946	)
Claims paid, discontinued operations		(635	)		(680	)		(1,315	)
Amounts paid for administrative services and other		(273	)		(1,838	)		(2,111	)
Balance as of December 31, 2009	$	94,930		$	67,506		$	162,436
Balance as of September 30, 2010	$	98,953		$	68,794		$	167,747
Current year provision, continuing operations		7,690			6,314			14,004
Current year provision, discontinued operations		3			5			8
Prior year reserve adjustments, continuing operations		13,100			-			13,100
Claims paid, continuing operations		(6,278	)		(4,990	)		(11,268	)
Claims paid, discontinued operations		(930	)		(417	)		(1,347	)
Amounts paid for administrative services and other		(667	)		(1,221	)		(1,888	)
Balance as of December 31, 2010	$	111,871		$	68,485		$	180,356

3

SCHEDULE II

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS

(in thousands)

		Column A		Column B		Column C		Column D			Column E
		Balance at		Charged to		Additions					Balance at
		Beginning		Costs and		Charged to		Deductions			End of
Description		of Period		Expenses(1)		Other Accounts(2)		Other(3)			Period
Year ended December 31, 2010
Allowance for doubtful accounts	$	55,402	$	21,175	$	-	$	(9,970	)	$	66,607
Other receivables reserve (4)	$	1,182	$	168	$	-	$	-		$	1,350
Allowance for deferred tax assets	$	27,572	$	-	$	-	$	(9,446	)	$	18,126
Year ended December 31, 2009
Allowance for doubtful accounts	$	44,830	$	21,196	$	214	$	(10,838	)	$	55,402
Other receivables reserve (4)	$	1,077	$	105	$	-	$	-		$	1,182
Allowance for deferred tax assets	$	34,321	$	-	$	-	$	(6,749	)	$	27,572
Year ended December 31, 2008
Allowance for doubtful accounts	$	42,144	$	15,283	$	180	$	(12,777	)	$	44,830
Other receivables reserve (4)	$	1,587	$	-	$	-	$	(510	)	$	1,077
Allowance for deferred tax assets	$	132,905	$	-	$	13,945	$	(112,529	)	$	34,321

(1)	Charges included in (adjustment) provision for losses on accounts receivable of $606, $(1), and $1,176 for the years ended December 31, 2010, 2009, and 2008, respectively, related to discontinued operations.
(2)	Column C primarily represents increases that resulted from acquisition activity (see Note 5 – “Acquisitions”).
(3)	Column D primarily represents write offs and recoveries of receivables that have been fully reserved or valuation allowance on deferred tax assets transferred to Sabra (see Note 9 – “Income Taxes”).
(4)	The other receivables reserve is classified in prepaid and other assets on our consolidated balance sheets.  Other receivables, net of reserves, were $2,424, $4,943, and $5,599 as of December 31, 2010, 2009 and 2008, respectively.

4

EX-3.1

Exhibit 3.1

AMENDED AND RESTATED

CERTIFICATE OF INCORPORATION

OF SHG SERVICES, INC.,

As Amended

          The present name of the corporation is SHG Services, Inc. (the "Corporation").  The Corporation was incorporated under the name "SHG Services, Inc." by the filing of its original Certificate of Incorporation with the Secretary of State of the State of Delaware on December 11, 2002.  This Amended and Restated Certificate of Incorporation of the Corporation, which both restates and further amends the provisions of the Corporation's Certificate of Incorporation, was duly adopted in accordance with the provisions of Sections 242 and 245 of the General Corporation Law of the State of Delaware and was approved by written consent of the sole stockholder of the Corporation in accordance with the provisions of Section 228 of the General Corporation Law of the State of Delaware.  The Certificate of Incorporation of the Corporation is hereby amended and restated to read in its entirety as follows:

FIRST.  The name of the Corporation is SHG Services, Inc.

SECOND.  The address of the Corporation's registered office in the State of Delaware is Corporation Trust Center, 1209 Orange Street, in the City of Wilmington, County of New Castle, 19801. The name of its registered agent at such address is The Corporation Trust Company.

THIRD.  The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware.

FOURTH.  The aggregate number of shares of capital stock which the Corporation shall have authority to issue is Forty Five Million (45,000,000) shares, divided into:

(a)  Forty One Million, Six Hundred Sixty-Six Thousand, Six Hundred and Sixty-Seven (41,666,667) shares of common stock with One Penny ($.01) par value; and

(b)  Three Million, Three Hundred Thirty-Three Thousand, Three Hundred and Thirty-Three (3,333,333) shares of preferred stock with One Penny ($.01) par value.

FIFTH.  The Board of Directors of the Corporation (the "Board") is authorized, subject to limitations prescribed by law and the provisions of Article FOURTH, to provide for the issuance of the shares of preferred stock in one or more series, and by filing a certificate pursuant to the applicable law of the State of Delaware, to establish from time to time the number of shares to be included in each such series, and to fix or, subject to applicable law, alter the designation, number, voting powers, preferences and relative, participating, optional and other special rights of the shares of each such series and the qualifications, limitations or restrictions thereof.

The authority of the Board with respect to each series shall include, but not be

1

limited to, determination of the following:

(a)        The number of shares constituting that series and the distinctive designation of that series;

(b)        The rights in respect of dividends, if any, of the shares of that series, whether dividends shall be cumulative, and, if so, from which date or dates, and the relative right of priority, if any, of payment of dividends on shares of that series;

(c)        Whether that series shall have voting rights, in addition to the voting rights provided by law, and, if so, the terms of such voting rights;

(d)        Whether the series shall have a right to elect one or more directors, and if so, the term or terms of such directors;

(e)        Whether that series shall have conversion privileges, and, if so, the terms and conditions of such conversion, including provision for adjustment of the conversion rate in such events as the Board shall determine;

(f)        Whether or not the shares of that series shall be redeemable, and, if so, the terms and conditions of such redemption, including the date or dates upon or after which they shall be redeemable, and the amount per share payable in case of redemption, which amount may vary under different conditions and at different redemption dates;

(g)        Whether that series shall have a sinking fund for the redemption or purchase of shares of that series, and, if so, the terms and amount of such sinking fund;

(h)        The rights of the shares of that series in the event of voluntary or involuntary liquidation, dissolution or winding up of the Corporation, and the relative rights of priority, if any, of payment of shares of that series; and

(i)        Any other relative rights, preferences and limitations of that series.

SIXTH. Unless and except to the extent that the by-laws of the Corporation shall so require, the election of directors of the Corporation need not be by written ballot.

SEVENTH.  (a)  The business and affairs of the Corporation shall be managed by, or under the direction of, the Board.  Except as otherwise provided for or fixed pursuant to the provisions of Article FIFTH of this Amended and Restated Certificate of Incorporation relating to the rights of the holders of any series of preferred stock to elect additional directors, the Board shall consist of one or more members, the number thereof to be determined from time to time by resolution of the Board.

                      (b) Subject to the rights of the holders of any one or more series of preferred stock then outstanding, newly created directorships resulting from any increase in the authorized number of directors or any vacancies on the Board resulting from death, resignation, retirement, disqualification, removal from office or other cause shall be filled solely by the affirmative vote of a majority of the remaining directors then in office, even though less than a

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quorum of the Board.  Any director so chosen shall hold office until the next election and until his successor shall be elected and qualified.  No decrease in the number of directors shall shorten the term of any incumbent director.

                         (c)  Except for such additional directors, if any, as are elected by the holders of any series of preferred stock as provided for or fixed pursuant to the provisions of Article FIFTH hereof, any director, or the entire Board, may be removed from office at any time, with or without cause and only by the affirmative vote of at least 66 2/3% in voting power of the outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class.

                         (d)  During any period when the holders of any series of preferred stock have the right to elect additional directors as provided for or fixed pursuant to the provisions of Article FIFTH hereof, then upon commencement and for the duration of the period during which such right continues:  (i) the then otherwise total authorized number of directors of the Corporation shall automatically be increased by such specified number of directors, and the holders of such preferred stock shall be entitled to elect the additional directors so provided for or fixed pursuant to said provisions, and (ii) each such additional director shall serve until such director's successor shall have been duly elected and qualified, or until such director's right to hold such office terminates pursuant to said provisions, whichever occurs earlier, subject to his earlier death, disqualification, resignation or removal.  Except as otherwise provided by the Board in the resolution or resolutions establishing such series, whenever the holders of any series of preferred stock having such right to elect additional directors are divested of such right pursuant to the provisions of such stock, the terms of office of all such additional directors elected by the holders of such stock, or elected to fill any vacancies resulting from the death, resignation, disqualification or removal of such additional directors, shall forthwith terminate and the total and authorized number of directors of the Corporation shall automatically be reduced accordingly.

EIGHTH.  (a)  In furtherance and not in limitation of the powers conferred by the laws of the State of Delaware, the Board is expressly authorized to make, amend, alter and repeal the by-laws of the Corporation.

      (b)  Notwithstanding anything in this Amended and Restated Certificate of Incorporation to the contrary, the affirmative vote of at least 66 2/3% in voting power of the outstanding shares of capital stock of the Corporation entitled to vote thereon, voting together as a single class, shall be required in order for the stockholders of the Corporation to make, amend, alter or repeal the by-laws of the Corporation.

NINTH.  A director of the Corporation shall not be liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except to the extent such exemption from liability or limitation thereof is not permitted under the General Corporation Law of the State of Delaware as the same exists or may hereafter be amended.  Any amendment, modification or repeal of the foregoing sentence shall not adversely affect any right or protection of a director of the Corporation hereunder in respect of any act or omission occurring prior to the time of such amendment, modification or repeal.

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TENTH.  The Corporation reserves the right at any time, and from time to time, to amend, alter, change or repeal any provision contained in this Amended and Restated Certificate of Incorporation, and other provisions authorized by the laws of the State of Delaware at the time in force may be added or inserted, in the manner now or hereafter prescribed by law; and all rights, preferences and privileges of whatsoever nature conferred upon stockholders, directors or any other persons whomsoever by and pursuant to this Amended and Restated Certificate of Incorporation in its present form or as hereafter amended are granted subject to the rights reserved in this article; provided, however, that notwithstanding anything contained in this Amended and Restated Certificate of Incorporation to the contrary, the affirmative vote of at least 66 2/3% in voting power of the outstanding shares of capital stock of the Corporation entitled to vote thereon, voting together as a single class, shall be required to amend, alter, or repeal Article SEVENTH, Article EIGHTH, Article NINTH or this Article TENTH, of this Amended and Restated Certificate of Incorporation.

IN WITNESS WHEREOF, the undersigned has executed this Amended and Restated Certificate of Incorporation as of October 20, 2010.

SHG SERVICES, INC.

By:  /s/ Michael Berg                   

Name: Michael Berg

Office:  Secretary

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CERTIFICATE OF AMENDMENT

OF

CERTIFICATE OF INCORPORATION

OF

SHG SERVICES, INC.

Pursuant to Section 242

of the General Corporation Law of the State of Delaware

SHG Services, Inc., a corporation duly organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), does hereby certify that:

1.     The Certificate of Incorporation of the Corporation is hereby amended by deleting Article FIRST thereof and inserting the following in lieu thereof:

"FIRST.  The name of the Corporation is Sun Healthcare Group, Inc."

2.     The foregoing amendment was duly adopted in accordance with the provisions of Sections 242 and 228 (by the written consent of the sole stockholder of the Corporation) of the General Corporation Law of the State of Delaware.

IN WITNESS WHEREOF, SHG Services, Inc. has caused this Certificate to be executed by its duly authorized officer on this 15th day of November, 2010.

/s/ Michael Berg                   

Name: Michael Berg

Title:  Secretary

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EX-3.2

Exhibit 3.2

AMENDED AND RESTATED

BY-LAWS

OF

SUN HEALTHCARE GROUP, INC.

(as Adopted on September 17, 2010)

ARTICLE I

Meetings of Stockholders

               Section 1.1.  Annual Meetings.  If required by applicable law, an annual meeting of stockholders shall be held for the election of directors at such date, time and place, either within or without the State of Delaware, as may be designated by resolution of the Board of Directors from time to time.  Any other proper business may be transacted at the annual meeting.

               Section 1.2.  Special Meetings.  Special meetings of stockholders for any purpose or purposes may be called at any time by any of the Chairman of the Board, the Chief Executive Officer or upon the majority vote of the Board of Directors, but such special meetings may not be called by any other person or persons.  Business transacted at any special meeting of stockholders shall be limited to the purposes stated in the notice.

               Section 1.3.  Notice of Meetings.  Whenever stockholders are required or permitted to take any action at a meeting, a notice of the meeting shall be given that shall state the place, if any, the date and hour of the meeting, the means of remote communication, if any, by which stockholders and proxy holders may be deemed to be present in person and vote at such meeting, the record date for determining the stockholders entitled to vote at the meeting (if such date is different from the record date for stockholders entitled to notice of the meeting), and, in the case of a special meeting, the purpose or purposes for which the meeting is called.  Unless otherwise provided by law, the certificate of incorporation or these by-laws, the notice of any meeting shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting to each stockholder entitled to vote at the meeting as of the record date for determining the stockholders entitled to notice of such meeting.  If mailed, such notice shall be deemed to be given when deposited in the United States mail, postage prepaid, directed to the stockholder at his address as it appears on the records of the corporation.

               Section 1.4.  Adjournments.  Any meeting of stockholders, annual or special, may adjourn from time to time to reconvene at the same or some other place, and notice need not be given of any such adjourned meeting if the time and place thereof are announced at the meeting at which the adjournment is taken.  At the adjourned meeting the corporation may transact any business which might have been transacted at the original meeting.  If the adjournment is for more than thirty (30) days, a notice of the adjourned meeting shall be given

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to each stockholder of record entitled to vote at the meeting.  If after the adjournment a new record date for determination of stockholders entitled to vote is fixed for the adjourned meeting, the Board of Directors shall fix as the record date for determining stockholders entitled to notice of such adjourned meeting the same or an earlier date as that fixed for determination of stockholders entitled to vote at the adjourned meeting, and shall give notice of the adjourned meeting to each stockholder of record as of the record date so fixed for notice of such adjourned meeting.

               Section 1.5.  Quorum.  Except as otherwise provided by law, the certificate of incorporation or these by-laws, at each meeting of stockholders the presence in person or by proxy of the holders of a majority in voting power of the outstanding shares of stock entitled to vote at the meeting shall be necessary and sufficient to constitute a quorum.  In the absence of a quorum, the stockholders so present may, by a majority in voting power thereof, adjourn the meeting from time to time in the manner provided in Section 1.4 of these by-laws until a quorum shall attend.  Shares of its own stock belonging to the corporation or to another corporation, if a majority of the shares entitled to vote in the election of directors of such other corporation is held, directly or indirectly, by the corporation, shall neither be entitled to vote nor be counted for quorum purposes; provided, however, that the foregoing shall not limit the right of the corporation or any subsidiary of the corporation to vote stock, including but not limited to its own stock, held by it in a fiduciary capacity.

               Section 1.6.  Organization.  Meetings of stockholders shall be presided over by the Chairman of the Board, if any, or in his absence by the Vice Chairman of the Board, if any, or in his absence by the Chief Executive Officer, or in his absence by the President or a Vice President, or in the absence of the foregoing persons by a chairman designated by the Board of Directors, or in the absence of such designation by a chairman chosen at the meeting.  The Secretary shall act as secretary of the meeting, but in his absence the chairman of the meeting may appoint any person to act as secretary of the meeting.

               Section 1.7. Voting; Proxies. (a) Except as otherwise provided by or pursuant to the provisions of the certificate of incorporation, each stockholder entitled to vote at any meeting of stockholders shall be entitled to one vote for each share of stock held by such stockholder which has voting power upon the matter in question. Each stockholder entitled to vote at a meeting of stockholders or to express consent to corporate action in writing without a meeting may authorize another person or persons to act for such stockholder by proxy, but no such proxy shall be voted or acted upon after three years from its date, unless the proxy provides for a longer period. A proxy shall be irrevocable if it states that it is irrevocable and if, and only as long as, it is coupled with an interest sufficient in law to support an irrevocable power. A stockholder may revoke any proxy which is not irrevocable by attending the meeting and voting in person or by delivering to the Secretary of the corporation a revocation of the proxy or a new proxy bearing a later date. Voting at meetings of stockholders need not be by written ballot.

(b) Except as otherwise provided by the certificate of incorporation or these by-laws, each director shall be elected by the vote of a majority of the votes cast with respect to that

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director’s election at any meeting for the election of directors at which a quorum is present.  If, however, as of the tenth day preceding the date the corporation first mails its notice of meeting for such meeting to the stockholders, the number of nominees exceeds the number of directors to be elected (a “Contested Election”), the directors shall be elected by the vote of a plurality of the votes cast. For purposes of this Section 1.7, a majority of the votes cast means that the number of votes cast “for” a nominee must exceed the number of votes cast “against” in respect of that nominee (with “abstentions” and “broker non-votes” not counted as a vote cast either “for” or “against”).

(c)  In order for any incumbent director to become a nominee of the Board of Directors for further service on the Board of Directors, such person must submit an irrevocable resignation, provided that such resignation shall be effective only if (i) that person shall not receive a majority of the votes cast in an election that is not a Contested Election, and (ii) the Board of Directors shall accept that resignation in accordance with the policies and procedures adopted by the Board of Directors for such purpose. If a nominee who is an incumbent director does not receive a majority of the votes cast in an election that is not a Contested Election, the Nominating and Governance Committee shall consider the facts and circumstances relating to the election and the resignation, and recommend to the Board of Directors, within sixty (60) days following certification of the election results, whether such resignation should be accepted or rejected or whether other action should be taken.  The Board of Directors shall act on the resignation within ninety (90) days following certification of the election results, taking into account the committee’s recommendation, and publicly disclose (by a press release and filing an appropriate disclosure with the Securities and Exchange Commission) its decision regarding the resignation. The committee in making its recommendation and the Board of Directors in making its decision each may consider any factors and other information that they consider appropriate and relevant.

(d)  If the Board of Directors accepts a director’s resignation pursuant to this Section 1.7, or if a nominee for director is not elected and the nominee is not an incumbent director, then the Board of Directors may fill the resulting vacancy pursuant to Article SEVENTH of the certificate of incorporation or may decrease the size of the Board of Directors pursuant to Section 2.1 of these by-laws.

(e)  All other elections and questions shall, unless otherwise provided by the certificate of incorporation, these by-laws, the rules or regulations of any stock exchange applicable to the corporation, or applicable law or pursuant to any regulation applicable to the corporation or its securities, be decided by the affirmative vote of the holders of a majority in voting power of the shares of stock of the corporation which are present in person or by proxy and entitled to vote thereon.

               Section 1.8.  Fixing Date for Determination of Stockholders of Record. (a)  In order that the corporation may determine the stockholders entitled to notice of any meeting of stockholders or any adjournment thereof, the Board of Directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which record date shall, unless otherwise required by

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law, not be more than sixty (60) nor less than ten (10) days before the date of such meeting.  If the Board of Directors so fixes a date, such date shall also be the record date for determining the stockholders entitled to vote at such meeting unless the Board of Directors determines, at the time it fixes such record date, that a later date on or before the date of the meeting shall be the date for making such determination.  If no record date is fixed by the Board of Directors, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held.  A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for determination of stockholders entitled to vote at the adjourned meeting, and in such case shall also fix as the record date for stockholders entitled to notice of such adjourned meeting the same or an earlier date as that fixed for determination of stockholders entitled to vote in accordance herewith at the adjourned meeting.

(b)  In order that the corporation may determine the stockholders entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix a record date, which shall not be more than sixty (60) days prior to such other action.  If no such record date is fixed, the record date for determining stockholders for any such purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto.

(c)  Unless otherwise restricted by the certificate of incorporation, in order that the corporation may determine the stockholders entitled to express consent to corporate action in writing without a meeting, the Board of Directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which record date shall not be more than ten (10) days after the date upon which the resolution fixing the record date is adopted by the Board of Directors.  If no record date for determining stockholders entitled to express consent to corporate action in writing without a meeting is fixed by the Board of Directors, (i) when no prior action of the Board of Directors is required by law, the record date for such purpose shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the corporation in accordance with applicable law, and (ii) if prior action by the Board of Directors is required by law, the record date for such purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution taking such prior action.

               Section 1.9.  List of Stockholders Entitled to Vote.  The Secretary shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting (provided, however, if the record date for determining the stockholders entitled to vote is less than ten (10) days before the date of the meeting, the list shall reflect the stockholders entitled to vote as of the tenth day before the meeting date), arranged in alphabetical order, and showing the address of each stockholder and

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the number of shares registered in the name of each stockholder.  Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, as required by applicable law.  If the meeting is to be held at a place, then a list of stockholders entitled to vote at the meeting shall be produced and kept at the time and place of the meeting during the whole time thereof and may be examined by any stockholder who is present.  If the meeting is to be held solely by means of remote communication, then the list shall also be open to the examination of any stockholder during the whole time of the meeting on a reasonably accessible electronic network, and the information required to access such list shall be provided with the notice of the meeting.  Except as otherwise provided by law, the stock ledger shall be the only evidence as to who are the stockholders entitled to examine the stock ledger, the list of stockholders or the books of the corporation, or to vote in person or by proxy at any meeting of stockholders.

               Section 1.10.  Inspectors of Election.  The corporation may, and shall if required by law, in advance of any meeting of stockholders, appoint one or more inspectors of election, who may be employees of the corporation, to act at the meeting or any adjournment thereof and to make a written report thereof.  The corporation may designate one or more persons as alternate inspectors to replace any inspector who fails to act.  In the event that no inspector so appointed or designated is able to act at a meeting of stockholders, the person presiding at the meeting shall appoint one or more inspectors to act at the meeting.  Each inspector, before entering upon the discharge of his or her duties, shall take and sign an oath to execute faithfully the duties of inspector with strict impartiality and according to the best of his or her ability.  The inspector or inspectors so appointed or designated shall (i) ascertain the number of shares of capital stock of the corporation outstanding and the voting power of each such share, (ii) determine the shares of capital stock of the corporation represented at the meeting and the validity of proxies and ballots, (iii) count all votes and ballots, (iv) determine and retain for a reasonable period a record of the disposition of any challenges made to any determination by the inspectors, and (v) certify their determination of the number of shares of capital stock of the corporation represented at the meeting and such inspectors’ count of all votes and ballots. Such certification and report shall specify such other information as may be required by law.  In determining the validity and counting of proxies and ballots cast at any meeting of stockholders of the corporation, the inspectors may consider such information as is permitted by applicable law.  No person who is a candidate for an office at an election may serve as an inspector at such election.

               Section 1.11.  Conduct of Meetings.  The date and time of the opening and the closing of the polls for each matter upon which the stockholders will vote at a meeting shall be announced at the meeting by the person presiding over the meeting.  The Board of Directors may adopt by resolution such rules and regulations for the conduct of the meeting of stockholders as it shall deem appropriate.  Except to the extent inconsistent with such rules and regulations as adopted by the Board of Directors, the person presiding over any meeting of stockholders shall have the right and authority to convene and (for any or no reason) to adjourn the meeting, to prescribe such rules, regulations and procedures and to do all such acts as, in the judgment of such chairman, are appropriate for the proper conduct of the meeting.  Such rules, regulations or procedures, whether adopted by the Board of Directors or prescribed by

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the presiding officer of the meeting, may include, without limitation, the following: (i) the establishment of an agenda or order of business for the meeting; (ii) rules and procedures for maintaining order at the meeting and the safety of those present; (iii) limitations on attendance at or participation in the meeting to stockholders entitled to vote at the meeting, their duly authorized and constituted proxies or such other persons as the chairman of the meeting shall determine; (iv) restrictions on entry to the meeting after the time fixed for the commencement thereof; and (v) limitations on the time allotted to questions or comments by participants.  Unless and to the extent determined by the Board of Directors or the person presiding over the meeting, meetings of stockholders shall not be required to be held in accordance with the rules of parliamentary procedure.

               Section 1.12.  Notice of Stockholder Business and Nominations.

                    (A)     Annual Meetings of Stockholders.  (1) Nominations of persons for election to the Board of Directors of the corporation and the proposal of other business to be considered by the stockholders may be made at an annual meeting of stockholders only (a) pursuant to the corporation’s notice of meeting (or any supplement thereto), (b) by or at the direction of the Board of Directors or any committee thereof or (c) by any stockholder of the corporation who was a stockholder of record of the corporation at the time the notice provided for in this Section 1.12 is delivered to the Secretary of the corporation, who is entitled to vote at the meeting and who complies with the notice procedures set forth in this Section 1.12.

                         (2)     For any nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (c) of paragraph (A)(1) of this Section 1.12, the stockholder must have given timely notice thereof in writing to the Secretary of the corporation and any such proposed business other than the nominations of persons for election to the Board of Directors must constitute a proper matter for stockholder action.  To be timely, a stockholder’s notice shall be delivered to the Secretary at the principal executive offices of the corporation not later than the close of business on the ninetieth day nor earlier than the close of business on the one hundred twentieth day prior to the first anniversary of the preceding year’s annual meeting (provided, however, that in the event that the date of the annual meeting is more than thirty days before or more than seventy days after such anniversary date, notice by the stockholder must be so delivered not earlier than the close of business on the one hundred twentieth day prior to such annual meeting and not later than the close of business on the later of the ninetieth day prior to such annual meeting or the tenth day following the day on which public announcement of the date of such meeting is first made by the corporation).  In no event shall the public announcement of an adjournment or postponement of an annual meeting commence a new time period (or extend any time period) for the giving of a stockholder’s notice as described above.  Such stockholder’s notice shall set forth: (a) as to each person whom the stockholder proposes to nominate for election as a director (i) all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors in an election contest, or is otherwise required, in each case pursuant to and in accordance with Section 14A of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the rules and regulations promulgated thereunder and (ii) such person’s written consent to being named in the proxy statement as a nominee and

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to serving as a director if elected; (b) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the text of the proposal or business (including the text of any resolutions proposed for consideration and in the event that such business includes a proposal to amend the by-laws of the corporation, the language of the proposed amendment), the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and the beneficial owner, if any, on whose behalf the proposal is made; and (c) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (i) the name and address of such stockholder, as they appear on the corporation’s books, and of such beneficial owner, (ii) the class and number of shares of capital stock of the corporation which are owned beneficially and of record by such stockholder and such beneficial owner, (iii) a description of any agreement, arrangement or understanding with respect to the nomination or proposal between or among such stockholder and/or such beneficial owner, any of their respective affiliates or associates, and any others acting in concert with any of the foregoing, including, in the case of a nomination, the nominee, (iv) a description of any agreement, arrangement or understanding (including any derivative or short positions, profit interests, options, warrants, convertible securities, stock appreciation or similar rights, hedging transactions, and borrowed or loaned shares) that has been entered into as of the date of the stockholder’s notice by, or on behalf of, such stockholder and such beneficial owners, whether or not such instrument or right shall be subject to settlement in underlying shares of capital stock of the corporation, the effect or intent of which is to mitigate loss to, manage risk or benefit of share price changes for, or increase or decrease the voting power of, such stockholder or such beneficial owner, with respect to securities of the corporation, (v) a representation that the stockholder is a holder of record of stock of the corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to propose such business or nomination, (vi) a representation whether the stockholder or the beneficial owner, if any, intends or is part of a group which intends (a) to deliver a proxy statement and/or form of proxy to holders of at least the percentage of the corporation’s outstanding capital stock required to approve or adopt the proposal or elect the nominee and/or (b) otherwise to solicit proxies or votes from stockholders in support of such proposal or nomination, and (vii) any other information relating to such stockholder and beneficial owner, if any, required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for, as applicable, the proposal and/or for the election of directors in an election contest pursuant to and in accordance with Section 14(a) of the Exchange Act and the rules and regulations promulgated thereunder.  The foregoing notice requirements of this paragraph (A) of this Section 1.12 shall be deemed satisfied by a stockholder with respect to business other than a nomination if the stockholder has notified the corporation of his or her intention to present a proposal at an annual meeting in compliance with applicable rules and regulations promulgated under the Exchange Act and such stockholder’s proposal has been included in a proxy statement that has been prepared by the corporation to solicit proxies for such annual meeting.  The corporation may require any proposed nominee to furnish such other information as it may reasonably require to determine the eligibility of such proposed nominee to serve as a director of the corporation.

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                         (3)     Notwithstanding anything in the second sentence of paragraph (A)(2) of this Section 1.12 to the contrary, in the event that the number of directors to be elected to the Board of Directors of the corporation at an annual meeting is increased effective after the time period for which nominations would otherwise be due under paragraph (A)(2) of this Section 1.12 and there is no public announcement by the corporation naming the nominees for the additional directorships at least one hundred days prior to the first anniversary of the preceding year’s annual meeting, a stockholder’s notice required by this Section 1.12 shall also be considered timely, but only with respect to nominees for the additional directorships, if it shall be delivered to the Secretary at the principal executive offices of the corporation not later than the close of business on the tenth day following the day on which such public announcement is first made by the corporation.

                    (B)     Special Meetings of Stockholders.  Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the corporation’s notice of meeting.  Nominations of persons for election to the Board of Directors may be made at a special meeting of stockholders at which directors are to be elected pursuant to the corporation’s notice of meeting (1) by or at the direction of the Board of Directors or any committee thereof or (2) provided that the Board of Directors has determined that directors shall be elected at such meeting, by any stockholder of the corporation who is a stockholder of record at the time the notice provided for in this Section 1.12 is delivered to the Secretary of the corporation, who is entitled to vote at the meeting and upon such election and who complies with the notice procedures set forth in this Section 1.12.  In the event the corporation calls a special meeting of stockholders for the purpose of electing one or more directors to the Board of Directors, any such stockholder entitled to vote in such election of directors may nominate a person or persons (as the case may be) for election to such position(s) as specified in the corporation’s notice of meeting, if the stockholder’s notice required by paragraph (A)(2) of this Section 1.12 shall be delivered to the Secretary at the principal executive offices of the corporation not earlier than the close of business on the one hundred twentieth day prior to such special meeting and not later than the close of business on the later of the ninetieth day prior to such special meeting or the tenth day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting.  In no event shall the public announcement of an adjournment or postponement of a special meeting commence a new time period (or extend any time period) for the giving of a stockholder’s notice as described above.

                    (C)     General.  (1)  Except as otherwise expressly provided in any applicable rule or regulation promulgated under the Exchange Act, only such persons who are nominated in accordance with the procedures set forth in this Section 1.12 shall be eligible to be elected at an annual or special meeting of stockholders of the corporation to serve as directors and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with the procedures set forth in this Section 1.12.  Except as otherwise provided by law, the chairman of the meeting shall have the power and duty (a) to determine whether a nomination or any business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with the procedures set forth in this

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Section 1.12 (including whether the stockholder or beneficial owner, if any, on whose behalf the nomination or proposal is made solicited (or is part of a group which solicited) or did not so solicit, as the case may be, proxies or votes in support of such stockholder’s nominee or proposal in compliance with such stockholder’s representation as required by clause (A)(2)(c)(vi) of this Section 1.12) and (b) if any proposed nomination or business was not made or proposed in compliance with this Section 1.12, to declare that such nomination shall be disregarded or that such proposed business shall not be transacted.  Notwithstanding the foregoing provisions of this Section 1.12, unless otherwise required by law, if the stockholder (or a qualified representative of the stockholder) does not appear at the annual or special meeting of stockholders of the corporation to present a nomination or proposed business, such nomination shall be disregarded and such proposed business shall not be transacted, notwithstanding that proxies in respect of such vote may have been received by the corporation.  For purposes of this Section 1.12, to be considered a qualified representative of the stockholder, a person must be a duly authorized officer, manager or partner of such stockholder or must be authorized by a writing executed by such stockholder or an electronic transmission delivered by such stockholder to act for such stockholder as proxy at the meeting of stockholders and such person must produce such writing or electronic transmission, or a reliable reproduction of the writing or electronic transmission, at the meeting of stockholders.

                         (2)      For purposes of this Section 1.12, “public announcement” shall include disclosure in a press release reported by the Dow Jones News Service, Associated Press, other national news service or in a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act and the rules and regulations promulgated thereunder.

                         (3)     Notwithstanding the foregoing provisions of this Section 1.12, a stockholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations promulgated thereunder with respect to the matters set forth in this Section 1.12; provided however, that any references in these by-laws to the Exchange Act or the rules and regulations promulgated thereunder are not intended to and shall not limit any requirements applicable to nominations or proposals as to any other business to be considered pursuant to this Section 1.12 (including paragraphs (A)(1)(c) and (B) hereof), and compliance with paragraphs (A)(1)(c) and (B) of this Section 1.12 shall be the exclusive means for a stockholder to make nominations or submit other business (other than, as provided in the penultimate sentence of paragraph (A)(2) hereof, business  other than nominations brought properly under and in compliance with Rule 14a-8 of the Exchange Act, as such Rule may be amended from time to time).  Nothing in this Section 1.12 shall be deemed to affect any rights (a) of stockholders to request inclusion of proposals in the corporation’s proxy statement pursuant to applicable rules and regulations promulgated under the Exchange Act or (b) of the holders of any series of Preferred Stock to elect directors pursuant to any applicable provisions of the certificate of incorporation.

ARTICLE II

Board of Directors

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               Section 2.1.  Number; Qualifications.  The Board of Directors shall consist of one or more members, the number thereof to be determined from time to time by resolution of the Board of Directors.  Directors need not be stockholders.

               Section 2.2.  Resignation.  Any director may resign at any time upon notice to the corporation.

               Section 2.3.  Regular Meetings.  Regular meetings of the Board of Directors may be held at such places within or without the State of Delaware and at such times as the Board of Directors may from time to time determine.

               Section 2.4.  Special Meetings.  Special meetings of the Board of Directors may be held at any time or place within or without the State of Delaware whenever called by the Chairman of the Board, the Chief Executive Officer, the Secretary, or not less than one-third of the members of the Board of Directors.  Notice of a special meeting of the Board of Directors shall be given by the person or persons calling the meeting at least twenty-four hours before the special meeting.

               Section 2.5.  Telephonic Meetings Permitted.  Members of the Board of Directors, or any committee designated by the Board of Directors, may participate in a meeting thereof by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this by-law shall constitute presence in person at such meeting.

               Section 2.6.  Quorum; Vote Required for Action.  At all meetings of the Board of Directors a majority of the whole Board of Directors shall constitute a quorum for the transaction of business.  Except in cases in which the certificate of incorporation, these by-laws or applicable law otherwise provides, the vote of a majority of the directors present at a meeting at which a quorum is present shall be the act of the Board of Directors.

               Section 2.7.  Organization.  Meetings of the Board of Directors shall be presided over by the Chairman of the Board, if any, or in his absence by the Vice Chairman of the Board, if any, or in his absence by the Chief Executive Officer or President, or in their absence by a chairman chosen at the meeting.  The Secretary shall act as secretary of the meeting, but in his absence the chairman of the meeting may appoint any person to act as secretary of the meeting.

               Section 2.8.  Action by Unanimous Consent of Directors.  Unless otherwise restricted by the certificate of incorporation or these by-laws, any action required or permitted to be taken at any meeting of the Board of Directors, or of any committee thereof, may be taken without a meeting if all members of the Board of Directors or such committee, as the case may be, consent thereto in writing or by electronic transmission and the writing or writings or electronic transmission or electronic transmissions are filed with the minutes of the proceedings of the Board of Directors or a committee thereof in accordance with applicable law.

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ARTICLE III

Committees

               Section 3.1.  Committees.  The Board of Directors may designate one or more committees, each committee to consist of one or more of the directors of the corporation.  The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee.  In the absence or disqualification of a member of the committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in place of any such absent or disqualified member.  Any such committee, to the extent permitted by law and to the extent provided in the resolution of the Board of Directors, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it.

               Section 3.2.  Committee Rules.  Unless the Board of Directors otherwise provides, each committee designated by the Board of Directors may make, alter and repeal rules for the conduct of its business.  In the absence of such rules each committee shall conduct its business in the same manner as the Board of Directors conducts its business pursuant to Article II of these by-laws.

ARTICLE IV

Officers

               Section 4.1.  Executive Officers; Election; Qualifications; Term of Office; Resignation; Removal; Vacancies.  The Board of Directors shall elect a Chief Executive Officer, Chief Financial Officer and Secretary, and it may, if it so determines, choose a Chairman of the Board and a Vice Chairman of the Board from among its members.  The Board of Directors may also elect a  President, one or more Vice Presidents, one or more Assistant Secretaries, a Trea­surer and one or more Assistant Treasurers.  Each such officer shall hold office until the first meeting of the Board of Directors after the annual meeting of stockholders next succeeding his election, and until his successor is elected and qualified or until his earlier resignation or removal.  Any officer may resign at any time upon written notice to the corporation.  The Board of Directors may remove any officer with or without cause at any time, but such removal shall be without prejudice to the contractual rights of such officer, if any, with the corporation.  Any number of offices may be held by the same person.  Any vacancy occurring in any office of the corporation by death, resignation, removal or otherwise may be filled for the unexpired portion of the term by the Board of Directors at any regular or special meeting.

               Section 4.2.  Powers and Duties of Executive Officers.  The officers of the corporation shall have such powers and duties in the management of the corporation as may be prescribed in these by-laws, in a resolution by the Board of Directors and, to the extent not so provided, as generally pertain to their respective offices, subject to the control of the Board of

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Directors.  The Board of Directors may require any officer, agent or employee to give security for the faithful performance of his duties.

ARTICLE V

Stock

               Section 5.1. Certificates; Uncertificated Shares. The shares of the corporation shall be represented by certificates, provided that the board of directors may provide by resolution or resolutions that some or all of any or all classes or series of its stock shall be uncertificated shares.  Any such resolution shall not apply to shares represented by a certificate until such certificate is surrendered to the corporation.  Every holder of stock represented by a certificate shall be entitled to have a certificate signed by or in the name of the corporation by the Chairman or Vice Chairman of the Board of Directors, if any, or the President or Vice-President, and by the Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary, of the corporation certifying the number of shares owned by the stockholder in the corporation. Any of or all the signatures on the certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent, or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer, transfer agent, or registrar at the date of issue.

               Section 5.2. Lost, Stolen or Destroyed Stock Certificates; Issuance of New Certificates or Uncertificated Shares. The corporation may issue a new stock certificate or uncertificated shares in the place of any certificate theretofore issued by it, alleged to have been lost, stolen or destroyed, and the corporation may require the owner of the lost, stolen or destroyed certificate, or his legal representative, to give the corporation a bond sufficient to indemnify it against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new certificate or uncertificated shares.

Section 5.3. Transfers of Stock. Shares of capital stock of the corporation shall be transferable in the manner prescribed by law and in these by-laws.  Shares of capital stock of the corporation shall only be transferred on the books of the corporation by the holder of record thereof or by such holder’s attorney duly authorized in writing, upon surrender to the corporation of the certificate or certificates representing such shares endorsed by the appropriate person or persons (or, with respect to uncertificated shares, by delivery of duly executed instructions or in any other manner permitted by applicable law), with such evidence of the authenticity of such endorsement or execution, transfer, authorization, and other matters as the corporation may reasonably require, and accompanied by all necessary stock transfer stamps.

ARTICLE VI

Indemnification and Advancement of Expenses

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               Section 6.1.  Right to Indemnification.  The corporation shall indemnify and hold harmless, to the fullest extent permitted by applicable law as it presently exists or may hereafter be amended, any person (a “Covered Person”) who was or is made or is threatened to be made a party or is otherwise involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative (a “proceeding”), by reason of the fact that he, or a person for whom he is the legal representative, is or was a director of the corporation or an officer of the corporation appointed by the Board of Directors or, while a director of the corporation or an officer of the corporation appointed by the Board of Directors, is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust, enterprise or nonprofit entity, including service with respect to employee benefit plans, against all liability and loss suffered and expenses (including attorneys’ fees) reasonably incurred by such Covered Person.  Notwithstanding the preceding sentence, except as otherwise provided in Section 6.3, the corporation shall be required to indemnify a Covered Person in connection with a proceeding (or part thereof) commenced by such Covered Person only if the commencement of such proceeding (or part thereof) by the Covered Person was authorized in the specific case by the Board of Directors of the corporation.

               Section 6.2.  Prepayment of Expenses.  The corporation, to the fullest extent not prohibited by law, shall pay the expenses (including attorneys’ fees) incurred by a Covered Person in defending any proceeding in advance of its final disposition, provided, however, that, to the extent required by law, such payment of expenses in advance of the final disposition of the proceeding shall be made only upon receipt of an undertaking by the Covered Person to repay all amounts advanced if it should be ultimately determined that the Covered Person is not entitled to be indemnified under this Article VI or otherwise.

               Section 6.3.  Claims.  If a claim for indemnification (following the final disposition of such proceeding) or advancement of expenses under this Article VI is not paid in full within thirty days after a written claim therefor by the Covered Person has been received by the corporation, the Covered Person may file suit to recover the unpaid amount of such claim and, if successful in whole or in part, shall be entitled to be paid the expense of prosecuting such claim to the fullest extent permitted by law.  In any such action the corporation shall have the burden of proving that the Covered Person is not entitled to the requested indemnification or advancement of expenses under applicable law.

               Section 6.4.  Nonexclusivity of Rights.  The rights conferred on any Covered Person by this Article VI shall not be exclusive of any other rights which such Covered Person may have or hereafter acquire under any statute, provision of the certificate of incorporation, these by-laws, agreement, vote of stockholders or disinterested directors or otherwise.

               Section 6.5.  Other Sources.  The corporation’s obligation, if any, to indemnify or to advance expenses to any Covered Person who was or is serving at its request as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, enterprise or nonprofit entity shall be reduced by any amount such Covered Person may collect as

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indemnification or advancement of expenses from such other corporation, partnership, joint venture, trust, enterprise or non-profit enterprise.

               Section 6.6.  Amendment or Repeal.  Any right to indemnification or to advancement of expenses of any Covered Person arising hereunder shall not be eliminated or impaired by an amendment to or repeal of these by-laws after the occurrence of the act or omission that is the subject of the civil, criminal, administrative or investigative action, suit or proceeding for which indemnification or advancement of expenses is sought.

              Section 6.7.  Other Indemnification and Advancement of Expenses.  This Article VI shall not limit the right of the corporation, to the extent and in the manner permitted by law, to indemnify and to advance expenses to persons other than Covered Persons when and as authorized by appropriate corporate action.

ARTICLE VII

Miscellaneous

               Section 7.1.  Fiscal Year.  The fiscal year of the corporation shall be determined by resolution of the Board of Directors.

               Section 7.2.  Seal.  The corporate seal shall have the name of the corpora­tion inscribed thereon and shall be in such form as may be approved from time to time by the Board of Directors.

               Section 7.3.  Manner of Notice.  Except as otherwise provided herein or permitted by applicable law, notices to directors and stockholders shall be in writing and delivered personally or mailed to the directors or stockholders at their addresses appearing on the books of the corporation.  Notice to directors may be given by telegram, telecopier, telephone or other means of electronic transmission.

               Section 7.4.  Waiver of Notice of Meetings of Stockholders, Directors and Committees.  Any waiver of notice, given by the person entitled to notice, whether before or after the time stated therein, shall be deemed equivalent to notice.  Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened.  Neither the business to be transacted at nor the purpose of any regular or special meeting of the stockholders, directors, or members of a committee of directors need be specified in a waiver of notice.

               Section 7.5.  Form of Records.  Any records maintained by the corporation in the regular course of its business, including its stock ledger, books of account, and minute books, may be kept on, or by means of, or be in the form of, any information storage device or

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method, provided that the records so kept can be converted into clearly legible paper form within a reasonable time.

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EX-10.2

Exhibit 10.2

SUN HEALTHCARE GROUP, INC.

2004 EQUITY INCENTIVE PLAN1

Effective as of November 12, 2010

1.           Purpose.  The Sun Healthcare Group, Inc. 2004 Equity Incentive Plan (the “Plan”) is intended to provide incentives which will attract, retain and motivate highly competent persons as officers, key employees and directors of, and consultants to, Sun Healthcare Group, Inc. and its Subsidiaries, by providing them opportunities to acquire shares of the Company’s common stock, par value $.01 per share (the “Common Stock”) or to receive monetary payments based on the value of such shares pursuant to the Benefits (as defined in Section 4 below) described herein.  “Subsidiary” means any corporation or other entity a majority of whose outstanding voting stock or voting power is beneficially owned directly or indirectly by Sun Healthcare Group, Inc.

2.           Administration.

(a)           Committee.  The Plan will be administered by the Compensation Committee of the Board of Directors or such other committee  designated by the Board of Directors of the Company (the “Committee”) from among its members and shall be comprised, unless otherwise determined by the Company’s Board of Directors, solely of not less than two (2) members who shall be (i) “Non-Employee Directors” within the meaning of Rule 16b-3(b)(3) (or any successor rule) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and (ii) “outside directors” within the meaning of Treasury Regulation Section 1.162-27(e)(3) under Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”).

 

1 The Plan has been established to evidence the terms of options and stock units originally granted by Sun Healthcare Group, Inc. (“Old Sun”) under Old Sun’s 2004 Equity Incentive Plan prior to the separation of Old Sun’s real estate assets and operating assets into two separate publicly traded companies (the “Spin-Off”).  The Spin-Off was accomplished by Old Sun’s distribution to its stockholders on a pro rata basis of all of the outstanding shares of common stock of SHG Services, Inc, which was renamed Sun Healthcare Group, Inc. following the completion of the Spin-Off (the “Company”).

Prior to the Spin-Off, the Plan was adopted by the Company’s Board of Directors on November 12, 2010 and was approved by Old Sun, as the Company’s sole shareholder, on November 12, 2010.  Other than the options and stock units originally granted by Old Sun prior to the Spin-Off that have been substituted and assumed under the Plan, no other awards with respect to shares of the Company’s Common Stock or other Benefits shall be made under the Plan following the Spin-Off.  Immediately following the Spin-Off, 1,171,821 shares of Common Stock were subject to such assumed and substituted options and stock units originally granted by Old Sun, and, subject to the adjustment provisions of Section 12 below, no additional shares of Common Stock shall be delivered under the Plan.  The provisions of the Plan otherwise reflect the terms of Old Sun’s 2004 Equity Incentive Plan as in effect immediately prior to the Spin-Off, and as a result certain references to the “Company” or other defined terms should be read and understood in light of this context.

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(b)           Authority.  The Committee is authorized, subject to the provisions of the Plan, to establish such rules and regulations as it deems necessary for the proper administration of the Plan and to make such determinations and interpretations and to take such action in connection with the Plan and any Benefits granted hereunder as it deems necessary or advisable.  All determinations and interpretations made by the Committee shall be binding and conclusive on all participants and their legal representatives.

(c)           Indemnification.  No member of the Committee and no employee of the Company shall be liable for any act or failure to act hereunder, except in circumstances involving his or her bad faith, gross negligence or willful misconduct, or for any act or failure to act hereunder by any other member or employee or by any agent to whom duties in connection with the administration of this Plan have been delegated.  The Company shall indemnify members of the Committee and any agent of the Committee who is an employee of the Company, a subsidiary or an affiliate against any and all liabilities or expenses to which they may be subjected by reason of any act or failure to act with respect to their duties on behalf of the Plan, except in circumstances involving such person’s bad faith, gross negligence or willful misconduct.

(d)           Delegation and Advisers.  The Committee may delegate to one or more of its members, or to one or more agents, such administrative duties as it may deem advisable, and the Committee, or any person to whom it has delegated duties as aforesaid, may employ one or more persons to render advice with respect to any responsibility the Committee or such person may have under the Plan.  The Committee may employ such legal or other counsel, consultants and agents as it may deem desirable for the administration of the Plan and may rely upon any opinion or computation received from any such counsel, consultant or agent.  Expenses incurred by the Committee in the engagement of such counsel, consultant or agent shall be paid by the Company, or the subsidiary or affiliate whose employees have benefited from the Plan, as determined by the Committee.

3.           Participants.  Participants will consist of such Eligible Persons as the Committee in its sole discretion determines to be significantly responsible for the success and future growth and profitability of the Company and whom the Committee may designate from time to time to receive Benefits under the Plan.  An “Eligible Person” is any person who is any one of:  (a) an officer (whether or not a director) or employee of the Company and its Subsidiaries; (b) a director of the Company or one of its Subsidiaries; or (c) an individual consultant or advisor who renders or has rendered bona fide services (other than services in connection with the offering or sale of securities of the Company or one of its Subsidiaries in a capital-raising transaction or as a market maker or promoter of the Company’s or a Subsidiary’s securities) to the Company or one of its Subsidiaries; provided, however, that a person who is otherwise an Eligible Person under clause (c) above may participate in this Plan only if such participation would not adversely affect either the Company’s eligibility to use Form S-8 to register under the Securities Act of 1933, as amended (the “Securities Act”), the offering and sale of shares issuable under this Plan by the Company and its Subsidiaries or the Company’s compliance with any other applicable laws.  Designation of an Eligible Person to receive a Benefit (a “participant”) in any year shall not require the Committee to designate such person to receive a Benefit in any other year or, once designated, to receive the same type or amount of Benefit as granted to the participant in any

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other year.  The Committee shall consider such factors as it deems pertinent in selecting participants and in determining the type and amount of their respective Benefits.

4.           Type of Benefits.  Benefits under the Plan may be granted in any one or a combination of (a) Stock Options, (b) Stock Appreciation Rights, (c) Stock Awards, (d) Stock Units, and (e) Performance-Based Awards, including cash awards granted consistent with Section 10 hereof (each as described below, and collectively, the “Benefits”).  Stock Awards and Stock Units may, as determined by the Committee in its discretion, constitute Performance-Based Awards, as described in Section 10 hereof.  Benefits shall be evidenced by agreements (which need not be identical) in such forms as the Committee may from time to time approve; provided, however, that in the event of any conflict between the provisions of the Plan and any such agreements, the provisions of the Plan shall prevail.

5.           Common Stock Available Under the Plan.2

(a)           Basic Limitations.  Subject to the provisions of Section 12, the capital stock that may be delivered under this Plan subject to Benefits shall be shares of the Company’s authorized but unissued Common Stock and any of its shares held as treasury shares.  The aggregate number of shares of Common Stock that may be subject to Benefits granted under this Plan (the “Share Limit”) shall be shall be equal to the sum of (x) 5,600,000 shares of Common Stock, plus (y) the number of any shares subject to stock options granted under the Company’s 2002 Non-Employee Director Equity Incentive Plan, as amended (the “2002 Director Plan”) and outstanding on March 31, 2004 which expire or have expired, or for any reason are, or have been, cancelled or terminated, since March 31, 2004 without being exercised; provided that in no event shall the Share Limit exceed 5,680,000 shares (which is the sum of the 5,600,000 shares set forth above, plus the number of shares subject to options previously granted and outstanding under the 2002 Director Plan as of March 31, 2004).  The following limits also apply with respect to Benefits under this Plan:

(i)           The maximum number of shares of Common Stock that may be delivered pursuant to Stock Options qualified as Incentive Stock Options granted under this Plan is 5,600,000 shares.

(ii)           The maximum number of shares of Common Stock subject to the Stock Options and Stock Appreciation Rights that are granted during any calendar year to any individual under this Plan is 600,000 shares.

(iii)           Additional limits with respect to Performance-Based Awards are set forth in Section 10.

Each of the foregoing numerical limits is subject to adjustment as contemplated by Section 5(b) and Section 12.

(b)           Additional Shares.  Any shares of Common Stock subject to a Stock Option or Stock Appreciation Right which for any reason is cancelled or terminated without having been exercised, or any shares subject to Stock Awards or Stock Units which are forfeited,

 

2 See Footnote 1.

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or any shares delivered to the Company as part or full payment for the exercise of a Stock Option, Stock Appreciation Right or Stock Award or any shares that are delivered or withheld by the Company or a Subsidiary to satisfy the tax withholding obligations related to any Benefit under this Plan shall again be available for award as Benefits under the Plan.  To the extent that a Benefit is settled in cash or a form other than shares of Common Stock, the shares that would have been delivered had there been no such cash or other settlement shall not be counted against the shares available for issuance under this Plan.  In the event that shares are delivered in respect of a Dividend Equivalent Right (as defined in Section 9(f) below), Stock Appreciation Right, or other Benefit, only the actual number of shares delivered with respect to the Benefit shall be counted against the share limits of this Plan.  The provisions of this Section 5(b) shall apply only for purposes of determining the aggregate number of shares of Common Stock subject to Benefits but shall not apply for purposes of determining the maximum number of shares of Common Stock with respect to which Benefits (including the maximum number of shares of Common Stock subject to Stock Options and Stock Appreciation Rights) may be granted to any individual participant under the Plan.

(c)           Acquisitions.  In connection with the acquisition of any business by the Company or any of its subsidiaries or affiliates, any outstanding grants, awards or sales of options or other similar rights pertaining to such business may be assumed or replaced by Benefits under the Plan upon such terms and conditions as the Committee determines.  The date of any such grant or award shall relate back to the date of the initial grant or award being assumed or replaced, and service with the acquired business shall constitute service with the Company or its subsidiaries or affiliates for purposes of such grant or award.  Any shares of Common Stock underlying any grant or award or sale pursuant to any such acquisition shall be disregarded for purposes of applying the limitations under and shall not reduce the number of shares of Common Stock available under Section 5(a) above.

6.           Stock Options.

(a)           Generally.  Stock Options will consist of awards from the Company that will enable the holder to purchase a number of shares of Common Stock, at set terms.  Stock Options may be “incentive stock options” (“Incentive Stock Options”), within the meaning of Section 422 of the Code, or Stock Options which do not constitute Incentive Stock Options (“Nonqualified Stock Options”).  The Committee will have the authority to grant to any participant one or more Incentive Stock Options, Nonqualified Stock Options, or both types of Stock Options (in each case with or without Stock Appreciation Rights).  Each Stock Option shall be subject to such terms and conditions consistent with the Plan as the Committee may impose from time to time, subject to the following limitations:

(b)           Exercise Price.  Each Stock Option granted hereunder shall have such per-share exercise price as the Committee may determine at the date of grant.  The per share exercise price for each Stock Option shall be not less than 100% of the Fair Market Value (as defined in Section 16 below) of a share of Common Stock on the date of grant of the Stock Option.

(c)           Payment of Exercise Price.  The option exercise price may be paid in cash or, in the discretion of the Committee, by the delivery of shares of Common Stock of the

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Company then owned by the participant, by the withholding of shares of Common Stock for which a Stock Option is exercisable or by a combination of these methods.  In the discretion of the Committee, payment may also be made by delivering a properly executed exercise notice to the Company together with a copy of irrevocable instructions to a broker to deliver promptly to the Company the amount of sale or loan proceeds to pay the exercise price.  To facilitate the foregoing, the Company may enter into agreements for coordinated procedures with one or more brokerage firms.  The Committee may prescribe any other method of paying the exercise price that it determines to be consistent with applicable law and the purpose of the Plan, including, without limitation, in lieu of the exercise of a Stock Option by delivery of shares of Common Stock of the Company then owned by a participant, providing the Company with a notarized statement attesting to the number of shares owned, where upon verification by the Company, the Company would issue to the participant only the number of incremental shares to which the participant is entitled upon exercise of the Stock Option.

(d)           Exercise Period.  Stock Options granted under the Plan shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee; provided, however, that no Stock Option shall be exercisable later than ten (10) years after the date it is granted except in the event of a participant’s death, in which case, the exercise period of such participant’s Stock Options may be extended beyond such period but no later than one (1) year after the participant’s death.  All Stock Options shall terminate at such earlier times and upon such conditions or circumstances as the Committee shall in its discretion set forth in such option agreement at the date of grant.

(e)           Restoration of Stock Options.  The Committee may, at the time of grant, provide for the grant of a subsequent Restoration Stock Option if the exercise price is paid for by delivering previously owned shares of Common Stock of the Company.  Restoration Stock Options (i) may be granted in respect of no more than the number of shares of Common Stock tendered in exercising the predecessor Stock Option, (ii) shall have an exercise price equal to the Fair Market Value (as defined in Section 16 below) on the date the Restoration Stock Option is granted, and (iii) may have an exercise period that does not extend beyond the remaining term of the predecessor Stock Option.  In determining which methods a participant may utilize to pay the exercise price, the Committee may consider such factors as it determines are appropriate.

(f)           Limitations on Incentive Stock Options.  Incentive Stock Options may be granted only to participants who are employees of the Company or of a “Parent Corporation” or “Subsidiary Corporation” (as defined in Sections 424(e) and (f) of the Code, respectively) at the date of grant.  The aggregate Fair Market Value (determined as of the time the Stock Option is granted) of the Common Stock with respect to which Incentive Stock Options are exercisable for the first time by a participant during any calendar year (under all option plans of the Company and of any Parent Corporation or Subsidiary Corporation) shall not exceed one hundred thousand dollars ($100,000).  For purposes of the preceding sentence, Incentive Stock Options will be taken into account in the order in which they are granted.  The per-share exercise price of an Incentive Stock Option shall not be less than one hundred percent (100%) of the Fair Market Value of the Common Stock on the date of grant, and no Incentive Stock Option may be exercised later than ten (10) years after the date it is granted.  In addition, no Incentive Stock Option may be issued to a participant in tandem with a Nonqualified Stock Option.

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(g)           Additional Limitations on Incentive Stock Options for Ten Percent Shareholders.  Incentive Stock Options may not be granted to any participant who, at the time of grant, owns stock possessing (after the application of the attribution rules of Section 424(d) of the Code) more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Parent Corporation or Subsidiary Corporation, unless the exercise price of the option is fixed at not less than one hundred ten percent (110%) of the Fair Market Value of the Common Stock on the date of grant and the exercise of such option is prohibited by its terms after the expiration of five (5) years from the date of grant of such option.

(h)           Modifications of Options/Repricing.  Subject to Section 5 and Section 22 and the specific limitations on Stock Options contained in this Plan, the Committee from time to time may authorize, generally or in specific cases only, for the benefit of any participant, adjustments in the terms and conditions of a Stock Option granted under this Plan.  Notwithstanding any provision in this Section 6(h) or the Plan to the contrary but subject to the adjustment provisions of Section 12, the per share exercise or base price of any Option or Stock Appreciation Right granted under the Plan may not be reduced (by amendment, substitution, cancellation and regrant, exchange, or other means) to a per share price that is less than the exercise or base price of the award, as applicable, as of the date the award was granted.

7.           Stock Appreciation Rights.

(a)           Generally.  The Committee may, in its discretion, grant Stock Appreciation Rights, including a concurrent grant of Stock Appreciation Rights in tandem with any Stock Option grant.  A Stock Appreciation Right means a right to receive a payment in cash, Common Stock or a combination thereof, in an amount equal to the excess of (i) the Fair Market Value, or other specified valuation, of a specified number of shares of Common Stock on the date the right is exercised over (ii) the Fair Market Value, of such shares of Common Stock on the date the right is granted, or other specified amount, all as determined by the Committee (the “Base Price”).  Each Stock Appreciation Right shall be subject to such terms and conditions as the Committee shall impose from time to time.

(b)           Exercise Period.  Stock Appreciation Rights granted under the Plan shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee; provided, however, that no Stock Appreciation Rights shall be exercisable later than ten (10) years after the date it is granted except in the event of a participant’s death, in which case, the exercise period of such participant’s Stock Appreciation Rights may be extended beyond such period but no later than one (1) year after the participant’s death.  All Stock Appreciation Rights shall terminate at such earlier times and upon such conditions or circumstances as the Committee shall in its discretion set forth in such right at the date of grant.

8.           Stock Awards.

(a)           Generally.  The Committee may, in its discretion, grant Stock Awards (which may include mandatory payment of any bonus in stock) consisting of Common Stock issued or transferred to participants with or without other payments therefor.  A Stock Award shall be construed as an offer by the Company to the participant to purchase the number of

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shares of Common Stock subject to the Stock Award at the purchase price, if any, established therefor.  Any right to acquire the shares under the Stock Award that is not exercised by the participant within thirty (30) days after the grant is communicated shall automatically expire.

(b)           Payment of the Purchase Price.  If the Stock Award requires payment therefor, the purchase price of any shares of Common Stock subject to a Stock Award may be paid in any manner authorized by the Committee, which may include any manner authorized under the Plan for the payment of the exercise price of a Stock Option.  Stock Awards may also be made in consideration of services rendered to the Company or its Subsidiaries.

(c)           Additional Terms.  Stock Awards may be subject to such terms and conditions as the Committee determines appropriate, including, without limitation, restrictions on the sale or other disposition of such shares, the right of the Company to reacquire such shares for no consideration upon termination of the participant’s employment within specified periods, and may constitute Performance-Based Awards, as described in Section 10 hereof.  The Committee may require the participant to deliver a duly signed stock power, endorsed in blank, relating to the Common Stock covered by such an Award.  The Committee may also require that the stock certificates evidencing such shares be held in custody or bear restrictive legends until the restrictions thereon shall have lapsed.

(d)           Rights as a Shareholder.  The Stock Award shall specify whether the participant shall have, with respect to the shares of Common Stock subject to a Stock Award, all of the rights of a holder of shares of Common Stock of the Company, including the right to receive dividends and to vote the shares.

9.           Stock Units.

(a)           Generally.  The Committee may, in its discretion, grant Stock Units (as defined in subsection (f) below) to participants hereunder.  The Committee shall determine the criteria for the vesting of Stock Units.  Stock Units may constitute Performance-Based Awards, as described in Section 10 hereof.  Stock Units granted by the Committee shall be payable in shares of Common Stock at such time as provided in this Section 9.  Shares of Common Stock issued pursuant to this Section 9 may be issued with or without other payments therefor as may be required by applicable law or such other consideration as may be determined by the Committee.  The Committee shall determine whether a participant granted a Stock Unit shall be entitled to a Dividend Equivalent Right (as defined in subsection (f) below).

(b)           Settlement of Stock Units.  Upon vesting of Stock Units, unless the Committee has determined to defer payment with respect to such unit in accordance with Section 409A of the Code or except as otherwise provided under subsection (c) below, such Stock Units shall be paid in a lump sum to the participant in shares of Common Stock on or as soon as practicable after the vesting date, but in no event later than two and one-half (2 ½) months after the year in which such Stock Units became vested; provided, however, that the Committee shall have discretion to provide for the payment of the Stock Units in cash equal to the value of the shares of Common Stock which would otherwise be paid to the participant or partly in cash and partly in shares of Common Stock.

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(c)           Irrevocable Election to Defer Payment of Stock Units.  At the time an award of Stock Units is granted (or at such other time as may be provided by the Committee and in all cases at a time that complies with the initial deferral election requirements of Section 409A of the Code), the participant may irrevocably elect, in accordance with rules prescribed by the Committee, not to receive a distribution upon the vesting of such Stock Units and instead have the Company continue to maintain such Stock Units on its books of account.  Unless provided otherwise by the Committee and set forth in the applicable deferral election form or award agreement, if a participant makes an election pursuant to this Section 9(c), the participant’s vested Stock Units will be paid (subject to earlier payment pursuant to subsections (d) and (e) below) on the earlier to occur of (i) a date specified by the participant at the time the award is granted, or (ii) the date of the participant’s Separation from Service (as defined in subsection (f)) from the Company and its Subsidiaries; provided, however, that if the participant is a “specified employee” (within the meaning of Treasury Regulation Section 1.409A-1(i)) on the date of the participant’s Separation from Service, the participant shall not be entitled to payment of any Stock Units that would otherwise be paid in connection with his or her Separation from Service until the earlier of (A) the date which is six (6) months after his or her Separation from Service with the Company for any reason other than death, or (B) the date of the participant’s death; provided, further, that this six-month delay shall apply only to the extent such delay in payment is required to comply with, and avoid the imputation of any tax, penalty or interest under, Section 409A of the Code.  Any Stock Units that have not vested as of the date specified by the participant shall be paid only if and when such Stock Units vest.  If the participant does not make an election under this Section 9(c), the participant’s Stock Units will be paid when and if such Stock Units vest.

(d)           Unforeseeable Emergency.  If a participant has elected payment of his or her Stock Units after the vesting date of such units, the participant may request a distribution of his or her Stock Units for an Unforeseeable Emergency (as defined in subsection (f)).  Such distribution for an Unforeseeable Emergency shall be subject to approval by the Committee and may be made only from the participant’s then vested Stock Units and only to the extent necessary to satisfy such emergency (plus amounts necessary to pay taxes reasonably anticipated as a result of the distribution) after taking into account the extent to which the hardship is or may be relieved (1) through reimbursement or compensation by insurance or otherwise or (2) by liquidation of the participant’s assets, to the extent the liquidation of such assets would not itself cause severe financial hardship.

(e)           Change in Control.  Notwithstanding anything in Section 9(b) or any participant’s distribution election to the contrary, a participant’s vested Stock Units shall be distributed immediately upon the occurrence of a Change in Control (as such term is defined in subsection (f) below).

(f)           Definitions.  For purposes of this Section 9, the definitions contained in this Section 9(f) shall apply.  A “Stock Unit” means a notional account representing one (1) share of Common Stock.  A “Dividend Equivalent Right” means the right to receive the amount of any dividend paid on the share of Common Stock underlying a Stock Unit, which shall be payable in cash or in the form of additional Stock Units.  A “Separation from Service” shall mean a “separation from service” within the meaning of Treasury Regulation Section 1.409A-1(h)(1), without regard to the optional alternative definitions available thereunder.  An

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“Unforeseeable Emergency” means a severe financial hardship to the participant resulting from (i) an illness or accident of the participant, the participant’s spouse, or a dependent (as defined in Section 152(a) of the Code without regard to paragraphs (b)(1), (b)(2) and (d)(1)(b) thereof) of the participant, (ii) loss of the participant’s property due to casualty, or (iii) other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant, all as determined by the Committee in its sole discretion.  “Change in Control” has the meaning ascribed to such term in Section 12(d) of this Plan; provided, however, that in all cases a Change in Control for purposes of Section 9(e) must qualify as a “change in the ownership,” a “change in the effective control” or a “change in the ownership of a substantial portion of the assets” of the Company, in each case as determined in accordance with Treasury Regulation Section 1.409A-3(i)(5).

10.           Performance-Based Awards.

(a)           Generally.  Any Benefits granted under the Plan may be granted in a manner such that the Benefits qualify for the performance-based compensation exemption of Section 162(m) of the Code (“Performance-Based Awards”).  Grants or awards under this Section 10 may be paid in cash or shares of Common Stock or any combination thereof.  As determined by the Committee in its sole discretion, either the granting or vesting of such Performance-Based Awards shall be based on achievement of hurdle rates and/or growth rates in one or more business criteria that apply to the individual participant, one or more business units or the Company as a whole.  The maximum number of shares of Common Stock which may be delivered pursuant to Performance-Based Awards (other than Stock Options and Stock Appreciation Rights, and other than cash awards covered by the following sentence) that are granted to any one participant in any one calendar year shall not exceed 600,000 shares, either individually or in the aggregate, subject to adjustment as provided in Section 12.  In addition, the aggregate amount of compensation to be paid to any one participant in respect of all Performance-Based Awards payable only in cash and not related to shares of Common Stock and granted to that participant in any one calendar year shall not exceed $1,000,000.00.  Awards that are cancelled during the year shall be counted against these limits to the extent permitted by Section 162(m) of the Code.

(b)           Business Criteria.  The business criteria shall be as follows, individually or in combination:  (i) net earnings; (ii) earnings per share; (iii) net sales growth; (iv) market share; (v) net operating profit; (vi) expense targets; (vii) working capital targets relating to inventory and/or accounts receivable; (viii) operating margin; (ix) return on equity; (x) return on assets; (xi) planning accuracy (as measured by comparing planned results to actual results); (xii) market price per share; (xiii) total return to stockholders, and (xiv) measurably improving quality of care outcomes at Company facilities.  In addition, Performance-Based Awards may include comparisons to the performance of other companies, such performance to be measured by one or more of the foregoing business criteria.

(c)           Establishment of Performance Goals.  With respect to Performance-Based Awards, the Committee shall establish in writing no later than ninety (90) days after the commencement of the performance period (but in no event after twenty-five percent (25%) of such period has elapsed) (i) the performance goals applicable to a given period, and such performance goals shall state, in terms of an objective formula or standard, the method for

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computing the amount of compensation payable to the participant if such performance goals are obtained and (ii) the individual employees or class of employees to which such performance goals apply.  The applicable performance measurement period may not be less than three months nor more than 10 years.

(d)           Certification of Performance.  No Performance-Based Awards shall be payable to or vest with respect to, as the case may be, any participant for a given period until the Committee certifies in writing that the objective performance goals (and any other material terms) applicable to such period have been satisfied.

(e)           Modification of Performance-Based Awards.  With respect to any Benefits intended to qualify as Performance-Based Awards, after establishment of a performance goal, the Committee shall not revise such performance goal or increase the amount of compensation payable thereunder (as determined in accordance with Section 162(m) of the Code) upon the attainment of such performance goal.  Notwithstanding the preceding sentence, the Committee may reduce or eliminate the number of shares of Common Stock or cash granted or the number of shares of Common Stock vested upon the attainment of such performance goal if the Committee preserves such authority at the time of grant by language to this effect in its authorizing resolutions or otherwise.

(f)           Expiration of Grant Authority.  As required pursuant to Section 162(m) of the Code and the regulations promulgated thereunder, the Committee’s authority to grant new awards that are intended to qualify as performance-based compensation within the meaning of Section 162(m) of the Code (other than Stock Options and Stock Appreciation Rights) shall terminate upon the first meeting of the Company’s shareholders that occurs in the fifth year following the Restatement Date.

11.           Foreign Laws.  The Committee may grant Benefits to individual participants who are subject to the tax laws of nations other than the United States, which Benefits may have terms and conditions as determined by the Committee as necessary to comply with applicable foreign laws.  The Committee may take any action which it deems advisable to obtain approval of such Benefits by the appropriate foreign governmental entity; provided, however, that no such Benefits may be granted pursuant to this Section 11 and no action may be taken which would result in a violation of the Exchange Act, the Code or any other applicable law.

12.           Adjustment Provisions; Change in Control.

(a)           Adjustment Generally.  If there shall be any change in the Common Stock of the Company, through merger, consolidation, reorganization, recapitalization, stock dividend, stock split, reverse stock split, split up, spin-off, combination of shares, exchange of shares, dividend in kind or other like change in capital structure or distribution (other than normal cash dividends) to stockholders of the Company, an adjustment shall be made to each outstanding Stock Option and Stock Appreciation Right such that each such Stock Option and Stock Appreciation Right shall thereafter be exercisable for such securities, cash and/or other property as would have been received in respect of the Common Stock subject to such Stock Option or Stock Appreciation Right had such Stock Option or Stock Appreciation Right been

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exercised in full immediately prior to such change or distribution, and such an adjustment shall be made successively each time any such change shall occur.

(b)           Modification of Benefits.  In the event of any change or distribution described in subsection (a) above, in order to prevent dilution or enlargement of participants’ rights under the Plan, the Committee will have authority to adjust, in an equitable manner, the number and kind of shares that may be issued under the Plan, the number and kind of shares subject to outstanding Benefits, the exercise price applicable to outstanding Benefits, and the Fair Market Value of the Common Stock and other value determinations applicable to outstanding Benefits;  provided, however,  that any such arithmetic adjustment to a Performance-Based Award shall not cause the amount of compensation payable thereunder to be increased from what otherwise would have been due upon attainment of the unadjusted award.  Appropriate adjustments may also be made by the Committee in the terms of any Benefits under the Plan to reflect such changes or distributions and to modify any other terms of outstanding Benefits on an equitable basis, including modifications of performance targets and changes in the length of performance periods; provided, however, that any such arithmetic adjustment to a Performance-Based Award shall not cause the amount of compensation payable thereunder to be increased from what otherwise would have been due upon attainment of the unadjusted award.  In addition, other than with respect to Stock Options, Stock Appreciation Rights, and other awards intended to constitute Performance-Based Awards, the Committee is authorized to make adjustments to the terms and conditions of, and the criteria included in, Benefits in recognition of unusual or nonrecurring events affecting the Company or the financial statements of the Company, or in response to changes in applicable laws, regulations, or accounting principles.  Notwithstanding the foregoing, (i) each such adjustment with respect to an Incentive Stock Option shall comply with the rules of Section 424(a) of the Code, and (ii) in no event shall any adjustment be made which would render any Incentive Stock Option granted hereunder other than an incentive stock option for purposes of Section 422 of the Code.

(c)           Effect of a Change in Control.  Notwithstanding any other provision of this Plan, if there is a Change in Control (as defined in subsection (d) below) of the Company, all then outstanding Stock Options, Stock Appreciation Rights and Stock Units shall immediately vest and become exercisable and any restrictions on Stock Awards or Stock Units shall immediately lapse.  Thereafter, all Benefits shall be subject to the terms of any agreement effecting the Change in Control, which agreement, may provide, without limitation, that each Stock Option and Stock Appreciation Right outstanding hereunder shall terminate within a specified number of days after notice to the holder, and that such holder shall receive, with respect to each share of Common Stock subject to such Stock Option or Stock Appreciation Right, an amount equal to the excess of the Fair Market Value of such shares of Common Stock immediately prior to the occurrence of such Change in Control over the exercise price per share underlying such Stock Option or Stock Appreciation Right with such amount payable in cash, in one or more kinds of property (including the property, if any, payable in the transaction) or in a combination thereof, as the Committee, in its discretion, shall determine.  A provision like the one contained in the preceding sentence shall be inapplicable to a Stock Option or Stock Appreciation Right granted within six (6) months before the occurrence of a Change in Control if the holder of such Stock Option or Stock Appreciation Right is subject to the reporting requirements of Section 16(a) of the Exchange Act and no exception from liability under Section 16(b) of the Exchange Act is otherwise available to such holder.

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(d)           Definitions.  For purposes of this Section 12, a “Change in Control” of the Company shall be deemed to have occurred if any of the following events occurs following the completion of the Spin-Off:

(i)           Any “person” or “group” (within the meaning of Sections 13(d) and 14(d)(2) of the Exchange Act), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company (an “Acquiring Person”), is or becomes the “beneficial owner” (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of more than 33 1/3% of the then outstanding voting stock of the Company;

(ii)           A merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least 51% of the combined voting power of the voting securities of the Company or surviving entity outstanding immediately after such merger or consolidation;

(iii)           A sale or other disposition by the Company of all or substantially all of the Company’s assets;

(iv)           During any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board of Directors of the Company and any new director (other than a director who is a representative or nominee of an Acquiring Person) whose election by the Company’s Board of Directors or nomination for election by the Company’s shareholders was approved by a vote of at least a majority of the directors then still in office who either were directors at the beginning of the period or whose election or nomination was previously so approved, no longer constitute a majority of the Company’s Board of Directors;

provided, however, in no event shall any acquisition of securities, a change in the composition of the Company’s Board of Directors or a merger or other consolidation pursuant to a plan of reorganization under chapter 11 of the Bankruptcy Code with respect to the Company (“Chapter 11 Plan”), or a liquidation under the Bankruptcy Code constitute a Change in Control.  In addition, notwithstanding Sections 12(d)(i), 12(d)(ii), 12(d)(iii) and 12(d)(iv) hereof, a Change in Control shall not be deemed to have occurred in the event of a sale or conveyance in which the Company continues as a holding company of an entity or entities that conduct the business or businesses formerly conducted by the Company, or any transaction undertaken for the purpose of reincorporating the Company under the laws of another jurisdiction, if such transaction does not materially affect the beneficial ownership of the Company’s capital stock.

13.           Nontransferability.  Each Benefit granted under the Plan to a participant shall not be transferable otherwise than by will or the laws of descent and distribution, and shall be exercisable, during the participant’s lifetime, only by the participant.  In the event of the death of a participant, each Stock Option or Stock Appreciation Right theretofore granted to him or her shall be exercisable during such period after his or her death as the Committee shall in its

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discretion set forth in such option or right at the date of grant and then only by the executor or administrator of the estate of the deceased participant or the person or persons to whom the deceased participant’s rights under the Stock Option or Stock Appreciation Right shall pass by will or the laws of descent and distribution.  Notwithstanding the foregoing, at the discretion of the Committee, an award of a Benefit other than an Incentive Stock Option may permit the transferability of a Benefit by a participant solely to the participant’s spouse, siblings, parents, children and grandchildren or trusts for the benefit of such persons or partnerships, corporations, limited liability companies or other entities owned solely by such persons, including trusts for such persons, subject to any restriction included in the award of the Benefit.  Consistent with Section 18, any permitted transfer shall be subject to the condition that the Committee receive evidence satisfactory to it that the transfer (a) is being made for essentially donative, estate and/or tax planning purposes on a gratuitous or donative basis and without consideration, and (b) will not compromise the Company’s ability to register shares issuable under this Plan on Form S-8 under the Securities Act.  Notwithstanding the foregoing, Incentive Stock Options and Stock Awards that are subject to “a substantial risk of forfeiture” under Section 83 of the Code shall be subject to any and all additional transfer restrictions under the Code to the extent necessary to maintain the intended tax consequences of such awards.

14.           Other Provisions.  The award of any Benefit under the Plan may also be subject to such other provisions (whether or not applicable to the Benefit awarded to any other participant) as the Committee determines appropriate, including, without limitation, for the installment purchase of Common Stock under Stock Options, for the installment exercise of Stock Appreciation Rights, to assist the participant in financing the acquisition of Common Stock, for the forfeiture of, or restrictions on resale or other disposition of, Common Stock acquired under any form of Benefit, for the acceleration of exercisability or vesting of Benefits in the event of a change in control of the Company, for the payment of the value of Benefits to participants in the event of a change in control of the Company, or to comply with federal and state securities laws, or understandings or conditions as to the participant’s employment in addition to those specifically provided for under the Plan.

15.           Effect of a Termination of Service on Benefits.

(a)           General.  The Committee shall establish the effect of a termination of employment or service on the rights and benefits under each award under this Plan and in so doing may make distinctions based upon, inter alia, the cause of termination and type of Benefit (including without limitation, the participant’s death, Disability, a termination for Good Cause or termination by the participant for Good Reason).  If the participant is not an employee or director of the Company or a Subsidiary and provides other services to the Company or a Subsidiary, the Committee shall be the sole judge for purposes of this Plan (unless a contract or the award otherwise provides) of whether the participant continues to render services to the Company or a Subsidiary and the date, if any, upon which such services shall be deemed to have terminated.

(b)           Events Not Deemed Terminations of Service.  Unless Company policy or the Committee otherwise provides, the employment relationship shall not be considered terminated in the case of (i) sick leave, (ii) military leave, or (iii) any other leave of absence authorized by the Company or the Committee; provided that unless reemployment upon the expiration of such leave is guaranteed by contract or law, such leave is for a period of not more

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than 90 days.  In the case of any employee of the Company on an approved leave of absence, continued vesting of the Benefit while on leave from the employ of the Company may be suspended until the employee returns to service, unless the Committee otherwise provides or applicable law otherwise requires.  In no event shall a Benefit be exercised after the expiration of the term set forth in the award agreement.

(c)           Effect of Change of Subsidiary Status.  For purposes of this Plan and any Benefit, if an entity ceases to be a Subsidiary of the Company a termination of employment or service shall be deemed to have occurred with respect to each Eligible Person in respect of such Subsidiary who does not continue as an Eligible Person in respect of another entity within the Company after giving effect to the Subsidiary’s change in status.

(d)           Definitions.  For purposes of this Section 15, the definitions contained in this Section 15(d) shall apply.

(i)           “Disability” with respect to a participant means that the participant has experienced one of the following:  (1) the participant is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, or (2) the participant is, by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than three months under an accident and health plan covering employees of the participant’s employer.

(ii)           “Good Cause” with respect to a participant means (unless otherwise expressly provided in the applicable agreement setting forth the terms and conditions of the award, or another applicable contract with the participant that defines such term for purposes of determining the effect that a “for cause” termination has on the participant’s awards) any one of the following:  (A) any criminal conviction of the participant under the laws of the United States or any state or other political subdivision thereof which, in the good faith determination of the Company renders participant unsuitable as an employee or officer of the Company or any Subsidiary; (B) the participant’s continued failure to substantially perform the duties reasonably requested by the Company and commensurate with the participant’s position and within the participant’s control in such position (other than any such failure resulting from participant’s incapacity due to the participant’s Disability) after a written demand for substantial performance is delivered to the participant by the Company, which demand specifically identifies the manner in which the Company believes that the participant has not substantially performed the participant’s duties, and which performance is not substantially corrected by the participant within ten (10) days of receipt of such demand; or (C) any material workplace misconduct or willful failure to comply with the Company’s general policies and procedures as they may exist from time to time by the Company which, in the good faith determination of the Company, renders the participant unsuitable as an employee or officer of Company.

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(iii)           “Good Reason” with respect to a participant means (unless otherwise expressly provided in the applicable agreement setting forth the terms and conditions of the award, or another applicable contract with the participant that defines such term for purposes of determining the effect that a “good reason” termination has on the participant’s awards) a resignation of the participant’s employment with the Company as a result of and within 60 days after the occurrence of any of the following without the participant’s written consent:  (A) a meaningful and detrimental reduction in the participant’s authority, duties or responsibilities, or a meaningful and detrimental change in the participant’s reporting responsibilities, as in effect immediately prior to the participant’s termination of employment; (B) a material reduction in the participant’s annual base salary as in effect immediately prior to the participant’s delivery of notice to the Company stating the basis of the participant’s allegation that “Good Reason” exists (the “Good Reason Notice”), a material reduction in the participant’s target annual bonus (expressed as a percentage of base salary), if any, as in effect immediately prior to the circumstances described in the Good Reason Notice, or a material failure to provide the participant with any other form of compensation or material employment benefit being provided to the participant immediately prior to the circumstances described in the Good Reason Notice (excluding however, any reduction in the amount of any annual bonus or the granting or withholding of incentive compensation (including without limitation options or restricted stock units) but including a material reduction to the target amount of the bonus as stated above); or (C) a relocation of the participant’s principal place of employment by more than fifty (50) miles (or the requirement that the participant be based at a different location), provided that such relocation results in a longer commute (measured by actual mileage) for the participant from his or her primary residence to such new location.  Notwithstanding the foregoing, for any of the foregoing circumstances to constitute “Good Reason” hereunder, (x) the participant must deliver the Good Reason Notice to the Company within 30 days of the date on which the circumstances creating “Good Reason” have first occurred, (y) such circumstances are not corrected by the Company in a manner that is reasonably satisfactory to the participant (including full retroactive correction with respect to any monetary matter) within 30 days of the Company’s receipt of the Good Reason Notice from the participant and, (z) the participant thereafter resigns his or her employment within the 60 day time period described above.

16.           Fair Market Value.  For purposes of this Plan and any Benefits awarded hereunder, Fair Market Value shall be the closing price of the Company’s Common Stock on the date of calculation (or on the last preceding trading date if Common Stock was not traded on such date) if the Company’s Common Stock is readily tradable on a national securities exchange or other market system, and if the Company’s Common Stock is not readily tradable, Fair Market Value shall mean the amount determined in good faith by the Committee as the fair market value of the Common Stock of the Company.

17.           Withholding.  All payments or distributions of Benefits made pursuant to the Plan shall be net of any amounts required to be withheld pursuant to applicable federal, state and local tax withholding requirements.  If the Company proposes or is required to distribute Common Stock pursuant to the Plan, it may require the recipient to remit to it or to the corporation that employs such recipient an amount sufficient to satisfy such tax withholding

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requirements prior to the delivery of any certificates for such Common Stock.  In lieu thereof, the Company or the employing corporation shall have the right to withhold the amount of such taxes from any other sums due or to become due from such corporation to the recipient as the Committee shall prescribe.  The Committee may, in its discretion and subject to such rules as it may adopt (including any as may be required to satisfy applicable tax and/or non-tax regulatory requirements), permit an optionee or award or right holder to pay all or a portion of the federal, state and local withholding taxes arising in connection with any Benefit consisting of shares of Common Stock by electing to have the Company withhold shares of Common Stock having a Fair Market Value equal to the amount of tax to be withheld, such tax calculated at rates required by statute or regulation.  In no event shall the shares withheld exceed the minimum whole number of shares required for tax withholding under applicable law.

18.           Compliance with Laws.  This Plan, the granting and vesting of Benefits under this Plan, the offer, issuance and delivery of shares of Common Stock, the acceptance of promissory notes and/or the payment of money under this Plan or under Benefits are subject to compliance with all applicable federal and state laws, rules and regulations (including but not limited to state and federal securities law, and federal margin requirements) and to such approvals by any listing, regulatory or governmental authority as may, in the opinion of counsel for the Company, be necessary or advisable in connection therewith.  The person acquiring any securities under this Plan will, if requested by the Company or one of its Subsidiaries, provide such assurances and representations to the Company or one of its Subsidiaries as the Committee may deem necessary or desirable to assure compliance with all applicable legal and accounting requirements.

19.           Employment Status; No Employment/Service Contract.  No person shall have any claim or rights to be granted a Benefit (or additional Benefits, as the case may be) under this Plan, subject to any express contractual rights (set forth in a document other than this Plan) to the contrary.  Nothing contained in this Plan (or in any other documents under this Plan or in any Benefit) shall confer upon any participant any right to continue in the employ or other service of the Company or one of its Subsidiaries, constitute any contract or agreement of employment or other service or affect an employee’s status as an employee at will, nor shall interfere in any way with the right of the Company or one of its Subsidiaries to change a person’s compensation or other benefits, or to terminate his or her employment or other service, with or without cause.  Nothing in this Section 19, however, is intended to adversely affect any express independent right of such person under a separate employment or service contract other than an award agreement.

20.           Unfunded Plan.  Participants shall have no right, title, or interest whatsoever in or to any investments which the Company may make to aid it in meeting its obligations under the Plan.  Nothing contained in the Plan, and no action taken pursuant to its provisions, shall create or be construed to create a trust of any kind, or a fiduciary relationship between the Company and any participant, beneficiary, legal representative or any other person.  To the extent that any person acquires a right to receive payments from the Company under the Plan, such right shall be no greater than the right of an unsecured general creditor of the Company.  All payments to be made hereunder shall be paid from the general funds of the Company and no special or separate fund shall be established and no segregation of assets shall be made to assure payment of such

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amounts except as expressly set forth in the Plan.  The Plan is not intended to be subject to the Employee Retirement Income Security Act of 1974, as amended.

21.           No Fractional Shares.  No fractional shares of Common Stock shall be issued or delivered pursuant to the Plan or any Benefit.  The Committee shall determine whether cash, or Benefits, or other property shall be issued or paid in lieu of fractional shares or whether such fractional shares or any rights thereto shall be forfeited or otherwise eliminated.

22.           Duration, Amendment and Termination.

(a)           No Benefit shall be granted more than ten (10) years after the Effective Date.

(b)           The Committee may amend the Plan from time to time or suspend or terminate the Plan at any time.  No Benefits may be granted during any period that the Committee suspends this Plan.  Without limiting any other express authority of the Committee under (but subject to) the express limits of this Plan, the Committee by agreement or resolution may waive conditions of or limitations on Benefits to participants that the Committee in the prior exercise of its discretion has imposed, without the consent of a participant, and may make other changes to the terms and conditions of Benefits.  Notwithstanding the foregoing, no amendment, suspension or termination of this Plan or change of or affecting any outstanding Benefit shall, without written consent of the participant, affect in any manner materially adverse to the participant any rights or benefits of the participant or obligations of the Company under any Benefit granted under this Plan prior to the effective date of such change.  Changes, settlements and other actions contemplated by Section 12 shall not be deemed to constitute changes or amendments for purposes of this Section 22(b).

(c)           To the extent then required by applicable law or any applicable listing agency or required under Sections 162, 422 or 424 of the Code to preserve the intended tax consequences of this Plan, or deemed necessary or advisable by the Committee, any amendment to this Plan shall be subject to stockholder approval.

23.           Governing Law.  This Plan, Benefits granted hereunder and actions taken in connection herewith shall be governed and construed in accordance with the laws of the State of Delaware (regardless of the law that might otherwise govern under applicable Delaware principles of conflict of laws).

24.           Effective Date.3  The Plan, originally entitled the 2002 Management Equity Incentive Plan, first became effective as of February 28, 2002 (the “Effective Date”) and was approved by the Company’s stockholders on February 6, 2002.  The Plan was subsequently amended and restated effective March 31, 2004 (the “2004 Restatement Date”).  The Plan was subsequently amended and restated effective March 29, 2006 (the “2006 Restatement Date”), subject to the approval of the Company’s stockholders no later than twelve months after the 2006 Restatement Date (the date of stockholder approval is referred to as the “Stockholder Approval Date”).  The Plan was subsequently amended and restated effective December 18, 2008 (the “2008 Restatement Date”).

 

3 See Footnote 1.

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25.           Non-Exclusivity of Plan.  Nothing in this Plan shall limit or be deemed to limit the authority of the Board or the Committee to grant awards or authorize any other compensation, with or without reference to the Common Stock, under any other plan or authority.

26.           No Corporate Action Restriction.  The existence of this Plan, the award agreements and the Benefits granted hereunder shall not limit, affect or restrict in any way the right or power of the Board or the shareholders of the Company to make or authorize:  (a) any adjustment, recapitalization, reorganization or other change in the capital structure or business of the Company or any subsidiary, (b) any merger, amalgamation, consolidation or change in the ownership of the Company or any subsidiary, (c) any issue of bonds, debentures, capital, preferred or prior preference stock ahead of or affecting the capital stock (or the rights thereof) of the Company or any subsidiary, (d) any dissolution or liquidation of the Company or any subsidiary, (e) any sale or transfer of all or any part of the assets or business of the Company or any subsidiary, or (f) any other corporate act or proceeding by the Company or any subsidiary.  No participant, beneficiary or any other person shall have any claim under any Benefit or award agreement against any member of the Board or the Committee, or the Company or any employees, officers or agents of the Company or any subsidiary, as a result of any such action.

27.           Other Company Benefit and Compensation Programs.  Payments and other benefits received by a participant under a Benefit made pursuant to this Plan shall not be deemed a part of a participant’s compensation for purposes of the determination of benefits under any other employee welfare or benefit plans or arrangements, if any, provided by the Company or any subsidiary, except where the Committee expressly otherwise provides or authorizes in writing.  Benefits under this Plan may be made in addition to, in combination with, as alternatives to or in payment of grants, awards or commitments under any other plans or arrangements of the Company or its subsidiaries.

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EX-10.3

Exhibit 10.3

SUN HEALTHCARE GROUP, INC.

2009 PERFORMANCE INCENTIVE PLAN

1.  PURPOSE OF PLAN

The purpose of this Sun Healthcare Group, Inc. 2009 Performance Incentive Plan (this “Plan”) of Sun Healthcare Group, Inc., a Delaware corporation formerly named SHG Services, Inc. (the “Corporation”), is to promote the success of the Corporation and to increase stockholder value by providing an additional means through the grant of awards to attract, motivate, retain and reward selected employees and other eligible persons.  This Plan was established by the Corporation prior to and in connection with the distribution by Sun Healthcare Group, Inc. (“Old Sun”) of the Corporation’s Common Stock (as defined below) to Old Sun’s stockholders in order to effect the separation of Old Sun’s real estate assets and operating assets into two separate publicly traded corporations (the “Spin-Off”).

2.  ELIGIBILITY

The Administrator (as such term is defined in Section 3.1) may grant awards under this Plan only to those persons that the Administrator determines to be Eligible Persons.  An “Eligible Person” is any person who is either:  (a) an officer (whether or not a director) or employee of the Corporation or one of its Subsidiaries; (b) a director of the Corporation or one of its Subsidiaries; or (c) an individual consultant or advisor who renders or has rendered bona fide services (other than services in connection with the offering or sale of securities of the Corporation or one of its Subsidiaries in a capital-raising transaction or as a market maker or promoter of securities of the Corporation or one of its Subsidiaries) to the Corporation or one of its Subsidiaries and who is selected to participate in this Plan by the Administrator; provided, however, that a person who is otherwise an Eligible Person under clause (c) above may participate in this Plan only if such participation would not adversely affect either the Corporation’s eligibility to use Form S-8 to register under the Securities Act of 1933, as amended (the “Securities Act”), the offering and sale of shares issuable under this Plan by the Corporation or the Corporation’s compliance with any other applicable laws.  An Eligible Person who has been granted an award (a “participant”) may, if otherwise eligible, be granted additional awards if the Administrator shall so determine.  As used herein, “Subsidiary” means any corporation or other entity a majority of whose outstanding voting stock or voting power is beneficially owned directly or indirectly by the Corporation; and “Board” means the Board of Directors of the Corporation.

3.  PLAN ADMINISTRATION

3.1 The Administrator.  This Plan shall be administered by and all awards under this Plan shall be authorized by the Administrator.  The “Administrator” means the Board or one or more committees appointed by the Board or another committee (within its delegated authority) to administer all or certain aspects of this Plan.  Any such committee shall be comprised solely of one or more directors or such number of directors as may be required under applicable law.  A committee may

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delegate some or all of its authority to another committee so constituted.  The Board or a committee comprised solely of directors may also delegate, to the extent permitted by Section 157(c) of the Delaware General Corporation Law and any other applicable law, to one or more officers of the Corporation, its powers under this Plan (a) to designate the officers and employees of the Corporation and its Subsidiaries who will receive grants of awards under this Plan, and (b) to determine the number of shares subject to, and the other terms and conditions of, such awards.  The Board may delegate different levels of authority to different committees with administrative and grant authority under this Plan.  Unless otherwise provided in the Bylaws of the Corporation or the applicable charter of any Administrator: (a) a majority of the members of the acting Administrator shall constitute a quorum, and (b) the vote of a majority of the members present assuming the presence of a quorum or the unanimous written consent of the members of the Administrator shall constitute action by the acting Administrator.

With respect to awards intended to satisfy the requirements for performance-based compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”), this Plan shall be administered by a committee consisting solely of two or more outside directors (as this requirement is applied under Section 162(m) of the Code); provided, however, that the failure to satisfy such requirement shall not affect the validity of the action of any committee otherwise duly authorized and acting in the matter.  Award grants, and transactions in or involving awards, intended to be exempt under Rule 16b-3 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), must be duly and timely authorized by the Board or a committee consisting solely of two or more non-employee directors (as this requirement is applied under Rule 16b-3 promulgated under the Exchange Act).  To the extent required by any applicable listing agency, this Plan shall be administered by a committee composed entirely of independent directors (within the meaning of the applicable listing agency).

3.2 Powers of the Administrator.  Subject to the express provisions of this Plan, the Administrator is authorized and empowered to do all things necessary or desirable in connection with the authorization of awards and the administration of this Plan (in the case of a committee or delegation to one or more officers, within the authority delegated to that committee or person(s)), including, without limitation, the authority to:

(a) determine eligibility and, from among those persons determined to be eligible, the particular Eligible Persons who will receive an award under this Plan;

(b) grant awards to Eligible Persons, determine the price at which securities will be offered or awarded and the number of securities to be offered or awarded to any of such persons, determine the other specific terms and conditions of such awards consistent with the express limits of this Plan, establish the installments (if any) in which such awards shall become

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exercisable or shall vest (which may include, without limitation, performance and/or time-based schedules), or determine that no delayed exercisability or vesting is required, establish any applicable performance targets, and establish the events of termination or reversion of such awards;

(c) approve the forms of award agreements (which need not be identical either as to type of award or among participants);

(d) construe and interpret this Plan and any agreements defining the rights and obligations of the Corporation, its Subsidiaries, and participants under this Plan, further define the terms used in this Plan, and prescribe, amend and rescind rules and regulations relating to the administration of this Plan or the awards granted under this Plan;

(e) cancel, modify, or waive the Corporation’s rights with respect to, or modify, discontinue, suspend, or terminate any or all outstanding awards, subject to any required consent under Section 8.6.5;

(f) accelerate or extend the vesting or exercisability or extend the term of any or all such outstanding awards (in the case of options or stock appreciation rights, within the maximum seven-year term of such awards) in such circumstances as the Administrator may deem appropriate (including, without limitation, in connection with a termination of employment or services or other events of a personal nature) subject to any required consent under Section 8.6.5;

(g) adjust the number of shares of Common Stock subject to any award, adjust the price of any or all outstanding awards or otherwise change previously imposed terms and conditions, in such circumstances as the Administrator may deem appropriate, in each case subject to Sections 4 and 8.6 (subject to the no repricing provision below);

(h) determine the date of grant of an award, which may be a designated date after but not before the date of the Administrator’s action (unless otherwise designated by the Administrator, the date of grant of an award shall be the date upon which the Administrator took the action granting an award);

(i) determine whether, and the extent to which, adjustments are required pursuant to Section 7 hereof and authorize the termination, conversion, substitution or succession of awards upon the occurrence of an event of the type described in Section 7;

(j) acquire or settle (subject to Sections 7 and 8.6) rights under awards in cash, stock of equivalent value, or other consideration (subject to the no repricing provision below); and

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(k) determine the fair market value of the Common Stock or awards under this Plan from time to time and/or the manner in which such value will be determined.

Notwithstanding the foregoing and except for an adjustment pursuant to Section 7.1 or a repricing approved by stockholders, in no case may the Administrator (1) amend an outstanding stock option or SAR to reduce the exercise price or base price of the award, (2) cancel, exchange, or surrender an outstanding stock option or SAR in exchange for cash or other awards for the purpose of repricing the award, or (3) cancel, exchange, or surrender an outstanding stock option or SAR in exchange for an option or SAR with an exercise or base price that is less than the exercise or base price of the original award.

3.3 Binding Determinations.  Any action taken by, or inaction of, the Corporation, any Subsidiary, or the Administrator relating or pursuant to this Plan and within its authority hereunder or under applicable law shall be within the absolute discretion of that entity or body and shall be conclusive and binding upon all persons.  Neither the Board nor any Board committee, nor any member thereof or person acting at the direction thereof, shall be liable for any act, omission, interpretation, construction or determination made in good faith in connection with this Plan (or any award made under this Plan), and all such persons shall be entitled to indemnification and reimbursement by the Corporation in respect of any claim, loss, damage or expense (including, without limitation, attorneys’ fees) arising or resulting therefrom to the fullest extent permitted by law and/or under any directors and officers liability insurance coverage that may be in effect from time to time.

3.4 Reliance on Experts.  In making any determination or in taking or not taking any action under this Plan, the Administrator may obtain and may rely upon the advice of experts, including employees and professional advisors to the Corporation.  No director, officer or agent of the Corporation or any of its Subsidiaries shall be liable for any such action or determination taken or made or omitted in good faith.

3.5 Delegation.  The Administrator may delegate ministerial, non-discretionary functions to individuals who are officers or employees of the Corporation or any of its Subsidiaries or to third parties.

4.  SHARES OF COMMON STOCK SUBJECT TO THE PLAN; SHARE LIMITS

4.1 Shares Available.  Subject to the provisions of Section 7.1, the capital stock that may be delivered under this Plan shall be shares of the Corporation’s authorized but unissued Common Stock and any shares of its Common Stock held as treasury shares.  For purposes of this Plan, “Common Stock” shall mean the common stock of the Corporation and such other securities or property as may become the subject of awards under this Plan, or may become subject to such awards, pursuant to an adjustment made under Section 7.1.

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4.2 Share Limits.  The maximum number of shares of Common Stock that may be delivered pursuant to awards granted to Eligible Persons under this Plan (the “Share Limit”) is equal to the sum of the following:

(1) 4,000,000 shares of Common Stock, plus

(2) the number of any shares subject to stock options and stock appreciation rights substituted and assumed under the Corporation’s 2004 Equity Incentive Plan (the “2004 Plan”) and under the Corporation’s 2002 Non-Employee Director Equity Incentive Plan (the “Director Plan”) in connection with the Spin-Off which expire, or for any reason are cancelled or terminated, after the date of the Spin-Off without being exercised, plus

(3) 1.0 times the number of any shares subject to restricted stock and restricted stock unit awards substituted and assumed under the 2004 Plan in connection with the Spin-Off that are forfeited, terminated, cancelled or otherwise reacquired by the Corporation after the date of the Spin-Off without having become vested.

Shares issued in respect of any “Full-Value Award” granted under this Plan shall be counted against the foregoing Share Limit as 1.0 share for every one share actually issued in connection with such award.  (For example, if a stock bonus of 100 shares of Common Stock is granted under this Plan, 100 shares shall be charged against the Share Limit in connection with that award.)  For this purpose, a “Full-Value Award” means any award under this Plan that is not a stock option grant or a stock appreciation right grant.

The following limits also apply with respect to awards granted under this Plan:

(a) The maximum number of shares of Common Stock that may be delivered pursuant to options qualified as incentive stock options granted under this Plan is 4,000,000 shares.

(b) The maximum number of shares of Common Stock subject to those options and stock appreciation rights that are granted during any calendar year to any individual under this Plan is 1,000,000 shares.

(c) Additional limits with respect to Performance-Based Awards are set forth in Section 5.2.3.

Each of the foregoing numerical limits is subject to adjustment as contemplated by Section 4.3, Section 7.1, and Section 8.10.

4.3 Awards Settled in Cash, Reissue of Awards and Shares.  To the extent that an award granted under this Plan is settled in cash or a form other than shares of Common Stock, the shares that would have been delivered had there been no such cash or other settlement shall not be counted against the shares available for issuance under this Plan.  In the event that shares of Common Stock are delivered

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in respect of a dividend equivalent right granted under this Plan, the actual number of shares delivered with respect to the award shall be counted against the share limits of this Plan (including, for purposes of clarity, the limits of Section 4.2 of this Plan).  (For purposes of clarity, if 1,000 dividend equivalent rights are granted and outstanding when the Corporation pays a dividend, and 50 shares are delivered in payment of those rights with respect to that dividend, 50 shares shall be counted against the share limits of this Plan).  To the extent that shares of Common Stock are delivered pursuant to the exercise of a stock appreciation right or stock option granted under this Plan, the number of underlying shares as to which the exercise related shall be counted against the applicable share limits under Section 4.2, as opposed to only counting the shares actually issued.  (For purposes of clarity, if a stock appreciation right relates to 100,000 shares and is exercised at a time when the payment due to the participant is 15,000 shares, 100,000 shares shall be charged against the applicable share limits under Section 4.2 with respect to such exercise.)  Shares that are subject to or underlie awards granted under this Plan which expire or for any reason are cancelled or terminated, are forfeited, fail to vest, or for any other reason are not paid or delivered under this Plan shall again be available for subsequent awards under this Plan.  Shares that are exchanged by a participant or withheld by the Corporation as full or partial payment in connection with any award under this Plan, as well as any shares exchanged by a participant or withheld by the Corporation or one of its Subsidiaries to satisfy the tax withholding obligations related to any award, shall not be available for subsequent awards under this Plan.  Refer to Section 8.10 for application of the foregoing share limits with respect to assumed awards.  The foregoing adjustments to the share limits of this Plan are subject to any applicable limitations under Section 162(m) of the Code with respect to awards intended as performance-based compensation thereunder.

4.4 Reservation of Shares; No Fractional Shares; Minimum Issue.  The Corporation shall at all times reserve a number of shares of Common Stock sufficient to cover the Corporation’s obligations and contingent obligations to deliver shares with respect to awards then outstanding under this Plan (exclusive of any dividend equivalent obligations to the extent the Corporation has the right to settle such rights in cash).  No fractional shares shall be delivered under this Plan.  The Administrator may pay cash in lieu of any fractional shares in settlements of awards under this Plan.  No fewer than 100 shares may be purchased on exercise of any award (or, in the case of stock appreciation or purchase rights, no fewer than 100 rights may be exercised at any one time) unless the total number purchased or exercised is the total number at the time available for purchase or exercise under the award.

5.  AWARDS

5.1 Type and Form of Awards.  The Administrator shall determine the type or types of award(s) to be made to each selected Eligible Person.  Awards may be granted singly, in combination or in tandem.  Awards also may be made in combination or in tandem with, in replacement of, as alternatives to, or as the payment form for

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grants or rights under any other employee or compensation plan of the Corporation or one of its Subsidiaries.  The types of awards that may be granted under this Plan are (subject, in each case, to the no repricing provisions of Section 3.2):

5.1.1 Stock Options.  A stock option is the grant of a right to purchase a specified number of shares of Common Stock during a specified period as determined by the Administrator.  An option may be intended as an incentive stock option within the meaning of Section 422 of the Code (an “ISO”) or a nonqualified stock option (an option not intended to be an ISO).  The award agreement for an option will indicate if the option is intended as an ISO; otherwise it will be deemed to be a nonqualified stock option.  The maximum term of each option (ISO or nonqualified) shall be seven (7) years.  The per share exercise price for each option shall be not less than 100% of the fair market value of a share of Common Stock on the date of grant of the option.  When an option is exercised, the exercise price for the shares to be purchased shall be paid in full in cash or such other method permitted by the Administrator consistent with Section 5.5.

5.1.2 Additional Rules Applicable to ISOs.  To the extent that the aggregate fair market value (determined at the time of grant of the applicable option) of stock with respect to which ISOs first become exercisable by a participant in any calendar year exceeds $100,000, taking into account both Common Stock subject to ISOs under this Plan and stock subject to ISOs under all other plans of the Corporation or one of its Subsidiaries (or any parent or predecessor corporation to the extent required by and within the meaning of Section 422 of the Code and the regulations promulgated thereunder), such options shall be treated as nonqualified stock options.  In reducing the number of options treated as ISOs to meet the $100,000 limit, the most recently granted options shall be reduced first.  To the extent a reduction of simultaneously granted options is necessary to meet the $100,000 limit, the Administrator may, in the manner and to the extent permitted by law, designate which shares of Common Stock are to be treated as shares acquired pursuant to the exercise of an ISO.  ISOs may only be granted to employees of the Corporation or one of its subsidiaries (for this purpose, the term “subsidiary” is used as defined in Section 424(f) of the Code, which generally requires an unbroken chain of ownership of at least 50% of the total combined voting power of all classes of stock of each subsidiary in the chain beginning with the Corporation and ending with the subsidiary in question).  There shall be imposed in any award agreement relating to ISOs such other terms and conditions as from time to time are required in order that the option be an “incentive stock option” as that term is defined in Section 422 of the Code.  No ISO may be granted to any person who, at the time the option is granted, owns (or is deemed to own under Section 424(d) of the Code) shares of outstanding Common Stock possessing more than 10% of the total combined voting power of all classes of stock of the Corporation, unless the exercise price

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of such option is at least 110% of the fair market value of the stock subject to the option and such option by its terms is not exercisable after the expiration of five years from the date such option is granted.

5.1.3 Stock Appreciation Rights.  A stock appreciation right or “SAR” is a right to receive a payment, in cash and/or Common Stock, equal to the excess of the fair market value of a specified number of shares of Common Stock on the date the SAR is exercised over the “base price” of the award, which base price shall be set forth in the applicable award agreement and shall be not less than 100% of the fair market value of a share of Common Stock on the date of grant of the SAR.  The maximum term of a SAR shall be seven (7) years.

5.1.4 Other Awards.  The other types of awards that may be granted under this Plan include: (a) stock bonuses, restricted stock, performance stock, stock units, phantom stock, dividend equivalents, or similar rights to purchase or acquire shares, whether at a fixed or variable price or ratio related to the Common Stock, upon the passage of time, the occurrence of one or more events, or the satisfaction of performance criteria or other conditions, or any combination thereof; (b) any similar securities with a value derived from the value of or related to the Common Stock and/or returns thereon; or (c) cash awards.

5.2 Section 162(m) Performance-Based Awards.  Without limiting the generality of the foregoing, any of the types of awards listed in Section 5.1.4 above may be, and options and SARs granted to officers and employees (“Qualifying Options” and “Qualifying SARS,” respectively) typically will be, granted as awards intended to satisfy the requirements for “performance-based compensation” within the meaning of Section 162(m) of the Code (“Performance-Based Awards”).  The grant, vesting, exercisability or payment of Performance-Based Awards may depend (or, in the case of Qualifying Options or Qualifying SARs, may also depend) on the degree of achievement of one or more performance goals relative to a pre-established targeted level or levels using one or more of the Business Criteria set forth below (on an absolute basis or relative to the performance of other companies or upon comparisons of any of the indicators of performance relative to other companies) for the Corporation on a consolidated basis or for one or more of the Corporation’s subsidiaries, segments, divisions or business units, or any combination of the foregoing.  Any Qualifying Option or Qualifying SAR shall be subject only to the requirements of Section 5.2.1 and 5.2.3 in order for such award to satisfy the requirements for “performance-based compensation” under Section 162(m) of the Code.  Any other Performance-Based Award shall be subject to all of the following provisions of this Section 5.2.

5.2.1 Class; Administrator.  The eligible class of persons for Performance-Based Awards under this Section 5.2 shall be officers and employees of the Corporation or one of its Subsidiaries.  The Administrator approving Performance-Based Awards or making any certification required pursuant

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to Section 5.2.4 must be constituted as provided in Section 3.1 for awards that are intended as performance-based compensation under Section 162(m) of the Code.

5.2.2 Performance Goals.  The specific performance goals for Performance-Based Awards (other than Qualifying Options and Qualifying SARs) shall be, on an absolute or relative basis, established based on one or more of the following business criteria (“Business Criteria”) as selected by the Administrator in its sole discretion:  earnings per share; cash flow (which means cash and cash equivalents derived from either net cash flow from operations or net cash flow from operations, financing and investing activities); stock price; total stockholder return; gross revenue; revenue growth; operating income (before or after taxes); net earnings (before or after interest, taxes, depreciation and/or amortization); return on equity or on assets or on net investment; cost containment or reduction; net sales growth; market share; net operating profit; expense targets; working capital targets relating to inventory and/or accounts receivable; operating margin; planning accuracy (as measured by comparing planned results to actual results); measurably improving quality of care outcomes at company facilities; net sales; earnings before interest, taxes, depreciation, amortization (EBITDA); earnings before interest, taxes, depreciation, amortization, and rents (EBITDAR); operating income (before or after taxes); pre- or after-tax income (before or after allocation of corporate overhead and bonus); appreciation in and/or maintenance of the price of the Common Stock or any other publicly-traded securities of the Corporation; gross profits; economic value-added models or equivalent metrics; comparisons with various stock market indices; cash flow per share (before or after dividends); return on capital (including return on total capital or return on invested capital); return on equity; return on assets; cash flow return on investment; gross margins or cash margin; year-end cash; debt reduction; stockholder equity; operating efficiencies; strategic partnerships or transactions (including in-licensing and out-licensing of intellectual property; establishing relationships with commercial entities with respect to the marketing, distribution and sale of the Corporation’s products (including with group purchasing organizations, distributors and other vendors); co-development, co-marketing, profit sharing, joint venture or other similar arrangements); financial ratios, including those measuring liquidity, activity, profitability or leverage; cost of capital or assets under management; financing and other capital raising transactions (including sales of the Corporation’s equity or debt securities; factoring transactions; sales or licenses of the Corporation’s assets, including its intellectual property, whether in a particular jurisdiction or territory or globally; or through partnering transactions); implementation, completion or attainment of measurable objectives with respect to research, development, manufacturing, commercialization, products or projects, production volume levels, acquisitions and divestitures and recruiting and maintaining personnel; or

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any combination thereof.  These terms are used as applied under generally accepted accounting principles or in the financial reporting of the Corporation or of its Subsidiaries.  To qualify awards as performance-based under Section 162(m), the applicable Business Criterion (or Business Criteria, as the case may be) and specific performance goal or goals (“targets”) must be established and approved by the Administrator during the first 90 days of the performance period (and, in the case of performance periods of less than one year, in no event after 25% or more of the performance period has elapsed) and while performance relating to such target(s) remains substantially uncertain within the meaning of Section 162(m) of the Code.  The terms of the Performance-Based Award may specify the manner, if any, in which performance targets shall be adjusted to mitigate the unbudgeted impact of material, unusual or nonrecurring gains and losses, accounting changes or other extraordinary events not foreseen at the time the targets were set unless the Administrator provides otherwise at the time of establishing the targets.  The applicable performance measurement period may not be less than three months nor more than 10 years.

5.2.3 Form of Payment; Maximum Performance-Based Award.  Grants or awards under this Section 5.2 may be paid in cash or shares of Common Stock or any combination thereof.  Grants of Qualifying Options and Qualifying SARs to any one participant in any one calendar year shall be subject to the limit set forth in Section 4.2(b).  The maximum number of shares of Common Stock which may be delivered pursuant to Performance-Based Awards (other than Qualifying Options and Qualifying SARs, and other than cash awards covered by the following sentence) that are granted to any one participant in any one calendar year shall not exceed 1,000,000 shares, either individually or in the aggregate, subject to adjustment as provided in Section 7.1.  In addition, the aggregate amount of compensation to be paid to any one participant in respect of all Performance-Based Awards payable only in cash and not related to shares of Common Stock and granted to that participant in any one calendar year shall not exceed $3,000,000.  Awards that are cancelled during the year shall be counted against these limits to the extent required by Section 162(m) of the Code.

5.2.4 Certification of Payment.  Before any Performance-Based Award under this Section 5.2 (other than Qualifying Options and Qualifying SARs) is paid and to the extent required to qualify the award as performance-based compensation within the meaning of Section 162(m) of the Code, the Administrator must certify in writing that the performance target(s) and any other material terms of the Performance-Based Award were in fact timely satisfied.

5.2.5 Reservation of Discretion.  The Administrator will have the discretion to determine the restrictions or other limitations of the individual awards

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granted under this Section 5.2 including the authority to reduce awards, payouts or vesting or to pay no awards, in its sole discretion, if the Administrator preserves such authority at the time of grant by language to this effect in its authorizing resolutions or otherwise.

5.2.6 Expiration of Grant Authority.  As required pursuant to Section 162(m) of the Code and the regulations promulgated thereunder, the Administrator’s authority to grant new awards that are intended to qualify as performance-based compensation within the meaning of Section 162(m) of the Code shall terminate upon the first regularly scheduled meeting of the Corporation’s stockholders that occurs more than twelve (12) months after the date of the Spin-Off.

5.3 Award Agreements.  Each award shall be evidenced by either (1) a written award agreement in a form approved by the Administrator and executed by the Corporation by an officer duly authorized to act on its behalf, or (2) an electronic notice of award grant in a form approved by the Administrator and recorded by the Corporation (or its designee) in an electronic recordkeeping system used for the purpose of tracking award grants under this Plan generally (in each case, an “award agreement”), as the Administrator may provide and, in each case and if required by the Administrator, executed or otherwise electronically accepted by the recipient of the award in such form and manner as the Administrator may require.  The Administrator may authorize any officer of the Corporation (other than the particular award recipient) to execute any or all award agreements on behalf of the Corporation.  The award agreement shall set forth the material terms and conditions of the award as established by the Administrator consistent with the express limitations of this Plan.

5.4 Deferrals and Settlements.  Payment of awards may be in the form of cash, Common Stock, other awards or combinations thereof as the Administrator shall determine, and with such restrictions as it may impose.  The Administrator may also require or permit participants to elect to defer the issuance of shares or the settlement of awards in cash under such rules and procedures as it may establish under this Plan.  The Administrator may also provide that deferred settlements include the payment or crediting of interest or other earnings on the deferral amounts, or the payment or crediting of dividend equivalents where the deferred amounts are denominated in shares.

5.5 Consideration for Common Stock or Awards.  The purchase price for any award granted under this Plan or the Common Stock to be delivered pursuant to an award, as applicable, may be paid by means of any lawful consideration as determined by the Administrator, including, without limitation, one or a combination of the following methods:

· services rendered by the recipient of such award;

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· cash, check payable to the order of the Corporation, or electronic funds transfer;

· notice and third party payment in such manner as may be authorized by the Administrator;

· the delivery of previously owned shares of Common Stock;

· by a reduction in the number of shares otherwise deliverable pursuant to the award; or

· subject to such procedures as the Administrator may adopt, pursuant to a “cashless exercise” with a third party who provides financing for the purposes of (or who otherwise facilitates) the purchase or exercise of awards.

In no event shall any shares newly-issued by the Corporation be issued for less than the minimum lawful consideration for such shares or for consideration other than consideration permitted by applicable state law.  Shares of Common Stock used to satisfy the exercise price of an option shall be valued at their fair market value on the date of exercise.  The Corporation will not be obligated to deliver any shares unless and until it receives full payment of the exercise or purchase price therefor and any related withholding obligations under Section 8.5 and any other conditions to exercise or purchase have been satisfied.  Unless otherwise expressly provided in the applicable award agreement, the Administrator may at any time eliminate or limit a participant’s ability to pay the purchase or exercise price of any award or shares by any method other than cash payment to the Corporation.

5.6 Definition of Fair Market Value.  For purposes of this Plan, “fair market value” shall mean, unless otherwise determined or provided by the Administrator in the circumstances, the last price (in regular trading) for a share of Common Stock as furnished by the National Association of Securities Dealers, Inc. (the “NASD”) through the NASDAQ Global Market Reporting System (the “Global Market”) for the date in question or, if no sales of Common Stock were reported by the NASD on the Global Market on that date, the last price (in regular trading) for a share of Common Stock as furnished by the NASD through the Global Market for the next preceding day on which sales of Common Stock were reported by the NASD.  The Administrator may, however, provide with respect to one or more awards that the fair market value shall equal the last price (in regular trading) for a share of Common Stock as furnished by the NASD through the Global Market on the last trading day preceding the date in question or the average of the high and low trading prices of a share of Common Stock as furnished by the NASD through the Global Market for the date in question or the most recent trading day.  If the Common Stock is no longer listed or is no longer actively traded on the Global Market as of the applicable date, the fair market value of the Common Stock shall be the value as reasonably determined by the Administrator for purposes of the award in the circumstances.  The Administrator also may adopt a

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different methodology for determining fair market value with respect to one or more awards if a different methodology is necessary or advisable to secure any intended favorable tax, legal or other treatment for the particular award(s) (for example, and without limitation, the Administrator may provide that fair market value for purposes of one or more awards will be based on an average of closing prices (or the average of high and low daily trading prices) for a specified period preceding the relevant date).

5.7 Transfer Restrictions.

5.7.1 Limitations on Exercise and Transfer.  Unless otherwise expressly provided in (or pursuant to) this Section 5.7 or required by applicable law: (a) all awards are non-transferable and shall not be subject in any manner to sale, transfer, anticipation, alienation, assignment, pledge, encumbrance or charge; (b) awards shall be exercised only by the participant; and (c) amounts payable or shares issuable pursuant to any award shall be delivered only to (or for the account of) the participant.

5.7.2 Exceptions.  The Administrator may permit awards to be exercised by and paid to, or otherwise transferred to, other persons or entities pursuant to such conditions and procedures, including limitations on subsequent transfers, as the Administrator may, in its sole discretion, establish in writing.  Any permitted transfer shall be subject to compliance with applicable federal and state securities laws and shall not be for value (other than nominal consideration, settlement of marital property rights, or for interests in an entity in which more than 50% of the voting interests are held by the Eligible Person or by the Eligible Person’s family members).

5.7.3 Further Exceptions to Limits on Transfer.  The exercise and transfer restrictions in Section 5.7.1 shall not apply to:

(a) transfers to the Corporation (for example, in connection with the expiration or termination of the award),

(b) the designation of a beneficiary to receive benefits in the event of the participant’s death or, if the participant has died, transfers to or exercise by the participant’s beneficiary, or, in the absence of a validly designated beneficiary, transfers by will or the laws of descent and distribution,

(c) subject to any applicable limitations on ISOs, transfers to a family member (or former family member) pursuant to a domestic relations order if approved or ratified by the Administrator,

(d) if the participant has suffered a disability, permitted transfers or exercises on behalf of the participant by his or her legal representative, or

(e) the authorization by the Administrator of “cashless exercise” procedures with third parties who provide financing for the purpose of (or who

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otherwise facilitate) the exercise of awards consistent with applicable laws and the express authorization of the Administrator.

5.8 International Awards.  One or more awards may be granted to Eligible Persons who provide services to the Corporation or one of its Subsidiaries outside of the United States.  Any awards granted to such persons may be granted pursuant to the terms and conditions of any applicable sub-plans, if any, appended to this Plan and approved by the Administrator.

6.  EFFECT OF TERMINATION OF EMPLOYMENT OR SERVICE ON AWARDS

6.1 General.  The Administrator shall establish the effect of a termination of employment or service on the rights and benefits under each award under this Plan and in so doing may make distinctions based upon, inter alia, the cause of termination and type of award.  If the participant is not an employee of the Corporation or one of its Subsidiaries and provides other services to the Corporation or one of its Subsidiaries, the Administrator shall be the sole judge for purposes of this Plan (unless a contract or the award otherwise provides) of whether the participant continues to render services to the Corporation or one of its Subsidiaries and the date, if any, upon which such services shall be deemed to have terminated.

6.2 Events Not Deemed Terminations of Service.  Unless the express policy of the Corporation or one of its Subsidiaries, or the Administrator, otherwise provides, the employment relationship shall not be considered terminated in the case of (a) sick leave, (b) military leave, or (c) any other leave of absence authorized by the Corporation or one of its Subsidiaries, or the Administrator; provided that, unless reemployment upon the expiration of such leave is guaranteed by contract or law or the Administrator otherwise provides, such leave is for a period of not more than three months.  In the case of any employee of the Corporation or one of its Subsidiaries on an approved leave of absence, continued vesting of the award while on leave from the employ of the Corporation or one of its Subsidiaries may be suspended until the employee returns to service, unless the Administrator otherwise provides or applicable law otherwise requires.  In no event shall an award be exercised after the expiration of the term set forth in the applicable award agreement.

6.3 Effect of Change of Subsidiary Status.  For purposes of this Plan and any award, if an entity ceases to be a Subsidiary of the Corporation a termination of employment or service shall be deemed to have occurred with respect to each Eligible Person in respect of such Subsidiary who does not continue as an Eligible Person in respect of the Corporation or another Subsidiary that continues as such after giving effect to the transaction or other event giving rise to the change in status.

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7.  ADJUSTMENTS; ACCELERATION

  7.1 Adjustments.  Subject to Section 7.2, after the completion of the Spin-Off, upon (or, as may be necessary to effect the adjustment, immediately prior to): any  reclassification, recapitalization, stock split (including a stock split in the form of a stock dividend) or reverse stock split; any merger, combination, consolidation, or other reorganization; any spin-off, split-up, or similar extraordinary dividend distribution in respect of the Common Stock; or any exchange of Common Stock or other securities of the Corporation, or any similar, unusual or extraordinary corporate transaction in respect of the Common Stock; then the Administrator shall equitably and proportionately adjust (1) the number and type of shares of Common Stock (or other securities) that thereafter may be made the subject of awards (including the specific share limits, maximums and numbers of shares set forth elsewhere in this Plan), (2) the number, amount and type of shares of Common Stock (or other securities or property) subject to any outstanding awards, (3) the grant, purchase, or exercise price (which term includes the base price of any SAR or similar right) of any outstanding awards, and/or (4) the securities, cash or other property deliverable upon exercise or payment of any outstanding awards, in each case to the extent necessary to preserve (but not increase) the level of incentives intended by this Plan and the then-outstanding awards.

Unless otherwise expressly provided in the applicable award agreement, upon (or, as may be necessary to effect the adjustment, immediately prior to) any event or transaction described in the preceding paragraph or a sale of all or substantially all of the business or assets of the Corporation as an entirety, the Administrator shall equitably and proportionately adjust the performance standards applicable to any then-outstanding performance-based awards to the extent necessary to preserve (but not increase) the level of incentives intended by this Plan and the then-outstanding performance-based awards.

It is intended that, if possible, any adjustments contemplated by the preceding two paragraphs be made in a manner that satisfies applicable U.S. legal, tax (including, without limitation and as applicable in the circumstances, Section 424 of the Code, Section 409A of the Code and Section 162(m) of the Code) and accounting (so as to not trigger any charge to earnings with respect to such adjustment) requirements.

Without limiting the generality of Section 3.3, any good faith determination by the Administrator as to whether an adjustment is required in the circumstances pursuant to this Section 7.1, and the extent and nature of any such adjustment, shall be conclusive and binding on all persons.

7.2 Corporate Transactions - Assumption and Termination of Awards.  Upon the occurrence of any of the following after the completion of the Spin-Off: any merger, combination, consolidation, or other reorganization in connection with which the Corporation does not survive (or does not survive as a public company in respect of its Common Stock); any exchange of Common Stock or other securities of the Corporation in connection with which the Corporation does not survive (or does not survive as a public company

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in respect of its Common Stock); a sale of all or substantially all the business, stock or assets of the Corporation in connection with which the Corporation does not survive (or does not survive as a public company in respect of its Common Stock); a dissolution of the Corporation; or any other event in which the Corporation does not survive (or does not survive as a public company in respect of its Common Stock); then the Administrator may make provision for a cash payment in settlement of, or for the assumption, substitution or exchange of any or all outstanding share-based awards or the cash, securities or property deliverable to the holder of any or all outstanding share-based awards, based upon, to the extent relevant under the circumstances, the distribution or consideration payable to holders of the Common Stock upon or in respect of such event.  Upon the occurrence of any event described in the preceding sentence, then, unless the Administrator has made a provision for the substitution, assumption, exchange or other continuation or settlement of the award or the award would otherwise continue in accordance with its terms in the circumstances: (1) unless otherwise provided in the applicable award agreement, each then-outstanding option and SAR shall become fully vested, all shares of restricted stock then outstanding shall fully vest free of restrictions, and each other award granted under this Plan that is then outstanding shall become payable to the holder of such award; and (2) each award shall terminate upon the related event; provided that the holder of an option or SAR shall be given reasonable advance notice of the impending termination and a reasonable opportunity to exercise his or her outstanding vested options and SARs (after giving effect to any accelerated vesting required in the circumstances) in accordance with their terms before the termination of such awards (except that in no case shall more than ten days’ notice of the impending termination be required and any acceleration of vesting and any exercise of any portion of an award that is so accelerated may be made contingent upon the actual occurrence of the event).

Without limiting the preceding paragraph, in connection with any event referred to in the preceding paragraph or any change in control event defined in any applicable award agreement, the Administrator may, in its discretion, provide for the accelerated vesting of any award or awards as and to the extent determined by the Administrator in the circumstances.

The Administrator may adopt such valuation methodologies for outstanding awards as it deems reasonable in the event of a cash or property settlement and, in the case of options, SARs or similar rights, but without limitation on other methodologies, may base such settlement solely upon the excess if any of the per share amount payable upon or in respect of such event over the exercise or base price of the award.

In any of the events referred to in this Section 7.2, the Administrator may take such action contemplated by this Section 7.2 prior to such event (as opposed to on the occurrence of such event) to the extent that the Administrator deems the

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action necessary to permit the participant to realize the benefits intended to be conveyed with respect to the underlying shares.  Without limiting the generality of the foregoing, the Administrator may deem an acceleration to occur immediately prior to the applicable event and/or reinstate the original terms of the award if an event giving rise to an acceleration does not occur.

Without limiting the generality of Section 3.3, any good faith determination by the Administrator pursuant to its authority under this Section 7.2 shall be conclusive and binding on all persons.

7.3 Other Acceleration Rules.  The Administrator may override the provisions of Section 7.2 by express provision in the award agreement and may accord any Eligible Person a right to refuse any acceleration, whether pursuant to the award agreement or otherwise, in such circumstances as the Administrator may approve.  The portion of any ISO accelerated in connection with an event referred to in Section 7.2 (or such other circumstances as may trigger accelerated vesting of the award) shall remain exercisable as an ISO only to the extent the applicable $100,000 limitation on ISOs is not exceeded.  To the extent exceeded, the accelerated portion of the option shall be exercisable as a nonqualified stock option under the Code.

8.  OTHER PROVISIONS

8.1 Compliance with Laws.  This Plan, the granting and vesting of awards under this Plan, the offer, issuance and delivery of shares of Common Stock, and/or the payment of money under this Plan or under awards are subject to compliance with all applicable federal and state laws, rules and regulations (including but not limited to state and federal securities law and federal margin requirements) and to such approvals by any listing, regulatory or governmental authority as may, in the opinion of counsel for the Corporation, be necessary or advisable in connection therewith.  The person acquiring any securities under this Plan will, if requested by the Corporation or one of its Subsidiaries, provide such assurances and representations to the Corporation or one of its Subsidiaries as the Administrator may deem necessary or desirable to assure compliance with all applicable legal and accounting requirements.

8.2 No Rights to Award.  No person shall have any claim or rights to be granted an award (or additional awards, as the case may be) under this Plan, subject to any express contractual rights (set forth in a document other than this Plan) to the contrary.

8.3 No Employment/Service Contract.  Nothing contained in this Plan (or in any other documents under this Plan or in any award) shall confer upon any Eligible Person or other participant any right to continue in the employ or other service of the Corporation or one of its Subsidiaries, constitute any contract or agreement of employment or other service or affect an employee’s status as an employee at will, nor shall interfere in any way with the right of the Corporation or one of its

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Subsidiaries to change a person’s compensation or other benefits, or to terminate his or her employment or other service, with or without cause.  Nothing in this Section 8.3, however, is intended to adversely affect any express independent right of such person under a separate employment or service contract other than an award agreement.

8.4 Plan Not Funded.  Awards payable under this Plan shall be payable in shares or from the general assets of the Corporation, and no special or separate reserve, fund or deposit shall be made to assure payment of such awards.  No participant, beneficiary or other person shall have any right, title or interest in any fund or in any specific asset (including shares of Common Stock, except as expressly otherwise provided) of the Corporation or one of its Subsidiaries by reason of any award hereunder.  Neither the provisions of this Plan (or of any related documents), nor the creation or adoption of this Plan, nor any action taken pursuant to the provisions of this Plan shall create, or be construed to create, a trust of any kind or a fiduciary relationship between the Corporation or one of its Subsidiaries and any participant, beneficiary or other person.  To the extent that a participant, beneficiary or other person acquires a right to receive payment pursuant to any award hereunder, such right shall be no greater than the right of any unsecured general creditor of the Corporation.

8.5 Tax Withholding.  Upon any exercise, vesting, or payment of any award or upon the disposition of shares of Common Stock acquired pursuant to the exercise of an ISO prior to satisfaction of the holding period requirements of Section 422 of the Code, the Corporation or one of its Subsidiaries shall have the right at its option to:

(a) require the participant (or the participant’s personal representative or beneficiary, as the case may be) to pay or provide for payment of at least the minimum amount of any taxes which the Corporation or one of its Subsidiaries may be required to withhold with respect to such award event or payment; or

(b) deduct from any amount otherwise payable in cash to the participant (or the participant’s personal representative or beneficiary, as the case may be) the minimum amount of any taxes which the Corporation or one of its Subsidiaries may be required to withhold with respect to such cash payment.

In any case where a tax is required to be withheld in connection with the delivery of shares of Common Stock under this Plan, the Administrator may in its sole discretion (subject to Section 8.1) require or grant (either at the time of the award or thereafter) to the participant the right to elect, pursuant to such rules and subject to such conditions as the Administrator may establish, that the Corporation reduce the number of shares to be delivered by (or otherwise reacquire) the appropriate number of shares, valued in a consistent manner at their fair market value or at the sales price in accordance with authorized procedures

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for cashless exercises, necessary to satisfy the minimum applicable withholding obligation on exercise, vesting or payment.  In no event shall the shares withheld exceed the minimum whole number of shares required for tax withholding under applicable law.

8.6 Effective Date, Termination and Suspension, Amendments.

8.6.1 Effective Date.  This Plan is effective as of November 12, 2010, the date of its approval by the Board (the “Effective Date”).  This Plan shall be submitted for and subject to stockholder approval no later than the date immediately prior to the Spin-Off.  Unless earlier terminated by the Board, this Plan shall terminate at the close of business on the day before the tenth anniversary of the Effective Date.  After the termination of this Plan either upon such stated expiration date or its earlier termination by the Board, no additional awards may be granted under this Plan, but previously granted awards (and the authority of the Administrator with respect thereto, including the authority to amend such awards) shall remain outstanding in accordance with their applicable terms and conditions and the terms and conditions of this Plan.

8.6.2 Board Authorization.  The Board may, at any time, terminate or, from time to time, amend, modify or suspend this Plan, in whole or in part.  No awards may be granted during any period that the Board suspends this Plan.

8.6.3 Stockholder Approval.  To the extent then required by applicable law or any applicable listing agency or required under Sections 162, 422 or 424 of the Code to preserve the intended tax consequences of this Plan, or deemed necessary or advisable by the Board, any amendment to this Plan shall be subject to stockholder approval.  In addition, the no repricing provision included in Section 3.2 may not be amended without shareholder approval.

8.6.4 Amendments to Awards.  Without limiting any other express authority of the Administrator under (but subject to) the express limits of this Plan, the Administrator by agreement or resolution may waive conditions of or limitations on awards to participants that the Administrator in the prior exercise of its discretion has imposed, without the consent of a participant, and (subject to the requirements of Sections 3.2 and 8.6.5) may make other changes to the terms and conditions of awards.  Any amendment or other action that would constitute a repricing of an award is subject to the limitations set forth in Section 3.2(g).

8.6.5 Limitations on Amendments to Plan and Awards.  No amendment, suspension or termination of this Plan or amendment of any outstanding award agreement shall, without written consent of the participant, affect in any manner materially adverse to the participant any rights or benefits of

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the participant or obligations of the Corporation under any award granted under this Plan prior to the effective date of such change.  Changes, settlements and other actions contemplated by Section 7 shall not be deemed to constitute changes or amendments for purposes of this Section 8.6.

8.7 Privileges of Stock Ownership.  Except as otherwise expressly authorized by the Administrator, a participant shall not be entitled to any privilege of stock ownership as to any shares of Common Stock not actually delivered to and held of record by the participant.  Except as expressly required by Section 7.1 or otherwise expressly provided by the Administrator, no adjustment will be made for dividends or other rights as a stockholder for which a record date is prior to such date of delivery.

8.8 Governing Law; Construction; Severability.

8.8.1 Choice of Law.  This Plan, the awards, all documents evidencing awards and all other related documents shall be governed by, and construed in accordance with the laws of the State of Delaware.

8.8.2 Severability.  If a court of competent jurisdiction holds any provision invalid and unenforceable, the remaining provisions of this Plan shall continue in effect.

8.8.3 Plan Construction.

(a) Rule 16b-3.  It is the intent of the Corporation that the awards and transactions permitted by awards be interpreted in a manner that, in the case of participants who are or may be subject to Section 16 of the Exchange Act, qualify, to the maximum extent compatible with the express terms of the award, for exemption from matching liability under Rule 16b-3 promulgated under the Exchange Act.  Notwithstanding the foregoing, the Corporation shall have no liability to any participant for Section 16 consequences of awards or events under awards if an award or event does not so qualify.

(b) Section 162(m).  Awards under Section 5.1.4 to persons described in Section 5.2 that are either granted or become vested, exercisable or payable based on attainment of one or more performance goals related to the Business Criteria, as well as Qualifying Options and Qualifying SARs granted to persons described in Section 5.2, that are approved by a committee composed solely of two or more outside directors (as this requirement is applied under Section 162(m) of the Code) shall be deemed to be intended as performance-based compensation within the meaning of Section 162(m) of the Code unless such committee provides otherwise at the time of grant of the award.  It is the further intent of the Corporation that (to the extent the Corporation or one of its Subsidiaries or awards

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under this Plan may be or become subject to limitations on deductibility under Section 162(m) of the Code) any such awards and any other Performance-Based Awards under Section 5.2 that are granted to or held by a person subject to Section 162(m) will qualify as performance-based compensation or otherwise be exempt from deductibility limitations under Section 162(m).

8.9 Captions.  Captions and headings are given to the sections and subsections of this Plan solely as a convenience to facilitate reference.  Such headings shall not be deemed in any way material or relevant to the construction or interpretation of this Plan or any provision thereof.

8.10 Stock-Based Awards in Substitution for Stock Options or Awards Granted by Other Corporation.  Awards may be granted to Eligible Persons in substitution for or in connection with an assumption of employee stock options, SARs, restricted stock or other stock-based awards granted by other entities to persons who are or who will become Eligible Persons in respect of the Corporation or one of its Subsidiaries, in connection with a distribution, merger or other reorganization by or with the granting entity or an affiliated entity, or the acquisition by the Corporation or one of its Subsidiaries, directly or indirectly, of all or a substantial part of the stock or assets of the employing entity.  The awards so granted need not comply with other specific terms of this Plan, provided the awards reflect only adjustments giving effect to the assumption or substitution consistent with the conversion applicable to the Common Stock in the transaction and any change in the issuer of the security.  Any shares that are delivered and any awards that are granted by, or become obligations of, the Corporation, as a result of the assumption by the Corporation of, or in substitution for, outstanding awards previously granted by an acquired company (or previously granted by a predecessor employer (or direct or indirect parent thereof) in the case of persons that become employed by the Corporation or one of its Subsidiaries in connection with a business or asset acquisition or similar transaction) shall not be counted against the Share Limit or other limits on the number of shares available for issuance under this Plan.  For the avoidance of doubt, any shares that are delivered and any awards that are granted by, or become obligations of, the Corporation under the Plan as a result of the Corporation’s substitution and assumption of awards originally granted by Old Sun in connection with the Spin-Off shall be counted against the Share Limit, but not for purposes of any of the other numerical limits specified in Section 4.2 or any other section of the Plan.

8.11 Non-Exclusivity of Plan.  Nothing in this Plan shall limit or be deemed to limit the authority of the Board or the Administrator to grant awards or authorize any other compensation, with or without reference to the Common Stock, under any other plan or authority.

8.12 No Corporate Action Restriction.  The existence of this Plan, the award agreements and the awards granted hereunder shall not limit, affect or restrict in any way the right or power of the Board or the stockholders of the Corporation to

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make or authorize: (a) any adjustment, recapitalization, reorganization or other change in the capital structure or business of the Corporation or any Subsidiary, (b) any merger, amalgamation, consolidation or change in the ownership of the Corporation or any Subsidiary, (c) any issue of bonds, debentures, capital, preferred or prior preference stock ahead of or affecting the capital stock (or the rights thereof) of the Corporation or any Subsidiary, (d) any dissolution or liquidation of the Corporation or any Subsidiary, (e) any sale or transfer of all or any part of the assets or business of the Corporation or any Subsidiary, or (f) any other corporate act or proceeding by the Corporation or any Subsidiary.  No participant, beneficiary or any other person shall have any claim under any award or award agreement against any member of the Board or the Administrator, or the Corporation or any employees, officers or agents of the Corporation or any Subsidiary, as a result of any such action.

8.13 Other Company Benefit and Compensation Programs.  Payments and other benefits received by a participant under an award made pursuant to this Plan shall not be deemed a part of a participant’s compensation for purposes of the determination of benefits under any other employee welfare or benefit plans or arrangements, if any, provided by the Corporation or any Subsidiary, except where the Administrator expressly otherwise provides or authorizes in writing.  Awards under this Plan may be made in addition to, in combination with, as alternatives to or in payment of grants, awards or commitments under any other plans or arrangements of the Corporation or its Subsidiaries.

9.  DEFINITIONS

Unless otherwise expressly provided in the applicable award agreement, the following terms shall have the meanings set forth in this Section 9 for purposes of awards granted hereunder to the extent any such terms are used with respect to such an award:

A “Change in Control” of the Corporation shall be deemed to have occurred if any of the following events occurs following the completion of the Spin-Off:

(i) Any “person” or “group” (within the meaning of Sections 13(d) and 14(d)(2) of the Exchange Act), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Corporation (an “Acquiring Person”), is or becomes the “beneficial owner” (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of more than 33 1/3% of the then outstanding voting stock of the Corporation;

(ii) A merger or consolidation of the Corporation with any other corporation, other than a merger or consolidation which would result in the voting securities of the Corporation outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least 51% of the combined voting power of the voting securities of the Corporation or surviving entity outstanding immediately after such merger or consolidation;

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(iii) A sale or other disposition by the Corporation of all or substantially all of the Corporation’s assets;

(iv) During any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board and any new director (other than a director who is a representative or nominee of an Acquiring Person) whose election by the Board or nomination for election by the Corporation’s shareholders was approved by a vote of at least a majority of the directors then still in office who either were directors at the beginning of the period or whose election or nomination was previously so approved, no longer constitute a majority of the Board;

provided, however, in no event shall any acquisition of securities, a change in the composition of the Board or a merger or other consolidation pursuant to a plan of reorganization under chapter 11 of the Bankruptcy Code with respect to the Corporation (“Chapter 11 Plan”), or a liquidation under the Bankruptcy Code constitute a Change in Control.  In addition, notwithstanding Sections 12(d)(i), 12(d)(ii), 12(d)(iii) and 12(d)(iv) hereof, a Change in Control shall not be deemed to have occurred in the event of a sale or conveyance in which the Corporation continues as a holding company of an entity or entities that conduct the business or businesses formerly conducted by the Corporation, or any transaction undertaken for the purpose of reincorporating the Corporation under the laws of another jurisdiction, if such transaction does not materially affect the beneficial ownership of the Corporation’s capital stock.

“Disability” with respect to a participant means that the participant has experienced one of the following: (1) the participant is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, or (2) the participant is, by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than three months under an accident and health plan covering employees of the participant’s employer.

“Good Cause” with respect to a participant means (unless otherwise expressly provided in the applicable agreement setting forth the terms and conditions of the award, or another applicable contract with the participant that defines such term for purposes of determining the effect that a “for cause” termination has on the participant’s awards) any one of the following: (A) any criminal conviction of the participant under the laws of the United States or any state or other political subdivision thereof which, in the good faith determination of the Corporation renders the participant unsuitable as an employee or officer of the Corporation or any Subsidiary; (B) the participant’s continued failure to substantially perform the duties reasonably requested by the Corporation and commensurate with the participant’s position and within the participant’s control in such position (other than any such failure resulting from participant’s incapacity due to the participant’s Disability) after a written demand for substantial performance is delivered to the participant by the Corporation, which demand specifically identifies the manner in which the Corporation believes that the participant has not substantially performed the

23

participant’s duties, and which performance is not substantially corrected by the participant within ten (10) days of receipt of such demand; or (C) any material workplace misconduct or willful failure to comply with the Corporation’s general policies and procedures as they may exist from time to time by the Corporation which, in the good faith determination of the Corporation, renders the participant unsuitable as an employee or officer of Corporation.

“Good Reason” with respect to a participant means (unless otherwise expressly provided in the applicable agreement setting forth the terms and conditions of the award, or another applicable contract with the participant that defines such term for purposes of determining the effect that a “good reason” termination has on the participant’s awards) a resignation of the participant’s employment with the Corporation as a result of and within 60 days after the occurrence of any of the following without the participant’s written consent:  (A) a meaningful and detrimental reduction in the participant’s authority, duties or responsibilities, or a meaningful and detrimental change in the participant’s reporting responsibilities, as in effect immediately prior to the participant’s termination of employment; (B) a material reduction in the participant’s annual base salary as in effect immediately prior to the participant’s delivery of notice to the Corporation stating the basis of the participant’s allegation that “Good Reason” exists (the “Good Reason Notice”), a material reduction in the participant’s target annual bonus (expressed as a percentage of base salary), if any, as in effect immediately prior to the circumstances described in the Good Reason Notice, or a material failure to provide the participant with any other form of compensation or material employment benefit being provided to the participant immediately prior to the circumstances described in the Good Reason Notice (excluding however, any reduction in the amount of any annual bonus or the granting or withholding of incentive compensation (including without limitation options or restricted stock units) but including a material reduction to the target amount of the bonus as stated above); or (C) a relocation of the participant’s principal place of employment by more than fifty (50) miles (or the requirement that the participant be based at a different location), provided that such relocation results in a longer commute (measured by actual mileage) for the participant from his or her primary residence to such new location.  Notwithstanding the foregoing, for any of the foregoing circumstances to constitute “Good Reason” hereunder, (x) the participant must deliver the Good Reason Notice to the Corporation within 30 days of the date on which the circumstances creating “Good Reason” have first occurred, (y) such circumstances are not corrected by the Corporation in a manner that is reasonably satisfactory to the participant (including full retroactive correction with respect to any monetary matter) within 30 days of the Corporation’s receipt of the Good Reason Notice from the participant and, (z) the participant thereafter resigns his or her employment within the 60 day time period described above.

A “Separation from Service” shall mean a “separation from service” within the meaning of Treasury Regulation Section 1.409A-1(h)(1), without regard to the optional alternative definitions available thereunder.

An “Unforeseeable Emergency” means a severe financial hardship to the participant resulting from (i) an illness or accident of the participant, the participant’s spouse, or a dependent (as defined in Section 152(a) of the Code without regard to paragraphs (b)(1),

24

(b)(2) and (d)(1)(b) thereof) of the participant, (ii) loss of the participant’s property due to casualty, or (iii) other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant, all as determined by the Administrator in its sole discretion and in all events constituting an “unforeseeable emergency” within the meaning of Section 409A of the Code.

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EX-10.4

Exhibit 10.4

Notice of Stock Option Grant

Sun Healthcare Group, Inc.

2009 Performance Incentive Plan

Name of Grantee: [______]

Shares Subject to Option: [______] shares of common stock, par value $0.01 (“Common Stock”), of Sun Healthcare Group, Inc. (the “Corporation”)

Type of Option: Nonqualified Stock Option

Exercise Price Per Share: [______]

Date of Grant: [______]

Date Exercisable/Vesting: This option may be exercised to the extent the shares of Common Stock subject to this option have vested at any time after the Date of Grant.  The option vests as follows if you are employed by or providing services to the Corporation or its subsidiaries on the applicable vesting date: (1) 25% of the shares subject to this option vest on each of the first four anniversaries of the Date of Grant; (2) the outstanding and unvested portion of this option will vest in full upon the termination of your employment or service with the Corporation or its subsidiaries either by the Corporation (or subsidiary) without Good Cause, by you for Good Reason, or due to your death or Disability; and (3) the outstanding and unvested portion of this option will vest in full upon the date of a Change in Control. The terms “Good Cause,” “Good Reason,” “Disability” and “Change in Control” are used as defined in the Plan.

Expiration Date: [______], subject to earlier termination in accordance with the Terms and Conditions of Nonqualified Stock Option.

By signing your name below, you accept this option and acknowledge and agree that this option is granted under and governed by the terms and conditions of the Sun Healthcare Group, Inc. 2009 Performance Incentive Plan (the “Plan”) and the Terms and Conditions of Nonqualified Stock Option, both of which are hereby made a part of this document.

Optionee:                                                                                     Sun Healthcare Group, Inc.

 ___________________                                                            ______________________

Signature                                                                                        By:  William A. Mathies

                                                          Title:  Chief Executive Officer

Terms and Conditions of Nonqualified Stock Option

Sun Healthcare Group, Inc.

2009 Performance Incentive Plan

1. General.

These Terms and Conditions of Nonqualified Stock Option (these “Terms”) apply to a particular stock option (the “Option”) if incorporated by reference in the Notice of Stock Option Grant  (the “Grant Notice”) corresponding to that particular grant.  The recipient of the Option identified in the Grant Notice is referred to as the “Grantee.”  The  per share exercise price of the Option as set forth in the Grant Notice is referred to as the “Exercise Price.”  The effective date of grant of the Option as set forth in the Grant Notice is referred to as the “Date of Grant.”  The exercise price and the number of shares covered by the Option are subject to adjustment under Section 7.1 of the Plan.

The Option was granted under and subject to the Sun Healthcare Group, Inc. 2009 Performance Incentive Plan (the “Plan”).  Capitalized terms are defined in the Plan if not defined herein.  The Option has been granted to the Grantee in addition to, and not in lieu of, any other form of compensation otherwise payable or to be paid to the Grantee.  The Grant Notice and these Terms are collectively referred to as the “Option Agreement” applicable to the Option.

2. Vesting; Limits on Exercise; Incentive Stock Option Status.

The Option shall vest and become exercisable in percentage installments of the aggregate number of shares subject to the Option as set forth on the Grant Notice.  The Option may be exercised only to the extent the Option is vested and exercisable.

· Cumulative Exercisability.  To the extent that the Option is vested and exercisable, the Grantee has the right to exercise the Option (to the extent not previously exercised), and such right shall continue, until the expiration or earlier termination of the Option.

· No Fractional Shares.  Fractional share interests shall be disregarded, but may be cumulated.

· Minimum Exercise.  No fewer than 100 shares of Common Stock (subject to adjustment under Section 7.1 of the Plan) may be purchased at any one time, unless the number purchased is the total number at the time exercisable under the Option.

· Nonqualified Stock Option.  The Option is a nonqualified stock option and is not, and shall not be, an incentive stock option within the meaning of Section 422 of the Code.

3. Continuance of Employment/Service Required; No Employment/Service Commitment.

The vesting schedule applicable to the Option requires continued employment or service through each applicable vesting date as a condition to the vesting of the applicable installment of the Option and the rights and benefits under this Option Agreement.  Employment or service for only a portion of the vesting period, even if a substantial portion, will not entitle the Grantee to any proportionate vesting or avoid or mitigate a termination of rights and benefits upon or following a termination of employment or services as provided in Section 5 below or under the

Plan.

Nothing contained in this Option Agreement or the Plan constitutes a continued employment or service commitment by the Corporation or any of its Subsidiaries, affects the Grantee’s status, if he or she is an employee, as an employee at will who is subject to termination without cause, confers upon the Grantee any right to remain employed by or in service to the Corporation or any Subsidiary, interferes in any way with the right of the Corporation or any Subsidiary at any time to terminate such employment or service, or affects the right of the Corporation or any Subsidiary to increase or decrease the Grantee’s other compensation.Nothing in this paragraph, however, is intended to adversely affect any independent contractual right of the Grantee under any written employment agreement with the Corporation.

4. Method of Exercise of Option.

The Option shall be exercisable by the delivery to the Secretary of the Corporation (or such other person as the Administrator may require pursuant to such administrative exercise procedures as the Administrator may implement from time to time) of:

· a written notice stating the number of shares of Common Stock to be purchased pursuant to the Option or by the completion of such other administrative exercise procedures as the Administrator may require from time to time,

· payment in full for the Exercise Price of the shares to be purchased in cash, check or by electronic funds transfer to the Corporation, or (subject to compliance with all applicable laws, rules, regulations and listing requirements and further subject to such rules as the Administrator may adopt as to any non-cash payment) in shares of Common Stock already owned by the Grantee, valued at their fair market value (as determined under the Plan) on the exercise date;

· any written statements or agreements required pursuant to Section 8.1 of the Plan; and

· satisfaction of the tax withholding provisions of Section 8.5 of the Plan.

The Administrator also may, but is not required to, authorize a non-cash payment alternative by notice and third party payment in such manner as may be authorized by the Administrator, or, subject to such procedures as the Administrator may adopt, authorize a “cashless exercise” with a third party who provides simultaneous financing for the purposes of (or who otherwise facilitates) the exercise of the Option.

5. Early Termination of Option.

5.1           Expiration Date.  Subject to earlier termination as provided below in this Section 5, the Option will terminate on the “Expiration Date” set forth in the Grant Notice (the “Expiration Date”).

5.2           Possible Termination of Option upon Certain Corporate Events.  The Option is subject to termination in connection with certain corporate events as provided in Section 7.2 of the Plan.

5.3           Termination of Option upon a Termination of Grantee’s Employment or Services.  Subject to earlier termination on the Expiration Date of the Option or pursuant to

Section 5.2 above, if the Grantee ceases to be employed by or ceases to provide services to the Corporation or a Subsidiary, the following rules shall apply, in each case after giving effect to any acceleration of vesting that may apply in the circumstances (the last day that the Grantee is employed by or provides services to the Corporation or a Subsidiary is referred to as the Grantee’s “Severance Date”):

· other than as expressly provided below in this Section 5.3, (a) the Grantee will have until the date that is 3 months after his or her Severance Date to exercise the Option (or portion thereof) to the extent that it was vested on the Severance Date, (b) the Option, to the extent not vested on the Severance Date, shall terminate on the Severance Date, and (c) the Option, to the extent exercisable for the 3-month period following the Severance Date and not exercised during such period, shall terminate at the close of business on the last day of the 3-month period;

· if the termination of the Grantee’s employment or services is the result of the Grantee’s Disability or retirement (pursuant to any then current formal retirement policy, as determined by the Administrator), (a) the Grantee (or his beneficiary or personal representative, as the case may be) will have until the date that is 6 months after the Grantee’s Severance Date to exercise the Option (or portion thereof) to the extent that it was vested on the Severance Date, (b) the Option, to the extent not vested on the Severance Date, shall terminate on the Severance Date, and (c) the Option, to the extent exercisable for the 6-month period following the Severance Date and not exercised during such period, shall terminate at the close of business on the last day of the 6-month period;

· if the termination of the Grantee’s employment or services is the result of the Grantee’s death, (a) the Grantee (or his beneficiary or personal representative, as the case may be) will have until the date that is 12 months after the Grantee’s Severance Date to exercise the Option (or portion thereof) to the extent that it was vested on the Severance Date, (b) the Option, to the extent not vested on the Severance Date, shall terminate on the Severance Date, and (c) the Option, to the extent exercisable for the 12-month period following the Severance Date and not exercised during such period, shall terminate at the close of business on the last day of the 12-month period;

· if the Grantee’s employment or services are terminated by the Corporation or a Subsidiary for Good Cause, the Option (whether vested or not) shall terminate on the Severance Date.

In all events the Option is subject to earlier termination on the Expiration Date of the Option or as contemplated by Section 5.2.  The Administrator shall be the sole judge of whether the Grantee continues to render employment or services for purposes of this Option Agreement.

6. Non-Transferability.

The Option and any other rights of the Grantee under this Option Agreement or the Plan are nontransferable and exercisable only by the Grantee, except as set forth in Section 5.7 of the Plan.

7. Notices.

Any notice to be given under the terms of this Option Agreement shall be in writing and addressed to the Corporation at its principal office to the attention of the Secretary, and to the Grantee at the address last reflected on the Corporation’s payroll records, or at such other address

as either party may hereafter designate in writing to the other.  Any such notice shall be delivered in person or shall be enclosed in a properly sealed envelope addressed as aforesaid, registered or certified, and deposited (postage and registry or certification fee prepaid) in a post office or branch post office regularly maintained by the United States Government.  Any such notice shall be given only when received, but if the Grantee is no longer employed by the Corporation or a Subsidiary, shall be deemed to have been duly given five business days after the date mailed in accordance with the foregoing provisions of this Section 7.

8. Plan.

The Option and all rights of the Grantee under this Option Agreement are subject to the terms and conditions of the Plan, incorporated herein by this reference.  The Grantee agrees to be bound by the terms of the Plan and this Option Agreement.  The Grantee acknowledges having read and understanding the Plan, the Prospectus for the Plan, and this Option Agreement.  Unless otherwise expressly provided in other sections of this Option Agreement, provisions of the Plan that confer discretionary authority on the Board or the Administrator do not and shall not be deemed to create any rights in the Grantee unless such rights are expressly set forth herein or are otherwise in the sole discretion of the Board or the Administrator so conferred by appropriate action of the Board or the Administrator under the Plan after the date hereof.

9. Entire Agreement.

This Option Agreement and the Plan together constitute the entire agreement and supersede all prior understandings and agreements, written or oral, of the parties hereto with respect to the subject matter hereof.  The Plan and this Option Agreement may be amended pursuant to Section 8.6 of the Plan.  Such amendment must be in writing and signed by the Corporation.  The Corporation may, however, unilaterally waive any provision hereof in writing to the extent such waiver does not adversely affect the interests of the Grantee hereunder, but no such waiver shall operate as or be construed to be a subsequent waiver of the same provision or a waiver of any other provision hereof.

10. Governing Law.

This Option Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Delaware without regard to conflict of law principles thereunder.

11. Clawback Policy.

The Option shall be subject to the terms of the Corporation’s recoupment, clawback or similar policy as it may be in effect from time to time, which policy could in certain circumstances require repayment or forfeiture of the Option, any shares acquired upon exercise of the Option or any value realized from the Option or any shares acquired upon exercise of the Option.

12. Effect of this Agreement.

Subject to the Corporation’s right to terminate the Option pursuant to Section 7.2 of the Plan, this Option Agreement shall be assumed by, be binding upon and inure to the benefit of any successor or successors to the Corporation.

13. Counterparts.

This Option Agreement may be executed simultaneously in any number of counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument.

14. Section Headings.

The section headings of this Option Agreement are for convenience of reference only and shall not be deemed to alter or affect any provision hereof.

EX-10.5

Exhibit 10.5

Notice of Stock Unit Grant

Sun Healthcare Group, Inc.

2009 Performance Incentive Plan

Name of Grantee: [______]

Number of Stock Units: [______]

Date of Grant: [______]

Vesting: The units shall become vested as follows if you are employed by or providing services to Sun Healthcare Group, Inc. or its subsidiaries on the applicable vesting date [and the Company achieves normalized consolidated EBITDA of $____ million in 201_ as determined by the Compensation Committee of the Board of Directors]:  (i) 25% of the units shall vest on each of the following anniversaries of the Date of Grant: 13 months, 24 months, 36 months, and 48 months, subject to earlier termination as provided in the Terms and Conditions of Stock Unit Award; and (ii) the units, to the extent then outstanding and unvested, shall become vested in full upon the date of your death or Disability (as defined in the Plan) or a Change in Control (as defined in the Plan).

By signing your name below, you accept this stock unit award and acknowledge and agree that the units are granted under and governed by the terms and conditions of the Sun Healthcare Group, Inc. 2009 Performance Incentive Plan (the “Plan”) and the Terms and Conditions of Stock Unit Award, both of which are hereby made a part of this document.

“GRANTEE”     _________________________________ Signature     SUN HEALTHCARE GROUP, INC., a Delaware corporation   __________________________________ By:  William A. Mathies Its:  Chief Executive Officer

Terms and Conditions of Stock Unit Award

Sun Healthcare Group, Inc.

2009 Performance Incentive Plan

1.           Grant of Stock Units.

(a)           Award.  These Terms and Conditions of Stock Unit Award (these “Terms”) apply to a particular stock unit award (the “Award”) if incorporated by reference in the Notice of Stock Unit Grant  (the “Grant Notice”) corresponding to that particular grant.  The recipient of the Award identified in the Grant Notice is referred to as the “Grantee.”  The effective date of grant of the Award as set forth in the Grant Notice is referred to as the “Date of Grant.”  The Award was granted under and subject to the Sun Healthcare Group, Inc. 2009 Performance Incentive Plan (the “Plan”).  The number of shares covered by the Award are subject to adjustment under Section 7.1 of the Plan.  Capitalized terms are defined in the Plan if not defined herein.  The Award has been granted to the Grantee in addition to, and not in lieu of, any other form of compensation otherwise payable or to be paid to the Grantee.  The Grant Notice and these Terms are collectively referred to as the “Award Agreement” applicable to the Award.

(b)           Stock Units.  As used herein, a “Stock Unit” is a non-voting unit of measurement which is deemed for bookkeeping purposes to be equivalent in value to one outstanding share of Common Stock of the Corporation.  The Stock Units shall be used solely as a device for the determination of any payment to eventually be made to the Grantee if and when such Stock Units vest pursuant to Section 2.  The Stock Units create no fiduciary duty to the Grantee and shall create only a contractual obligation on the part of the Corporation to make payments, subject to vesting and the other terms and conditions hereof, as provided in Section 6 below.  The Stock Units shall not be treated as property or as a trust fund of any kind.  No assets have been secured or set aside by the Corporation with respect to the Award and, if amounts become payable to the Grantee pursuant to this Award Agreement, the Grantee’s rights with respect to such amounts shall be no greater than the rights of any general unsecured creditor of the Corporation.

2.           Vesting.  As set forth in the Grant Notice, this Award shall vest in percentage installments, subject to earlier termination or acceleration and subject to adjustment as provided herein and in the Plan.

3.           Continuance of Employment/Service Required; No Employment/Service Commitment.  The vesting schedule requires continued employment or service through each applicable vesting date as a condition to the vesting of the applicable installment of the Award and the rights and benefits under this Award Agreement.  Employment or service for only a portion of the vesting period, even if a substantial portion, will not entitle the Grantee to any proportionate vesting or avoid or mitigate a termination of rights and benefits upon or following a termination of employment or services as provided in Section 7 below or under the Plan.

Nothing contained in this Award Agreement or the Plan constitutes a continued employment or service commitment by the Corporation or any of its Subsidiaries, affects the Grantee’s status, if he or she is an employee, as an employee at will who is subject to termination without cause, confers upon the Grantee any right to remain employed by or in service to the Corporation or any Subsidiary, interferes in any way with the right of the Corporation or any Subsidiary at any time to terminate such employment or service, or affects the right of the Corporation or any Subsidiary to increase or decrease the Grantee’s other compensation.  Nothing

in this paragraph, however, is intended to adversely affect any independent contractual right of the Grantee under any written employment agreement with the Corporation.

4.           Dividend and Voting Rights.

(a)           Limitations on Rights Associated with Units.  The Grantee shall have no rights as a stockholder of the Corporation, no dividend rights (except as expressly provided in Section 4(b) hereof) and no voting rights with respect to the Stock Units or any shares of Common Stock issuable in respect of such Stock Units, until shares of Common Stock are actually issued to and held of record by the Grantee.  No adjustments will be made for dividends or other rights of a holder for which the record date is prior to the date of issuance of the stock certificate evidencing the shares.

(b)           Dividend Equivalent Reinvestment.  No later than sixty (60) days following each date that the Corporation pays an ordinary cash dividend on its outstanding Common Stock (if any ordinary cash dividends are paid), for which the related record date occurs after the Date of Grant and prior to the date all Stock Units subject to the Award have either been paid or have terminated, the Corporation shall credit the Grantee with an additional number of Stock Units equal to (a) the amount of the ordinary cash dividend paid by the Corporation on a single share of Common Stock, multiplied by (b) the number of Stock Units subject to the Award outstanding and unpaid as of such record date (including any Stock Units previously credited under this Section 4(b) and with such total number subject to adjustment pursuant to Section 7.1 of the Plan), divided by (c) the closing price of a share of Common Stock on the date the ordinary cash dividend is paid.  Any Stock Units credited pursuant to the foregoing provisions of this Section 4(b) will be subject to the same vesting, payment, termination and other terms, conditions and restrictions as the original Stock Units to which they relate.  No crediting of Stock Units will be made pursuant to this Section 4(b) with respect to any Stock Units which, as of the related record date, have either been paid or have terminated.

5.           Restrictions on Transfer.  Prior to the time the Stock Units are vested and paid, neither the Stock Units comprising the Award nor any interest therein or amount payable in respect thereof may be sold, assigned, transferred, pledged or otherwise disposed of, alienated or encumbered, either voluntarily or involuntarily, other than by will or the laws of descent and distribution.

6.           Timing and Manner of Payment of Stock Units.  Except as otherwise provided in the Grant Notice, Stock Units subject to this Award Agreement shall be paid in an equivalent number of whole shares of Common Stock (with any fractional Stock Units credited in respect of the Stock Units that are paid rounded down to the nearest whole number of shares of Common Stock)  promptly after the vesting of such Stock Units (and in all events not later than the first March 15 following the year in which such Stock Units became vested) in accordance with the terms hereof; provided, however, that the Administrator may provide for all or a portion of such vested Stock Units to be paid in cash.  Such payment shall be subject to the tax withholding provisions of Section 9 hereof and Section 8.5 of the Plan and subject to adjustment as provided in Section 7.1 of the Plan and shall be in complete satisfaction of such vested Stock Units.  The Grantee or any other person entitled under the Plan to receive a payment of shares of Common Stock shall deliver to the Corporation any representations or other documents or assurances required pursuant to Section 8.1 of the Plan.

Notwithstanding the foregoing paragraph, the Grantee may elect (a “Distribution Election”) on the Date of Grant or at such other time as may be provided by the Administrator (and in all cases at a time that complies with the initial deferral election requirements of Section 409A of the Code) and in accordance with rules prescribed the Administrator, not to receive payment upon the vesting of such Stock Units and instead have the Corporation continue to

maintain such Stock Units on its books of account.  Distribution Elections may only be made by delivering a written election to the Corporation on a deferral election form provided by the Corporation. Subject to approval by the Administrator, the distribution of such deferred Stock Units shall be payable as elected by the Grantee on the deferral election form.

7.           Effect of Termination of Employment or Services.  The Grantee’s Stock Units shall be forfeited to the extent such units have not become vested upon the first date the Grantee is no longer employed by or providing services to the Corporation or one of its Subsidiaries, regardless of the reason for the termination of such employment or services, whether with or without cause, voluntarily or involuntarily; provided, however, that if the Grantee’s termination of employment or service is the result of the Grantee’s death or Disability, any then-outstanding and otherwise unvested Stock Units subject to this Award shall thereupon fully vest.  If the Grantee is employed by a Subsidiary and that entity ceases to be a Subsidiary, such event shall be deemed to be a termination of employment of the Grantee for purposes of this Award Agreement, unless the Grantee otherwise continues to be employed by the Corporation or another of its Subsidiaries following such event.  If the Grantee is not an employee or director of the Corporation or a Subsidiary, the Administrator shall be the sole judge for purposes of this Award Agreement whether the Grantee continues to render services to the Corporation or a Subsidiary and the date, if any, upon which such services shall be deemed to have terminated.

8.           Adjustments Upon Specified Events.  Upon the occurrence of certain events relating to the Corporation’s stock contemplated by Section 7.1 of the Plan, the Administrator will make adjustments if appropriate in the number of Stock Units contemplated hereby and the number and kind of securities that may be issued in respect of the Award.

9.           Tax Withholding.  The Corporation shall reasonably determine the amount of any federal, state, local or other income, employment, or other taxes which the Corporation or any of its affiliates may reasonably be obligated to withhold with respect to the grant, vesting, or other event with respect to the Stock Units.  The Corporation may, in its sole discretion, withhold a sufficient number of shares of Common Stock in connection with the vesting of the Stock Units at the then fair market value of the Common Stock (determined either as of the date of such withholding or as of the immediately preceding trading day, as determined by the Corporation in its discretion) to satisfy the amount of any such withholding obligations that arise with respect to the vesting of such Stock Units.  The Corporation may take such action(s) without notice to the Grantee and shall remit to the Grantee the balance of any proceeds from withholding such shares in excess of the amount reasonably determined to be necessary to satisfy such withholding obligations.  The Grantee shall have no discretion as to the satisfaction of tax withholding obligations in such manner.  If, however, any withholding event occurs with respect to the Stock Units other than the vesting of such units, or if the Corporation for any reason does not satisfy the withholding obligations with respect to the vesting of the Stock Units as provided above in this Section 9, the Corporation shall be entitled to require a cash payment by or on behalf of the Grantee and/or to deduct from other compensation payable to the Grantee the amount of any such withholding obligations.

10.           Notices.  Any notice to be given under the terms of this Award Agreement shall be in writing and addressed to the Corporation at its principal office to the attention of the Secretary, and to the Grantee at the Grantee’s last address reflected on the Corporation’s records, or at such other address as either party may hereafter designate in writing to the other.  Any such notice shall be given only when received, but if the Grantee is no longer an employee of the Corporation or one of its Subsidiaries, shall be deemed to have been duly given by the Corporation when enclosed in a properly sealed envelope addressed as aforesaid, registered or certified, and deposited (postage and registry or certification fee prepaid) in a post office or branch post office regularly maintained by the United States Government.

11.           Plan.  The Award and all rights of the Grantee under this Award Agreement are subject to, and the Grantee agrees to be bound by, all of the terms and conditions of the provisions of the Plan, incorporated herein by this reference.  The Grantee agrees to be bound by the terms of the Plan and of this Award Agreement.  The Grantee acknowledges reading and understanding the Plan, the Prospectus for the Plan, and this Award Agreement.  Unless otherwise expressly provided in other sections of this Award Agreement, provisions of the Plan that confer discretionary authority on the Board or the Administrator do not (and shall not be deemed to) create any rights in the Grantee unless such rights are expressly set forth herein or are otherwise in the sole discretion of the Board or the Administrator so conferred by appropriate action of the Board or the Administrator under the Plan after the date hereof.

12.           Entire Agreement.  This Award Agreement and the Plan together constitute the entire agreement and supersede all prior understandings and agreements, written or oral, of the parties hereto with respect to the subject matter hereof.  The Plan and this Award Agreement may be amended pursuant to Section 8.6 of the Plan.  Such amendment must be in writing and signed by the Corporation.  The Corporation may, however, unilaterally waive any provision hereof in writing to the extent such waiver does not adversely affect the interests of the Grantee hereunder, but no such waiver shall operate as or be construed to be a subsequent waiver of the same provision or a waiver of any other provision hereof.

13.           Counterparts.  This Award Agreement may be executed simultaneously in any number of counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument.

14.           Section Headings.  The section headings of this Award Agreement are for convenience of reference only and shall not be deemed to alter or affect any provision hereof.

15.           Governing Law.  This Award Agreement and the rights of the parties hereunder with respect to the Award shall be governed by and construed and enforced in accordance with the laws of the State of Delaware without regard to conflict of law principles thereunder.

16.           Clawback Policy.  The Stock Units shall be subject to the terms of the Corporation’s recoupment, clawback or similar policy as it may be in effect from time to time, which policy could in certain circumstances require repayment or forfeiture of the Stock Units or any value realized from the Stock Units.

17.           Construction. It is intended that the terms of the Award will not result in the imposition of any tax liability pursuant to Section 409A of the Code.  This Award Agreement shall be construed and interpreted consistent with that intent.

EX-10.6

Exhibit 10.6

Notice of Stock Unit Grant

Sun Healthcare Group, Inc.

2009 Performance Incentive Plan

Name of Grantee: [______]

Date of Vesting:  [______]

Date of Grant: [______]

Date of Vesting:  [______]

Date of Vesting:  Notwithstanding the timing rules of Section 6 of the Terms and Conditions of Stock Unit Award, the shares of common stock underlying the vested stock units shall be distributed to the Grantee within 30 days following the earliest to occur of: (i) the date of the Grantee’s Separation from Service (as defined in the Plan), (ii) the five-year anniversary of the Date of Grant, or (iii) a Change in Control.

 

By signing your name below, you accept this stock unit award and acknowledge and agree that the units are granted under and governed by the terms and conditions of the Sun Healthcare Group, Inc. 2009 Performance Incentive Plan (the “Plan”) and the Terms and Conditions of Stock Unit Award, both of which are hereby made a part of this document.

“GRANTEE”     _________________________________ Signature SUN HEALTHCARE GROUP, INC., a Delaware corporation     ________________________________ By:  William A. Mathies Its:  Chief Executive Officer

Terms and Conditions of Stock Unit Award

Sun Healthcare Group, Inc.

2009 Performance Incentive Plan

1.           Grant of Stock Units.

(a)           Award.  These Terms and Conditions of Stock Unit Award (these “Terms”) apply to a particular stock unit award (the “Award”) if incorporated by reference in the Notice of Stock Unit Grant  (the “Grant Notice”) corresponding to that particular grant.  The recipient of the Award identified in the Grant Notice is referred to as the “Grantee.”  The effective date of grant of the Award as set forth in the Grant Notice is referred to as the “Date of Grant.”  The Award was granted under and subject to the Sun Healthcare Group, Inc. 2009 Performance Incentive Plan (the “Plan”).  The number of shares covered by the Award are subject to adjustment under Section 7.1 of the Plan.  Capitalized terms are defined in the Plan if not defined herein.  The Award has been granted to the Grantee in addition to, and not in lieu of, any other form of compensation otherwise payable or to be paid to the Grantee.  The Grant Notice and these Terms are collectively referred to as the “Award Agreement” applicable to the Award.

(b)           Stock Units.  As used herein, a “Stock Unit” is a non-voting unit of measurement which is deemed for bookkeeping purposes to be equivalent in value to one outstanding share of Common Stock of the Corporation.  The Stock Units shall be used solely as a device for the determination of any payment to eventually be made to the Grantee if and when such Stock Units vest pursuant to Section 2.  The Stock Units create no fiduciary duty to the Grantee and shall create only a contractual obligation on the part of the Corporation to make payments, subject to vesting and the other terms and conditions hereof, as provided in Section 6 below.  The Stock Units shall not be treated as property or as a trust fund of any kind.  No assets have been secured or set aside by the Corporation with respect to the Award and, if amounts become payable to the Grantee pursuant to this Award Agreement, the Grantee’s rights with respect to such amounts shall be no greater than the rights of any general unsecured creditor of the Corporation.

2.           Vesting.  The Award is subject to vesting, with the vesting schedule as set forth in the Grant Notice, and subject to earlier termination or acceleration and subject to adjustment as provided herein and in the Plan.

3.           Continuance of Employment/Service Required; No Employment/Service Commitment.  The vesting schedule requires continued employment or service through each applicable vesting date as a condition to the vesting of the applicable installment of the Award and the rights and benefits under this Award Agreement.  Employment or service for only a portion of the vesting period, even if a substantial portion, will not entitle the Grantee to any proportionate vesting or avoid or mitigate a termination of rights and benefits upon or following a termination of employment or services as provided in Section 7 below or under the Plan.

Nothing contained in this Award Agreement or the Plan constitutes a continued employment or service commitment by the Corporation or any of its Subsidiaries, affects the Grantee’s status, if he or she is an employee, as an employee at will who is subject to termination without cause, confers upon the Grantee any right to remain employed by or in service to the

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Corporation or any Subsidiary, interferes in any way with the right of the Corporation or any Subsidiary at any time to terminate such employment or service, or affects the right of the Corporation or any Subsidiary to increase or decrease the Grantee’s other compensation.  Nothing in this paragraph, however, is intended to adversely affect any independent contractual right of the Grantee under any written employment agreement with the Corporation.

4.           Dividend and Voting Rights.

(a)           Limitations on Rights Associated with Units.  The Grantee shall have no rights as a stockholder of the Corporation, no dividend rights (except as expressly provided in Section 4(b) hereof) and no voting rights with respect to the Stock Units or any shares of Common Stock issuable in respect of such Stock Units, until shares of Common Stock are actually issued to and held of record by the Grantee.  No adjustments will be made for dividends or other rights of a holder for which the record date is prior to the date of issuance of the stock certificate evidencing the shares.

(b)           Dividend Equivalent Reinvestment.  No later than sixty (60) days following each date that the Corporation pays an ordinary cash dividend on its outstanding Common Stock (if any ordinary cash dividends are paid), for which the related record date occurs after the Date of Grant and prior to the date all Stock Units subject to the Award have either been paid or have terminated, the Corporation shall credit the Grantee with an additional number of Stock Units equal to (a) the amount of the ordinary cash dividend paid by the Corporation on a single share of Common Stock, multiplied by (b) the number of Stock Units subject to the Award outstanding and unpaid as of such record date (including any Stock Units previously credited under this Section 4(b) and with such total number subject to adjustment pursuant to Section 7.1 of the Plan), divided by (c) the closing price of a share of Common Stock on the date the ordinary cash dividend is paid.  Any Stock Units credited pursuant to the foregoing provisions of this Section 4(b) will be subject to the same vesting, payment, termination and other terms, conditions and restrictions as the original Stock Units to which they relate.  No crediting of Stock Units will be made pursuant to this Section 4(b) with respect to any Stock Units which, as of the related record date, have either been paid or have terminated.

5.           Restrictions on Transfer.  Prior to the time the Stock Units are vested and paid, neither the Stock Units comprising the Award nor any interest therein or amount payable in respect thereof may be sold, assigned, transferred, pledged or otherwise disposed of, alienated or encumbered, either voluntarily or involuntarily, other than by will or the laws of descent and distribution.

6.           Timing and Manner of Payment of Stock Units.  Except as otherwise provided in the Grant Notice, Stock Units subject to this Award Agreement shall be paid in an equivalent number of whole shares of Common Stock (with any fractional Stock Units credited in respect of the Stock Units that are paid rounded down to the nearest whole number of shares of Common Stock) promptly after the vesting of such Stock Units (and in all events not later than the first March 15 following the year in which such Stock Units became vested) in accordance with the terms hereof.  Such payment shall be subject to the tax withholding provisions of Section 9 hereof and Section 8.5 of the Plan and subject to adjustment as provided in Section 7.1 of the Plan and shall be in complete satisfaction of such vested Stock Units.  The Grantee or any other person entitled under the Plan to receive a payment of shares of Common Stock shall deliver to the

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Corporation any representations or other documents or assurances required pursuant to Section 8.1 of the Plan.

Notwithstanding the foregoing paragraph, the Grantee may elect (a “Distribution Election”) on the Date of Grant or at such other time as may be provided by the Administrator (and in all cases at a time that complies with the initial deferral election requirements of Section 409A of the Code) and in accordance with rules prescribed the Administrator, not to receive payment upon the vesting of such Stock Units and instead have the Corporation continue to maintain such Stock Units on its books of account.  Distribution Elections may only be made by delivering a written election to the Corporation on a deferral election form provided by the Corporation. Subject to approval by the Administrator, the distribution of such deferred Stock Units shall be payable as elected by the Grantee on the deferral election form.

7.           Effect of Termination of Employment or Services.  The Grantee’s Stock Units shall be forfeited to the extent such units have not become vested upon the first date the Grantee is no longer employed by or providing services to the Corporation or one of its Subsidiaries, regardless of the reason for the termination of such employment or services, whether with or without cause, voluntarily or involuntarily; provided, however, that if the Grantee’s termination of employment or service is the result of the Grantee’s death or Disability, any then-outstanding and otherwise unvested Stock Units subject to this Award shall thereupon fully vest.  If the Grantee is employed by a Subsidiary and that entity ceases to be a Subsidiary, such event shall be deemed to be a termination of employment of the Grantee for purposes of this Award Agreement, unless the Grantee otherwise continues to be employed by the Corporation or another of its Subsidiaries following such event.  If the Grantee is not an employee or director of the Corporation or a Subsidiary, the Administrator shall be the sole judge for purposes of this Award Agreement whether the Grantee continues to render services to the Corporation or a Subsidiary and the date, if any, upon which such services shall be deemed to have terminated.  The Corporation shall have no obligation as to any Stock Units that are forfeited pursuant to this Section 7.

8.           Adjustments Upon Specified Events.  Upon the occurrence of certain events relating to the Corporation’s stock contemplated by Section 7.1 of the Plan, the Administrator will make adjustments if appropriate in the number of Stock Units contemplated hereby and the number and kind of securities that may be issued in respect of the Award.

9.           Tax Withholding.  The Corporation shall reasonably determine the amount of any federal, state, local or other income, employment, or other taxes which the Corporation or any of its affiliates may reasonably be obligated to withhold with respect to the grant, vesting, or other event with respect to the Stock Units.  The Corporation may, in its sole discretion, withhold a sufficient number of shares of Common Stock in connection with the vesting of the Stock Units at the then fair market value of the Common Stock (determined either as of the date of such withholding or as of the immediately preceding trading day, as determined by the Corporation in its discretion) to satisfy the minimum amount of any such withholding obligations that arise with respect to the vesting of such Stock Units.  The Corporation may take such action(s) without notice to the Grantee and shall remit to the Grantee the balance of any proceeds from withholding such shares in excess of the amount reasonably determined to be necessary to satisfy such withholding obligations.  The Grantee shall have no discretion as to the satisfaction of tax withholding obligations in such manner.  If, however, any withholding event occurs with respect to the Stock Units other than the vesting of such units, or if the Corporation for any reason does

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 not satisfy the withholding obligations with respect to the vesting of the Stock Units as provided above in this Section 9, the Corporation shall be entitled to require a cash payment by or on behalf of the Grantee and/or to deduct from other compensation payable to the Grantee the amount of any such withholding obligations.

10.           Notices.  Any notice to be given under the terms of this Award Agreement shall be in writing and addressed to the Corporation at its principal office to the attention of the Secretary, and to the Grantee at the Grantee’s last address reflected on the Corporation’s records, or at such other address as either party may hereafter designate in writing to the other.  Any such notice shall be given only when received, but if the Grantee is no longer an employee of the Corporation or one of its Subsidiaries, shall be deemed to have been duly given by the Corporation when enclosed in a properly sealed envelope addressed as aforesaid, registered or certified, and deposited (postage and registry or certification fee prepaid) in a post office or branch post office regularly maintained by the United States Government.

11.           Plan.  The Award and all rights of the Grantee under this Award Agreement are subject to, and the Grantee agrees to be bound by, all of the terms and conditions of the provisions of the Plan, incorporated herein by this reference.  The Grantee agrees to be bound by the terms of the Plan and of this Award Agreement.  The Grantee acknowledges reading and understanding the Plan, the Prospectus for the Plan, and this Award Agreement.  Unless otherwise expressly provided in other sections of this Award Agreement, provisions of the Plan that confer discretionary authority on the Board or the Administrator do not (and shall not be deemed to) create any rights in the Grantee unless such rights are expressly set forth herein or are otherwise in the sole discretion of the Board or the Administrator so conferred by appropriate action of the Board or the Administrator under the Plan after the date hereof.

12.           Entire Agreement.  This Award Agreement and the Plan together constitute the entire agreement and supersede all prior understandings and agreements, written or oral, of the parties hereto with respect to the subject matter hereof.  The Plan and this Award Agreement may be amended pursuant to Section 8.6 of the Plan.  Such amendment must be in writing and signed by the Corporation.  The Corporation may, however, unilaterally waive any provision hereof in writing to the extent such waiver does not adversely affect the interests of the Grantee hereunder, but no such waiver shall operate as or be construed to be a subsequent waiver of the same provision or a waiver of any other provision hereof.

13.           Counterparts.  This Award Agreement may be executed simultaneously in any number of counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument.

14.           Section Headings.  The section headings of this Award Agreement are for convenience of reference only and shall not be deemed to alter or affect any provision hereof.

15.           Governing Law.  This Award Agreement and the rights of the parties hereunder with respect to the Award shall be governed by and construed and enforced in accordance with the laws of the State of Delaware without regard to conflict of law principles thereunder.

16.           Clawback Policy. The Plan and any awards under the Plan are subject to the terms of the Corporation’s recoupment, clawback or similar policy as it may be in effect from time to

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time, as well as any similar provisions of applicable law, any of which could in certain circumstances require repayment or forfeiture of any award under the Plan (including, without limitation and if an award is paid in shares, the repayment of any value received from a disposition of any such shares).

17.           Construction. It is intended that the terms of the Award will not result in the imposition of any tax liability pursuant to Section 409A of the Code.  This Award Agreement shall be construed and interpreted consistent with that intent.

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EX-10.7

Exhibit 10.7

SUN HEALTHCARE GROUP, INC.

2009 PERFORMANCE INCENTIVE PLAN

NON-EMPLOYEE DIRECTORS STOCK-FOR-FEES PROGRAM1

1.           Establishment.  Sun Healthcare Group, Inc. has established this Sun Healthcare Group, Inc. Non-Employee Directors Stock-for-Fees Program, as set forth herein (this “Program”).  This Program was originally effective as of July 1, 2008 (the “Effective Date”).  This Program is an Appendix to, and any shares of Common Stock issued under this Program on and after the Effective Date shall be charged against the applicable share limits of, the Sun Healthcare Group, Inc. 2009 Performance Incentive Plan (the “Plan”).2  Except as otherwise expressly provided herein, the provisions of the Plan shall govern all Stock Units (as such term is defined below) credited, and shares issued, pursuant to this Program.  Capitalized terms are defined in the Plan if not defined herein.

2.           Purpose.  The purpose of this Program is to promote the success of the Company and the interests of its stockholders by providing members of the Company’s Board of Directors (the “Board”) who are not officers or employees of the Company or one of its Subsidiaries (“Non-Employee Directors”) an opportunity to elect to receive their Annual Cash Retainer in the form of Stock Units and more closely aligning the interests of Non-Employee Directors and stockholders.

3.           Election to Receive Stock Units in Lieu of Annual Cash Retainer.

(a)           Definitions.  For purposes of this Program, the following definitions shall apply:

· “Annual Cash Retainer” shall mean the basic annual retainer (including any additional fees for serving as a chairperson of the Board or a committee thereof, but excluding any meeting fees), to the extent otherwise payable in cash, payable to a Non-Employee Director for services as a member of the Board.

· “Program Account” shall mean the unfunded bookkeeping account maintained by the Company on behalf of each Non-Employee Director to which the Non-Employee Director’s Stock Units shall be credited.

· “Program Year” shall mean the 12 consecutive month period beginning January 1 each year and ending December 31 each year, except that the initial Program Year shall commence on July 1, 2008 and end on December 31, 2008.

 

1 The Program was originally established by Sun Healthcare Group, Inc. (“Old Sun”) prior to the separation of Old Sun’s real estate assets and operating assets into two separate publicly traded companies (the “Spin-Off”).  The Spin-Off was accomplished by Old Sun’s distribution to its stockholders on a pro rata basis of all of the outstanding shares of common stock of SHG Services, Inc, which was renamed Sun Healthcare Group, Inc. following the completion of the Spin-Off (the “Company”).  The Company assumed the Program prior to and in connection with the Spin-Off, and has continued the Program as an Appendix to the Company’s 2009 Performance Incentive Plan.  The terms of each Non-Employee Directors’ election under the Program with respect to the 2010 calendar year (the year in which the Spin-Off occurred) were not changed or affected as a result of the assumption of the Plan by the Company.

 

2 This Program was originally an Appendix to Old Sun’s 2004 Equity Incentive Plan.  The Company has adopted the Sun Healthcare Group, Inc. 2004 Equity Incentive Plan to evidence the terms of awards originally granted by Old Sun under its 2004 Equity Incentive Plan that have been substituted and assumed by the Company, including Stock Units credited pursuant to this Program.

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· “Stock Unit” shall mean a non-voting unit of measurement which is deemed for bookkeeping purposes to be equivalent to one outstanding share of Common Stock (subject to adjustment as provided in Section 7 of the Plan) solely for purposes of the Program.  Stock Units shall be used solely as a device for the determination of the number of shares of Common Stock eventually to be delivered to a Non-Employee Director upon payment of such Stock Units.  Stock Units shall not be treated as property or as a trust fund of any kind.  Stock Units granted to a Non-Employee Director pursuant to the Program shall be credited to the Non-Employee Director’s Program Account.

(b)           Election Form.  A Non-Employee Director may elect to exchange the right to receive payment of all or a portion of his or her Annual Cash Retainer payable with respect to a particular Program Year for the right to receive a grant of Stock Units under this Program in lieu of such retainer (or portion thereof, as applicable).  Such election shall be made by completing the election form attached hereto as  Exhibit 1 (or such other form as the Board may prescribe from time to time) (an “Election Form”) and filing such completed form with the Company by the deadline determined under Section 3(c), (d) or (e) below, as applicable.

(c)           Election for Initial Program Year.  Any individual who is a Non-Employee Director on the Effective Date may file an Election Form with the Company no later than June 30, 2008.  Such Election Form shall be irrevocable and shall be effective with respect to the Annual Cash Retainer for the initial Program Year commencing July 1, 2008 and ending December 31, 2008.

(d)           Election for Subsequent Program Years.  With respect to any Program Year commencing on or after January 1, 2009, and except as otherwise provided in Section 3(e) of this Program, a Non-Employee Director may file an Election Form with the Company on or before December 31 immediately preceding the start of such Program Year or any earlier deadline that may be established with respect to the particular year.  Such Election Form shall become irrevocable as of such December 31 and shall be effective with respect to the Annual Cash Retainer for the Program Year commencing on the January 1 that next follows such December 31.

(e)           Election for First Year of Eligibility.  Notwithstanding anything to the contrary in this Program, other than in connection with the Spin-Off, any individual who first becomes a Non-Employee Director after the Effective Date and during the first three (3) quarters of a particular Program Year may file an Election Form with the Company no later than thirty (30) days after such individual first becomes a Non-Employee Director for purposes of this Program.  Such Election Form shall be irrevocable and shall be effective with respect to the director’s Annual Cash Retainer paid for services rendered during the Program Year in which the Election Form is filed for any quarter in such Program Year that commences after such Election Form is filed with the Company.

(f)           Credit of Stock Units.  Annual Cash Retainers are paid by the Company on a quarterly basis.  Upon the last business day of each quarter of a Program Year for which a Non-Employee Director has made a valid and timely election to receive Stock Units under this Program in lieu of all or a portion of his or her Annual Cash Retainer for that quarter (each, a “Crediting Date”), the Company shall credit the Non-Employee Director’s Program Account with a number of Stock Units determined by dividing (i) the amount of the Exchanged Retainer, by (ii) the Fair Market Value of a share of Common Stock on that Crediting Date, rounded down to the nearest whole unit.  The “Exchanged Retainer” is that portion of the Non-Employee Director’s Annual Cash Retainer that would have otherwise been paid in cash to the Non-Employee Director for his or her service on the Board during that quarter but for his or her election pursuant to this Program.  Any fractional amount less than the Fair Market Value of a share of the Common Stock as of such Crediting Date shall be paid in cash.  Not less frequently than annually, the Company shall provide each Non-Employee Director with a current statement of his or her Program

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Account reflecting all credits of Stock Units as of such date.  The term “Fair Market Value” as used in this Program has the same meaning as in the Plan.

(g)           Dividend and Voting Rights.

           (i)           A Non-Employee Director shall have no rights as a stockholder of the Company, no dividend rights (except as expressly provided in Section 3(g)(ii) of this Program with respect to dividend equivalent rights) and no voting rights, with respect to Stock Units credited under this Program and any shares of Common Stock underlying or issuable in respect of such Stock Units until such shares are actually issued to and held of record by the Non-Employee Director.  No adjustments will be made for dividends or other rights of a holder for which the record date is prior to the date of issuance of the shares.

(ii)           As of any date that the Company pays an ordinary cash dividend on its Common Stock (and in all events no later than two-and-one-half months after such date and in the same calendar year as such date), the Company shall pay each Non-Employee Director with a Program Account balance an amount in cash equal to the per-share cash dividend paid by the Company on its Common Stock on such date, multiplied by the number of outstanding and unpaid Stock Units credited to such Non-Employee Director’s Program Account as of the related dividend payment record date.  No such payment shall be made with respect to any Stock Units which, as of such record date, have been paid pursuant to Section 3(h).

(h)           Payment of Stock Units.  Any Stock Units credited to a Non-Employee Director’s Program Account shall be fully vested at all times, and shall be payable in an equivalent number of shares of Common Stock (either by delivering one or more certificates, registered in the name of the Non-Employee Director, for such shares or by entering such shares in the name of the Non-Employee Director in book-entry form, as determined by the Company in its discretion) on or within sixty (60) days following the first to occur of (A) the date of the Non-Employee Director’s Separation from Service or (B) the fifth (5th) anniversary of the date the Stock Unit was credited to the Non-Employee Director.  As used herein, a “Separation from Service” occurs when the Non-Employee Director dies, retires, or otherwise has a termination of service with the Company that constitutes a “separation from service” within the meaning of Treasury Regulation Section 1.409A-1(h), without regard to the optional alternative definitions available thereunder.  Notwithstanding the foregoing, in the event the Non-Employee Director is a “specified employee” (within the meaning of Treasury Regulation Section 1.409A-1(i)) on the date of the Non-Employee Director’s Separation from Service, the Non-Employee Director shall not be entitled to payment of any Stock Units that would otherwise be paid in connection with his or her Separation from Service until the earlier of (A) the date which is six (6) months after his or her Separation from Service with the Company for any reason other than death, or (ii) the date of the Non-Employee Director’s death (and, in either case, payment will be made within thirty (30) days following that event); provided that this six-month delay shall apply only to the extent such delay in payment is required to comply with, and avoid the imputation of any tax, penalty or interest under, Section 409A of the Code.  Shares of Common Stock issued with respect to this Program may be issued under the Plan (and, in such case, shall be charged against the Share Limit set forth in Section 4.2 of the Plan) or may be issued under any other authority of the Company.  Notwithstanding the foregoing provisions, in the event that the Company is not able to issue shares of Common Stock in payment of any Stock Units credited under this Program, such Stock Units shall be settled by payment in cash equal to the applicable number of Stock Units not eligible to be paid in shares, multiplied by the Fair Market Value of a share of Common Stock on the date the Stock Units are paid.

4.           Plan Provisions.  Stock Units credited under this Program, and the issuance of shares of Common Stock in respect thereof (and any shares so issued), shall otherwise be subject to the terms of the

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Plan (including, without limitation, the provisions of Sections 7, 5.7 and 8.1 of the Plan); provided that no payment of the Stock Units shall be made earlier than the payment date determined pursuant to this Program.

5.           Amendment; Administration; Construction.  The Board may at any time amend, modify or suspend this Program without stockholder approval; provided that no such amendment, modification or suspension shall materially and adversely affect the rights of participants in this Program, without their consent, as to any Exchanged Retainer for the Program Year in which such amendment, modification or suspension occurs that has not theretofore been satisfied by the crediting of Stock Units pursuant to this Program or as to any Stock Units previously credited or to be credited for that or any prior year.  The Company may terminate this Program and pay all outstanding Stock Units hereunder in accordance with the requirements of Treasury Regulation 1.409A-3(j)(4)(ix)(A), (B) or (C).  This Program does not limit the Board’s authority to make other, discretionary award grants to Non-Employee Directors pursuant to the Plan.  The Administrator’s power and authority to construe and interpret the Plan and awards thereunder pursuant to Section 3.2 of the Plan shall extend to this Program and any Stock Units credited and shares issued hereunder.  As provided in Section 3.3 of the Plan, any action taken by, or inaction of, the Administrator relating or pursuant to this Program and within its authority or under applicable law shall be within the absolute discretion of that entity or body and shall be conclusive and binding upon all persons.  This Program, including any Election Forms filed hereunder, shall be construed and interpreted to comply with Section 409A of the Code.  Notwithstanding anything to the contrary in the Plan or this Program, the Company reserves the right to amend this Program to the extent it reasonably determines is necessary in order to preserve the intended tax consequences of elections made under this Program in light of Section 409A of the Code and any regulations or other guidance promulgated thereunder.

6.           Restrictions on Transfer.  Notwithstanding anything contained herein or in the Plan to the contrary, prior to the time the Stock Units are vested and paid, neither the Stock Units nor any interest therein or amount payable in respect thereof may be sold, assigned, transferred, pledged or otherwise disposed of, alienated or encumbered, either voluntarily or involuntarily, other than by will or the laws of descent and distribution.

7.           Limitation on Non-Employee Director’s Rights.  The Stock Units create no fiduciary duty to the Non-Employee Director and shall create only a contractual obligation on the part of the Company to make payments, subject to vesting and the other terms and conditions hereof, as provided above.  No assets have been secured or set aside by the Company with respect to the Stock Units and, if amounts become payable to the Non-Employee Director pursuant to this Program, the Non-Employee Director’s rights with respect to such amounts shall be no greater than the rights of any general unsecured creditor of the Company.

8.           Effect of this Program.  This Program shall be assumed by, be binding upon and inure to the benefit of any successor or successors to the Company.

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SUN HEALTHCARE GROUP, INC.

NON-EMPLOYEE DIRECTORS STOCK-FOR-FEES PROGRAM

DIRECTOR STOCK UNIT AWARD AND PAYMENT ELECTION FORM

For the Program Year January 1, 201_ –December 31, 201_

Director:  __________________________________________________________________

                 (Print Full Name)

I, the Director named above, hereby irrevocably make the elections set forth below pursuant to the Non-Employee Director Stock-for-Fees Program (the “Program”) adopted under the Sun Healthcare Group, Inc. 2009 Performance Incentive Plan (the “Plan”).  I understand that this election will apply to my Annual Cash Retainer for the Program Year indicated above and each subsequent Program Year unless I timely file a subsequent election with respect to such Program Year.  (Capitalized terms used in this form and not otherwise defined herein have the meanings ascribed to them in the Program.)

I have read and understand this form.  I have received, read and understand the Program and Plan documents and the Prospectus for the Plan.  I agree to be bound by the terms and conditions of the Program and the Plan.  If there is any inconsistency between this form and the Program or the Plan, the Program or the Plan, as applicable, controls.  I understand and agree that if I elect to receive any portion of my Annual Cash Retainer in the form of stock units, the stock units will be distributed in accordance with the provisions of the Program and the Plan at the time specified below.

Stock-for-Fees Election

Check and initial one of the following options to indicate whether you wish to receive a portion of your Annual Cash Retainer for the above Program Year in the form of stock units (“Units”), and, if so, indicate the amount of your Annual Cash Retainer you wish to receive as Units by filling in a whole percentage and/or a fixed dollar amount, as applicable.  Please note that your “Annual Cash Retainer” is the amount of your annual retainer (including any additional Chairperson fees, but not including any meeting fees) that, but for your election, would have been payable to you in cash.   If you do not select any of these options, you will be deemed to have elected to receive your Annual Cash Retainer for the applicable Program Year in the form of a cash payment.

I hereby make the following election with respect to my Annual Cash Retainer for the above Program Year and each subsequent Program Year (unless I timely file a subsequent election with respect to such Program Year):

   _____	I elect to receive my entire Annual Cash Retainer in cash.
 _____	I elect to receive _____ % of my Annual Cash Retainer in the form of Units in accordance with the Program; the balance of my Annual Cash Retainer (if I elect to receive less than 100% in Units) will be paid in cash.  The percentage that I elect will apply equally to my Annual Cash Retainer for any service each quarter during the applicable Program Year.

I understand and agree that the foregoing election is irrevocable and may not be changed once this form has been filed with the Company.

________________________________________________________

(Signature of Director)

ACKNOWLEDGEMENT OF DELIVERY OF ELECTION

On behalf of the Company, I hereby acknowledge that the above election was received on or before December 31, 201_.

SUN HEALTHCARE GROUP, INC.

By___________________________________________

EX-10.12

EXHIBIT 10.12

NON-EMPLOYEE DIRECTOR COMPENSATION POLICY

Sun Healthcare Group, Inc.

The Non-Employee Directors of the Board of Directors of Sun Healthcare Group, Inc. (“Directors”) shall be compensated as follows:

 1. Annual Fees for Directors.  Each Director shall receive an annual fee of $35,000, which is payable in four equal quarterly installments.

 2. Annual Fees for Chairpersons.  Each Chairperson of a Committee of the Board of Directors shall receive an additional annual fee, payable in four equal quarterly installments, as follows:  $8,000 for Audit, $6,000 for Compliance, and $5,000 for each of Compensation, Nominating or Executive.

 3. Meeting Fees.  Each Director shall receive: (i) $1,750 for a Board of Directors or Committee meeting attended in person, (ii) the following amounts for each additional Committee meeting attended in person on the same date: $1,500 for Audit or Compliance Committee meetings and $1,000 for Compensation or Nominating and Governance Committee meetings, and (iii) $1,000 for any Board or Committee meetings attended by telephone.

 4. Restricted Stock Unit Awards.  Each Director shall receive an award of $100,000 of restricted stock units on the date that the Compensation Committee grants regular annual equity awards to its officers and employees using the closing sale price of Sun’s common stock as of such date.  The stock unit awards shall have the following terms:  (i) the units shall vest monthly over one year, (ii) the vested units shall not be distributed as common stock until the earlier of the five year anniversary of the date of grant or separation of service from the Board, and (iii) the vesting of the units and the distribution of the vested units would accelerate at death, disability or change in control.

 5. Conversion of Cash Retainers into Stock Units.  Each Director shall be entitled to convert his or her cash retainers under Items 1 and 2 above into additional stock units.  Directors choosing such conversion must make an irrevocable election each year and the conversion would occur quarterly as of the last day business day of each quarter using the closing sale price of Sun’s common stock.

 6. Reimbursement of Expenses.  Each Director is reimbursed for out-of-pocket expenses for attendance at Board and committee meetings.

1

EX-21.1

EXHIBIT 21.1

SUN HEALTHCARE GROUP, INC. SUBSIDIARIES

as of February 16, 2011

	Jurisdiction of Incorporation
Sun Healthcare Group, Inc.	Delaware
Masthead Corporation	New Mexico
CareerStaff Unlimited, Inc.	Delaware
Harborside Rehabilitation Limited Partnership	Massachusetts
ProCare One Nurses, LLC	Delaware
SunDance Rehabilitation Corporation	Connecticut
SunAlliance Healthcare Services, Inc.	Delaware
SunDance Rehabilitation Agency, Inc.	Delaware
SunBridge Healthcare, LLC	New Mexico
Harborside Healthcare, LLC	Delaware
Belmont Nursing Center LLC	Massachusetts
Countryside Care Center Corp.	Massachusetts
Florida Holdings III, LLC	Delaware
1501 SE 24th Road, LLC	Delaware
1980 Sunset Point Road, LLC	Delaware
2600 Highlands Boulevard, North, LLC	Delaware
3865 Tampa Road, LLC	Delaware
4927 Voorhees Road, LLC	Delaware
KHI LLC	Delaware
Harborside Healthcare Advisors Limited Partnership	Massachusetts
Florida Holdings I, LLC	Delaware
1775 Huntington Lane, LLC	Delaware
Huntington Place Limited Partnership	Florida
Harborside Health I LLC	Delaware
Vital Care Services, LLC	Delaware
Harborside Connecticut Limited Partnership	Massachusetts
Harborside Danbury Limited Partnership	Massachusetts
Hbr Danbury, LLC	Delaware
Hbr Trumbull, LLC	Delaware
Hbr Stamford, LLC	Delaware
Harborside Healthcare Baltimore Limited Partnership	Massachusetts
Harborside Massachusetts Limited Partnership	Massachusetts
Massachusetts Holdings I, LLC	Delaware
Falmouth Healthcare, LLC	Delaware
Mashpee Healthcare, LLC	Delaware
Wakefield Healthcare, LLC	Delaware
Westfield Healthcare, LLC	Delaware
Harborside North Toledo Limited Partnership	Massachusetts
Harborside Point Place, LLC	Delaware
Harborside Sylvania, LLC	Delaware
Harborside of Cleveland Limited Partnership	Massachusetts
Harborside of Dayton Limited Partnership	Massachusetts
Harborside of Ohio Limited Partnership	Massachusetts
Harborside Rhode Island Limited Partnership	Massachusetts
Riverside Retirement Limited Partnership	Massachusetts
Harborside Holdings I, LLC	Delaware

Harborside Toledo Business LLC	Massachusetts
HHCI Limited Partnership	Massachusetts
Florida Holdings II, LLC	Delaware
1240 Pinebrook Road, LLC	Delaware
2900 Twelfth Street North, LLC	Delaware
4602 Northgate Court, LLC	Delaware
Harborside New Hampshire Limited Partnership	Massachusetts
Harborside Toledo Limited Partnership	Massachusetts
Harborside Swanton, LLC	Delaware
Harborside Troy, LLC	Delaware
Ohio Holdings I, LLC	Delaware
Marietta Healthcare, LLC	Delaware
Harford Gardens LLC	Maryland
Harborside Healthcare Limited Partnership	Massachusetts
Florida Administrative Services, LLC	Delaware
Hbr Kentucky, LLC	Delaware
Bradford Square Nursing, LLC	Delaware
Crestview Nursing, LLC	Delaware
Grant Manor LLC	Delaware
HBR Bardwell LLC	Delaware
HBR Barkely Drive, LLC	Delaware
HBR Bowling Green LLC	Delaware
HBR Brownsville, LLC	Delaware
HBR Campbell Lane, LLC	Delaware
HBR Elizabethtown, LLC	Delaware
HBR Lewisport, LLC	Delaware
HBR Madisonville, LLC	Delaware
HBR Owensboro, LLC	Delaware
HBR Paducah, LLC	Delaware
HBR Woodburn, LLC	Delaware
Klondike Manor LLC	Delaware
Leisure Years Nursing, LLC	Delaware
Owenton Manor Nursing, LLC	Delaware
Pine Tree Villa LLC	Delaware
Regency Nursing, LLC	Delaware
Woodspoint LLC	Delaware
HHC Nutrition Services, LLC	Delaware
LTC Leasing, LLC	Delaware
Maryland Harborside Corp.	Massachusetts
Bowie Center, Limited Partnership	Maryland
Massachusetts Holdings II, Limited Partnership	Massachusetts
Harborside Administrative Services, LLC	Delaware
Peak Medical, LLC	Delaware
Peak Medical Ancillary Services, Inc.	Delaware
SolAmor Hospice Corporation	Oklahoma
Countryside Hospice Care, Inc.	Illinois
Allegiance Hospice Group, Inc.	Delaware
Allegiance Hospice Care of Connecticut, LLC	Delaware
Allegiance Hospice Care of Maine, LLC	Delaware
Allegiance Hospice Care of Massachusetts, Inc.	Delaware
Allegiance Hospice Care of New Hampshire, LLC	Delaware
Allegiance Hospice Care of Rhode Island, LLC	Delaware

2

Allegiance Hospice Care of Southeastern Massachusetts, LLC	Delaware
Peak Medical Assisted Living, LLC	Delaware
Peak Medical Colorado No. 2, Inc.	Delaware
Peak Medical Colorado No. 3, Inc.	Delaware
Peak Medical Farmington, Inc.	Delaware
Peak Medical Gallup, Inc.	Delaware
Peak Medical Idaho Operations, Inc.	Delaware
Peak Medical Las Cruces No. 2, Inc.	Delaware
Peak Medical Las Cruces, Inc.	Delaware
Peak Medical Montana Operations, Inc.	Delaware
Great Falls Health Care Company, L.L.C.	Montana
Peak Medical New Mexico No. 3, Inc.	Delaware
Peak Medical NM Management Services, Inc.	Delaware
Peak Medical of Boise, Inc.	Delaware
Peak Medical of Colorado, LLC	Delaware
Peak Medical of Idaho, Inc.	Delaware
Peak Medical of Utah, Inc.	Delaware
Peak Medical Oklahoma Holdings--McLoud, Inc.	Delaware
Peak Medical Oklahoma No. 1, Inc.	Delaware
Peak Medical Oklahoma No. 10, LLC	Delaware
Peak Medical Oklahoma No. 11, Inc.	Delaware
Peak Medical Oklahoma No. 12, Inc.	Delaware
Peak Medical Oklahoma No. 13, Inc.	Delaware
Peak Medical Oklahoma No. 3, Inc.	Delaware
Peak Medical Oklahoma No. 4, Inc.	Delaware
Peak Medical Oklahoma No. 5, Inc.	Delaware
Peak Medical Oklahoma No. 7, Inc.	Delaware
Peak Medical Oklahoma No. 8, Inc.	Delaware
Peak Medical Oklahoma No. 9, Inc.	Delaware
Peak Medical PeachTree, Inc.	Delaware
Peak Medical Roswell, Inc.	Delaware
Peak Medical Utah No. 2, Inc.	Delaware
PM Henryetta Holdings, Inc.	Delaware
PM Oxygen Services, Inc.	Delaware
Regency Health Services, Inc.	Delaware
SunBridge Braswell Enterprises, Inc.	California
SunBridge Brittany Rehabilitation Center, Inc.	California
SunBridge Care Enterprises, Inc.	Delaware
SunBridge Beckley Health Care Corp.	West Virginia
SunBridge Care Enterprises West	Utah
SunBridge Circleville Health Care Corp.	Ohio
SunBridge Dunbar Health Care Corp.	West Virginia
SunBridge Glenville Health Care, Inc.	West Virginia
SunBridge Marion Health Care Corp.	Ohio
SunBridge Putnam Health Care Corp.	West Virginia
SunBridge Salem Health Care Corp.	West Virginia
SunBridge Carmichael Rehabilitation Center	California
SunBridge Hallmark Health Services, Inc.	Delaware
SunBridge Harbor View Rehabilitation Center	California
SunBridge Meadowbrook Rehabilitation Center	California

SunBridge Paradise Rehabilitation Center, Inc.	California
SunBridge Regency Rehab Hospitals, Inc.	California

3

SunBridge San Bernardino Rehabilitation Hospital, Inc.	Delaware
SunBridge Regency-North Carolina, Inc.	North Carolina
SunBridge Regency-Tennessee, Inc.	Tennessee
SunBridge Shandin Hills Rehabilitation Center	California
SunBridge Stockton Rehabilitation Center, Inc.	California
SunBridge Clipper Home of North Conway, Inc.	New Hampshire
SunBridge Clipper Home of Portsmouth, Inc.	New Hampshire
SunBridge Clipper Home of Rochester, Inc.	New Hampshire
SunBridge Clipper Home of Wolfeboro, Inc.	New Hampshire
SunBridge G. P. Corporation	New Mexico
SunBridge Goodwin Nursing Home, Inc.	New Hampshire
SunBridge Mountain Care Management, Inc.	West Virginia
SunBridge Nursing Home, Inc.	Washington
SunBridge Retirement Care Associates, LLC	Colorado
Americare Health Services Corp.	Delaware
SunBridge Charlton Healthcare, LLC	Georgia
SunBridge Gardendale Health Care Center, LLC	Georgia
SunBridge Jeff Davis Healthcare, LLC	Georgia
SunBridge of Harriman, LLC	Tennessee
SunBridge Statesboro Health Care Center, Inc.	Georgia
SunBridge Summers Landing, Inc.	Georgia
SunBridge West Tennessee, Inc.	Georgia
SunHealth Specialty Services, Inc.	New Mexico
SunMark of New Mexico, Inc.	New Mexico
The Mediplex Group, Inc.	New Mexico
CareerStaff Services Corporation	Colorado
SunDance Services Corporation	Tennessee

4

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-115851, No. 333-135525, No. 333-161138 and No. 333-157728) of Sun Healthcare Group, Inc. of our report dated March 3, 2011 relating to the consolidated financial statements, financial statement schedule and the effectiveness of internal control over financial reporting, which appears in this Form 10-K.

/s/ PricewaterhouseCoopers LLP

Irvine, California

March 3, 2011

EX-31.1

EXHIBIT 31.1

CERTIFICATION PURSUANT TO

SECTION 302 OF

THE SARBANES-OXLEY ACT OF 2002

I, William A. Mathies, certify that:

1. I have reviewed this annual report on Form 10-K 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: March 1, 2011	/s/ William A. Mathies
	William A. Mathies 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 annual report on Form 10-K 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: March 1, 2011	/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, William A. Mathies, 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 Annual Report on Form 10-K for the year ended December 31, 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: March 1, 2011	/s/ William A. Mathies
	William A. Mathies

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 Annual Report on Form 10-K for the year ended December 31, 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: March 1, 2011	/s/ L. Bryan Shaul
	L. Bryan Shaul