10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2012

or

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

Commission File Number: 1-12040

SUN HEALTHCARE GROUP, INC.

(Exact name of Registrant as specified in its charter)

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

18831 Von Karman, Suite 400

Irvine, CA  92612

(949) 255-7100

(Address, zip code and telephone number of Registrant)

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

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

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

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

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

As of May 7, 2012, there were 25,531,447 shares of the Registrant’s $.01 par value Common Stock outstanding.

1

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Index

		Page Numbers
PART I.  FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets (unaudited)	3
	As of March 31, 2012
	As of December 31, 2011
	Consolidated Statements of Comprehensive Income (unaudited)	5
	For the three months ended March 31, 2012 and 2011
	Consolidated Statements of Cash Flows (unaudited)	6
	For the three months ended March 31, 2012 and 2011
	Notes to Consolidated Financial Statements (unaudited)	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4.	Controls and Procedures	28
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 6.	Exhibits	29
Signature		31

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

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Quarterly Report on Form 10-Q (this “Form 10-Q”) contain “forward-looking” information as that term is defined by the Private Securities Litigation Reform Act of 1995 (the “Act”) and the federal securities laws.  Any statements that do not relate to historical or current facts or matters are forward-looking statements. Examples of forward-looking statements include all statements regarding our expected future financial position, results of operations, cash flows, liquidity, financing plans, business strategy, budgets, the impact of reductions in reimbursements and other changes in government reimbursement programs,  the scope, timing and effectiveness of our efforts to mitigate the impact on our business of the CMS Final Rule (described below), the outcome and costs of litigation, projected expenses and capital expenditures, growth opportunities, ability to refinance our indebtedness on favorable terms, 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, although not all forward-looking statements contain these identifying words.

The forward-looking statements are based on the information currently available and are applicable 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 are urged to carefully review the disclosures we make concerning risks and other factors that may affect our business and operating results, including those made in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and in our other reports filed with the Securities and Exchange Commission.  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 you that any forward-looking statements made in this Form 10-Q are not guarantees of future performance and that you should not place undue reliance on any of such forward-looking statements, which speak only as of the date of this document.  There may be additional risks of which we are presently unaware or that we currently deem immaterial.  We do not intend, and undertake no obligation, to update our forward-looking statements to reflect future events or circumstances.

_______________________

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PART I.     FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (unaudited)

ASSETS

(in thousands)

	March 31, 2012		December 31, 2011
Current assets:
Cash and cash equivalents	$	44,771	$	57,908
Restricted cash	14,325		15,706
Accounts receivable, net of allowance for doubtful accounts of $66,191
and $67,640 at March 31, 2012 and December 31, 2011, respectively	206,813		202,229
Prepaid expenses and other assets	28,022		29,075
Assets held for sale	4,537		—
Deferred tax assets	63,993		63,170
Total current assets	362,461		368,088
Property and equipment, net	146,033		148,298
Intangible assets, net	34,630		35,294
Goodwill	34,905		34,496
Restricted cash, non-current	353		353
Deferred tax assets	123,458		123,974
Other assets	42,825		45,163
Total assets	$	744,665	$	755,666

See accompanying notes.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (unaudited) (CONTINUED)

LIABILITIES AND STOCKHOLDERS’ EQUITY

(in thousands, except per share data)

	March 31, 2012			December 31, 2011
Current liabilities:
Accounts payable	$	48,836		$	55,888
Accrued compensation and benefits	56,494			61,101
Accrued self-insurance obligations, current portion	59,687			57,810
Other accrued liabilities	44,746			43,139
Current portion of long-term debt and capital lease obligations	995			1,017
Total current liabilities	210,758			218,955
Accrued self-insurance obligations, net of current portion	152,921			157,267
Long-term debt and capital lease obligations, net of current portion	88,500			88,768
Unfavorable lease obligations, net	6,492			7,110
Other long-term liabilities	58,454			58,110
Total liabilities	517,125			530,210
Commitments and contingencies (Note 5)
Stockholders' equity:
Preferred stock of $.01 par value, authorized 3,333
shares, zero shares issued and outstanding as of
March 31, 2012 and December 31, 2011	—			—
Common stock of $.01 par value, authorized  41,667
shares, 25,272 and 25,146 shares issued and outstanding
as of March 31, 2012 and December 31, 2011, respectively	253			251
Additional paid-in capital	728,801			726,861
Accumulated deficit	(500,214		)	(500,427		)
Accumulated other comprehensive loss, net	(1,300		)	(1,229		)
Total stockholders' equity	227,540			225,456
Total liabilities and stockholders' equity	$	744,665		$	755,666

See accompanying notes.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

(in thousands, except per share data)

	For the Three Months Ended
	March 31, 2012			March 31, 2011
Total net revenues	$	458,493		$	466,307
Costs and expenses:
Operating salaries and benefits	261,090			262,480
Self-insurance for workers’ compensation and general and
professional liability insurance	15,317			14,557
Operating administrative expenses	12,406			13,067
Other operating costs	96,566			91,135
Center rent expense	36,377			35,692
General and administrative expenses	16,041			15,379
Depreciation and amortization	8,430			7,449
Provision for losses on accounts receivable	4,808			5,176
Interest, net of interest income of $68 and $58, respectively	4,411			4,999
Restructuring costs	—			136
Total costs and expenses	455,446			450,070
Income before income taxes and discontinued operations	3,047			16,237
Income tax expense	1,188			6,619
Income from continuing operations	1,859			9,618
Loss from discontinued operations, net	(1,646		)	(1,506		)
Net income	$	213		$	8,112
Other comprehensive income, net of tax:
(Loss) gain from cash flow hedge, net of related tax (benefit) expense of ($47) and $22, respectively	(71		)	32
Other comprehensive income, net of tax	(71		)	32
Comprehensive income	$	142		$	8,144
Basic earnings per common and common equivalent share:
Income from continuing operations	$	0.07		$	0.37
Loss from discontinued operations, net	(0.06		)	(0.05		)
Net income	$	0.01		$	0.32
Diluted earnings per common and common equivalent share:
Income from continuing operations	$	0.07		$	0.37
Loss from discontinued operations, net	(0.06		)	(0.06		)
Net income	$	0.01		$	0.31
Weighted average number of common and common
equivalent shares outstanding:
Basic	26,207			25,740
Diluted	26,207			25,838

See accompanying notes.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

	For the Three Months Ended
	March 31, 2012			March 31, 2011
Cash flows from operating activities:
Net income	$	213		$	8,112
Adjustments to reconcile net income to net cash (used for) provided by operating activities, including discontinued operations:
Depreciation and amortization	8,582			7,681
Amortization of favorable and unfavorable lease intangibles	(513		)	(484		)
Provision for losses on accounts receivable	5,122			5,644
Stock-based compensation expense	2,232			1,449
Deferred taxes	(260		)	2,032
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable	(9,781		)	(5,393		)
Restricted cash	1,381			(1,946		)
Prepaid expenses and other assets	1,752			(249		)
Accounts payable	(6,036		)	(1,919		)
Accrued compensation and benefits	(4,607		)	3,438
Accrued self-insurance obligations	(2,469		)	(1,342		)
Income taxes payable	—			478
Other accrued liabilities	1,531			(731		)
Other long-term liabilities	227			(727		)
Net cash (used for) provided by operating activities	(2,626		)	16,043
Cash flows from investing activities:
Capital expenditures	(9,961		)	(8,837		)
Acquisitions, net of cash acquired	(260		)	—
Net cash used for investing activities	(10,221		)	(8,837		)
Cash flows from financing activities:
Principal repayments of long-term debt and capital lease
obligations	(290		)	(2,798		)
Net cash used for financing activities	(290		)	(2,798		)
Net (decrease) increase in cash and cash equivalents	(13,137		)	4,408
Cash and cash equivalents at beginning of period	57,908			81,163
Cash and cash equivalents at end of period	$	44,771		$	85,571

See accompanying notes.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(1)  Nature of Business

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

Business

Our subsidiaries provide long-term, post-acute and related specialty healthcare in the United States.  We operate through three principal business segments: (i) inpatient services, (ii) rehabilitation therapy services, and (iii) medical staffing services.  Inpatient services represent the most significant portion of our business.  Our continuing operations include 190 healthcare centers in 23 states as of March 31, 2012.

Other Information

The accompanying unaudited consolidated financial statements have been prepared in accordance with our customary accounting practices and accounting principles generally accepted in the United States (“GAAP”) for interim financial statements.  In our opinion, the accompanying interim consolidated financial statements are a fair statement of our financial position at March 31, 2012, and our consolidated results of operations and cash flows for the three-month periods ended March 31, 2012 and 2011.  These statements are unaudited, and certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted, as permitted under the applicable rules and regulations of the Securities and Exchange Commission.  The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of only normal recurring items.  Readers of these statements should refer to our audited consolidated financial statements and notes thereto for the year ended December 31, 2011, which are included in our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”).

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

Recent Accounting Pronouncements

The FASB issued an Accounting Standards Update in June 2011 regarding the presentation of comprehensive income within financial statements.  GAAP now requires that comprehensive income and its components of net income and other comprehensive income be presented in either (1) a single continuous statement of comprehensive income or (2) two separate but consecutive statements.  This new guidance is now effective for us and our accompanying consolidated financial statements have been presented with one single continuous statement of comprehensive income.

Reclassifications

Certain reclassifications have been made to the prior period financial statements to conform to the 2012 financial statement presentation.  We have reclassified the results of operations of nine skilled nursing centers of our Inpatient Services segment (see Note 4 – “Discontinued Operations”) for all periods presented to discontinued operations within the income statement, in accordance with GAAP.

7

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

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

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

	March 31, 2012			December 31, 2011
Revolving loans	$	—		$	—
Mortgage note payable due monthly through 2014, interest at
at a rate of 8.5%, collateralized by real property with
carrying values totaling $1.7 million	1,888			2,076
Term loans	87,358			87,389
Capital leases	249			320
Total long-term obligations	89,495			89,785
Less amounts due within one year	(995		)	(1,017		)
Long-term obligations, net of current portion	$	88,500		$	88,768

The scheduled or expected maturities of long-term obligations as of March 31, 2012, were as follows (in thousands):

For the twelve months ending March 31:
2013	$	995
2014	913
2015	229
2016	—
2017	87,358
	$	89,495

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 also may enter into interest rate cap agreements that effectively limit the maximum interest rate that we pay on an agreed to notional principal amount.  We use interest rate hedges to manage interest rate risk related to borrowings.  Our intent is to only enter into such arrangements that qualify for hedge accounting treatment in accordance with GAAP.  Accordingly, we designate all such arrangements as cash-flow hedges and perform initial and quarterly effectiveness testing using the hypothetical derivative method.  To the extent that such arrangements are effective hedges, changes in fair value are recognized through other comprehensive income.  Ineffectiveness, if any, would be recognized in earnings.

Our credit agreement requires that at least 50% of our term loans be subject to at least a three-year hedging agreement. To satisfy this requirement, we executed two hedging instruments on January 18, 2011: a two-year interest rate cap and a two-year “forward starting” interest rate swap.  The two-year interest rate cap limits our exposure to increases in interest rates for $82.5 million of debt through December 31, 2012.  This cap is effective when LIBOR rises above 1.75%, effectively fixing the interest rate on $82.5 million of our term loans at 8.75% through December 31, 2012.  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.  The two-year “forward starting” interest rate swap effectively converts the interest rate on $82.5 million of our term loans to a fixed rate from January 1, 2013 through December 31, 2014.  LIBOR is fixed at 3.185%, making the all-in rate effectively a fixed 10.185% for this portion of the term loans.  There was no fee for this swap agreement.  Both arrangements qualify for hedge accounting treatment.

8

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

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

	Derivatives
	March 31, 2012			December 31, 2011
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments:	Other Long-Term			Other Long-Term
Interest rate hedging agreements	Liabilities	$	2,167	Liabilities	$	2,049

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

	Amount of (Loss)/Gain in Other Comprehensive (Loss)/Income					Gain Reclassified from Accumulated Other Comprehensive Income to Income (ineffective portion)
	2012			2011		2012		2011
Derivatives designated as cash flow hedges:
Interest rate hedging agreements	$	(71	)	$	32	$	—	$	—

(3)Fair Value of Financial Instruments

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

	March 31, 2012				December 31, 2011
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Cash and cash equivalents	$	44,771	$	44,771	$	57,908	$	57,908
Restricted cash	$	14,678	$	14,678	$	16,059	$	16,059
Long-term debt and capital lease obligations,
including current portion	$	89,495	$	86,492	$	88,785	$	74,545
Interest rate hedging agreements	$	2,167	$	2,167	$	2,049	$	2,049

The cash and cash equivalents and restricted cash carrying amounts approximate fair value because of the short maturity of these instruments. At March 31, 2012 and December 31, 2011, the fair value of our long-term debt, including current maturities, and our interest rate hedging agreements was based on estimates using present value techniques that are significantly affected by the assumptions used concerning the amount and timing of estimated future cash flows and discount rates that reflect varying degrees of risk.

GAAP establishes a hierarchy for ranking the quality and reliability of the information used to determine fair values.  The applicable guidance requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

Level 1:     Unadjusted quoted market prices in active markets for identical assets or liabilities.

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

Level 3:    Unobservable inputs for the asset or liability.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

We endeavor to utilize the best available information in measuring fair value.  The following tables summarize the valuation of our financial instruments by the above pricing levels as of March 31, 2012 and December 31, 2011, respectively (in thousands):

	March 31, 2012
	Total	Unadjusted Quoted Market Prices (Level 1)	Significant Other Observable Inputs (Level 2)
Interest rate hedging agreements – liability	$2,167	$—	$2,167

	December 31, 2011
	Total	Unadjusted Quoted Market Prices (Level 1)	Significant Other Observable Inputs (Level 2)
Interest rate hedging agreements - liability	$2,049	$—	$2,049

We currently have no other financial instruments subject to fair value measurement on a recurring basis. The fair value for our cash and cash equivalents and restricted cash disclosed above were determined by Level 1 valuation techniques and our long-term debt and capital lease obligations fair value above was determined by Level 2 valuation techniques.

(4)Discontinued Operations

The results of operations of assets to be disposed of, disposed assets and the losses related to these divestitures have been classified as discontinued operations for all periods presented in the accompanying consolidated income statements as their operations and cash flows have been (or will be) eliminated from our ongoing operations and we will not have any significant continuing involvement in their operations after their disposal.

During the three months ended March 31, 2012, we developed plans to dispose of nine skilled nursing centers in three different markets within our Inpatient Services segment, whose results have been reclassified to discontinued operations for all periods presented in accordance with GAAP.  As of March 31, 2012, assets held for sale for these nine centers of $4.5 million consisted of (i) a net carrying amount of $3.2 million of property and equipment, (ii) $0.8 million of other non-current assets and (iii) $0.5 million of prepaid expenses and other assets.

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

	For the Three Months Ended
	March 31, 2012									March 31, 2011
	Inpatient Services			Other			Total			Inpatient Services			Other			Total
Net operating revenues	$	16,746		$	—		$	16,746		$	20,145		$	—		$	20,145
Loss from discontinued operations, net (1)	$	(1,645	)	$	(1	)	$	(1,646	)	$	(1,498	)	$	(8	)	$	(1,506	)

(1) Net of related tax benefit of $1,052 and $981, respectively

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

(5)  Commitments and Contingencies

(a) 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 from such reviews are reflected in current earnings. Claims are paid over varying periods, and future payments may be different than the estimated reserves.

We evaluate the adequacy of our self-insurance reserves on a quarterly basis and perform detailed actuarial analyses semi-annually in the second and fourth quarters. The analyses use generally accepted actuarial methods in evaluating the workers’ compensation reserves and general and professional liability reserves.  For both the workers’ compensation reserves and the general and professional liability reserves, those methods include reported and paid loss development methods, expected loss method and the reported and paid Bornhuetter-Ferguson methods.  Reported loss methods focus on development of case reserves for incurred losses through claims closure.  Paid loss methods focus on development of claims actually paid to date.  Expected loss methods are based upon an anticipated loss per unit of measure.  The Bornhuetter-Ferguson method is a combination of loss development methods and expected methods.

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

The use of multiple methods tends to eliminate any biases that one particular method might have.  Management’s judgment based upon each method’s inherent limitation is applied when weighting the results of each method.  The results of each of the methods are estimates of ultimate losses which include the case reserves plus an estimate for future development of these reserves based on past trends, and an estimate for losses incurred but not reported. These results are compared by accident year, and an estimated unpaid loss and allocated loss adjustment expense is determined for the open accident years based on judgment reflecting the range of estimates produced by the methods.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

Activity in our professional liability and workers’ compensation self-insurance reserves as of and for the periods ended March 31, 2012 and 2011 is as follows (in thousands):

	For the Three Months Ended March 31, 2011
	Professional Liability			Workers’ Compensation			Total
Gross balance, beginning of period	$	113,971		$	96,585		$	210,556
Less: anticipated insurance recoveries	(2,100		)	(28,100		)	(30,200		)
Net balance, beginning of period	$	111,871		$	68,485		$	180,356
Current year provision, continuing operations	6,974			7,583			14,557
Current year provision, discontinued operations	467			384			851
Claims paid, continuing operations	(9,515		)	(4,667		)	(14,182		)
Claims paid, discontinued operations	(346		)	(366		)	(712		)
Amounts paid for administrative services and other	(809		)	(1,744		)	(2,553		)
Net balance, end of period	$	108,642		$	69,675		$	178,317
Plus: anticipated insurance recoveries	2,100			28,100			30,200
Gross balance, end of period	$	110,742		$	97,775		$	208,517

	For the Three Months Ended March 31, 2012
	Professional Liability			Workers’ Compensation			Total
Gross balance, beginning of period	$	120,857		$	87,242		$	208,099
Less: anticipated insurance recoveries	(2,390		)	(21,930		)	(24,320		)
Net balance, beginning of period	$	118,467		$	65,312		$	183,779
Current year provision, continuing operations	8,135			7,182			15,317
Current year provision, discontinued operations	467			326			793
Claims paid, continuing operations	(6,419		)	(4,828		)	(11,247		)
Claims paid, discontinued operations	(3,269		)	(370		)	(3,639		)
Amounts paid for administrative services and other	(1,145		)	(2,009		)	(3,154		)
Net balance, end of period	$	116,236		$	65,613		$	181,849
Plus: anticipated insurance recoveries	2,390			21,930			24,320
Gross balance, end of period	$	118,626		$	87,543		$	206,169

    The anticipated insurance recoveries relate primarily to our workers’ compensation programs associated with policy years 1996 through 2001 where the claim losses have exceeded the policies' aggregate retention limits. Obligations above these retention limits are covered by our excess insurance carriers, which all have carrier ratings of at least “A,” “XIV” or better.

12

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

A summary of the assets and liabilities related to insurance risks at March 31, 2012 and December 31, 2011 is as indicated below (in thousands):

	March 31, 2012							December 31, 2011
	Professional Liability		Workers’ Compensation		Total		| |	Professional Liability		Workers’ Compensation		Total
Assets:							|
Restricted cash (1)							|
Current	$	5,617	$	8,544	$	14,161	|	$	6,254	$	9,332	$	15,586
Non-current	—		—		—		|	—		—		—
	$	5,617	$	8,544	$	14,161	|	$	6,254	$	9,332	$	15,586
							|
Anticipated insurance recoveries (2)							|
Current	$	524	$	2,730	$	3,254	|	$	524	$	2,730	$	3,254
Non-current	1,866		19,200		21,066		|	1,866		19,200		21,066
	$	2,390	$	21,930	$	24,320	|	$	2,390	$	21,930	$	24,320
Total Assets	$	8,007	$	30,474	$	38,481	|	$	8,644	$	31,262	$	39,906
Liabilities (3)(4):							|
Self-insurance liabilities							|
Current	$	32,030	$	21,218	$	53,248	|	$	28,758	$	22,074	$	50,832
Non-current	86,596		66,325		152,921		|	92,099		65,168		157,267
Total Liabilities	$	118,626	$	87,543	$	206,169	|	$	120,857	$	87,242	$	208,099

(1) Total restricted cash includes cash collateral deposits and other cash held by third parties.  Total restricted cash above excludes $517 and $473 at March 31, 2012 and December 31, 2011, respectively, held for bank collateral, various mortgages, bond payments and capital expenditures on HUD-insured buildings.

(2) Anticipated insurance recovery assets are presented as Other Assets (both current and long-term) in our March 31, 2012 and December 31, 2011 consolidated balance sheets.  

(3) Total self-insurance liabilities above exclude $6,439 and $6,978 at March 31, 2012 and December 31, 2011, respectively, related to our employee health insurance liabilities.

(4) Total self-insurance liabilities for workers’ compensation claims are collateralized, in addition to the restricted cash, by letters of credit of $57,538 as of March 31, 2012 and $55,335 as of December 31, 2011.

(b)  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.  The ability to predict the ultimate outcome of such matters involves judgments, estimates and inherent uncertainties.  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 or 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, the industries in which we operate are frequently subject to the regulatory supervision of fiscal intermediaries. If a provider is found to have engaged in improper practices, it could be subject to civil, administrative or criminal fines, penalties or restitutionary relief; and reimbursement authorities could also seek the suspension

13

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

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 or cash flows.

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. Our appeal is currently pending with the Kentucky Court of Appeals. We believe our reserves are adequate for this matter.

(c)  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.

(6)  Income Taxes

The provision for income taxes of $1.2 million for the three months ended March 31, 2012 results in an effective tax rate of approximately 39%. The provision for income taxes of $6.6 million for the three months ended March 31, 2011 resulted in an effective tax rate of approximately 41%. The rates for 2012 and 2011 differ from the statutory tax rate of 35% primarily due to state taxes.

The realization of our deferred tax assets is dependent upon generation of taxable income during periods in which deductions and/or credits can be utilized.  As a result, we consider the level of historical taxable income, historical non-recurring credits and charges, the scheduled reversal of deferred tax liabilities, tax-planning strategies and projected future taxable income in determining the amount of the valuation allowance.  The valuation allowance of $17.9 million at March 31, 2012 and December 31, 2011 relates primarily to state net operating loss (“NOL”) carryforwards and other deferred tax assets for which realization is uncertain.

In evaluating the need to establish a valuation allowance on our net deferred tax assets, all items of positive evidence (e.g., future sources of taxable income, including the ability to reliably forecast and to continue our mitigation initiatives implemented in 2011) and negative evidence (e.g., impact of the Centers for Medicare and Medicaid Services ("CMS") final rule for skilled nursing facilities for the 2012 federal fiscal year, which commenced on October 1, 2011 (the "CMS Final Rule") and subsequent impairment of goodwill in 2011) were considered.  We were in a cumulative pre-tax book loss of approximately $217 million for the three-year period ended December 31, 2011.  However, because approximately $324 million of the book expenses (principally related to our 2011 non-cash loss on asset impairment for goodwill and other intangibles) were not deductible for tax purposes, we generated taxable income and utilized existing net operating loss carryforwards in each of the last three years.  As a result of the negative impact of the CMS Final Rule on our business, we commenced a broad based mitigation initiative in 2011, which includes infrastructure cost reductions. Our ability to generate sufficient future taxable income to realize our deferred tax assets is dependent on our ability to continue our mitigation initiatives. Based upon our current estimates of future taxable income, we believe that we will more likely than not realize our net deferred tax assets.  However, if we are unable to continue realizing enough savings through our mitigation initiative to offset the negative impact of the CMS Final Rule, we may be required to increase our valuation allowance in future periods.

After consideration of the November 2010 restructuring of our former parent company, which, among other matters resulted in Sabra Health Care REIT, Inc. holding substantially all of our former parent’s owned real property, and utilization of NOL carryforwards through 2011, the Internal Revenue Code (“IRC”) Section 382 annual base limitation to be applied to our tax attribute carryforwards is approximately $7.4 million. Accordingly, our NOL and tax credit carryforwards have been reduced to take into account this limitation and the respective carryforward periods for these tax attributes.  As a result of unused IRC Section 382 limitations from prior years and post-ownership change NOLs, we estimate there is approximately $47.6 million of NOLs which can be used to offset U.S. taxable income in 2012.  Considering annual IRC Section 382 limitations and built-in gains, we estimate a total of approximately $145.4 million of utilizable NOL carryforwards to offset taxable income in 2012 and future years.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

(7)  Segment Information

We operate predominantly in the long-term care segment of the healthcare industry. We are a provider of long-term, sub-acute and related ancillary care services to nursing home patients.  Our reportable segments are composed of operating segments, which are aggregated, comprising strategic business units that provide different products and services. They are managed separately because each business has different marketing strategies due to differences in types of customers, distribution channels and capital resource needs.  More complete descriptions and accounting policies of the segments are described in Note 13 – “Segment Information” and  Note 2 – “Summary of Significant Accounting Policies” of our 2011 Form 10-K.  The following tables summarize, for the periods indicated, operating results and other financial information, by business segment (in thousands):

As of and for the
Three Months Ended
March 31, 2012
	Inpatient Services			Rehabilitation Therapy Services		Medical Staffing Services			Corporate			Intersegment Eliminations			Consolidated
Revenues from external customers	$	405,788		$	30,629	$	22,069		$	7		$	—		$	458,493
Intersegment revenues	—			33,464		831			—			(34,295		)	—
Total net revenues	405,788			64,093		22,900			7			(34,295		)	458,493
Operating salaries and benefits	189,707			53,896		17,487			—			—			261,090
Self-insurance for workers’ compensation and
general and professional liability insurance	14,289			609		355			64			—			15,317
Other operating costs	125,669			2,497		2,695			—			(34,295		)	96,566
General and administrative expenses(1)	9,260			2,530		615			16,042			—			28,447
Provision for losses on
accounts receivable	4,430			414		(36		)	—			—			4,808
Segment operating income (loss)	$	62,433		$	4,147	$	1,784		$	(16,099	)	$	—		$	52,265
Center rent expense	36,075			134		168			—			—			36,377
Depreciation and amortization	7,028			251		185			966			—			8,430
Interest, net	(19		)	—		—			4,430			—			4,411
Net segment income (loss)	$	19,349		$	3,762	$	1,431		$	(21,495	)	$	—		$	3,047
Identifiable segment assets	$	385,342		$	18,701	$	20,287		$	287,188		$	20,829		$	732,347
Goodwill	$	30,297		$	75	$	4,533		$	—		$	—		$	34,905
Segment capital expenditures	$	8,676		$	399	$	51		$	835		$	—		$	9,961

______________________________________

(1) 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, restructuring costs, income tax expense and discontinued operations.

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

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

As of and for the
Three Months Ended
March 31, 2011
	Inpatient Services			Rehabilitation Therapy Services		Medical Staffing Services			Corporate			Intersegment Eliminations			Consolidated
Revenues from external customers	$	413,888		$	30,096	$	22,316		$	7		$	—		$	466,307
Intersegment revenues	—			32,694		623			—			(33,317		)	—
Total net revenues	413,888			62,790		22,939			7			(33,317		)	466,307
Operating salaries and benefits	190,931			54,132		17,417			—			—			262,480
Self-insurance for workers’ compensation and
general and professional liability insurance	13,501			642		347			67			—			14,557
Other operating costs	119,422			2,169		2,861			—			(33,317		)	91,135
General and administrative expenses(1)	10,014			2,398		655			15,379			—			28,446
Provision for losses on
accounts receivable	4,953			324		(101		)	—			—			5,176
Segment operating income (loss)	$	75,067		$	3,125	$	1,760		$	(15,439	)	$	—		$	64,513
Center rent expense	35,392			127		173			—			—			35,692
Depreciation and amortization	6,206			226		187			830			—			7,449
Interest, net	(6		)	—		1			5,004			—			4,999
Net segment income (loss)	$	33,475		$	2,772	$	1,399		$	(21,273	)	$	—		$	16,373
Identifiable segment assets	$	691,111		$	15,890	$	20,541		$	346,930		$	20,867		$	1,095,339
Goodwill	$	345,064		$	75	$	4,533		$	—		$	—		$	349,672
Segment capital expenditures	$	6,507		$	729	$	53		$	1,548		$	—		$	8,837

______________________________________

(1) 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, restructuring costs, income tax expense and discontinued operations.

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

Measurement of Segment Income

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

	For the Three Months Ended March 31,
	2012		2011
Net segment income	$	3,047	$	16,373
Restructuring costs	—		136
Consolidated income before income taxes
and discontinued operations	$	3,047	$	16,237

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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

Overview

Our subsidiaries are providers of nursing, rehabilitative and related specialty healthcare services primarily to the senior population in the United States. Our core business is providing inpatient services, primarily through 158 skilled nursing centers, 13 combined skilled nursing, assisted and independent living centers, 10 assisted living centers, 2 independent living centers and 7 mental health centers with 21,414 licensed beds located in 23 states as of March 31, 2012. Our subsidiaries also provide hospice services, rehabilitation therapy services and temporary medical staffing services to skilled nursing centers.

2011 Restructuring

On July 29, 2011, the Centers for Medicare and Medicaid Services (“CMS”) released its final rule for skilled nursing facilities for the 2012 federal fiscal year, which commenced on October 1, 2011 (the “CMS Final Rule”).  As a result of the expected negative impact of the CMS Final Rule on our business, we implemented a broad-based mitigation initiative, which included infrastructure cost reductions without affecting the quality of our patient care. These reductions in infrastructure costs were, and continue to be, necessary to mitigate the impact on our business and remain in compliance with financial covenants under the Credit Agreement. For additional information regarding the impact to us of the CMS Final Rule, please see Item 2 - “Management's Discussion and Analysis of Financial Condition and Results of Operations - Medicare” below.

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 federal and state budgets resulting from the current economic conditions in the United States may intensify these efforts. This focus has not been limited to skilled nursing centers, but includes specialty services provided by us, such as skilled therapy services, to third parties. 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.

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 (dollars in thousands):

	For the Three Months Ended
Sources of Revenues	March 31, 2012				March 31, 2011
Consolidated:
Medicaid	$	186,443	40.7	%	177,645	38.1	%
Medicare	136,288		29.7		151,251	32.4
Private pay and other	112,425		24.5		114,402	24.6
Managed care and commercial insurance	23,337		5.1		23,009	4.9
Total	$	458,493	100.0	%	466,307	100.0	%
Inpatient Only:
Medicaid	$	186,423	45.9	%	177,595	42.9	%
Medicare	131,517		32.4		146,608	35.4
Private pay and other	64,854		16.0		66,945	16.2
Managed care and commercial insurance	22,994		5.7		22,740	5.5
Total	$	405,788	100.0	%	413,888	100.0	%

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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 legislative and rule changes. PPS regulations predetermine a payment amount per patient, per day, based on the 1995 costs of treating patients indexed forward. Prior to October 1, 2010, the amount to be paid was determined by classifying each patient into one of 53 Resource Utilization Groups (“RUGs”), which were collectively referred to as “RUGs III”. After October 1, 2010, the RUGs were expanded to 66 categories to provide further refinement and are referred to collectively as “RUGs IV”. Each RUGs level represents the level of services required to treat the patient's condition or level of acuity.

The RUGs III system reimbursed for therapy service delivered concurrently, in a group or individually, at the same rate. The RUGs IV system changes maintain the same reimbursement methodology for group and individual therapy, but only considers 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 to the required qualifications for each RUGs level.

On July 29, 2011, CMS released its final rule for skilled nursing facilities for the 2012 federal fiscal year that commenced on October 1, 2011 (the "CMS Final Rule"). Pursuant to the CMS Final Rule, Medicare Part A payment rates were reduced by 12.6% (i.e., the Medicare rate parity adjustment) to correct what CMS perceived as a lack of parity between RUGs III and RUGs IV. The CMS Final Rule also changed the reimbursement rules associated with group therapy and introduced new change-of-therapy provisions as patients move through their post-acute stay. The CMS Final Rule therapy reimbursement changes resulted in further reductions in our revenues from the Medicare program (prior to implementation of our therapy mitigation plans) and also served to increase our costs of providing such therapy services. On October 1, 2011, we also received a net 1.7% market basket increase to our prospective Medicare rates. Based on operating results through the end of the first quarter of 2012, we continue to expect the impact of the CMS Final Rule on our full year 2012 operations to be a year-over-year reduction in income before income taxes of approximately $40.0 million to $45.0 million due to the ramp-up nature of many elements of our management mitigation plans.

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

For the Three Months Ended
March 31, 2012	March 31, 2011
$463.10	$522.11

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, 2012.

CMS has notified providers that they will not issue a Notice of Proposed Rulemaking - SNF for the 2013 fiscal year which commences on October 1, 2012.  They will instead issue an Update Notice, prior to July 31, 2012.  This Notice will make updates that are required by current law rather than changes to the current system.  We anticipate the net impact of this Update to be an increase in rates of 1.8%.  Any additional changes prior to October 1, 2013 would require legislative action.

On February 17, 2012, Congress passed the Middle Class Tax Relief and Job Creation Act of 2011, which included a provision reducing the reimbursement of Medicare bad debts. Medicare bad debts are primarily generated when states do not reimburse the provider for co-insurance for Medicare/Medicaid dually eligible patients. Providers are not permitted to bill this co-insurance to any other party when Medicaid does not reimburse the provider cost of service. Prior to this legislation, Medicare reimbursed providers 100% for this uncollectable co-insurance associated with dually eligible patients. Under the newly enacted legislation, Medicare will now phase in a reduction in the percentage of reimbursement for uncollectable co-insurance starting with cost reports beginning in federal fiscal year 2013, which primarily impacts our cost reports beginning on January 1, 2013. It is not clear if

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

states will reimburse for dually eligible patient co-insurance under the state Medicaid programs as a result of this new legislation. If states do not begin to reimburse for dually eligible patient co-insurance then we are projecting the result will be a reduction in our revenues from reimbursement of Medicare bad debts of approximately $2.3 million in 2013, $4.7 million in 2014 and $6.7 million in subsequent years. Fourteen of the twenty-three states in which we operate do not reimburse the Medicaid co-insurance for dually eligible patients.

On August 2, 2011, Congress passed the Budget Control Act of 2011, which created The Joint Select Committee on Deficit Reduction.  This Committee was tasked to find $1.5 trillion in savings by November 23, 2011.  The Committee was unable to reach an agreement and as a result, sequestration as provided for in the Budget Control Act was triggered.  Sequestration will result in a 2% reduction in Medicare payments effective January 1, 2013, which we estimate will reduce our revenues by approximately $2.5 million per quarter in 2013.

Historically we have been able to mitigate a portion of revenue reductions resulting from changes in CMS' reimbursement regulations.

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 lower routine home care rate.

· 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 number of 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 the excess.

In July 2011, CMS issued its final rule for hospice services for the 2012 federal fiscal year.  The rule includes a market basket increase of 3.0% and a 0.6% 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 and updated wage index data 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 our Inpatient Services segment operates impose a provider tax on nursing homes as a method of increasing federal matching funds paid to those states for Medicaid.

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

For the Three Months Ended
March 31, 2012	March 31, 2011
$178.64	$173.69

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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

For the Three Months Ended
March 31, 2012	March 31, 2011
$161.61	$158.62

Managed Care and Insurance

During the three months ended March 31, 2012, we received 5.1% of our revenues from managed care and insurance, of which the Medicare Advantage program is the primary component.  As discussed above, Medicare Advantage is the managed care option for Medicare beneficiaries.  Medicare Advantage is administered by contracted third party payors.  The managed care and insurance payors are continuing their efforts to control healthcare costs through direct contracts with healthcare providers and increased utilization review.  These payors are increasingly demanding discounted fee structures and the assumption by healthcare providers of all or a portion of the financial risk.

The following table sets forth the average amounts of inpatient revenues per patient, per day, recorded by our healthcare centers from these revenue sources for the periods indicated below. The increase in the average rate per patient, per day between the first quarter of 2011 and the first quarter of 2012 resulted from the unusually low prior year first quarter 2011 rate which included the negative impact of a $0.6 million prior year revenue reduction adjustment related to 2010 recorded in the first quarter of 2011 associated with a prior year managed care settlement payback. 

For the Three Months Ended
March 31, 2012	March 31, 2011
$381.54	$368.69

Private Payors, Veterans and Other

During the three months ended March 31, 2012, we received 24.5% of our revenues from private payors, veterans’ coverage, healthcare centers that utilize our specialty medical services, self-pay center residents and other third party payors. These private and other payors are continuing their efforts to control healthcare costs.  Private payor rates are set at a price point that enables continued competition; they are driven by the markets in which our healthcare centers operate.

The following table sets forth the average amounts of inpatient revenues per patient, per day, recorded by our healthcare centers from these revenue sources for the periods indicated below.  The decrease in the average rate per patient, per day between the first quarter of 2011 and the first quarter of 2012 resulted from a combination of the following:  (1) we experienced a proportionally larger amount of hospice and assisted living private pay customers in the first quarter of 2012 than in the prior year first quarter of 2011 and those hospice and private pay customers have a lower average per patient, per day private rate than our skilled nursing private pay customers thereby resulting in a lower blended inpatient services average per patient, per day private rate in 2012 as compared to 2011;  (2) the 2011 average rate per patient, per day included the positive benefit of $1.4 million greater prior year revenue increase adjustments recorded in the first quarter of 2011 than in the first quarter of 2012. 

For the Three Months Ended
March 31, 2012	March 31, 2011
$194.17	$199.38

Other Reimbursement Matters

Net revenues realizable under third-party payor agreements are subject to change due to examination and retroactive adjustment by payors during the settlement process. Under cost-based reimbursement plans, payors may either delay or 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

Recent Accounting Pronouncements

Discussion of recent accounting pronouncements can be found in the “Recent Accounting Pronouncements” portion of Note 1 – “Nature of Business” to our consolidated financial statements included in this Form 10-Q.

Results of Operations

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

	For the Three Months Ended						As a Percentage of Net Revenues
	March 31, 2012			March 31, 2011			March 31, 2012		March 31, 2011
Total net revenues	$	458,493		$	466,307		100.0	%	100.0	%
Costs and expenses:
Operating salaries and benefits	261,090			262,480			56.9		56.3
Self-insurance for workers’ compensation and
general and professional liabilities	15,317			14,557			3.3		3.1
Other operating costs (1)	108,972			104,202			23.8		22.3
Center rent expense	36,377			35,692			7.9		7.7
General and administrative expenses	16,041			15,379			3.5		3.3
Depreciation and amortization	8,430			7,449			1.8		1.6
Provision for losses on accounts receivable	4,808			5,176			1.0		1.1
Interest, net	4,411			4,999			1.0		1.1
Other (2)	—			136			—		—
Income before income taxes and         discontinued operations	3,047			16,237			0.7		3.5
Income tax expense	1,188			6,619			0.3		1.4
Income from continuing operations	1,859			9,618			0.4		2.1
Loss from discontinued operations, net	(1,646		)	(1,506		)	(0.4	)	(0.3	)
Net income	$	213		$	8,112		—	%	1.7	%
Supplemental Financial Information (3):
EBITDA	$	15,888		$	28,685		3.5	%	6.2	%
Adjusted EBITDA	$	15,888		$	28,821		3.5	%	6.2	%
Adjusted EBITDAR	$	52,265		$	64,513		11.4	%	13.8	%

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

(2) Other expenses consist of restructuring costs.

(3) We define EBITDA as net income before loss from discontinued operations, interest expense (net of interest income), income tax expense, depreciation and amortization.  EBITDA margin is EBITDA as a percentage of revenue.  Adjusted EBITDA is EBITDA adjusted for restructuring costs.  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 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 and depreciation and amortization expense, which may

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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. The additional items we exclude from Adjusted EBITDA and Adjusted EBITDAR are also charges that we believe are unrelated to the operation of our underlying business.  As a result, we believe that the use of EBITDA, Adjusted EBITDA and Adjusted EBITDAR provides a meaningful and consistent comparison of our underlying business between periods by eliminating certain items required by GAAP which have little or no significance in our day-to-day operations.

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

Despite the importance of these measures in analyzing our underlying business, maintaining our financial requirements, designing incentive compensation and for our goal setting both on an aggregate and facility level basis, EBITDA, Adjusted EBITDA and Adjusted EBITDAR are non-GAAP financial measures that have no standardized meaning defined by GAAP.  As the items excluded from EBITDA, Adjusted EBITDA and Adjusted EBITDAR are significant components in understanding and assessing our financial performance, EBITDA, Adjusted EBITDA and Adjusted EBITDAR should not be considered in isolation or as alternatives to net income, cash flows generated by or used in operating, investing or financing activities or other financial statement data presented in the consolidated financial statements included in this Form 10-Q as indicators of financial performance or liquidity.  Therefore, our EBITDA, Adjusted EBITDA and Adjusted EBITDAR measures have limitations as analytical tools, and they should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP.  Some of these limitations are:

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

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

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

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

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

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

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

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

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

	For the Three Months Ended March 31,
	2012			2011
Net income	$	213		$	8,112
Plus:
Loss from discontinued operations, net	(1,646		)	(1,506		)
Income tax expense	1,188			6,619
Interest expense, net	4,411			4,999
Depreciation and amortization	8,430			7,449
EBITDA	$	15,888		$	28,685
Plus:
Restructuring costs	—			136
Adjusted EBITDA	$	15,888		$	28,821
Plus:
Center rent expense	36,377			35,692
Adjusted EBITDAR	$	52,265		$	64,513

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

The following discussion of the “Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011” is based, in part, on the financial information presented in Note 7 – “Segment Information” in our consolidated financial statements included in this Form 10-Q.

Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011

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

Total net revenues decreased $7.8 million, or 1.7%, to $458.5 million for the three months ended March 31, 2012 from $466.3 million for the three months ended March 31, 2011.  We reported net income for the three months ended March 31, 2012 of $0.2 million and net income of $8.1 million for the three months ended March 31, 2011.

The decrease in net revenues for the 2012 period included $8.1 million of reduced revenues in our Inpatient Services segment and a $0.2 million decrease in nonaffiliated revenues from our Medical Staffing segment, which were partially offset by a $0.5 million increase in nonaffiliated revenues from our Rehabilitation Therapy Services segment.

Operating salaries and benefits decreased $1.4 million, or 0.5%, to $261.1 million (56.9% of net revenues) for the three months ended March 31, 2012 from $262.5 million (56.3% of net revenues) for the three months ended March 31, 2011.  The decrease resulted primarily from decreased wages and benefits in our housekeeping and laundry departments following the outsourcing of the majority of our housekeeping and laundry services.

Self-insurance for workers’ compensation and general and professional liability insurance expense increased $0.8 million, or 5.2%, to $15.3 million (3.3% of net revenues) for the three months ended March 31, 2012 from $14.6 million (3.1% of net revenues) for the three months ended March 31, 2011, which was primarily due to increased medical, legal and administrative costs associated with general and professional liability claims.

Other operating costs increased $4.8 million, or 4.6%, to $109.0 million (23.8% of net revenues) for the three months ended March 31, 2012 from $104.2 million (22.3% of net revenues) for the three months ended March 31, 2011.  The increase was primarily due to increased provider taxes, coupled with increases in purchased services for housekeeping and laundry services.

Center rent expense increased $0.7 million, or 1.9%, to $36.4 million (7.9% of net revenues) for the three months ended March 31, 2012 from $35.7 million (7.7% of net revenues) for the three months ended March 31, 2011.  The increase was primarily attributable to the scheduled inflationary increases in accordance with our lease agreements.

General and administrative expenses increased $0.7 million, or 4.3%, to $16.0 million (3.5% of net revenues) for the three months ended March 31, 2012 from $15.4 million (3.3% of net revenues) for the three months ended March 31, 2011.  The increase was primarily due to increased compensation and benefits.

Depreciation and amortization increased $1.0 million, or 13.2%, to $8.4 million (1.8% of net revenues) for the three months ended March 31, 2012 from $7.4 million (1.6% of net revenues) for the three months ended March 31, 2011.  The increase was due to new property and equipment placed into service since March 31, 2011.

The provision for losses on accounts receivable decreased $0.4 million, or 7.1%, to $4.8 million (1.0% of net revenues) for the three months ended March 31, 2012 from $5.2 million (1.1% of net revenues) for the three months ended March 31, 2011.  The decrease resulted primarily from decreased revenues associated with the CMS Final Rule that become effective October 1, 2011.

Net interest expense decreased $0.6 million, or 11.8%, to $4.4 million (1.0% of net revenues) for the three months ended March 31, 2012 from $5.0 million (1.1% of net revenues) for the three months ended March 31, 2011 due to lower aggregate indebtedness.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Segment Information

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

	2012					2011
Inpatient Services	$	405,788		88.5	%	$	413,888		88.8	%
Rehabilitation Therapy Services	64,093			14.0		62,790			13.5
Medical Staffing Services	22,900			5.0		22,939			4.9
Corporate	7			—		7			—
Intersegment Eliminations	(34,295		)	(7.5	)	(33,317		)	(7.2	)
Total net revenues	$	458,493		100.0	%	$	466,307		100.0	%

Inpatient Services revenues include revenues billed to patients for therapy and medical staffing provided by our affiliated operations.  The following table sets forth a summary of the intersegment revenues for the three months ended March 31 (in thousands):

	2012		2011
Rehabilitation Therapy Services	$	33,464	$	32,694
Medical Staffing Services	831		623
Total intersegment revenue	$	34,295	$	33,317

The following table sets forth the amount of net segment income for the three months ended March 31 (in thousands):

	2012			2011
Inpatient Services	$	19,349		$	33,475
Rehabilitation Therapy Services	3,762			2,772
Medical Staffing Services	1,431			1,399
Net segment income before Corporate	24,542			37,646
Corporate	(21,495		)	(21,273		)
Net segment income	$	3,047		$	16,373

Our reportable segments are strategic business units that provide different products and services.  They are managed separately because each business has different marketing strategies due to differences in types of customers, distribution channels and capital resource needs.  We evaluate the operational strengths and performance of each segment based on financial measures, including net segment income.  Net segment income is defined as earnings before income tax expense, restructuring costs and discontinued operations.  Net segment income for the three months ended March 31, 2012 for (1) our Inpatient Services segment decreased $14.1 million, or 42.2%, to $19.3 million, (2) our Rehabilitation Therapy Services segment increased $1.0 million, or 35.7%, to $3.8 million and (3) our Medical Staffing Services segment remained unchanged at $1.4 million in comparison to the three months ended March 31, 2011, due to the factors discussed below for each segment.  We use net segment income among other things to help identify opportunities for improvement and assist in allocating resources to each segment. 

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Inpatient Services

Total net revenues decreased $8.1 million, or 2.0%, to $405.8 million for the three months ended March 31, 2012 from $413.9 million for the three months ended March 31, 2011.  The decrease was primarily the result of:

-	a $16.1 million decrease in Medicare revenues due to a $13.6 million decrease in revenues related to Medicare Part A rates primarily resulting from the CMS Final Rule parity rate adjustment, and a $3.9 million decrease due to a lower customer base, offset in part by a $1.4 million increase in Medicare Part B revenues; and
-	a $2.9 million decrease in private revenues driven by lower customer base and rates;
	Offset in part by:
-	an $8.8 million increase in Medicaid revenues consisting of $5.1 million from an increase in rates and a $3.7 million increase related to higher customer base;
-	a $1.0 million increase in hospice revenues due primarily to growth in customer base;
-	a $0.9 million increase in other revenues, including veterans' coverage and other various inpatient services; and
-	a $0.2 million increase in managed care and commercial insurance revenues driven by improved rates but partially offset by a decrease in customer base.

Operating salaries and benefits expenses decreased $1.2 million, or 0.6%, to $189.7 million for the three months ended March 31, 2012 from $190.9 million for the three months ended March 31, 2011.  The decrease was attributable to the following:

-	a decrease of $4.1 million due to the outsourcing of housekeeping and laundry services in many centers to a third party service provider; and
-	a $0.9 million decrease in overtime for all staff;
	Offset in part by:
-	an increase of $3.8 million in staff compensation and benefits to remain competitive in local markets.

Self-insurance for workers’ compensation and general and professional liability insurance expense increased $0.8 million, or 5.8%, to $14.3 million for the three months ended March 31, 2012 as compared to $13.5 million for the three months ended March 31, 2011, which was primarily due to increased medical, legal and administrative costs associated with general and professional liability claims.

Other operating costs increased $6.2 million, or 5.2%, to $125.7 million for the three months ended March 31, 2012 from $119.4 million for the three months ended March 31, 2011.  The increase was attributable to the following:

-	a $3.6 million increase in purchased services, driven by a $4.1 million increase related to outsourced housekeeping and laundry services, which was partially offset by a $0.5 million decrease in other purchased services;
-	a $2.9 million increase in taxes, consisting primarily of provider taxes;
-	a $0.3 million increase in contract labor, principally driven by affiliated therapy services; and
-	a $0.2 million decrease in vendor rebates;
	Offset in part by:
-	a $0.5 million decrease in supplies, of which $0.2 million relates to housekeeping and laundry supplies now included in our outsourcing arrangement discussed above; and
-	a $0.3 million decrease in administrative costs including advertising, legal fees, community awareness and other miscellaneous expenses.

Operating administrative expenses decreased $0.8 million, or 7.5%, to $9.3 million for the three months ended March 31, 2012 compared to $10.0 million for the three months ended March 31, 2011, primarily due to lower salaries, benefits and contract labor expense in accordance with our cost mitigation plans necessitated by the impact of the CMS Final Rule.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Center rent expense increased $0.7 million, or 1.9%, to $36.1 million for the three months ended March 31, 2012 from $35.4 million for the three months ended March 31, 2011.  The increase was primarily attributable to the scheduled inflationary increases in accordance with our lease agreements.

Depreciation and amortization increased $0.8 million, or 13.2%, to $7.0 million for the three months ended March 31, 2012 from $6.2 million for the three months ended March 31, 2011.  The increase was due to new property and equipment placed into service since March 31, 2011.

The provision for losses on accounts receivable decreased $0.5 million, or 10.6%, to $4.4 million for the three months ended March 31, 2012 from $5.0 million for the three months ended March 31, 2011.   The decrease resulted primarily from decreased revenues associated with the CMS Final Rule that became effective October 1, 2011.

Rehabilitation Therapy Services

Total net revenues from the Rehabilitation Therapy Services segment increased $1.3 million, or 2.1%, to $64.1 million for the three months ended March 31, 2012 from $62.8 million for the three months ended March 31, 2011. The revenue increase was the result of:

-	an increase of $0.8 million attributable to increased billable minutes, primarily due to increased therapist productivity, and growth in Medicare Part B volume; and
-	an increase of $0.6 million due to a higher revenue per minute resulting from nonaffiliated rate increases combined with an affiliated market basket rate increase effective October 1, 2011;
	Offset in part by:
-	a decrease in other revenue of $0.1 million primarily due to non-recurring personnel buy-outs received in the three months ended March 31, 2011 but not recurring in the three months ended March 31, 2012.

Operating salaries and benefits expenses decreased $0.2 million, or 0.4%, to $53.9 million for the three months ended March 31, 2012 from $54.1 million for the three months ended March 31, 2011.  The decrease was driven primarily by reduced health insurance and other benefits but partially offset by wage rate increases to remain competitive in local markets.

Medical Staffing Services

Total net revenues from the Medical Staffing Services segment were flat at $22.9 million for the three months ended March 31, 2012 compared to the three months ended March 31, 2011.  

Operating salaries and benefits expenses increased $0.1 million, or 0.4%, to $17.5 million for the three months ended March 31, 2012 as compared to $17.4 million for the three months ended March 31, 2011. The increase in operating salaries and benefits is due to wage rate increases to remain competitive in local markets.

Corporate

General and administrative expenses not directly attributed to segments increased $0.7 million, or 4.3%, to $16.0 million for the three months ended March 31, 2012 from $15.4 million for the three months ended March 31, 2011.  The increase was primarily due to increased compensation and benefits.

Interest expense not directly attributed to operating segments decreased $0.6 million, or 11.5%, to $4.4 million for the three months ended March 31, 2012 from $5.0 million for the three months ended March 31, 2011 due to lower aggregate indebtedness.

Liquidity and Capital Resources

For the three months ended and as of March 31, 2012, our net income was $0.2 million and our working capital was $151.7 million. As of March 31, 2012, we had cash and cash equivalents of $44.8 million, $60.0 million available on our revolving credit facility and $89.5 million in borrowings. As of March 31, 2012, we were in compliance with the covenants contained in the credit agreement governing the revolving credit facility and our term loan indebtedness as described under "Loan Agreements" below.

Based on current levels of operations, we believe that our operating cash flows (which were an outflow of $2.6 million during

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

the three months ended March 31, 2012, but were an inflow of $83.0 million for the year ended December 31, 2011), 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 in our 2011 Form 10-K under “Capital Expenditures”, scheduled debt service payments and our other commitments (as described in the table under “Obligations and Commitments” of our 2011 Form 10-K) 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” below, 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. In December 2011, we voluntarily paid down $50 million of term loans in conjunction with amending the Credit Agreement.  The amendment increased our interest rate by 1.25% in return for greater flexibility to our financial covenants. As a result of the expected negative impact of the CMS Final Rule on our business, we implemented a broad-based mitigation initiative, which includes infrastructure cost reductions without affecting the quality of our patient care. These reductions in infrastructure costs were, and continue to be, necessary to mitigate the impact on our business and remain in compliance with financial covenants under the Credit Agreement.   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 three months ended March 31, 2012, net cash provided by operating activities decreased by $18.7 million as compared to the same period last year as we used $2.7 million of net cash in our operating activities for the three months ended March 31, 2012.  In addition to decreased net income of $7.9 million, the decrease in cash flows from operating activities was primarily the result of (i) our period-over-period increase in working capital needs of $9.6 million, driven principally by increased accounts receivable balances coupled with temporary cash usage from the impact of timing differences on scheduled payroll and accounts payable disbursement cycles and (ii) a period-over-period decrease of $1.2 million in non-cash adjustments to net income.  For additional information, please see “Results of Operations” above.

Net cash used for investing activities of $10.2 million for the three months ended March 31, 2012 was for capital expenditures and payments related to a February 2012 hospice acquisition.

Net cash used for financing activities was $0.3 million for the three months ended March 31, 2012, which was attributable to repayments of long-term debt and capital lease obligations.

Capital Expenditures

We incurred capital expenditures, related primarily to improvements in continuing operations, as reflected in our consolidated statements of cash flows, of $10.0 million for the three months ended March 31, 2012.

Loan Agreements

In October 2010, we 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 ($87.4 million was outstanding at March 31, 2012), 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 ($74.8 million was utilized at March 31, 2012). The revolving credit facility was undrawn on March 31, 2012. 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

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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 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. Our obligations under the Credit Agreement are guaranteed by most of our subsidiaries and are collateralized by our assets and the assets of most of our subsidiaries.

In December 2011, we amended the Credit Agreement and the associated $50.0 million voluntary repayment effectively satisfied any required quarterly principal payments until the facility's maturity in 2016. Accrued interest is payable at the end of an interest period, but no less frequently than every three months. Upon amendment, borrowings under the Credit Agreement bear interest on the outstanding unpaid principal amount at a rate equal to an applicable percentage plus, at our option, either (a) the greater of 1.75% or 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 0.5%, and (iii) the greater of 1.75% or one-month LIBOR adjusted for statutory reserves plus 1%.  As of March 31, 2012, the applicable percentage for term loans and revolving loans was 6.00% for alternative base rate loans and 7.00% for LIBOR loans.  Each year, commencing in 2012, within 90 days of the prior fiscal year end, we are 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, we are 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.

The Credit Agreement requires that at least 50% of our term loans be subject to at least a three-year hedging agreement. To satisfy this requirement, we executed two hedging instruments on January 18, 2011: a two-year interest rate cap and a two-year “forward starting” interest rate swap.  The two-year interest rate cap limits our exposure to increases in interest rates for $82.5 million of debt through December 31, 2012.  This cap is effective when LIBOR rises above 1.75%, effectively fixing the interest rate on $82.5 million of our term loans at 8.75% through December 31, 2012.  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.  The two-year “forward starting” interest rate swap effectively converts the interest rate on $82.5 million of our term loans to a fixed rate from January 1, 2013 through December 31, 2014.  LIBOR is fixed at 3.185%, making the all-in rate effectively a fixed 10.185% for this portion of the term loans.  There was no fee for this swap agreement.  Both arrangements qualify for hedge accounting treatment.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

																			Fair Value		Fair Value
	Expected Maturity Dates - the Twelve Months Ending March 31,																		March 31,		December 31,
	2013			2014			2015			2016		2017			Thereafter		Total		2012 (1)		2011 (1)
	(Dollars in thousands)
Long-term debt:
Fixed rate debt	$	995		$	913		$	229		$	—	$	—		$	—	$	2,137	$	2,191	$	2,450
Rate	8.7		%	8.6		%	8.6		%	—		—			—
Variable rate debt	$	—		$	—		$	—		$	—	$	87,358		$	—	$	87,358	$	84,301	$	72,096
Rate	—			—			—			—		8.75		%	—
Interest rate hedges:																			$	2,167	$	2,049
Cap	$	82,500		$	—		$	—		$	—	$	—		$	—
Maximum rate	1.75		%	—			—			—		—			—
Variable to fixed	$	—		$	82,500		$	82,500		$	—	$	—		$	—
Average pay rate	—			3.185		%	3.185		%	—		—			—
Average receive rate	—			1.75		%	1.75		%	—		—			—

(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.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

ITEM 4.  CONTROLS AND PROCEDURES

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

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of management, including our Chief Executive Officer, William A. Mathies, and our Chief Financial Officer, L. Bryan Shaul, of the effectiveness of the Company’s disclosure controls and procedures.  Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2012.

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

PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

For a description of our legal proceedings, see Note 5(b) – “Commitments and Contingencies – Litigation” of our consolidated financial statements included in this Form 10-Q, which is incorporated by reference to this item.

ITEM 1A. RISK FACTORS

There have been no material changes in our assessment of our risk factors from those set forth in our 2011 Form 10-K.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

ITEM 6. EXHIBITS

10.1	Sun Healthcare Group, Inc. 2012 Cash Bonus Plan
10.2	Sun Healthcare Group, Inc. Non-Employee Director Compensation Policy
10.3	Sun Healthcare Group, Inc. 2011 Executive Bonus Retention Plan
10.4	Form of Stock Unit Agreement for Employees
10.5	Form of Restricted Stock Agreement
31.1	Section 302 Sarbanes-Oxley Certification by Chief Executive Officer
31.2	Section 302 Sarbanes-Oxley Certification by Chief Financial Officer
32.1	Section 906 Sarbanes-Oxley Certification by Chief Executive Officer
32.2	Section 906 Sarbanes-Oxley Certification by Chief Financial Officer
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

SIGNATURE

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

SUN HEALTHCARE GROUP, INC.

By:  /s/ L. Bryan Shaul                                       

L. Bryan Shaul

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)

May 8, 2012

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EX-10.1

EXHIBIT 10.1

SUN HEALTHCARE GROUP, INC.

2012 CASH BONUS PLAN

1. PURPOSE OF PLAN

The purpose of this Sun Healthcare Group, Inc. 2012 Cash Bonus Plan (this “Plan”) of Sun Healthcare Group, Inc., a Delaware corporation (the “Corporation”), is to promote the success of the Corporation and to increase stockholder value by providing an additional means through the grant of cash performance incentive bonuses to attract, motivate, retain and reward selected executives and employees. This Plan is intended to provide cash incentive bonuses that qualify for the performance-based compensation exemption of Section 162(m) (“Section 162(m)”) of the Internal Revenue Code of 1986, as amended (the “Code”).

2. ELIGIBILITY

The Administrator (as such term is defined in Section 3) may grant incentive bonus awards under this Plan only to an officer (whether or not a director) or key employee of the Corporation or one of its Subsidiaries (each, an “Eligible Person”). An Eligible Person who has been granted an incentive bonus award under this Plan is referred to as a “Participant”. 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.

3. PLAN ADMINISTRATION

This Plan shall be administered by and all incentive bonus awards under this Plan shall be granted by the Administrator. The “Administrator” means a committee of the Board of Directors of the Corporation (the “Board”) consisting solely of two or more outside directors, as this requirement is applied under Section 162(m) of the Code. 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 grant of incentive bonus awards and the administration of this Plan. The Administrator's authority includes, without limitation, the authority to: (1) determine the Eligible Persons and the particular Eligible Persons who will be Participants; (2) grant incentive bonus awards to Participants and determine the specific terms and conditions of such awards consistent with the express provisions of this Plan; and (3) 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 incentive bonus awards granted under this Plan. 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 Administrator nor any member thereof shall be liable for any act, omission, interpretation, construction or determination made in good faith in connection with 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.

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4. INCENTIVE BONUS AWARDS

4.1    Awards. Incentive bonus awards may be granted under this Plan to those Eligible Persons determined to be Participants by the Administrator. The Administrator will determine the amount of each Participant's incentive bonus award opportunity and the other terms and conditions of each Participant's incentive bonus award.

4.2    Performance Period. Incentive bonus awards granted under this Plan will become payable based on performance during a performance period designated by the Administrator. The performance period will generally be the calendar year. However, the Administrator may designate that the performance period will be any period of time that is longer or shorter than one calendar year, provided that the performance period may not be less than three months nor more than 10 years.

4.3    Performance Goals. For each performance period, the payment of any incentive bonus awards granted under this Plan will depend on the degree of achievement of one or more objective 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. Performance goals will 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 goals remains substantially uncertain within the meaning of Section 162(m) of the Code.

4.4    Business Criteria. The specific performance goals 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; revenue; 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; 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; earnings before interest, taxes, depreciation, amortization (EBITDA); normalized EBITDA; earnings before interest, taxes, depreciation, amortization, and rents (EBITDAR); pre- or after-tax income (before or after allocation of corporate overhead and bonus); appreciation in and/or maintenance of the price of the Corporation's common stock or any other

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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 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 any combination thereof. Any Business Criterion may also be stated as a “growth” measure (for example, and without limitation, revenue growth instead of revenue on an absolute basis). These terms are used, where applicable, as applied under generally accepted accounting principles or in the financial reporting of the Corporation or of its Subsidiaries.

4.5    Adjustments. At the time it grants any incentive bonus award under this Plan, the Administrator may specify the manner, if any, in which performance goals shall be adjusted to mitigate the unbudgeted impact of material, unusual or nonrecurring gains and losses, discontinued operations, actuarial adjustments for self insurance for general and professional liability, accounting changes or other extraordinary events not foreseen at the time the goals were set.

4.6    Maximum Payment. The aggregate amount of compensation to be paid to any one Participant in respect of incentive bonus awards granted under this Plan in any one calendar year shall not exceed $3,000,000.

4.7    Continued Employment Required. Unless otherwise determined by the Administrator (whether before or after the start of the applicable performance period) or otherwise specifically provided in a Participant's employment or severance agreement or any other plan or agreement covering the Participant, if a Participant's employment is terminated for any reason prior to the end of the applicable performance period, the Participant's rights to receive any payment of the incentive bonus award shall immediately terminate, and the Participant will no longer be eligible for any payment of the incentive bonus award.

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4.8 Reservation of Discretion. Notwithstanding the successful achievement of the performance goals for any performance period, the Administrator will have the discretion to reduce the amount of any incentive bonus award to any Participant to any amount, including zero, in its sole discretion.

4.9 Certification of Payment. Before any incentive bonus award granted under this Plan is paid, the Administrator must certify in writing that the performance goal(s) and any other material terms of the incentive bonus award were in fact timely satisfied.

4.10 Cash Payment. Any incentive bonus award granted under this Plan that becomes payable shall be paid in cash no later than the 15^th day of the third month following the end of the performance period (e.g., if the performance period is the calendar year, any bonus amount that becomes payable will be paid prior to March 15 of the calendar year following the calendar year to which the bonus relates).

5.CHANGE IN CONTROL

The Administrator shall have the discretion to determine the effects, if any, that a change in control event or similar extraordinary corporate transaction will have on outstanding incentive bonus awards granted under this Plan.

6. DEFERRALS

The Administrator may require or permit Participants to elect to defer the payment of incentive bonus awards granted under this Plan under such rules and procedures as it may establish under this Plan. The Administrator may also provide that deferred payments 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.

7. RECOUPMENT

This Plan and all incentive bonus awards granted under this Plan are subject to the terms of the Corporation's recoupment, clawback or similar policy as it may be in effect from time to time, as well as any similar provisions of applicable law, any of which could in certain circumstances require repayment or forfeiture of any incentive bonus award under this Plan.

8. OTHER PROVISIONS

8.1 Limitations on Transfer. Incentive bonus awards granted under this Plan are non-transferable and shall not be subject in any manner to sale, transfer, anticipation, alienation, assignment, pledge, encumbrance or charge, and during the lifetime of the Participant awards shall only be paid to the Participant.

8.2 Compliance with Laws. This Plan and the granting and payment of incentive bonus awards under this Plan are subject to compliance with all applicable federal and state laws, rules and regulations and to such approvals by any listing,

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regulatory or governmental authority as may, in the opinion of counsel for the Corporation, be necessary or advisable in connection therewith.

8.3 No Rights to Award. No person shall have any claim or rights to be granted an incentive bonus 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.

8.4 No Employment Contract. Nothing contained in this Plan (or in any other documents under this Plan or in any incentive bonus award) shall confer upon any Eligible Person any right to continue in the employ of the Corporation or one of its Subsidiaries, constitute any contract or agreement of employment 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 Subsidiaries to change a person's compensation or other benefits, or to terminate his or her employment, with or without cause. Nothing in this Section 8.4, however, is intended to adversely affect any express independent right of such person under a separate employment contract.

8.5 Plan Not Funded. Incentive bonus awards payable under this Plan shall be payable 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 of the Corporation or one of its Subsidiaries by reason of any incentive bonus 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 incentive bonus award hereunder, such right shall be no greater than the right of any unsecured general creditor of the Corporation.

8.6 Tax Withholding. Upon any payment of an incentive bonus award, 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 payment; or (b) deduct from the 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.

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8.7 Effective Date, Termination and Suspension, Amendments.

8.7.1 Effective Date. This Plan is effective as of January 1, 2012 (the “Effective Date”). This Plan shall be submitted for and subject to stockholder approval at the 2012 annual meeting of the Corporation's stockholders. If the Corporation's stockholders fail to approve this Plan, this Plan shall not become effective and no incentive bonus awards will be paid under this Plan.

8.7.2 Termination. Unless earlier terminated by the Board, this Plan shall terminate upon the first meeting of the Corporation's stockholders that occurs in the 2017 calendar year, subject to any subsequent extension that may be approved by stockholders. After the termination of this Plan either upon such stated expiration date or its earlier termination by the Board, no additional incentive bonus awards may be granted under this Plan, but previously granted incentive bonus awards shall remain outstanding in accordance with their applicable terms and conditions and the terms and conditions of this Plan.

8.7.3 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 incentive bonus awards may be granted during any period that the Board suspends this Plan.

8.7.4 Stockholder Approval. To the extent then required by applicable law or any applicable listing agency or required under Section 162(m) 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.

8.8    Governing Law; Construction; Severability.

8.8.1 Choice of Law. This Plan, the incentive bonus awards, all documents evidencing the 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. This Plan is intended to provide incentive bonus awards that qualify for the performance-based compensation exemption of Section 162(m) of the Code. Any provision, application or interpretation of this Plan inconsistent with this intent to satisfy the standards in Section 162(m) of the Code shall be disregarded. This Plan is intended to provide incentive bonus awards that are exempt from (i.e., not a deferral of compensation within the meaning of) Section 409A of the Code as short-term deferrals. Any provision, application or interpretation of this Plan

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inconsistent with this intent with respect to Section 409A of the Code shall be disregarded.

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 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 under any other plan or authority.

8.11 Other Company Benefit and Compensation Programs. Payments received by a Participant under an incentive bonus 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.

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EX-10.2

EXHIBIT 10.2

NON-EMPLOYEE DIRECTOR COMPENSATION POLICY

Sun Healthcare Group, Inc.

(Effective as of March 15, 2012)

The members of the Board of Directors of Sun Healthcare Group, Inc. (“Sun”) who are not employed by Sun or one of its subsidiaries (“Directors”) shall be compensated as provided below. This policy is effective as of the date set forth above and supersedes all prior policies concerning compensation of the Directors as to their service from and after that time. The Board of Directors has the right to amend this policy from time to time.

1. Annual Fees for Directors. Each Director shall receive an annual fee of $75,000, which is payable in four equal quarterly installments. Any installment payable pursuant to this Policy (including Section 2 or 3 below) for a particular quarter shall be paid on or around the first day of that quarter.

2. Annual Fees for Chairpersons. Each Chairperson of a Committee of the Board of Directors (a “Committee”) shall receive an additional annual fee of $8,000 for Audit, $6,000 for Compliance, and $5,000 for each of Compensation and Nominating, each payable in four equal quarterly installments.

3. Annual Fees for Lead Independent Director. The Lead Independent Director shall receive an additional annual fee of $5,000, payable in four equal quarterly installments.

4. Meeting Fees. Each Director shall receive: (i) $1,750 for a meeting of the Board of Directors attended in person, (ii) $1,750 for a meeting of a Committee attended in person if the meeting occurs on a date on which the Director did not attend a meeting of the Board of Directors or another Committee, (iii) the following amount for a Committee meeting attended in person on the same date as a meeting of the Board of Directors or another Committee attended by the Director: $1,500 for a meeting of the Audit or Compliance Committee and $1,000 for a meeting of the Compensation or Nominating and Governance Committee, and (iv) $1,000 for any Board or Committee meeting attended by telephone.

4. Restricted Stock Unit Awards. Each Director shall receive an award of $60,000 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 of Sun.

5. Conversion of Cash Retainers into Stock. Each Director may convert 50% or more of his or her cash retainer under Item 1 above into shares of Sun's common stock. Directors choosing such conversion must make an irrevocable election in advance of the quarter the election is to take effect. For an quarter in which such a conversion election is in effect, the conversion of cash retainer to shares for that quarter will occur as of the first trading day of that quarter using the

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closing sale price of Sun's common stock on that day. The shares will be delivered to the Director promptly following that day. Until further determined, Directors are no longer able to participate in the Non-Employee Directors Stock-For-Fees Program under the Sun Healthcare Group, Inc. 2009 Performance Incentive Plan, provided that this suspension of the Program doesn't affect elections previously made under the program and benefits with respect to those elections.

6. Reimbursement of Expenses. Each Director is reimbursed for out-of-pocket expenses for attendance at Board and committee meetings. The Company will make reimbursement to a non-employee director within a reasonable amount of time following submission by the non-employee director of reasonable written substantiation for the expenses, which the Director agrees to promptly provide so that the Company may make timely reimbursement (and in all cases not later than the end of the year following the year in which the related expenses were incurred).

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EX-10.3

EXHIBIT 10.3

2011 Executive Retention Bonus Plan

Objective:

To provide a retention incentive for select key executives that is tied to company financial performance.

Plan Provisions & Triggers:

There are two triggers that must be achieved for the payment of the bonus:

• Sun Healthcare Group must hit an annual EPS level at or above the mid-point of guidance for the designated performance periods; and

• The participating executive must be employed on the vesting dates.

Program:

• The Retention Bonus Plan has two performance periods: (i) the fiscal year ended 12/31/11 (the “2011 PP”) and (ii) the fiscal year ended 12/31/12 (the “2012 PP”).

• The Retention Bonus Plan has a two year vesting schedule: 50% of the bonus amount vests on 10/31/12 and 50% of the bonus amount vests on 10/31/13.

• The performance target that the company must achieve is the mid-point of its EPS guidance ($0.885 for the 2011 PP and TBD for the 2012 PP) for any Executive Retention Bonus to be payable the following October 31st.

• If the company hits the high end of its EPS guidance, then the executive's bonus will be increased by an additional 20% of the executive's annual retention bonus target (prorated on a straight line basis between mid-point and high-end of guidance). If the company hits 2% above the high end of its EPS guidance, then the executive's bonus will be further increased by an additional 10% of the executive's annual retention bonus target (again prorated on a straight line basis for numbers between high-end and 2% above high-end). The maximum annual payout is 130% of the individual executive's annual retention bonus target.

• The aggregate retention bonus target for the 2-year period is calculated as follows:

▪ Salary X Time Factor X Level Factor = retention bonus target

▪ Salary is the executive's base salary on 10/31/11

▪ Time Factor is determined by adding 1.0 plus an additional 0.1 for each full year of service that the executive has been employed by the company between 2/28/02 and 10/31/11. As an example, an executive with a hire date of 6/1/08 would have a time factor of 1.3.

▪ Level Factor is determined as follows:

• Level 1 - CEO - 40%

• Level 2 - designated Officers of SHG and Subsidiary Presidents - 30%

• Level 3 - designated SVPs - 20%

• Level 4 - designated Vice Presidents and Directors - 10%

• An executive who is granted the Executive Retention Bonus whose position is eliminated (for all reasons other than a Change of Control) will remain in the plan on a prorated basis. The executive will be eligible to receive a prorated portion of the annual target associated with the job elimination date (prorated for the number of months in the relevant 11/1 - 10/31 cycle) if the company hits the EPS targets (as described above) for the relevant performance period. The prorated amount (if earned) is still payable on the relevant 10/31 payout date. As an example, if the executive's position is eliminated 4/1/12, the executive would be eligible to receive 5/12 of his/her annual target, payable on 10/31/12, assuming the company had hit its 2011 EPS target as defined above.

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• An executive who is granted the Executive Retention Bonus whose position is eliminated as a result of a Change of Control will automatically vest at 100% of the total (all remaining years) target bonus.

• Under no circumstances will bonuses be paid to participants who voluntarily resign before the relevant 10/31 vesting date.

Payment of Incentives:

Retention awards are paid on the first paycheck following each of the two vesting dates, assuming that the EPS goals were met the previous year. Target vesting amounts do not change, even if there is a salary change.

Miscellaneous:

This Retention Plan is adopted under Section 5.2.2 of Sun's 2009 Performance Incentive Plan (the “Plan”), and bonuses awarded under this plan shall be awards under the Plan that are subject to all of the terms and conditions of the Plan. This Retention Plan shall be administered by the Compensation Committee of Sun's Board of Directors (the “Committee”).

No Retention Bonus shall be paid to an executive unless and until the Committee has certified, by resolution or other appropriate action in writing, the normalized actual EPS earned by the company for the applicable performance period, the normalized actual EPS earned by Sun for the applicable period as a percentage of the target and the amount of the retention bonus earned by each executive.

Actual EPS shall be measured using the normalized actual EPS of Sun as published by Sun in its press releases announcing financial results for the years ending December 31, 2011 and 2012. When determining whether the target has been achieved, the Compensation Committee of Sun's Board of Directors shall make adjustments to the target to eliminate the effect of discontinued operations or any change in accounting policies or practices.

This Plan neither constitutes a contract of employment nor grants any rights for an employee to be retained in employment. Rather, all employment remains “at will” unless otherwise required by applicable law. This document constitutes the entire Plan, supersedes all prior agreements and there are no oral terms or conditions to the contrary.

The company reserves the right to reduce, eliminate or postpone payments to employees who are on a written performance plan, have engaged in conduct that is in direct violation of the company's Code of Conduct/Compliance Process or such conduct/performance that is detrimental to the company.

The company retains the discretion to modify the Plan at any time, with or without notice.

Recoupment of Bonus Payments. A retention bonus paid to an executive is subject to recoupment, to the extent determined to be appropriate by the Committee, if each of the following circumstances occur: (1) the amount of the retention bonus was calculated based on the achievement of EPS, the calculation of which was based on financial statements that are subsequently the subject of an accounting restatement due to noncompliance with any financial reporting requirement under the securities laws; (2) fraud or intentional misconduct by any executive, or any officer or employee that reports to an executive was a significant contributing factor to such noncompliance; and (3) the restated financial statements are issued and completed prior to the issuance and completion of the financial statements for the applicable fiscal year. In such circumstances, a retention bonus will be subject to recoupment only to the extent a lesser retention bonus would have been paid to an executive based upon EPS, as restated, and only as to the net amount of such portion of the retention bonus after reduction for the Executive's tax liability on that portion of the retention bonus. By accepting a retention bonus, each executive agrees to promptly make any retention bonus reimbursement required by the Committee in accordance with this section, and that Sun, SunBridge and their respective affiliates may deduct from any amounts owed to the executive from time to time (such as wages or

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other compensation) any amounts the Executive is required to reimburse Sun and/or SunBridge pursuant to this section. This section does not limit any other remedies Sun, SunBridge or their respective affiliates may have available in the circumstances, which may include, without limitation, dismissing the executive or initiating other disciplinary procedures. The provisions of this section are in addition to (and not in lieu of) any rights to repayment Sun, SunBridge or their respective affiliates may have under Section 304 of the Sarbanes-Oxley Act of 2002 and other applicable laws.

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EX-10.4

EXHIBIT 10.4

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: (i) 33.33% of the units shall vest on each of the following dates: [____________], 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 (A) the date of your death or Disability (as defined in the Plan) or (B) if, upon or after a Change in Control (as defined in the Plan), your employment by Sun Healthcare Group, Inc. or one of its subsidiaries is terminated either by your employer for any reason other than Good Cause (as defined in the Plan) or you terminate employment for Good Reason (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

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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 10 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 any then-outstanding and otherwise unvested Stock Units subject to this Award shall vest as set forth in the Grant Notice if the Grantee's termination of employment or service is the result of a reason specified in the Grant Notice. 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.    Limitation on Benefits. Notwithstanding anything contained in this Award Agreement, the Plan or any other plan, arrangement or agreement to the contrary, but subject to the last sentence of this Section 9, if upon or following a change in the “ownership or effective control” of the Corporation or in the “ownership of a substantial portion of the assets” of the Corporation (each within the meaning of Section 280G of the Code), the tax imposed by Section 4999 of the Code or any similar or successor tax (the “Excise Tax”) applies, solely because of such transaction, to any payments, benefits and/or amounts received by the Grantee pursuant to the Plan, this Award Agreement, any retention bonus program, any employment or severance benefit plan, agreement or arrangement or otherwise (collectively, the “Total Payments”), then the Total Payments shall be reduced (but not below zero) so that the maximum amount of the Total Payments (after reduction) shall be one dollar ($1.00) less than the amount which would cause the Total Payments to be subject to the Excise Tax; provided that such reduction to the Total Payments shall be made only if the total after-tax benefit to the Grantee is greater after giving

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effect to such reduction than if no such reduction had been made. If such a reduction is required, the Corporation shall reduce or eliminate the Total Payments by first reducing or eliminating any cash severance benefits, then by reducing or eliminating any equity awards the vesting or payment of which depends on an event other than the performance of services, then by reducing or eliminating any accelerated vesting of any other equity awards other than stock options, then by reducing or eliminating any accelerated vesting of stock options, then by reducing or eliminating any other remaining Total Payments, in each case in reverse order beginning with the payments which are to be paid the farthest in time from the date of the transaction triggering the Excise Tax. Subject to the next sentence, the preceding provisions of this Section 9 shall take precedence over the provisions of any other plan, arrangement or agreement governing the Grantee's rights and entitlements to any benefits or compensation. This Section 9 shall not apply to any Grantee who is entitled to a “gross up” or similar payment from the Corporation or any of its affiliates with respect to the Excise Tax.

10.    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 not satisfy the withholding obligations with respect to the vesting of the Stock Units as provided above in this Section 10, 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.

11.    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.

12.    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

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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.

13.    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.

14.    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.

15.    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.

16.    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.

17.    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 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).

18.    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-10.5

EXHIBIT 10.5

Notice of Restricted Stock Grant

Sun Healthcare Group, Inc.

2009 Performance Incentive Plan

Name of Grantee:	[_____________]
Number of
Restricted Shares:	[_____________]
Date of Grant:	[____________]
Vesting:	Performance Requirement. The restricted shares are subject to a performance requirement, which is the attainment by Sun Healthcare Group, Inc. (the “Corporation”) of a performance target based on one of the Business Criteria (as defined in Section 5.2.2 of the Plan) for the performance period beginning on [____________] and ending on [____________]. Except as described below with respect to certain terminations of your employment or services occurring before the end of the performance period, your restricted shares will only become eligible to vest if the performance requirement is achieved. If the Corporation fails to achieve the performance requirement, your unvested restricted shares will automatically terminate at the end of the performance period. The Corporation will establish the applicable Business Criteria and performance target constituting the performance requirement prior to the start of the performance period.
	Continued Service Vesting Schedule. The restricted shares that are eligible to become vested pursuant to the performance requirement described above shall become vested and nonforfeitable as follows if you are employed by or providing services to the Corporation or its subsidiaries on the applicable vesting date: (i) 25% of the restricted shares shall vest on each of the following dates: [____________], subject to earlier termination as provided in the Terms and Conditions of Restricted Stock Award; and (ii) the restricted shares, to the extent then outstanding and unvested, shall become vested in full upon (A) the date of your death or Disability (as defined in the Plan) or (B) if, upon or after a Change in Control (as defined in the Plan), your employment by Sun Healthcare Group, Inc. or one of its subsidiaries is terminated either by your employer for any reason other than Good Cause (as defined in the Plan) or you terminate employment for Good Reason (as defined in the Plan).

By signing your name below, you accept this restricted stock award and acknowledge and agree that the restricted shares 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 Restricted Stock Award, both of which are hereby made a part of this document.

“GRANTEE” _________________________________ Signature SUN HEALTHCARE GROUP, INC., a Delaware corporation _________________________ By: Its:

Terms and Conditions of Restricted Stock Award

Sun Healthcare Group, Inc.

2009 Performance Incentive Plan

1.    Grant of Restricted Stock.

These Terms and Conditions of Restricted Stock Award (these “Terms”) apply to a particular restricted stock award (the “Award”) if incorporated by reference in the Notice of Restricted Stock 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 restricted shares of the Common Stock of the Corporation covered by the Award (the “Restricted Stock”) 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.

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 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. After the Date of Grant, the Grantee shall be entitled to cash dividends and voting rights with respect to the shares of Restricted Stock subject to the Award even though such shares are not vested, provided that such rights shall terminate immediately as to any shares of Restricted Stock that are forfeited pursuant to Section 7 below.

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5.    Restrictions on Transfer. Prior to the time the shares of Restricted Stock subject to the Award have become vested, neither the Restricted Stock, nor any interest therein, amount payable in respect thereof, or Restricted Property (as defined in Section 8 hereof) may be sold, assigned, transferred, pledged or otherwise disposed of, alienated or encumbered, either voluntarily or involuntarily, other than transfers to the Corporation or by will or the laws of descent and distribution.

6.    Stock Certificates.

(a)    Book Entry Form. The Corporation shall issue the shares of Restricted Stock subject to the Award either: (a) in certificate form as provided in Section 6(b) below; or (b) in book entry form, registered in the name of the Grantee with notations regarding the applicable restrictions on transfer imposed under this Award Agreement.

(b)    Certificates to be Held by Corporation; Legend. Any certificates representing shares of Restricted Stock that may be delivered to the Grantee by the Corporation prior to vesting shall be redelivered to the Corporation to be held by the Corporation until the restrictions on such shares shall have lapsed and the shares shall thereby have become vested or the shares represented thereby have been forfeited hereunder. Such certificates shall bear the following legend and any other legends the Corporation may determine to be necessary or advisable to comply with all applicable laws, rules, and regulations:

“The ownership of this certificate and the shares of stock evidenced hereby and any interest therein are subject to substantial restrictions on transfer under an Agreement entered into between the registered owner and Sun Healthcare Group, Inc. A copy of such Agreement is on file in the office of the Secretary of Sun Healthcare Group, Inc.”

(c)    Delivery of Certificates Upon Vesting. Promptly after the vesting of any shares of Restricted Stock in accordance with the terms hereof and the satisfaction of any and all related tax withholding obligations pursuant to Section 10, the Corporation shall, as applicable, either remove the notations on any shares of Restricted Stock issued in book entry form which have vested or deliver to the Grantee a certificate or certificates evidencing the number of shares of Restricted Stock which have vested (or, in either case, such lesser number of shares as may result after giving effect to Section 10). The Grantee (or the beneficiary or personal representative of the Grantee in the event of the Grantee's death or disability, as the case may be) shall deliver to the Corporation any representations or other documents or assurances as the Corporation or its counsel may determine to be necessary or advisable in order to ensure compliance with all applicable laws, rules, and regulations with respect to the grant of the Award and the delivery of shares of Common Stock in respect thereof. The shares so delivered shall no longer be restricted shares hereunder.

(d)    Stock Power; Power of Attorney. Concurrently with the execution and delivery of this Award Agreement, the Grantee shall deliver to the Corporation an executed stock power in the form attached hereto as Exhibit A, in blank, with respect to such shares. The Corporation shall not deliver any share certificates in accordance with this Award Agreement unless and until the Corporation shall have received such stock power executed by the Grantee. The Grantee, by acceptance of the Award, shall be deemed to appoint, and does so appoint by

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execution of this Award Agreement, the Corporation and each of its authorized representatives as the Grantee's attorney(s) in fact to effect any transfer of unvested forfeited shares (or shares otherwise reacquired by the Corporation hereunder) to the Corporation as may be required pursuant to the Plan or this Award Agreement and to execute such documents as the Corporation or such representatives deem necessary or advisable in connection with any such transfer.

7.    Effect of Termination of Employment or Services. The Grantee's shares of Restricted Stock (and related Restricted Property as defined in Section 8 hereof) shall be forfeited to the Corporation to the extent such shares 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 any then-outstanding and otherwise unvested shares of Restricted Stock subject to this Award shall vest as set forth in the Grant Notice if the Grantee's termination of employment or service is the result of a reason specified in the Grant Notice. 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. Upon the occurrence of any forfeiture of shares of Restricted Stock hereunder, such unvested, forfeited shares and related Restricted Property shall be automatically transferred to the Corporation as of the date of forfeiture, without any other action by the Grantee (or the Grantee's beneficiary or personal representative in the event of the Grantee's death or disability, as applicable). No consideration shall be paid by the Corporation with respect to such transfer. The Corporation may exercise its powers under Section 6(d) hereof and take any other action necessary or advisable to evidence such transfer. The Grantee (or the Grantee's beneficiary or personal representative in the event of the Grantee's death or disability, as applicable) shall deliver any additional documents of transfer that the Corporation may request to confirm the transfer of such unvested, forfeited shares and related Restricted Property to the Corporation. The Corporation shall have no obligation as to any shares of Restricted Stock 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 shares of Restricted Stock contemplated hereby and the number and kind of securities that may be issued in respect of the Award. If any adjustment shall be made under Section 7.1 of the Plan or an event described in Section 7.2 of the Plan shall occur and the shares of Restricted Stock are not fully vested upon such event or prior thereto, the restrictions applicable to such shares of Restricted Stock shall continue in effect with respect to any consideration, property or other securities (the “Restricted Property” and, for the purposes of this Award Agreement, “Restricted Stock” shall include “Restricted Property”, unless the context otherwise requires) received in respect of such Restricted Stock. Such Restricted Property shall vest at such times and in such proportion as the shares of Restricted Stock to which the Restricted Property is attributable vest, or would have vested pursuant to the terms hereof if such shares of Restricted Stock had remained outstanding. To the extent that the Restricted Property includes

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any cash (other than regular cash dividends), such cash shall be invested, pursuant to policies established by the Administrator, in interest bearing, FDIC-insured (subject to applicable insurance limits) deposits of a depository institution selected by the Administrator, the earnings on which shall be added to and become a part of the Restricted Property.

9.    Limitation on Benefits. Notwithstanding anything contained in this Award Agreement, the Plan or any other plan, arrangement or agreement to the contrary, but subject to the last sentence of this Section 9, if upon or following a change in the “ownership or effective control” of the Corporation or in the “ownership of a substantial portion of the assets” of the Corporation (each within the meaning of Section 280G of the Code), the tax imposed by Section 4999 of the Code or any similar or successor tax (the “Excise Tax”) applies, solely because of such transaction, to any payments, benefits and/or amounts received by the Grantee pursuant to the Plan, this Award Agreement, any retention bonus program, any employment or severance benefit plan, agreement or arrangement or otherwise (collectively, the “Total Payments”), then the Total Payments shall be reduced (but not below zero) so that the maximum amount of the Total Payments (after reduction) shall be one dollar ($1.00) less than the amount which would cause the Total Payments to be subject to the Excise Tax; provided that such reduction to the Total Payments shall be made only if the total after-tax benefit to the Grantee is greater after giving effect to such reduction than if no such reduction had been made. If such a reduction is required, the Corporation shall reduce or eliminate the Total Payments by first reducing or eliminating any cash severance benefits, then by reducing or eliminating any equity awards the vesting or payment of which depends on an event other than the performance of services, then by reducing or eliminating any accelerated vesting of any other equity awards other than stock options, then by reducing or eliminating any accelerated vesting of stock options, then by reducing or eliminating any other remaining Total Payments, in each case in reverse order beginning with the payments which are to be paid the farthest in time from the date of the transaction triggering the Excise Tax. Subject to the next sentence, the preceding provisions of this Section 9 shall take precedence over the provisions of any other plan, arrangement or agreement governing the Grantee's rights and entitlements to any benefits or compensation. This Section 9 shall not apply to any Grantee who is entitled to a “gross up” or similar payment from the Corporation or any of its affiliates with respect to the Excise Tax.

10.    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 shares of Restricted Stock subject to the Award. The Corporation may, in its sole discretion, withhold and reacquire a sufficient number of shares of Restricted Stock in connection with the vesting of the Restricted Stock 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 the Restricted Stock. 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. In the event that the Corporation cannot satisfy such withholding obligations by withholding and reacquiring shares of Restricted Stock, or in the event that the Grantee makes or has made an

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election pursuant to Section 83(b) of the Code or the occurrence of any other withholding event with respect to the Award, the Corporation (or a Subsidiary) 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 any sums required by federal, state or local tax law to be withheld with respect to such vesting of any Restricted Stock or such Section 83(b) election.

11.    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.

12.    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.

13.    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.

14.    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.

15.    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.

16.    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.

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17.    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 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).

18.    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.

19.    No Advice Regarding Grant. The Grantee is hereby advised to consult with his or her own tax, legal and/or investment advisors with respect to any advice the Grantee may determine is needed or appropriate with respect to the Restricted Stock (including, without limitation, to determine the foreign, state, local, estate and/or gift tax consequences with respect to the Award, the advantages and disadvantages of making an election under Section 83(b) of the Code with respect to the Award, and the process and requirements for such an election). Neither the Corporation nor any of its officers, directors, affiliates or advisors makes any representation (except for the terms and conditions expressly set forth in this Award Agreement) or recommendation with respect to the Award or the making an election under Section 83(b) of the Code with respect to the Award. In the event the Grantee desires to make an election under Section 83(b) of the Code with respect to the Award, it is the Grantee's sole responsibility to do so timely. Except for the withholding rights set forth in Section 10 above, the Grantee is solely responsible for any and all tax liability that may arise with respect to the Award.

[Remainder of page intentionally left blank.]

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EXHIBIT A

STOCK POWER

FOR VALUE RECEIVED and pursuant to that certain Notice of Restricted Grant and the accompanying Terms and Conditions of Restricted Stock Award (together, the “Award Agreement”) between Sun Healthcare Group, Inc., a Delaware corporation (the “Corporation”), and the individual named below (the “Individual”) dated as of _____________, 20__, the Individual, hereby sells, assigns and transfers to the Corporation, an aggregate ________ shares of Common Stock of the Corporation, standing in the Individual's name on the books of the Corporation and represented by stock certificate number(s) _______________________________ to which this instrument is attached, and hereby irrevocably constitutes and appoints _________________ ____________________________________ as his or her attorney in fact and agent to transfer such shares on the books of the Corporation, with full power of substitution in the premises.

Dated _____________, ________

__________________________________

Signature

__________________________________

Print Name

(Instruction: Please do not fill in any blanks other than the signature line. The purpose of the assignment is to enable the Corporation to exercise its sale/purchase option set forth in the Award Agreement without requiring additional signatures on the part of the Individual.)

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 quarterly report on Form 10-Q of Sun Healthcare Group, Inc.;

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

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

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

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

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

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

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

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

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

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

Date: May 8, 2012	/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 quarterly report on Form 10-Q of Sun Healthcare Group, Inc.;

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

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

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

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

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

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

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

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

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

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

Date: May 8, 2012	/s/ L. Bryan Shaul
	L. Bryan Shaul Executive Vice President and Chief Financial Officer (Principal Financial 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 Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 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: May 8, 2012	/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 Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 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: May 8, 2012	/s/ L. Bryan Shaul
	L. Bryan Shaul

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Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2012

Notes to Financial Statements [Abstract]

Fair Value of Financial Instruments

Fair Value of Financial Instruments

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

	March 31, 2012				December 31, 2011
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Cash and cash equivalents	$	44,771	$	44,771	$	57,908	$	57,908
Restricted cash	$	14,678	$	14,678	$	16,059	$	16,059
Long-term debt and capital lease obligations,
including current portion	$	89,495	$	86,492	$	88,785	$	74,545
Interest rate hedging agreements	$	2,167	$	2,167	$	2,049	$	2,049

The cash and cash equivalents and restricted cash carrying amounts approximate fair value because of the short maturity of these instruments. At March 31, 2012 and December 31, 2011, the fair value of our long-term debt, including current maturities, and our interest rate hedging agreements was based on estimates using present value techniques that are significantly affected by the assumptions used concerning the amount and timing of estimated future cash flows and discount rates that reflect varying degrees of risk.

GAAP establishes a hierarchy for ranking the quality and reliability of the information used to determine fair values.  The applicable guidance requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

Level 1:     Unadjusted quoted market prices in active markets for identical assets or liabilities.

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

Level 3:    Unobservable inputs for the asset or liability.

We endeavor to utilize the best available information in measuring fair value.  The following tables summarize the valuation of our financial instruments by the above pricing levels as of March 31, 2012 and December 31, 2011, respectively (in thousands):

	March 31, 2012
	Total	Unadjusted Quoted Market Prices (Level 1)	Significant Other Observable Inputs (Level 2)
Interest rate hedging agreements – liability	$2,167	$—	$2,167

	December 31, 2011
	Total	Unadjusted Quoted Market Prices (Level 1)	Significant Other Observable Inputs (Level 2)
Interest rate hedging agreements - liability	$2,049	$—	$2,049

We currently have no other financial instruments subject to fair value measurement on a recurring basis. The fair value for our cash and cash equivalents and restricted cash disclosed above were determined by Level 1 valuation techniques and our long-term debt and capital lease obligations fair value above was determined by Level 2 valuation techniques.

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Long-Term Debt, Capital Lease Obligations and Hedging Arrangements

3 Months Ended

Mar. 31, 2012

Notes to Financial Statements [Abstract]

Long-Term Debt, Capital Lease Obligations and Hedging Arrangements

Long-Term Debt, Capital Lease Obligations and Hedging Arrangements

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

	March 31, 2012			December 31, 2011
Revolving loans	$	—		$	—
Mortgage note payable due monthly through 2014, interest at
at a rate of 8.5%, collateralized by real property with
carrying values totaling $1.7 million	1,888			2,076
Term loans	87,358			87,389
Capital leases	249			320
Total long-term obligations	89,495			89,785
Less amounts due within one year	(995		)	(1,017		)
Long-term obligations, net of current portion	$	88,500		$	88,768

The scheduled or expected maturities of long-term obligations as of March 31, 2012, were as follows (in thousands):

For the twelve months ending March 31:
2013	$	995
2014	913
2015	229
2016	—
2017	87,358
	$	89,495

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 also may enter into interest rate cap agreements that effectively limit the maximum interest rate that we pay on an agreed to notional principal amount.  We use interest rate hedges to manage interest rate risk related to borrowings.  Our intent is to only enter into such arrangements that qualify for hedge accounting treatment in accordance with GAAP.  Accordingly, we designate all such arrangements as cash-flow hedges and perform initial and quarterly effectiveness testing using the hypothetical derivative method.  To the extent that such arrangements are effective hedges, changes in fair value are recognized through other comprehensive income.  Ineffectiveness, if any, would be recognized in earnings.

Our credit agreement requires that at least 50% of our term loans be subject to at least a three-year hedging agreement. To satisfy this requirement, we executed two hedging instruments on January 18, 2011: a two-year interest rate cap and a two-year “forward starting” interest rate swap.  The two-year interest rate cap limits our exposure to increases in interest rates for $82.5 million of debt through December 31, 2012.  This cap is effective when LIBOR rises above 1.75%, effectively fixing the interest rate on $82.5 million of our term loans at 8.75% through December 31, 2012.  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.  The two-year “forward starting” interest rate swap effectively converts the interest rate on $82.5 million of our term loans to a fixed rate from January 1, 2013 through December 31, 2014.  LIBOR is fixed at 3.185%, making the all-in rate effectively a fixed 10.185% for this portion of the term loans.  There was no fee for this swap agreement.  Both arrangements qualify for hedge accounting treatment.

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

	Derivatives
	March 31, 2012			December 31, 2011
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments:	Other Long-Term			Other Long-Term
Interest rate hedging agreements	Liabilities	$	2,167	Liabilities	$	2,049

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

	Amount of (Loss)/Gain in Other Comprehensive (Loss)/Income					Gain Reclassified from Accumulated Other Comprehensive Income to Income (ineffective portion)
	2012			2011		2012		2011
Derivatives designated as cash flow hedges:
Interest rate hedging agreements	$	(71	)	$	32	$	—	$	—

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CONSOLIDATED BALANCE SHEETS (unaudited) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2012	Dec. 31, 2011
Current assets:
Cash and cash equivalents	$ 44,771	$ 57,908
Restricted cash	14,325	15,706
Accounts receivable, net of allowance for doubtful accounts of $66,191 and $ 67,640 at March 31, 2012 and December 31, 2011, respectively	206,813	202,229
Prepaid expenses and other assets	28,022	29,075
Assets held for sale	4,537	0
Deferred tax assets	63,993	63,170
Total current assets	362,461	368,088
Property and equipment, net	146,033	148,298
Intangible assets, net	34,630	35,294
Goodwill	34,905	34,496
Restricted cash, non-current	353	353
Deferred tax assets	123,458	123,974
Other assets	42,825	45,163
Total assets	744,665	755,666
Current liabilities:
Accounts payable	48,836	55,888
Accrued compensation and benefits	56,494	61,101
Accrued self-insurance obligations, current portion	59,687	57,810
Other accrued liabilities	44,746	43,139
Current portion of long-term debt and capital lease obligations	995	1,017
Total current liabilities	210,758	218,955
Accrued self-insurance obligations, net of current portion	152,921	157,267
Long-term debt and capital lease obligations, net of current portion	88,500	88,768
Unfavorable lease obligations, net	6,492	7,110
Other long-term liabilities	58,454	58,110
Total liabilities	517,125	530,210
Commitments and contingencies (Note 5)
Stockholders' equity:
Preferred stock of $.01 par value, authorized 3,333 shares, zero shares issued and outstanding as of March 31, 2012 and December 31, 2011	0	0
Common stock of $.01 par value, authorized 41,667 shares, 25,272 and 25,146 shares issued and outstanding as of March 31, 2012 and December 31, 2011, respectively	253	251
Additional paid-in capital	728,801	726,861
Accumulated deficit	(500,214)	(500,427)
Accumulated other comprehensive loss, net	(1,300)	(1,229)
Total stockholders' equity	227,540	225,456
Total liabilities and stockholders' equity	$ 744,665	$ 755,666

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CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (USD $) In Thousands, unless otherwise specified	3 Months Ended
	Mar. 31, 2012	Mar. 31, 2011
Cash flows from operating activities:
Net income	$ 213	$ 8,112
Adjustments to reconcile net income to net cash (used for) provided by operating activities, including discontinued operations:
Depreciation and amortization	8,582	7,681
Amortization of favorable and unfavorable lease intangibles	(513)	(484)
Provision for losses on accounts receivable	5,122	5,644
Stock-based compensation expense	2,232	1,449
Deferred taxes	(260)	2,032
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable	(9,781)	(5,393)
Restricted cash	1,381	(1,946)
Prepaid expenses and other assets	1,752	(249)
Accounts payable	(6,036)	(1,919)
Accrued compensation and benefits	(4,607)	3,438
Accrued self-insurance obligations	(2,469)	(1,342)
Income taxes payable	0	478
Other accrued liabilities	1,531	(731)
Other long-term liabilities	227	(727)
Net cash (used for) provided by operating activities	(2,626)	16,043
Cash flows from investing activities:
Capital expenditures	(9,961)	(8,837)
Acquisitions, net of cash acquired	(260)	0
Net cash used for investing activities	(10,221)	(8,837)
Cash flows from financing activities:
Principal repayments of long-term debt and capital lease obligations	(290)	(2,798)
Net cash used for financing activities	(290)	(2,798)
Net (decrease) increase in cash and cash equivalents	(13,137)	4,408
Cash and cash equivalents at beginning of period	57,908	81,163
Cash and cash equivalents at end of period	$ 44,771	$ 85,571

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Nature of Business

3 Months Ended

Mar. 31, 2012

Notes to Financial Statements [Abstract]

Nature of Business

Nature of Business

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

Business

Our subsidiaries provide long-term, post-acute and related specialty healthcare in the United States.  We operate through three principal business segments: (i) inpatient services, (ii) rehabilitation therapy services, and (iii) medical staffing services.  Inpatient services represent the most significant portion of our business.  Our continuing operations include 190 healthcare centers in 23 states as of March 31, 2012.

Other Information

The accompanying unaudited consolidated financial statements have been prepared in accordance with our customary accounting practices and accounting principles generally accepted in the United States (“GAAP”) for interim financial statements.  In our opinion, the accompanying interim consolidated financial statements are a fair statement of our financial position at March 31, 2012, and our consolidated results of operations and cash flows for the three-month periods ended March 31, 2012 and 2011.  These statements are unaudited, and certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted, as permitted under the applicable rules and regulations of the Securities and Exchange Commission.  The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of only normal recurring items.  Readers of these statements should refer to our audited consolidated financial statements and notes thereto for the year ended December 31, 2011, which are included in our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”).

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

Recent Accounting Pronouncements

The FASB issued an Accounting Standards Update in June 2011 regarding the presentation of comprehensive income within financial statements.  GAAP now requires that comprehensive income and its components of net income and other comprehensive income be presented in either (1) a single continuous statement of comprehensive income or (2) two separate but consecutive statements.  This new guidance is now effective for us and our accompanying consolidated financial statements have been presented with one single continuous statement of comprehensive income.

Reclassifications

Certain reclassifications have been made to the prior period financial statements to conform to the 2012 financial statement presentation.  We have reclassified the results of operations of nine skilled nursing centers of our Inpatient Services segment (see Note 4 – “Discontinued Operations”) for all periods presented to discontinued operations within the income statement, in accordance with GAAP.

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CONSOLIDATED BALANCE SHEETS (unaudited) (Parenthetical) (USD $) In Thousands, except Per Share data, unless otherwise specified	Mar. 31, 2012	Dec. 31, 2011
Current assets:
Accounts receivable, allowance for doubtful accounts	$ 66,191	$ 67,640
Stockholders' equity:
Preferred stock, par value (in dollars per share)	$ 0.01	$ 0.01
Preferred stock, shares authorized (in shares)	3,333	3,333
Preferred stock, shares issued (in shares)	0	0
Preferred stock, shares outstanding (in shares)	0	0
Common stock, par value (in dollars per share)	$ 0.01	$ 0.01
Common stock, shares authorized (in shares)	41,667	41,667
Common stock, shares issued (in shares)	25,272	25,146
Common stock, shares outstanding (in shares)	25,272	25,146

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Document And Entity Information In Thousands, unless otherwise specified	3 Months Ended
	Mar. 31, 2012	Apr. 30, 2012
Entity Information [Line Items]
Entity Registrant Name	SUN HEALTHCARE GROUP INC
Entity Central Index Key	0000904978
Current Fiscal Year End Date	--12-31
Entity Well-known Seasoned Issuer	No
Entity Voluntary Filers	No
Entity Current Reporting Status	Yes
Entity Filer Category	Accelerated Filer
Entity Common Stock, Shares Outstanding		25,272,379
Document Fiscal Year Focus	2012
Document Fiscal Period Focus	Q1
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Mar. 31, 2012

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (USD $) In Thousands, except Per Share data, unless otherwise specified	3 Months Ended
	Mar. 31, 2012	Mar. 31, 2011
Income Statement [Abstract]
Total net revenues	$ 458,493	$ 466,307
Costs and expenses:
Operating salaries and benefits	261,090	262,480
Self-insurance for workers' compensation and general and professional liability insurance	15,317	14,557
Operating administrative expenses	12,406	13,067
Other operating costs	96,566	91,135
Center rent expense	36,377	35,692
General and administrative expenses	16,041	15,379
Depreciation and amortization	8,430	7,449
Provision for losses on accounts receivable	4,808	5,176
Interest, net of interest income of $68 and $58, respectively	4,411	4,999
Restructuring costs	0	136
Total costs and expenses	455,446	450,070
Income before income taxes and discontinued operations	3,047	16,237
Income tax expense	1,188	6,619
Income from continuing operations	1,859	9,618
Discontinued operations:
Loss from discontinued operations, net	(1,646)	(1,506)
Net income	213	8,112
(Loss) gain from cash flow hedge, net of related tax (benefit) expense of ($47) and $22, respectively	(71)	32
Other comprehensive income, net of tax	(71)	32
Comprehensive income	$ 142	$ 8,144
Basic earnings per common and common equivalent share:
Income from continuing operations	$ 0.07	$ 0.37
Loss from discontinued operations, net	$ (0.06)	$ (0.05)
Net income	$ 0.01	$ 0.32
Diluted earnings per common and common equivalent share:
Income from continuing operations	$ 0.07	$ 0.37
Loss from discontinued operations, net	$ (0.06)	$ (0.06)
Net income	$ 0.01	$ 0.31
Weighted average number of common and common equivalent shares outstanding:
Basic	26,207	25,740
Diluted	26,207	25,838

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Income Taxes

3 Months Ended

Mar. 31, 2012

Notes to Financial Statements [Abstract]

Income Taxes

Income Taxes

The provision for income taxes of $1.2 million for the three months ended March 31, 2012 results in an effective tax rate of approximately 39%. The provision for income taxes of $6.6 million for the three months ended March 31, 2011 resulted in an effective tax rate of approximately 41%. The rates for 2012 and 2011 differ from the statutory tax rate of 35% primarily due to state taxes.

The realization of our deferred tax assets is dependent upon generation of taxable income during periods in which deductions and/or credits can be utilized.  As a result, we consider the level of historical taxable income, historical non-recurring credits and charges, the scheduled reversal of deferred tax liabilities, tax-planning strategies and projected future taxable income in determining the amount of the valuation allowance.  The valuation allowance of $17.9 million at March 31, 2012 and December 31, 2011 relates primarily to state net operating loss (“NOL”) carryforwards and other deferred tax assets for which realization is uncertain.

In evaluating the need to establish a valuation allowance on our net deferred tax assets, all items of positive evidence (e.g., future sources of taxable income, including the ability to reliably forecast and to continue our mitigation initiatives implemented in 2011) and negative evidence (e.g., impact of the Centers for Medicare and Medicaid Services ("CMS") final rule for skilled nursing facilities for the 2012 federal fiscal year, which commenced on October 1, 2011 (the "CMS Final Rule") and subsequent impairment of goodwill in 2011) were considered.  We were in a cumulative pre-tax book loss of approximately $217 million for the three-year period ended December 31, 2011.  However, because approximately $324 million of the book expenses (principally related to our 2011 non-cash loss on asset impairment for goodwill and other intangibles) were not deductible for tax purposes, we generated taxable income and utilized existing net operating loss carryforwards in each of the last three years.  As a result of the negative impact of the CMS Final Rule on our business, we commenced a broad based mitigation initiative in 2011, which includes infrastructure cost reductions. Our ability to generate sufficient future taxable income to realize our deferred tax assets is dependent on our ability to continue our mitigation initiatives. Based upon our current estimates of future taxable income, we believe that we will more likely than not realize our net deferred tax assets.  However, if we are unable to continue realizing enough savings through our mitigation initiative to offset the negative impact of the CMS Final Rule, we may be required to increase our valuation allowance in future periods.

After consideration of the November 2010 restructuring of our former parent company, which, among other matters resulted in Sabra Health Care REIT, Inc. holding substantially all of our former parent’s owned real property, and utilization of NOL carryforwards through 2011, the Internal Revenue Code (“IRC”) Section 382 annual base limitation to be applied to our tax attribute carryforwards is approximately $7.4 million. Accordingly, our NOL and tax credit carryforwards have been reduced to take into account this limitation and the respective carryforward periods for these tax attributes.  As a result of unused IRC Section 382 limitations from prior years and post-ownership change NOLs, we estimate there is approximately $47.6 million of NOLs which can be used to offset U.S. taxable income in 2012.  Considering annual IRC Section 382 limitations and built-in gains, we estimate a total of approximately $145.4 million of utilizable NOL carryforwards to offset taxable income in 2012 and future years.

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Commitments and Contingencies

3 Months Ended

Mar. 31, 2012

Notes to Financial Statements [Abstract]

Commitments and Contingencies

Commitments and Contingencies

(a) 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 from such reviews are reflected in current earnings. Claims are paid over varying periods, and future payments may be different than the estimated reserves.

We evaluate the adequacy of our self-insurance reserves on a quarterly basis and perform detailed actuarial analyses semi-annually in the second and fourth quarters. The analyses use generally accepted actuarial methods in evaluating the workers’ compensation reserves and general and professional liability reserves.  For both the workers’ compensation reserves and the general and professional liability reserves, those methods include reported and paid loss development methods, expected loss method and the reported and paid Bornhuetter-Ferguson methods.  Reported loss methods focus on development of case reserves for incurred losses through claims closure.  Paid loss methods focus on development of claims actually paid to date.  Expected loss methods are based upon an anticipated loss per unit of measure.  The Bornhuetter-Ferguson method is a combination of loss development methods and expected methods.

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

The use of multiple methods tends to eliminate any biases that one particular method might have.  Management’s judgment based upon each method’s inherent limitation is applied when weighting the results of each method.  The results of each of the methods are estimates of ultimate losses which include the case reserves plus an estimate for future development of these reserves based on past trends, and an estimate for losses incurred but not reported. These results are compared by accident year, and an estimated unpaid loss and allocated loss adjustment expense is determined for the open accident years based on judgment reflecting the range of estimates produced by the methods.

Activity in our professional liability and workers’ compensation self-insurance reserves as of and for the periods ended March 31, 2012 and 2011 is as follows (in thousands):

	For the Three Months Ended March 31, 2011
	Professional Liability			Workers’ Compensation			Total
Gross balance, beginning of period	$	113,971		$	96,585		$	210,556
Less: anticipated insurance recoveries	(2,100		)	(28,100		)	(30,200		)
Net balance, beginning of period	$	111,871		$	68,485		$	180,356
Current year provision, continuing operations	6,974			7,583			14,557
Current year provision, discontinued operations	467			384			851
Claims paid, continuing operations	(9,515		)	(4,667		)	(14,182		)
Claims paid, discontinued operations	(346		)	(366		)	(712		)
Amounts paid for administrative services and other	(809		)	(1,744		)	(2,553		)
Net balance, end of period	$	108,642		$	69,675		$	178,317
Plus: anticipated insurance recoveries	2,100			28,100			30,200
Gross balance, end of period	$	110,742		$	97,775		$	208,517

	For the Three Months Ended March 31, 2012
	Professional Liability			Workers’ Compensation			Total
Gross balance, beginning of period	$	120,857		$	87,242		$	208,099
Less: anticipated insurance recoveries	(2,390		)	(21,930		)	(24,320		)
Net balance, beginning of period	$	118,467		$	65,312		$	183,779
Current year provision, continuing operations	8,135			7,182			15,317
Current year provision, discontinued operations	467			326			793
Claims paid, continuing operations	(6,419		)	(4,828		)	(11,247		)
Claims paid, discontinued operations	(3,269		)	(370		)	(3,639		)
Amounts paid for administrative services and other	(1,145		)	(2,009		)	(3,154		)
Net balance, end of period	$	116,236		$	65,613		$	181,849
Plus: anticipated insurance recoveries	2,390			21,930			24,320
Gross balance, end of period	$	118,626		$	87,543		$	206,169

    The anticipated insurance recoveries relate primarily to our workers’ compensation programs associated with policy years 1996 through 2001 where the claim losses have exceeded the policies' aggregate retention limits. Obligations above these retention limits are covered by our excess insurance carriers, which all have carrier ratings of at least “A,” “XIV” or better.

A summary of the assets and liabilities related to insurance risks at March 31, 2012 and December 31, 2011 is as indicated below (in thousands):

	March 31, 2012							December 31, 2011
	Professional Liability		Workers’ Compensation		Total		| |	Professional Liability		Workers’ Compensation		Total
Assets:							|
Restricted cash (1)							|
Current	$	5,617	$	8,544	$	14,161	|	$	6,254	$	9,332	$	15,586
Non-current	—		—		—		|	—		—		—
	$	5,617	$	8,544	$	14,161	|	$	6,254	$	9,332	$	15,586
							|
Anticipated insurance recoveries (2)							|
Current	$	524	$	2,730	$	3,254	|	$	524	$	2,730	$	3,254
Non-current	1,866		19,200		21,066		|	1,866		19,200		21,066
	$	2,390	$	21,930	$	24,320	|	$	2,390	$	21,930	$	24,320
Total Assets	$	8,007	$	30,474	$	38,481	|	$	8,644	$	31,262	$	39,906
Liabilities (3)(4):							|
Self-insurance liabilities							|
Current	$	32,030	$	21,218	$	53,248	|	$	28,758	$	22,074	$	50,832
Non-current	86,596		66,325		152,921		|	92,099		65,168		157,267
Total Liabilities	$	118,626	$	87,543	$	206,169	|	$	120,857	$	87,242	$	208,099

(1) Total restricted cash includes cash collateral deposits and other cash held by third parties.  Total restricted cash above excludes $517 and $473 at March 31, 2012 and December 31, 2011, respectively, held for bank collateral, various mortgages, bond payments and capital expenditures on HUD-insured buildings.

(2) Anticipated insurance recovery assets are presented as Other Assets (both current and long-term) in our March 31, 2012 and December 31, 2011 consolidated balance sheets.  

(3) Total self-insurance liabilities above exclude $6,439 and $6,978 at March 31, 2012 and December 31, 2011, respectively, related to our employee health insurance liabilities.

(4) Total self-insurance liabilities for workers’ compensation claims are collateralized, in addition to the restricted cash, by letters of credit of $57,538 as of March 31, 2012 and $55,335 as of December 31, 2011.

(b)  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.  The ability to predict the ultimate outcome of such matters involves judgments, estimates and inherent uncertainties.  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 or 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, the industries in which we operate are frequently subject to the regulatory supervision of fiscal intermediaries. If a provider is found to have engaged in improper practices, it could be subject to civil, administrative or criminal fines, penalties or restitutionary relief; and reimbursement authorities could also seek the suspension or exclusion of the provider or individual from participation in their program. We believe that there has been, and will continue to be, an increase in governmental investigations of long-term care providers, particularly in the area of Medicare/Medicaid false claims, as well as an increase in enforcement actions resulting from these investigations. Adverse determinations in legal proceedings or governmental investigations, whether currently asserted or arising in the future, could have a material adverse effect on our financial position, results of operations or cash flows.

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. Our appeal is currently pending with the Kentucky Court of Appeals. We believe our reserves are adequate for this matter.

(c)  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.

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Segment Information

3 Months Ended

Mar. 31, 2012

Notes to Financial Statements [Abstract]

Segment Information

Segment Information

We operate predominantly in the long-term care segment of the healthcare industry. We are a provider of long-term, sub-acute and related ancillary care services to nursing home patients.  Our reportable segments are composed of operating segments, which are aggregated, comprising strategic business units that provide different products and services. They are managed separately because each business has different marketing strategies due to differences in types of customers, distribution channels and capital resource needs.  More complete descriptions and accounting policies of the segments are described in Note 13 – “Segment Information” and  Note 2 – “Summary of Significant Accounting Policies” of our 2011 Form 10-K.  The following tables summarize, for the periods indicated, operating results and other financial information, by business segment (in thousands):

As of and for the
Three Months Ended
March 31, 2012
	Inpatient Services			Rehabilitation Therapy Services		Medical Staffing Services			Corporate			Intersegment Eliminations			Consolidated
Revenues from external customers	$	405,788		$	30,629	$	22,069		$	7		$	—		$	458,493
Intersegment revenues	—			33,464		831			—			(34,295		)	—
Total net revenues	405,788			64,093		22,900			7			(34,295		)	458,493
Operating salaries and benefits	189,707			53,896		17,487			—			—			261,090
Self-insurance for workers’ compensation and
general and professional liability insurance	14,289			609		355			64			—			15,317
Other operating costs	125,669			2,497		2,695			—			(34,295		)	96,566
General and administrative expenses(1)	9,260			2,530		615			16,042			—			28,447
Provision for losses on
accounts receivable	4,430			414		(36		)	—			—			4,808
Segment operating income (loss)	$	62,433		$	4,147	$	1,784		$	(16,099	)	$	—		$	52,265
Center rent expense	36,075			134		168			—			—			36,377
Depreciation and amortization	7,028			251		185			966			—			8,430
Interest, net	(19		)	—		—			4,430			—			4,411
Net segment income (loss)	$	19,349		$	3,762	$	1,431		$	(21,495	)	$	—		$	3,047
Identifiable segment assets	$	385,342		$	18,701	$	20,287		$	287,188		$	20,829		$	732,347
Goodwill	$	30,297		$	75	$	4,533		$	—		$	—		$	34,905
Segment capital expenditures	$	8,676		$	399	$	51		$	835		$	—		$	9,961

______________________________________

(1) 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, restructuring costs, income tax expense and discontinued operations.

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

As of and for the
Three Months Ended
March 31, 2011
	Inpatient Services			Rehabilitation Therapy Services		Medical Staffing Services			Corporate			Intersegment Eliminations			Consolidated
Revenues from external customers	$	413,888		$	30,096	$	22,316		$	7		$	—		$	466,307
Intersegment revenues	—			32,694		623			—			(33,317		)	—
Total net revenues	413,888			62,790		22,939			7			(33,317		)	466,307
Operating salaries and benefits	190,931			54,132		17,417			—			—			262,480
Self-insurance for workers’ compensation and
general and professional liability insurance	13,501			642		347			67			—			14,557
Other operating costs	119,422			2,169		2,861			—			(33,317		)	91,135
General and administrative expenses(1)	10,014			2,398		655			15,379			—			28,446
Provision for losses on
accounts receivable	4,953			324		(101		)	—			—			5,176
Segment operating income (loss)	$	75,067		$	3,125	$	1,760		$	(15,439	)	$	—		$	64,513
Center rent expense	35,392			127		173			—			—			35,692
Depreciation and amortization	6,206			226		187			830			—			7,449
Interest, net	(6		)	—		1			5,004			—			4,999
Net segment income (loss)	$	33,475		$	2,772	$	1,399		$	(21,273	)	$	—		$	16,373
Identifiable segment assets	$	691,111		$	15,890	$	20,541		$	346,930		$	20,867		$	1,095,339
Goodwill	$	345,064		$	75	$	4,533		$	—		$	—		$	349,672
Segment capital expenditures	$	6,507		$	729	$	53		$	1,548		$	—		$	8,837

______________________________________

(1) 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, restructuring costs, income tax expense and discontinued operations.

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

Measurement of Segment Income

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

	For the Three Months Ended March 31,
	2012		2011
Net segment income	$	3,047	$	16,373
Restructuring costs	—		136
Consolidated income before income taxes
and discontinued operations	$	3,047	$	16,237

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (Parenthetical) (USD $) In Thousands, unless otherwise specified	3 Months Ended
	Mar. 31, 2012	Mar. 31, 2011
Income Statement [Abstract]
Interest income	$ 68	$ 58
Tax (benefit) expense on cash flow hedge	$ (47)	$ 22

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Discontinued Operations

3 Months Ended

Mar. 31, 2012

Notes to Financial Statements [Abstract]

Discontinued Operations

Discontinued Operations

The results of operations of assets to be disposed of, disposed assets and the losses related to these divestitures have been classified as discontinued operations for all periods presented in the accompanying consolidated income statements as their operations and cash flows have been (or will be) eliminated from our ongoing operations and we will not have any significant continuing involvement in their operations after their disposal.

During the three months ended March 31, 2012, we developed plans to dispose of nine skilled nursing centers in three different markets within our Inpatient Services segment, whose results have been reclassified to discontinued operations for all periods presented in accordance with GAAP.  As of March 31, 2012, assets held for sale for these nine centers of $4.5 million consisted of (i) a net carrying amount of $3.2 million of property and equipment, (ii) $0.8 million of other non-current assets and (iii) $0.5 million of prepaid expenses and other assets.

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

	For the Three Months Ended
	March 31, 2012									March 31, 2011
	Inpatient Services			Other			Total			Inpatient Services			Other			Total
Net operating revenues	$	16,746		$	—		$	16,746		$	20,145		$	—		$	20,145
Loss from discontinued operations, net (1)	$	(1,645	)	$	(1	)	$	(1,646	)	$	(1,498	)	$	(8	)	$	(1,506	)

(1) Net of related tax benefit of $1,052 and $981, respectively