----

**FORM      10-K**

| x    Annual                Report Pursuant to Section 13(a) or 15(d) of the Securities Exchange                Act of 1934                                                                                                                                                                                                             |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **For                the fiscal year ended December 31, 2006**                                                                                                                                                                                                                                                                                             |
| OR                                                                                                                                                                                                                                                                                                                                                              |
| o    Transition                Report Pursuant to Section 13(a) or 15(d) of the Securities Exchange                Act of 1934For                the transition period from                           to                           |

**SUN      HEALTHCARE GROUP, INC.**

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

**18831      Von Karman, Suite 400**

**Irvine,      CA 92612**

**(949)      255-7100**

**Common      Stock, par value $.01 per share**

**None**

**     **

| Large                accelerated filero | Accelerated                filerx | Non-accelerated                filero |
|-----------------------------------------|-----------------------------------|---------------------------------------|

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**SUN        HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**F**
**ORM        10-K**

**FOR      THE FISCAL YEAR ENDED DECEMBER 31, 2006**

**INDEX**

|                    |                                                                                                     | **Page** |
|-------------------------|----------------------------------------------------------------------------------------------------------|----------|
| PART                I   |                                                                                                     |     |
|                    |                                                                                                     |     |
| Item                1.  | Business                                                                                                 | 1        |
| Item                1A. | Risk                Factors                                                                              | 8        |
| Item                1B. | Unresolved                Staff Comments                                                                 | 13       |
| Item                2.  | Properties                                                                                               | 13       |
| Item                3.  | Legal                Proceedings                                                                         | 15       |
| Item                4.  | Submission                of Matters to a Vote of Security Holders                                       | 15       |
|                    |                                                                                                     |     |
| PART                II  |                                                                                                     |     |
|                    |                                                                                                     |     |
| Item                5.  | Market                for Registrant's Common Equity, Related Stockholder Matters and Issuer             |     |
|                    | Purchases                of Equity Securities                                                            | 16       |
| Item                6.  | Selected                Financial Data                                                                   | 18       |
| Item                7.  | Management's                Discussion and Analysis of Financial Condition and Results of                |     |
|                    | Operations                                                                                               | 20       |
| Item                7A. | Quantitative                and Qualitative Disclosures About Market Risk                                | 43       |
| Item                8.  | Financial                Statements and Supplementary Data                                               | 44       |
| Item                9.  | Changes                in and Disagreements With Accountants on Accounting and Financial                 |     |
|                    | Disclosure                                                                                               | 44       |
| Item                9A. | Controls                and Procedures                                                                   | 44       |
| Item                9B. | Other                Information                                                                         | 45       |
|                    |                                                                                                     |     |
| PART                III |                                                                                                     |     |
|                    |                                                                                                     |     |
| Item                10. | Directors,                Executive Officers and Corporate Governance                                    | 46       |
| Item                11. | Executive                Compensation                                                                    | 46       |
| Item                12. | Security                Ownership of Certain Beneficial Owners and Management and                Related |     |
|                    | Stockholder                Matters                                                                       | 46       |
| Item                13. | Certain                Relationships and Related Transactions and Director                Independence   | 46       |
| Item                14. | Principal                Accounting Fees and Services                                                    | 46       |
|                    |                                                                                                     |     |
| PART                IV  |                                                                                                     |     |
|                    |                                                                                                     |     |
| Item                15. | Exhibits,                Financial Statements and Schedules                                              | 47       |
|                    |                                                                                                     |     |
| Signatures              |                                                                                                     | 51       |

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**SUN      HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**PART      I**

**Item      1.  Business**

**Overview**

| Ø   | increase                the scale of operations, thus leveraging our corporate and regional                infrastructure; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------|

| Ø   | improve                our payor mix with increased revenue derived from Medicare; |
|--------------------|------------------------------------------------------------------------------------|

| Ø   | increase                our services to high-acuity patients, for whom we are reimbursed                at higher                rates; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------|

| Ø   | increase                our percentage of owned skilled nursing facilities; and |
|--------------------|---------------------------------------------------------------------------------|

| Ø   | increase                our presence in four states and expand into six contiguous states. |
|--------------------|--------------------------------------------------------------------------------------------|

**Industry**

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**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

**Business      Segments**

| Ø   | inpatient                services, primarily skilled nursing facilities; |
|--------------------|--------------------------------------------------------------------------|

| Ø   | rehabilitation                therapy services; and |
|--------------------|-----------------------------------------------------|

| Ø   | medical                staffing services. |
|--------------------|-------------------------------------------|

*Inpatient      services*

*Rehabilitation      therapy services*

*Medical      staffing services*
*** ***
*** ***

**Competition**

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**SUN        HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**Competitive      Strengths**

***National      footprint.***

***Core      inpatient business.***

***Quality      of care and strong brand image.***

***Ancillary      businesses support our inpatient services and provide      diversification.***

***Infrastructure      in place to leverage growth***
**.**

----

**SUN        HEALTHCARE GROUP, INC. AND SUBSIDIARIES**
***Experienced      management team with a proven track      record.***

**Business      Strategy**

***Continue      our inpatient growth.***

***Seek      growth in our ancillary businesses.***

***Increase      operational efficiency and leverage our existing      platform.***

| Ø   | reduce                labor and billing expenses through technological advances and operational                improvements that allow management to more efficiently allocate employees; |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| Ø   | reduce                overhead through process improvement initiatives and frequent                re-examination of costs; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------|

| Ø   | continue                to improve therapist productivity in our rehabilitation services                business; |
|--------------------|-------------------------------------------------------------------------------------------------------------------|

| Ø   | control                litigation expense by focusing on risk management; and |
|--------------------|-------------------------------------------------------------------------------|

| Ø   | monitor                and analyze the operations and profitability of individual business                units. |
|--------------------|------------------------------------------------------------------------------------------------------------------|

***Complete      successful integration of Harborside.***
**          **

**Employees      and Labor Relations**

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**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

**Federal      and State Regulatory Oversight **

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**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

| - | the                “anti-kickback” provisions of the Medicare and Medicaid programs, which                prohibit, among other things, knowingly and willfully soliciting,                receiving, offering or paying any remuneration (including any kickback,                bribe or rebate) directly or indirectly in return for or to induce                the                referral of an individual to a person for the furnishing or arranging                for                the furnishing of any item or service for which payment may be made                in                whole or in part under Medicare or Medicaid; and |
|---|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| - | the                “Stark laws” which prohibit, with limited exceptions, the referral of                patients by physicians for certain services, including physical therapy                and occupational therapy, to an entity in which the physician has                a                financial interest.                                                                                                                                                                                                                                                                                                                                 |

** **

**Compliance      Process**

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**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

***Written      Policies, Procedures and Standards of Conduct.***

***Designated      Compliance Officer and Compliance Committee.***

***Effective      Training and Education***
**.**

***Effective      Lines of Communication***
**.**

***Internal      Monitoring and Auditing***
**.**

***Enforcement      of Standards***
**.**

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**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

***Responses      to Detected Offenses and Development of Corrective      Actions.***

**General      Information**

**Item      1A. Risk Factors**

**Healthcare      reform legislation or regulatory action may adversely affect our business.      **

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**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**Possible      changes in the case mix of residents and patients as well as payor mix and      payment methodologies may significantly affect our profitability.**

**Our      proposed acquisition of Harborside may be delayed or not be consummated.**

**We      may not be able to successfully integrate our proposed acquisition of Harborside      or realize the potential benefits of the acquisition, which could cause our      business to suffer. **

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**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

**We      will incur a significant amount of debt in connection with the proposed      acquisition of Harborside.**

**We      are subject to a number of lawsuits and rely primarily on self-funded insurance      programs for general and professional liability claims against us.**

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

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**We      have in the past sustained losses, and may not be able to maintain profitability      or generate sufficient operating cash flows to fund our operations.**

**We      face national, regional and local competition. **

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

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

----

**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

**Delays      in collection of our accounts receivable could adversely affect our cash flows      and financial condition. **

**If      we lose our key management personnel, we may not be able to successfully manage      our business and achieve our objectives. **

**We      do not expect to pay any dividends for the foreseeable future.**

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

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**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**Item      1B.  Unresolved Staff Comments**

**Item      2.  Properties**

**Inpatient      Services**

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

|                          |   |                                                                   |   |                                                                        |   | **Number                of Beds/Units****(1)** |   |
|-------------------------------|--------|------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------|--------|------------------------------------------------|--------|
| **State**                     |   | **Total****Number                of****Licensed****Beds/Units****(1)** |   | **Total****Number                of****  Facilities  ** |   | **Skilled****Nursing**                         |   | **Assisted****  Living  ** |   | **Independent****and                Senior****     Living     ** |   | **Mental****  Health  ** |   | **Specialty****Acute****   Care   ** |   |
| Oklahoma                      |   |                                                                   | 1,662  |                                                                        |   | 12                                             |   |   | 1,440 |   |   | 162 |   |   | - |   |   | 60 |   |   | - |   |
| California                    |   |                                                                   | 1,501  |                                                                        |   | 17                                             |   |   | 858 |   |   | - |   |   | - |   |   | 473 |   |   | 170 |   |
| Colorado                      |   |                                                                   | 1,276  |                                                                        |   | 9                                              |   |   | 1,179 |   |   | - |   |   | 97 |   |   | - |   |   | - |   |
| Idaho                         |   |                                                                   | 1,136  |                                                                        |   | 10                                             |   |   | 1,114 |   |   | - |   |   | - |   |   | - |   |   | 22 |   |
| New                Hampshire  |   |                                                                   | 1,068  |                                                                        |   | 9                                              |   |   | 865 |   |   | 203 |   |   | - |   |   | - |   |   | - |   |
| New                Mexico     |   |                                                                   | 1,065  |                                                                        |   | 12                                             |   |   | 945 |   |   | 100 |   |   | 20 |   |   | - |   |   | - |   |
| Georgia                       |   |                                                                   | 1,034  |                                                                        |   | 9                                              |   |   | 1,002 |   |   | 32 |   |   | - |   |   | - |   |   | - |   |
| Massachusetts                 |   |                                                                   | 1,022  |                                                                        |   | 11                                             |   |   | 965 |   |   | - |   |   | 57 |   |   | - |   |   | - |   |
| North                Carolina |   |                                                                   | 994    |                                                                        |   | 8                                              |   |   | 994 |   |   | - |   |   | - |   |   | - |   |   | - |   |
| Tennessee                     |   |                                                                   | 919    |                                                                        |   | 9                                              |   |   | 897 |   |   | 22 |   |   | - |   |   | - |   |   | - |   |
| Alabama                       |   |                                                                   | 783    |                                                                        |   | 7                                              |   |   | 757 |   |   | 26 |   |   | - |   |   | - |   |   | - |   |
| West                Virginia  |   |                                                                   | 739    |                                                                        |   | 7                                              |   |   | 739 |   |   | - |   |   | - |   |   | - |   |   | - |   |
| Montana                       |   |                                                                   | 650    |                                                                        |   | 5                                              |   |   | 538 |   |   | 97 |   |   | 15 |   |   | - |   |   | - |   |
| Washington                    |   |                                                                   | 588    |                                                                        |   | 6                                              |   |   | 552 |   |   | 36 |   |   | - |   |   | - |   |   | - |   |
| Ohio                          |   |                                                                   | 395    |                                                                        |   | 4                                              |   |   | 395 |   |   | - |   |   | - |   |   | - |   |   | - |   |
| Utah                          |   |                                                                   | 231    |                                                                        |   | 3                                              |   |   | 204 |   |   | 27 |   |   | - |   |   | - |   |   | - |   |
| Maryland                      |   |                                                                   | 177    |                                                                        |   | 1                                              |   |   | 177 |   |   | - |   |   | - |   |   | - |   |   | - |   |
| Arizona                       |   |                                                                   | 161    |                                                                        |   | 1                                              |   |   | 161 |   |   | - |   |   | - |   |   | - |   |   | - |   |
| Wyoming                       |   |                                                                   | 46     |                                                                        |   | 1                                              |   |   | 46 |   |   | - |   |   | - |   |   | - |   |   | - |   |
| **Total**                     |   |                                                                   | 15,447 |                                                                        |   | 141                                            |   |   | 13,828 |   |   | 705 |   |   | 189 |   |   | 533 |   |   | 192 |   |

| *(1)* | *“Licensed                Beds” refers to the number of beds for which a license has been issued,                which may vary in some instances from licensed beds available for                use,                which is used in the computation of occupancy. Available beds for                the 141                facilities were 14,726.* |
|-------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**Rehabilitation      Therapy Services **

**Medical      Staffing Services **

**Corporate      **

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**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**Item        3.  Legal Proceedings**

**Item      4.  Submission of Matters to a Vote of Security      Holders**

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**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

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

|                          |   |     |   |    |   |
|-------------------------------|--------|----------|--------|---------|--------|
|                          |   | **High** |   | **Low** |   |
| **2006**                      |   |     |        |    |   |  |   |
| Fourth                Quarter |   | $        | 14.00  |    | $      | 9.79 |   |
| Third                Quarter  |   | $        | 11.83  |    | $      | 7.69 |   |
| Second                Quarter |   | $        | 10.01  |    | $      | 7.38 |   |
| First                Quarter  |   | $        | 7.99   |    | $      | 6.05 |   |
|                          |   |     |   |    |   |   |   |
| **2005**                      |   |     |        |    |   |  |   |
| Fourth                Quarter |   | $        | 8.65   |    | $      | 6.10 |   |
| Third                Quarter  |   | $        | 7.57   |    | $      | 6.03 |   |
| Second                Quarter |   | $        | 7.48   |    | $      | 5.86 |   |
| First                Quarter  |   | $        | 9.60   |    | $      | 5.90 |   |

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**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

**STOCK      PRICE PERFORMANCE GRAPH**

|                                      | 4/2/02  | 12/31/02 | 12/31/03     | 12/31/04     | 12/31/05     | 12/31/06     |
|-------------------------------------------|---------|----------|--------------|--------------|--------------|--------------|
|                                      |    |     |         |         |         |         |
| Sun                Healthcare Group, Inc. | $100.00 | $10.56   | $ 53.07 | $ 49.13 | $ 35.25 | $ 67.36 |
| Long-Term                Care Index       | 100.00  | 75.63    | 154.16       | 166.45       | 200.33       | 246.35       |
| S&P                500 Index          | 100.00  | 77.69    | 99.97        | 110.85       | 116.29       | 134.66       |

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

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**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**Item        6.  Selected Financial Data**

|                                                                                                             |   | **Reorganized                Company (1)** |      |                                  |    |  **Predecessor****Company (1)** |   |
|------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|-----------|---------------------------------------|---------|-------------------------------------------|--------|
|                                                                                                             |   | **At                or For**                    |      |  **At                or For**    |    |  **At                or For**        |   |  **At                or For** |   |  **At                or For** |   |   |   |  **At                or For** |   |
|                                                                                                             |   | **The                Year**                     |      |  **The                Year**     |    |  **The                Year**         |   |  **The                Year** |   |  **The                Ten** |   |   |   |  **The                Two** |   |
|                                                                                                             |   | **Ended**                                       |      |  **Ended**                       |    |  **Ended**                           |   |  **Ended** |   |  **Months                Ended** |   |   |   |  **Months                Ended** |   |
|                                                                                                             |   | **December                31,**                 |      |  **December                31,** |    |  **December                31,**     |   |  **December                31,** |   |  **December                31,** |   |   |   |  **February                28,** |   |
|                                                                                                             |   | **2006(2)**                                     |      |  **2005(3)**                     |    |  **2004(4)**                         |   |  **2003(5)** |   |  **2002(6)** |   |   |   |  **2002(7)** |   |
|                                                                                                             |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                net revenues                                                                                |   | $                                               | 1,045,637 |                                  | $       | 765,782                                   |   | $ | 700,863 |   | $ | 663,644 |   | $ | 542,393 |   |   | **|** |   | $ | 301,846 |   |
| Income                (loss) before income                                                                       |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   taxes                and discontinued                                                                |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   operations                                                                                           |   |                                            | 15,419    |                                  |    | (2,761                                    | )      |   | 540 |   |   | (40,259 | ) |   | (301,509 | ) |   | **|** |   |   | 1,493,157 |   |
| Income                (loss) from                                                                                |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   continuing                operations                                                                 |   |                                            | 14,688    |                                  |    | (1,975                                    | )      |   | 1,698 |   |   | (40,924 | ) |   | (301,919 | ) |   | **|** |   |   | 1,493,010 |   |
| Income                (loss) on discontinued                             |   |                                            |      |                                  |    |                                      |   |   |   | **|** |   |   |   |   |
|   operations                                                                                           |   |                                            | 12,430    |                                  |    | 26,736                                    |   |   | (20,325 | ) |   | 41,278 |   |   | (136,067 | ) |   | **|** |   |   | (7,639 | ) |
| Net                income (loss)                                                                                 |   | $                                               | 27,118    |                                  | $       | 24,761                                    |   | $ | (18,627 | ) | $ | 354 |   | $ | (437,986 | ) |   | **|** |   | $ | 1,485,371 |   |
| Basic                earnings per                                                                                |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   common                and common                                                                     |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   equivalent                share:                                                                     |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
| Income                (loss) from                                                                                |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   continuing                operations                                                                 |   | $                                               | 0.46      |                                  | $       | (0.12                                     | )      | $ | 0.12 |   | $ | (4.07 | ) | $ | (30.19 | ) |   | **|** |   | $ | 24.44 |   |
| Income                (loss) from discontinued            |   |                                            |      |                                  |    |                                      | **|**  |   |   |   |   |
|   operations                                                                                           |   |                                            | 0.40      |                                  |    | 1.67                                      |   |   | (1.41 | ) |   | 4.11 |   |   | (13.61 | ) |   | **|** |   |   | (0.12 | ) |
| Net                income (loss)                                                                                 |   | $                                               | 0.86      |                                  | $       | 1.55                                      |   | $ | (1.29 | ) | $ | 0.04 |   | $ | (43.80 | ) |   | **|** |   | $ | 24.32 |   |
| Diluted                earnings per common                                                                       |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   and                common equivalent                                                                 |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   share:                                                                                               |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
| Income                (loss) from                                                                                |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   continuing                operations                                                                 |   | $                                               | 0.46      |                                  | $       | (0.12                                     | )      | $ | 0.12 |   | $ | (4.07 | ) | $ | (30.19 | ) |   | **|** |   | $ | 24.44 |   |
| Income                (loss) from discontinued            |   |                                            |      |                                  |    |                                      | **|**  |   |   |   |   |
|   operations                                                                                           |   |                                            | 0.39      |                                  |    | 1.67                                      |   |   | (1.40 | ) |   | 4.11 |   |   | (13.61 | ) |   | **|** |   |   | (0.12 | ) |
| Net                income (loss)                                                                                 |   | $                                               | 0.85      |                                  | $       | 1.55                                      |   | $ | (1.28 | ) | $ | 0.04 |   | $ | (43.80 | ) |   | **|** |   | $ | 24.32 |   |
| Weighted                average number of                                                                        |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   common                and common                                                                     |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   equivalent                shares:                                                                    |   |                                            |      |                                  |    |                                      |   |   |   |   |   |   |   |   |   |   |   | **|** |   |   |   |   |
|   Basic                                                                                                |   |                                            | 31,638    |                                  |    | 16,003                                    |   |   | 14,456 |   |   | 10,050 |   |   | 10,000 |   |   | **|** |   |   | 61,080 |   |
|   Diluted                                                                                              |   |                                            | 31,788    |                                  |    | 16,003                                    |   |   | 14,548 |   |   | 10,050 |   |   | 10,000 |   |   | **|** |   |   | 61,080 |   |
| Working                capital (deficit)                                                                         |   | $                                               | 96,245    |                                  | $       | (62,786                                   | )      | $ | (30,595 | ) | $ | (57,377 | ) | $ | (66,412 | ) |   | **|** |   | $ | 69,762 |   |
| Total                assets                                                                                      |   | $                                               | 621,423   |                                  | $       | 512,306                                   |   | $ | 313,153 |   | $ | 300,398 |   | $ | 475,835 |   |   | **|** |   | $ | 828,416 |   |
| Long-term                debt, including current  portion                                         | $      | 172,975                                         |      | $                                     | 186,575 |                                      | $      | 107,182 |   | $ | 78,514 |   | $ | 196,223 |   |   | **||** |   | $ | 190,146 |   |
| Capital                leases, including current  portion                                              |   | $                                               | 1,190     |                                  | $       | 11,204                                    |   | $ | - |   | $ | 364 |   | $ | - |   |   | **||** |   | $ | - |   |
| Stockholders'                equity (deficit)                                                                    |   | $                                               | 144,133   |                                  | $       | (2,895                                    | )      | $ | (123,380 | ) | $ | (166,398 | ) | $ | (187,218 | ) |   | **|** |   | $ | 237,600 |   |

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**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

| (1)    | On                February 28, 2002, we emerged from proceedings under the Bankruptcy                Code                pursuant to the terms of our Plan of Reorganization.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (2)    | Results                for the year ended December 31, 2006 include a $2.5 million non-cash                charge to account for certain lease rate escalation clauses (see“Note 3 -                Significant Accounting Policies” in our consolidated financial                statements), a net loss on sale of assets of $0.2 million and a $1.0                million charge for the termination of a management contract associated                with the acquisition of hospice operations. Income from discontinued                operations of $12.4 million was comprised of: (i) a $6.8 million                gain from                the sale of our home health operations in the fourth quarter of 2006,                (ii)                a net $6.0 million reduction of reserves for self-insurance for general                and professional liability and workers’ compensation for prior years on                divested facilities, (iii) a $4.2 million non-cash gain primarily                related                to the sale in July 2003 of our pharmaceutical services operations                to                Omnicare, Inc., and (iv) a $1.3 million gain on the sale of one of                our                inpatient facilities in fourth quarter of 2006, offset in part by                (v) a                $3.6 million non-cash charge for closed facilities with a continuing                rent                obligation, (vi) a net $1.3 million loss from divested operations                from                inpatient services and home health services, (vii) a $0.2 million                loss                related to the discontinued clinical laboratory and radiology operations,                and (viii) a $0.8 million net tax provision for discontinued                operations. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (3)    | Results                for the year ended December 31, 2005 include revenues and expenses                for                Peak for the month of December 2005 (See "Note 7 - Acquisitions"                in our                consolidated financial statements), a $1.1 million non-cash charge                for                transaction costs related to the Peak acquisition, a net loss on                sale of                assets of $0.4 million primarily due to a write-down of a property                held                for sale, a net loss on extinguishment of debt of $0.4 million related                to                mortgage restructurings. Income from discontinued operations was                $26.7                million due primarily to net reductions of $14.6 million in self-insurance                reserves for general and professional liability and workers' compensation                for prior years on divested facilities and an $8.9 million gain from                disposal of discontinued operations primarily due to receipt in September                2005 of $7.7 million in cash proceeds from the 2003 sale of our                pharmaceutical services operations, pursuant to the terms of the                sale                agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (4)    | Results                for the year ended December 31, 2004 include a non-cash charge of                $1.0                million representing an impairment to our carrying values of other                long-lived assets (See "Note 8 - Impairment of Intangible and Long-Lived                Assets" in our consolidated financial statements), a $2.0 million                charge                related to restructuring, a net loss on sale of assets of $1.5 million                mainly due to the write-down of a property held for sale, and a net                gain                on extinguishment of debt of $3.4 million related to mortgage                restructurings, a loss of $15.0 million from discontinued operations                and a                loss of $5.3 million from disposal of discontinued operations due                primarily to the sale of our clinical laboratory and radiology operations                located in California and a reserve recorded in connection with the                sale                of a previously divested segment (See "Note 9 - Discontinued Operations                and Assets and Liabilities Held for Sale" in our consolidated financial                statements).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (5)    | Results                for the year ended December 31, 2003 include a non-cash charge of                $2.8                million representing an impairment to our carrying values of lease                intangibles and other long-lived assets (See "Note 8 - Impairment                of                Intangible and Long-Lived Assets" in our consolidated financial                statements), a $14.7 million charge related to restructuring, a net                gain                on sale of assets of $4.2 million mainly due to the sale of land                and                buildings, a loss of $14.4 million from discontinued operations and                a gain                of $55.6 million from disposal of discontinued operations due primarily                to                the sale of our pharmaceutical and software development operations,                termination of 126 facility lease agreements, sale of one other facility                and the reductions of the carrying amount of the assets associated                with                the above described facilities, which facilities and assets were                determined not to be integral to our core business operations (See                "Note 9                - Discontinued Operations and Assets                and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

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**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

|   |  Liabilities              Held for Sale" in our consolidated financial statements).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (6)    | Results                for the ten month period ended December 31, 2002 include a non-cash                charge                of $272.3 million representing an impairment to our carrying values                of                goodwill and other long-lived assets for continuing operations (See                "Note                8 - Intangible and Long-Lived Assets" in our consolidated financial                statements), a net gain on sale of assets of $8.7 million due to                the                termination of ten facility lease agreements and the reduction of                the                carrying amount of the assets associated with the above described                facilities, which facilities and assets were determined not to be                integral                to our core business operations and a loss of $136.1 million from                discontinued operations, of which $135.5 million relates to the impairment                to our carrying values of goodwill and other long-lived assets for                discontinued operations. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (7)    | Results                for the two month period ended February 28, 2002 include a $1.5 billion                non-cash gain on extinguishment of debt, a $1.5 million gain for                reorganization items due to our chapter 11 filings, a net non-cash                loss on                discontinued operations of $7.6 million due to the anticipated termination                of ten facility lease agreements and the reduction of the carrying                amount                of the assets associated with the above described facilities, which                facilities and assets were determined not to be integral to our core                business operations.                                                                                                                                                                                                                                                                                                                                                                                                                   |

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

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

**Overview**

| -      | inpatient                services, primarily skilled nursing facilities; |
|--------|--------------------------------------------------------------------------|
|   |                                                                     |
| -      | rehabilitation                therapy services; and                      |
|   |                                                                     |
| -      | medical                staffing services.                                |

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**Revenues      from Medicare, Medicaid and Other Sources**

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

|                                 |   | **For                the Year Ended**     |      |
|--------------------------------------|--------|-------------------------------------------|-----------|
|                                 |   | **December                31, 2006**      |      |  **December                31, 2005** |   |  **December                31, 2004** |   |
|                                 |   | **(dollars                in thousands)** |      |
| *Consolidated:*                      |   |                                      |      |    |   |    |   |    |   |    |   |    |   |
| Sources                of Revenues   |   |                                      |      |    |   |    |   |    |   |    |   |    |   |
| Medicaid                             |   | $                                         | 403,882   |   |   | 38.6 | % | $ | 289,503 |   |   | 37.8 | % | $ | 270,369 |   |   | 38.6 | % |
| Medicare                             |   |                                      | 279,693   |   |   | 26.7 |   |   | 196,571 |   |   | 25.7 |   |   | 170,163 |   |   | 24.3 |   |
| Private                pay and other |   |                                      | 362,062   |   |   | 34.7 |   |   | 279,708 |   |   | 36.5 |   |   | 260,331 |   |   | 37.1 |   |
| Total                                |   | $                                         | 1,045,637 |   |   | 100.0 | % | $ | 765,782 |   |   | 100.0 | % | $ | 700,863 |   |   | 100.0 | % |

|                                 |   | **For                the Year Ended**     |    |
|--------------------------------------|--------|-------------------------------------------|---------|
|                                 |   | **December                31, 2006**      |    |  **December                31, 2005** |   |  **December                31, 2004** |   |
|                                 |   | **(dollars                in thousands)** |    |
| *Inpatient                Only:*     |   |                                      |    |    |   |    |   |    |   |    |   |    |   |
| Sources                of Revenues   |   |                                      |    |    |   |    |   |    |   |    |   |    |   |
| Medicaid                             |   | $                                         | 403,770 |   |   | 45.9 | % | $ | 289,390 |   |   | 47.1 | % | $ | 270,369 |   |   | 47.7 | % |
| Medicare                             |   |                                      | 273,790 |   |   | 31.1 |   |   | 189,842 |   |   | 30.9 |   |   | 170,066 |   |   | 30.0 |   |
| Private                pay and other |   |                                      | 201,552 |   |   | 23.0 |   |   | 135,681 |   |   | 22.0 |   |   | 126,225 |   |   | 22.3 |   |
| Total                                |   | $                                         | 879,112 |   |   | 100.0 | % | $ | 614,913 |   |   | 100.0 | % | $ | 566,660 |   |   | 100.0 | % |

**Medicare**

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**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

|     |   | **For                the Year Ended** |     |
|----------|--------|---------------------------------------|----------|
|     |   | **December                31,**       |     |
|     |   | **2006**                              |     | **2005** |   | **2004** |   |
| SNF      |   | $                                     | 344.45   |   | $ | 326.28 |   | $ | 314.83 |   |
| Hospital |   | $                                     | 1,171.44 |   | $ | 1,063.24 |   | $ | 1,045.03 |   |

***Skilled      nursing facilities***

| -      | The                Centers for Medicaid and Medicare Services (CMS) issued a 3.1% market                basket increase for both the 2006 Federal fiscal year beginning                October 1, 2005, and the 2007 Federal fiscal year beginning October                1, 2006. Geographic location and a two year phase-in of a change                in the                wage index applied, created an effective increase of 2.6% for Federal                fiscal 2006 and 2.5% for Federal fiscal year 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| -      | Effective                January 1, 2006, Medicare RUG refinement and related legislation                replaced two temporary add-on payments with an 8.5% increase to nursing                weights and increased the number of RUG categories from 44 to 53.                The nine                new RUG categories provide for increased reimbursement for treating                patients who require both rehabilitation and extensive services.                As a                result, our Medicare revenues increased for residents that qualified                for                the new RUG categories. As a result of patients shifting into the                nine new                RUG categories during the year ended December 31, 2006, our average                Medicare rate increased $9.85 per patient day compared to the rate                in                effect during the year ended December 31,                2005. |

***Rehabilitation      therapy***

| -      | Effective                January 1, 2006, the "therapy caps," which limit the amount of                Medicare Part B reimbursement we receive for providing rehabilitation                therapy, were implemented. However, the Deficit Reduction Act of                2005,                required that CMS create an                exception process for claims for services on or after January 1,                2006.                Residents of long-term care facilities qualify for an automatic exception.                Congress extended this exception through December 31, 2007. To date,                the                therapy cap regulations have not had a measurable impact on our                earnings.                                                                                                                                                                                                 |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| -      | The                refinements to the RUG III system that became effective on January                1,                2006 resulted in some patients defaulting to a category that has a                lower level of rehabilitation than was provided but has a higher                rate.                This anomaly was created by the 8.5% add-on made to the relative                nursing                weights. Contractually, we billed customers based upon the rehabilitation                RUG category into which patients were classified. As patients defaulted                into the lower rehabilitation category, in certain circumstances,                the rate                we charged defaulted to a rate that was lower than the delivered                services.                Pricing has been renegotiated to ensure that we are reimbursed for                the                services delivered. |

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**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

**Medicaid**

|     |   | **For                the Year Ended** |   |
|----------|--------|---------------------------------------|--------|
|     |   | **December                31,**       |   |
|     |   | **2006**                              |   | **2005** |   | **2004** |   |
| SNF      |   | $                                     | 142.95 |   | $ | 139.87 |   | $ | 133.34 |   |
| Hospital |   | $                                     | 916.85 |   | $ | 839.07 |   | $ | 820.31 |   |

**Private      payors**

**Other      reimbursement matters**

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**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**Results      of Operations**

|                                           |   | **2006** |      |  **2005** |   |  **2004** |   |
|------------------------------------------------|--------|----------|-----------|----------------|--------|----------------|--------|
| Inpatient                Services              |   | $        | 879,112   |           |   | 84.1           | %      | $ | 614,913 |   |   | 80.3 | % | $ | 566,060 |   |   | 80.8 | % |
| Rehabilitation                Therapy Services |   |     | 119,286   |           |   | 11.4           | %      |   | 116,626 |   |   | 15.2 | % |   | 112,753 |   |   | 16.1 | % |
| Medical                Staffing Services       |   |     | 86,864    |           |   | 8.3            | %      |   | 71,147 |   |   | 9.3 | % |   | 56,816 |   |   | 8.1 | % |
| Corporate                                      |   |     | 36        |           |   | 0.0            | %      |   | 661 |   |   | 0.1 | % |   | (35 | ) |   | 0.0 | % |
| Intersegment                eliminations       |   |     | (39,661   | )              |   | (3.8           | )%     |   | (37,565 | ) |   | (4.9 | )% |   | (34,731 | ) |   | (5.0 | )% |
|   Total                net revenues  |   | $        | 1,045,637 |           |   | 100.0          | %      | $ | 765,782 |   |   | 100.0 | % | $ | 700,863 |   |   | 100.0 | % |

|                                                |   | **2006** |   |  **2005** |   |  **2004** |   |
|-----------------------------------------------------|--------|----------|--------|----------------|--------|----------------|--------|
| Inpatient                Services                   |   | $        | -      |           | $      | -              |   | $ | (600 | ) |
| Rehabilitation                Therapy Services      |   |     | 38,663 |           |   | 36,952         |   |   | 33,310 |   |
| Medical                Staffing Services            |   |     | 998    |           |   | 613            |   |   | 2,103 |   |
| Corporate                and Other                  |   |     | -      |           |   | -              |   |   | (82 | ) |
|   Total                affiliated revenue |   | $        | 39,661 |           | $      | 37,565         |   | $ | 34,731 |   |

|                                                                 |   | **2006** |    |  **2005** |   |  **2004** |   |
|----------------------------------------------------------------------|--------|----------|---------|----------------|--------|----------------|--------|
| Inpatient                Services                                    |   | $        | 63,454  |           | $      | 41,355         |   | $ | 44,177 |   |
| Rehabilitation                Therapy Services                       |   |     | 3,038   |           |   | 4,185          |   |   | 6,286 |   |
| Medical                Staffing Services                             |   |     | 6,981   |           |   | 4,907          |   |   | 3,205 |   |
|    Net                segment income before Corporate |   |     | 73,473  |           |   | 50,447         |   |   | 53,668 |   |
| Corporate                                                            |   |     | (56,907 | )              |   | (52,342        | )      |   | (48,484 | ) |
|    Net                segment income (loss)           |   | $        | 16,566  |           | $      | (1,895         | )      | $ | 5,184 |   |

**Year      Ended December 31, 2006 Compared to Year Ended December 31,      2005**

|   |                                                                          |
|--------|-------------------------------------------------------------------------------|
| -      | $264.2                million of revenue in our Inpatient Services segment;   |
| -      | $15.8                million of revenue in our Medical Staffing segment; and  |
| -      | $2.7                million of revenue in our Rehabilitation Therapy segment. |

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**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

| -      | $15.4                million of income from continuing operations before income taxes,                which                included the following unusual adjustments primarily to Inpatient                Services: |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | -                                                                                                                                                                                                                     | a                net $11.7 million reduction of self-insurance reserves for general                and                professional liability and workers’ compensation insurance related to                incidents in prior periods; |
|   |                                                                                                                                                                                                                  | *offset                by* |
|   | -                                                                                                                                                                                                                     | a                net $2.8 million in adjustments due to the finalization during the                year of                the accounting for the acquisition of Peak, which consisted of: (i)                $2.8                million in additional reserves for pre-acquisition accounts receivable,                (ii) $0.8 million in additional reserves for the collection of management                fees related to managed properties acquired in the Peak acquisition,                offset in part by (iii) a $0.8 million credit to workers’ compensation                expense as a result of the finalization of the insurance reserves; |
|   | -                                                                                                                                                                                                                     | a                $2.5 million non-cash charge to account for certain lease rate escalation                clauses (see “Note 3 - Significant Accounting Policies” in our                consolidated financial statements); and |
|   | -                                                                                                                                                                                                                     | a                $1.0 million charge for the termination of a management contract                in the                third quarter associated with the acquisition of hospice operations; |
|   |                                                                                                                                                                                                                  |
| -      | $12.4                million of income from discontinued operations, comprised of:                                                                                                                                    |
|   | -                                                                                                                                                                                                                     | a                $6.8 million gain from the sale of our home health operations in                fourth                quarter of 2006 (see “Note 9 - Discontinued Operations and Assets and                Liabilities Held for Sale” in our consolidated financial                statements); |
|   | -                                                                                                                                                                                                                     | a                net $6.0 million reduction of reserves for the year, for general                and                professional liability and workers’ compensation insurance, related to                incidents in prior periods; and |
|   | -                                                                                                                                                                                                                     | a                $4.2 million non-cash gain primarily related to the sale in July                2003 of                our pharmaceutical services operations to Omnicare, Inc.;                and |
|   | -                                                                                                                                                                                                                     | a                $1.3 million gain on the sale of one of our Inpatient facilities                in fourth                quarter of 2006; |
|   |                                                                                                                                                                                                                  | *offset                by* |
|   | -                                                                                                                                                                                                                     | a                $3.6 million non-cash charge for previously closed facilities with                a                continuing rent obligation; |
|   | -                                                                                                                                                                                                                     | a                net $1.3 million in losses from operations comprised of (i) $1.6                million                from Inpatient Services, primarily related to the facilities divested                in                2006, (ii) $1.2 million from a small rehabilitation/special education                services operation held for sale, offset in part by (iii) $1.5 million                in                income from our home health operations sold in fourth quarter of                2006; |
|   | -                                                                                                                                                                                                                     | a                $0.8 million net tax provision for discontinued operations;                and |
|   | -                                                                                                                                                                                                                     | a                $0.3 million loss related to the clinical laboratory and radiology                operations located in California that were sold in 2004; |
|   |                                                                                                                                                                                                                  |   |
|   | *offset                by*                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                  |   |
| -      | a                $0.7 million net tax provision for continuing                operations.                                                                                                                             |

| -      | $26.7                million of income from discontinued operations, comprised primarily                of: |
|--------|-------------------------------------------------------------------------------------------------------------|
|   | -                                                                                                           | income                of $15.5 million associated with divested inpatient services operations,                which primarily consisted of a net $14.6 million favorable adjustment                for                general and professional liability and workers’ compensation                insurance;* * |
|   | -                                                                                                           | a                gain of $7.6 million primarily related to receipt of $7.7 million                for the                deferred purchase price holdback related to the sale in July 2003                of our                pharmaceutical services operations to Omnicare, Inc.; |
|   | -                                                                                                           | income                of $3.1 million related to a small rehabilitation/special education                services business held for sale at the end of 2006; and |
|   | -                                                                                                           | $2.5                million of income from our home health operations, which were sold                in                fourth quarter of 2006 (see “Note 9 - Discontinued Operations and Assets                and Liabilities Held for Sale” in                our |

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**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

|   |                                                                                                                                                                                                        | consolidated                financial statements);                                                                                                                                                                                                                                                                                                                                        |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                        | *offset                by*                                                                                                                                                                                                                                                                                                                                                                |
|   | -                                                                                                                                                                                                           | a                $1.0 million loss related to the sale of our clinical laboratory                and                radiology operations in California sold in 2004 and our mobile radiology                operations sold in 2005;                                                                                                                                                      |
|   | -                                                                                                                                                                                                           | losses                of $1.0 million, of which $0.8 million related to our remaining laboratory                and radiology business held for sale at the end of 2006 and $0.2                million                related to the closure of our comprehensive outpatient rehabilitation                facilities in Colorado, which occurred at the end of 2004;                and |
|   |                                                                                                                                                                                                        |
| -      | a                $0.8 million net tax benefit from continuing operations;                                                                                                                                   |
|   |                                                                                                                                                                                                        |
|   | *offset                by*                                                                                                                                                                                  |
|   |                                                                                                                                                                                                        |
| -      | $2.8                million of loss from continuing operations before income taxes, which                included the following unusual adjustments related primarily to Inpatient                Services: |
|   | -                                                                                                                                                                                                           | $1.1                million of transaction costs related to the Peak acquisition as a                result                of conforming Peak’s methodologies for inventory and accounts receivable                management to ours;                                                                                                                                              |
|   | -                                                                                                                                                                                                           | a                $0.4 million loss on extinguishment of debt associated with debt                refinancing; and                                                                                                                                                                                                                                                                         |
|   | -                                                                                                                                                                                                           | a                $0.4 million loss on sale of assets related primarily to write-downs                for                land and buildings;                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                        | *offset                by*                                                                                                                                                                                                                                                                                                                                                                |
|   | -                                                                                                                                                                                                           | a                net $6.8 million reduction of reserves for general and professional                liability and workers’ compensation insurance related to incidents in                prior periods.                                                                                                                                                                             |

***Segment      information***

*Inpatient      Services.*

| -      | an                increase of $10.3 million in Medicaid revenues due primarily to improved                rates of 3.7%;                                                                                                                        |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                            |
| -      | an                increase of $7.3 million in Medicare revenues driven by a 4.2% increase                in                Medicare Part A rates;                                                                                               |
|   |                                                                                                                                                                                                                                            |
| -      | an                additional increase of $6.1 million                in Medicare revenues due to an improvement in Medicare patient mix                of                53 basis                points to 14.5% from 14.0% of total; |
|   |                                                                                                                                                                                                                                            |
| -      | a                $5.8 million increase in commercial insurance revenues;                and                                                                                                                                                     |
|   |                                                                                                                                                                                                                                            |
| -      | a                $1.3 million increase in management fee revenue;                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                            |
|   | *offset                by*                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                            |
| -      | a                $3.2 million decrease in Medicaid revenue caused by lower customer                base                due to the improvement in Medicare mix; and                                                                              |
|   |                                                                                                                                                                                                                                            |
| -      | a                $1.6 million decrease in Medicare part B                revenue.                                                                                                                                                               |

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**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

| -      | wage                increases and related benefits and taxes of $8.1 million to remain                competitive in local markets;                                                                                             |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| -      | an                increase of $0.8 million in overtime expenses; and                                                                                                                                                            |
|   |                                                                                                                                                                                                                            |
| -      | a                $0.6 million increase in bonus expense;                                                                                                                                                                        |
|   |                                                                                                                                                                                                                            |
|   | *offset                by*                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                            |
| -      | a                $2.1 million decrease in health insurance costs relative to the prior                period due to improved claims experience that occurred in 2005 but                did not                reoccur in 2006. |

| -      | a                $3.0 million decrease related to workers’ compensation costs primarily                related to incidents in prior periods; and                             |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                |
| -      | a                $2.0 million decrease related to general and professional liability                insurance costs primarily related to incidents in prior                periods. |

| -      | a                $4.7 million increase in therapy, pharmacy and medical                supplies expense attributable to the increase in Medicare patient mix                and to a decrease in rebates and discounts, net of savings resulting                from                more favorable pricing and payment terms with significant vendors                ($0.1                million of the savings was attributable to a new agreement, effective                as                of October 1, 2006, with our institutional pharmacy vendor that resulted                in favorable pharmacy pricing; we expect that the resulting savings                during                2007 from this agreement will approximate $3.3 million); |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| -      | a                $1.1 million increase in taxes primarily due to higher provider,                real                estate and personal property taxes;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| -      | a                $1.2 million increase in contract nursing labor;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| -      | a                $1.1 million increase in utility expense; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| -      | a                $1.2 million increase in legal                fees.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

*“Consolidation      of Variable Interest Entities”*

*Rehabilitation      Therapy Services*

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

*Medical      Staffing Services.*

| -      | $9.6                million resulting from the acquisition of ProCare in August 2005                and two                small acquisitions earlier in the year; and                                                                  |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                    |
| -      | $8.0                million attributable to an increase of approximately 56,000 billable                hours, an average 5.1% bill rate increase and an increase in the                school                business of $1.1 million; |
|   |                                                                                                                                                                                                                                    |
|   | *offset                by*                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                    |
| -      | $1.9                million due to offices permanently closed in 2006 due mainly to Hurricane                Katrina.                                                                                                                   |

----

**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

*Corporate.*

***Interest      expense***

**Year      Ended December 31, 2005 Compared to Year Ended December 31,      2004**

|   |                                                                         |
|--------|------------------------------------------------------------------------------|
| -      | $48.9                million of revenue in our Inpatient Services segment;   |
| -      | $14.3                million of revenue in our Medical Staffing segment; and |
| -      | $3.9                million in our Rehabilitation Therapy segment revenue.   |

| -      | $26.7                million of income from discontinued operations, comprised primarily                of: |
|--------|-------------------------------------------------------------------------------------------------------------|
|   | -                                                                                                           | income                of $15.5 million associated with divested inpatient services operations,                which primarily consisted of a net $14.6 million pre-tax favorable                adjustment for general and professional liability and workers’                compensation insurance;* * |
|   | -                                                                                                           | a                gain of $7.6 million primarily related to receipt of $7.7 million                for the                deferred purchase price holdback related to the sale in July 2003                of our                pharmaceutical services operations to Omnicare, Inc.; |
|   | -                                                                                                           | income                of $3.1 million related to a small rehabilitation/special education                services business held for sale at the end of 2006; and |
|   | -                                                                                                           | $2.5                million of income from our Home Health operations, which were sold                in                fourth quarter of 2006 (see “Note 9 - Discontinued Operations and Assets                and Liabilities Held for Sale” in our consolidated financials                statements); |
|   |                                                                                                        | *offset                by* |
|   | -                                                                                                           | a                $1.0 million loss related to the sale of our clinical laboratory                and                radiology operations in California sold in 2004 and our mobile radiology                operations sold in 2005; and |
|   | -                                                                                                           | losses                of $1.0 million, of which $0.8 million related to our remaining laboratory                and radiology operations held for sale at the end of 2006 and $0.2                million                related to the closure of our comprehensive outpatient rehabilitation                facilities in Colorado, which occurred at the end of 2004;                and |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

| -      | a                $0.8 million net tax benefit from continuing operations;                                                                                                                                            |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                 |
|   | *offset                by*                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                 |
| -      | $2.8                million of losses from continuing operations before income taxes,                which                included the following unusual adjustments primarily to Inpatient                Services: |
|   | -                                                                                                                                                                                                                    | $1.1                million of transaction costs related to the Peak acquisition as a                result                of conforming Peak’s methodologies for inventory and accounts receivable                management to ours; |
|   | -                                                                                                                                                                                                                    | a                $0.4 million loss on extinguishment of debt associated with debt                refinancing; and |
|   | -                                                                                                                                                                                                                    | a                $0.4 million loss on sale of assets related primarily to write-downs                for                land and buildings; |
|   |                                                                                                                                                                                                                 | *offset                by* |
|   | -                                                                                                                                                                                                                    | a                net $6.8 million reduction of reserves for general and professional                liability and workers’ compensation insurance related to incidents in                prior periods; and |
|   | -                                                                                                                                                                                                                    | $0.3                million of revenue related to prior periods for retroactive rate                increases. |

| -      | $20.3                million of losses from discontinued operations, comprised primarily                of:                                                           |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | -                                                                                                                                                                     | $17.6                million of losses associated with the California clinical laboratory                and                radiology operations that were sold in 2004 that included a revenue                adjustment of $3.3 million related to a prior year and a provision                for                loss adjustment of $3.4 million; |
|   | -                                                                                                                                                                     | losses                of $5.0 million associated with divested inpatient services operations,                including a net $3.3 million charge for general and professional                liability                and workers’ compensation reserves related to prior periods;* * |
|   | -                                                                                                                                                                     | $4.3                million of residual costs associated with the sale of our pharmacy                operations, which occurred in 2003; |
|   | -                                                                                                                                                                     | a                $1.1 million loss from operations from our mobile radiology operations                sold in 2005; and |
|   | -                                                                                                                                                                     | a                $0.7 million loss on the closure of our comprehensive outpatient                rehabilitation facilities in Colorado in 2004; |
|   |                                                                                                                                                                  | *offset                by* |
|   | -                                                                                                                                                                     | income                of $4.0 million related to a small rehabilitation/special education                services business held for sale at the end of 2006; |
|   | -                                                                                                                                                                     | $3.5                million of income from our home health operations, which were sold                in                fourth quarter of 2006 (see “Note 9 - Discontinued Operations and Assets                and Liabilities Held for Sale” in our consolidated financial                statements); |
|   | -                                                                                                                                                                     | a                $0.5 million gain related to a holdback received in 2004 for the                sale of                our software development assets in 2003; and |
|   | -                                                                                                                                                                     | income                of $0.4 million related to our remaining laboratory and radiology                business                held for sale at the end of 2006; |
|   |                                                                                                                                                                  |
|   | *offset                by*                                                                                                                                            |
|   |                                                                                                                                                                  |
| -      | a                $1.2 million net tax benefit from continuing operations;                and                                                                          |
|   |                                                                                                                                                                  |
| -      | $0.5                million of income from continuing operations before income taxes,                which                included the following unusual adjustments: |
|   | -                                                                                                                                                                     | a                net $16.5 million reduction of reserves for general and professional                liability and workers’ compensation insurance related to incidents in                prior periods; and |
|   | -                                                                                                                                                                     | a                net $3.4 million gain on extinguishment of debt due to mortgage                restructurings; |
|   |                                                                                                                                                                  | *offset                by* |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

|   | - | $2.0                million of restructuring costs associated with professional fees                and                one-time terminations;                                                    |
|--------|---|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | - | a                $1.5 million loss on the sale of assets associated primarily with                the                write-down of land and a building held for sale in 2004;                and |
|   | - | a                $1.0 million loss on asset                impairment.                                                                                                                           |

***Segment      information***

*Inpatient      Services.*

| -      | an                increase of $9.3 million in Medicare revenues due to an improvement                in                Medicare patient mix of 80 basis points to 13.8% from 13.0% of total                occupancy;     |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                      |
| -      | an                increase of $4.5 million in Medicare revenues driven by 2.7% higher                Medicare rates; and                                                                                                  |
|   |                                                                                                                                                                                                                      |
| -      | an                increase of $14.6 million in Medicaid revenues due primarily to improved                rates, including $5.5 million resulting from a California Medicaid                rate                increase. |

| -      | increases                in wages and related benefits of $10.1 million to remain competitive                in                local markets, in addition to increased hours due to increased Medicare                customer base; |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                 |
| -      | an                increase of $1.9 million in salaries and benefits at two hospitals                in                California to meet or exceed new staffing requirements, and                                                    |
|   |                                                                                                                                                                                                                                 |
| -      | a                $1.7 million increase in health insurance                costs.                                                                                                                                                     |

| -      | a                $4.8 million increase in 2005 over the prior year as a result of                a                significant reduction of liabilities due to an improvement in settlement                trends for prior periods that was recorded in 2004; |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                          |
|   | *offset                by*                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                          |
| -      | a                $1.7 million decrease related to workers' compensation costs primarily                related to the reduction in the number of claims related to prior                years.                                                                |

| - | a                $3.8 million increase in therapy, pharmacy and medical supplies expense                attributable to the increase |
|---|--------------------------------------------------------------------------------------------------------------------------------------|

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

|   | in Medicare              patient              mix;                        |
|--------|---------------------------------------------------------------------------|
|   |                                                                      |
| -      | a                net change in gain on extinguishment of $3.8 million;    |
|   |                                                                      |
| -      | a                $2.0 million increase in provider taxes; and             |
| -      | a                $0.9 million increase in utility                expense. |

*Rehabilitation      Therapy Services*

----

**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

*Medical      Staffing Services.*

| -      | $6.1                million resulting from the acquisition of ProCare in August 2005                and two                small acquisitions earlier in the year; |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                               |
| -      | $4.6                million attributable to an increase of 196,000 billable hours;                and                                                              |
|   |                                                                                                                                                               |
| -      | $3.7                million due to an average 5.6% bill rate per hour                increase.                                                                     |

*Corporate.*

| -      | $1.3 million                of accounts payable vendor settlement refunds related to the 2004                restructuring efforts that did not reoccur in 2005;                                                                                                  |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                   |
| -      | $0.9                million of bank service charges of which $0.4 million of the increase                related to a recovery of fees in 2004 as a result of the refinance                of our                credit facility in 2004 that did not reoccur in 2005; |
|   |                                                                                                                                                                                                                                                                   |
| -      | $0.7                million of travel and meeting                expenses;                                                                                                                                                                                             |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

|        | $0.5                million of professional and consultant fees recorded in 2005 related                to                various improvement initiatives; and |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                           |
| -      | $0.5 million                of gain on an asset held for sale in 2004 that did not reoccur in                2005;                                        |

*offset      by*

| - | a                $0.6 million decrease in staff salaries and                benefits. |
|---|---------------------------------------------------------------------------------------|

***Interest      expense***

**Liquidity      and Capital Resources**

***Cash      flows***

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

***Revolving      Loan Agreement***

***Acquisitions***

*Harborside*

----

**SUN      HEALTHCARE GROUP, INC. AND      SUBSIDIARIES**

*Peak*

*Other      Acquisitions*

***Assets      held for sale***

***Debt***

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

***Capital      expenditures***

**Obligations      and Commitments **

|                                           |   | **Payments                Due by Period** |    |
|------------------------------------------------|--------|-------------------------------------------|---------|
|                                           |   |                                      |    |   |   |   |   |   |   |   |   |   |   | **After** |   |
|                                           |   | **Total**                                 |    | **2007** |   | **2008** |   | **2009** |   | **2010** |   | **2011** |   | **2011** |   |
| *Contractual                Obligations:*      |   |                                      |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Debt,                including interest        |   |                                      |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| payments(1)(2)                                 |   | $                                         | 263,390 |   | $ | 36,025 |   | $ | 34,879 |   | $ | 22,732 |   | $ | 20,182 |   | $ | 21,644 |   | $ | 127,928 |   |
| Capital                leases (3)              |   |                                      | 1,395   |   |   | 613 |   |   | 604 |   |   | 178 |   |   | - |   |   | - |   |   | - |   |
| Construction                commitments        |   |                                      | 6,047   |   |   | 6,047 |   |   | - |   |   | - |   |   | - |   |   | - |   |   | - |   |
| Purchase                obligations            |   |                                      | 215,706 |   |   | 67,601 |   |   | 52,460 |   |   | 47,646 |   |   | 47,999 |   |   | - |   |   | - |   |
| Operating                leases                |   |                                      | 431,675 |   |   | 65,937 |   |   | 61,795 |   |   | 61,224 |   |   | 58,894 |   |   | 53,543 |   |   | 130,282 |   |
| Other                long-term liabilities (4) |   |                                      | 9,343   |   |   | 2,036 |   |   | 2,036 |   |   | 2,036 |   |   | 3,235 |   |   | - |   |   | - |   |
|                                           |   |                                      |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                          |   | $                                         | 927,556 |   | $ | 178,259 |   |   | 151,774 |   |   | 133,816 |   |   | 130,310 |   | $ | 75,187 |   | $ | 258,210 |   |

|                                           |   | **Amount                of Commitment Expiration Per Period** |   |
|------------------------------------------------|--------|---------------------------------------------------------------|--------|
|                                           |   | **Total**                                                     |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                           |   | **Amounts**                                                   |   |   |   |   |   |   |   |   |   |   |   | **After** |   |
|                                           |   | **Committed**                                                 |   | **2007** |   | **2008** |   | **2009** |   | **2010** |   | **2011** |   | **2011** |   |
| *Other                Commercial Commitments:* |   |                                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Letters                of credit               |   | $                                                             | 14,971 |   | $ | 14,247 |   | $ | 724 |   | $ | - |   | $ | - |   | $ | - |   | $ | - |   |
|                                           |   |                                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                          |   | $                                                             | 14,971 |   | $ | 14,247 |   | $ | 724 |   | $ | - |   | $ | - |   | $ | - |   | $ | - |   |

| (1) | Debt                includes principal payments and interest payments through the maturity                dates. Total interest on debt, based on contractual rates, is $90.4                million, of which $7.2 million is attributable to variable interest                rates                determined using the weighted average method. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Includes                $50.1 million of debt related to Clipper, of which $30.3 million                is                interest. (See "Note 10 - Variable Interest Entities" in our consolidated                financial statements.)                                                                                                          |
| (3) | Includes                principal payments and interest of $0.2 million.                                                                                                                                                                                                                                                                           |
| (4) | We                entered into an agreement that granted us options, exercisable                sequentially over a period of seven years, pursuant to which we can                acquire up to 100 percent of the ownership of nine entities for an                aggregate remaining amount of $9.7 million, of which                $0.4      |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

|   | million                  is recorded in other accrued liabilities in our consolidated balance                  sheet. The agreement also provides the owners of those entities                  the right                  to require us to purchase those ownership interests at the above                  described                  times and option prices. (See "Note 10 - Variable Interest Entities"                  in                  our consolidated financial                  statements.) |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**Critical      Accounting Estimates**

*     Net      revenues. *

*     Accounts      receivable and related allowance. *

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

*     Insurance.       *

*Impairment      of assets.*

*      Goodwill and Other Intangible Assets*

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

*Accounting      for the Impairment or Disposal of Long-Lived Assets*

**Recent      Accounting Pronouncements**

*The      Fair Value Option for Financial Assets and Financial      Liabilities*

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

*Accounting      for Uncertainty in Income Taxes, an interpretation of FASB Statement No.      109”*

**Item      7A.  Quantitative and Qualitative Disclosures About Market      Risk**

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

|                               |   |                                       |   |      |   |                             |   |                       |   |      |   |            |   |       |   |  **Fair                Value** |   | **Fair                Value** |   |
|------------------------------------|--------|--------------------------------------------|--------|----------------|--------|---------------------------------------|--------|---------------------------------|--------|----------------|--------|----------------------|--------|-----------------|--------|-------------------------------------|--------|-------------------------------|--------|
|                               |   | **Expected                Maturity Dates** |   |      |   |  **December                31,** |   | **December                31,** |   |
|                               |   | **2007**                                   |   |  **2008** |   |  **2009**                        |   |  **2010**                  |   |  **2011** |   |  **Thereafter** |   |  **Total** |   |  **2006**                      |   | **2005(1)(2)**                |   |
|                               |   | **(Dollars                in thousands)**  |   |
| Fixed                rate debt (3) |   | $                                          | 7,978  |           | $      | 24,139                                |   | $                               | 3,768  |           | $      | 11,811               |   | $               | 3,725  |                                | $      | 85,022                        |   | $ | 136,443 |   | $ | 126,728 |   | $ | 147,783 |   |
|    Rate             |   |                                       | 5.8    | %              |   | 7.8                                   | %      |                            | 8.5    | %              |   | 8.5                  | %      |            | 8.5    | %                                   |   | 7.2                           | %      |   |   |   |   |   |   |   |   |   |
| Variable                rate debt  |   | $                                          | 16,350 |           | $      | 657                                   |   | $                               | 9,619  |           | $      | 185                  |   | $               | 10,911 |                                | $      | -                             |   | $ | 37,722 |   | $ | 34,714 |   | $ | 35,185 |   |
|    Rate             |   |                                       | 9.6    | %              |   | 6.9                                   | %      |                            | 8.1    | %              |   | 8.0                  | %      |            | 8.0    | %                                   |   | -                             | %      |   |   |   |   |   |   |   |   |   |

| (1)    | Total                debt increased by $95.7 million in connection with the Peak                acquisition.                                                                                                                                                                                                                                 |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                         |
| (2)    | The                fair value of fixed and variable rate debt was determined based on                the                current rates offered for debt with similar risks and                maturities.                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                         |
| (3)    | Fixed                rate long-term debt includes $50.1 million related to the consolidation                of                Clipper as of December 31, 2006 and $50.2 million as of December                31, 2005.                (See "Note 10 - Variable Interest Entities" in our consolidated financial                statements.) |

**Item      8.  Financial Statements and Supplementary Data**

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

**Item      9A.  Controls and Procedures**

**Management's      Report on Disclosure Controls and Procedures**

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**Management's        Report on Internal Control over Financial Reporting**

*Internal*
*Control      - Integrated Framework.*
*“*
*“An      Audit of Internal Control Over Financial Reporting Performed in Conjunction      with      an Audit of Financial Statements.*

**Changes      to Internal Control over Financial Reporting**

**Item      9B.  Other Information**

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**PART      III**

**Item      10.  Directors, Executive Officers and Corporate      Governance**

**Item      11.  Executive Compensation**

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

**Item      13.  Certain Relationships and Related Transactions and Director      Independence**

**Item      14.  Principal Accounting Fees and Services**

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**PART      IV**

**Item      15.  Exhibits, Financial Statements and      Schedules**

| (a)    | (1)      | The                following consolidated financial statements of Sun Healthcare Group,                Inc.                and subsidiaries are filed as part of this report under Item 8 -                Financial                Statements and Supplementary Data: |
|--------|----------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |     |
|   |     | Reports                of Ernst & Young LLP, Independent Registered Public Accounting                Firm                                                                                                                                                          |
|   |     |                                                                                                                                                                                                                                                                   |
|   |     | Consolidated                Balance Sheets as of December 31, 2006 and 2005                                                                                                                                                                                            |
|   |     |                                                                                                                                                                                                                                                                   |
|   |     | Consolidated                Statements of Operations for the years ended December 31, 2006, 2005                and                2004                                                                                                                                |
|   |     |                                                                                                                                                                                                                                                                   |
|   |     | Consolidated                Statements of Stockholders' Equity (Deficit) for the years                ended December 31, 2006, 2005 and 2004                                                                                                                           |
|   |     |                                                                                                                                                                                                                                                                   |
|   |     | Consolidated                Statements of Cash Flows for the years                ended December 31, 2006, 2005 and 2004                                                                                                                                               |
|   |     |                                                                                                                                                                                                                                                                   |
|   |     | Notes                to Consolidated Financial Statements                                                                                                                                                                                                              |
|   |     |                                                                                                                                                                                                                                                                   |
|   | (2)      | Financial                schedules required to be filed by Item 8 of this form, and by Item                15(a)(2) below:                                                                                                                                             |
|   |     |                                                                                                                                                                                                                                                                   |
|   |     | Schedule                II Valuation and Qualifying Accounts for the years ended December                31,                2006, 2005 and 2004                                                                                                                        |
|   |     |                                                                                                                                                                                                                                                                   |
|   |     | All                other financial schedules are not required under the related instructions                or are inapplicable and therefore have been omitted.                                                                                                       |
|   |     |                                                                                                                                                                                                                                                                   |
| (b)    | Exhibits |

| **Exhibit** |   |                                                                                                                                                                                                          |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  |   | **Description                of Exhibits**                                                                                                                                                                    |
|        |   |                                                                                                                                                                                                          |
| 2.1(22)     |   | Agreement                and Plan of Merger dated October 19, 2006 by and among Sun Healthcare                Group, Inc., Horizon Merger, Inc. and Harborside Healthcare                Corporation.         |
|        |   |                                                                                                                                                                                                          |
| 3.1(1)      |   | Amended                and Restated Certificate of Incorporation of Sun Healthcare Group,                Inc.                                                                                                 |
|        |   |                                                                                                                                                                                                          |
| 3.2(1)      |   | Amended                and Restated Bylaws of Sun Healthcare Group, Inc.                                                                                                                                      |
|        |   |                                                                                                                                                                                                          |
| 4.1(1)      |   | Sample                Common Stock Certificate of Sun Healthcare Group, Inc.                                                                                                                                  |
|        |   |                                                                                                                                                                                                          |
| 4.2(3)      |   | Form                of Warrant issued by Sun Healthcare Group, Inc. in February 2004                to each                of the purchasers named on the list of purchasers attached                thereto  |
|        |   |                                                                                                                                                                                                          |
| 4.3(3)      |   | Form                of Registration Rights Agreement dated February 2004 between Sun                Healthcare Group, Inc. and the purchasers named on the list of purchasers                attached thereto |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

| 4.4(18)         |   | Registration                Rights Agreement dated as of May 16, 2005, by and among Sun Healthcare                Group, Inc., the stockholders of Peak Medical Corporation named therein                and James A. Parsons, as Stockholders Agent                                                                                                   |
|-----------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 4.4.1(19)       |   | Amendment                No. 1, dated as of July 7, 2005, to the Registration Rights Agreement,                dated as of May 16, 2005, by and among Sun Healthcare Group, Inc.,                the                stockholders of Peak Medical Corporation named therein and James                A.                Parsons, as Stockholders Agent   |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 4.4.2(27)  |   | Agreement,                dated as of January 17, 2007, by and between Sun Healthcare Group,                Inc.,                DFW Capital Partners, L.P., Steelhead Investments Ltd. and, for purposes                of Sections 3 and 4 of the Agreement only, RFE Investment Partners                V, L.P                and RFE VI SBIC, L.P. |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 4.5             |   | The                Registrant has instruments that define the rights of holders of long-term                debt that are not being filed herewith, in reliance upon Item 601(b)(iii)                of Regulation S-K. The Registrant agrees to furnish to the SEC, upon                request, copies of these instruments                          |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.1(14)        |   | Amended                and Restated Loan and Security Agreement dated December 2, 2005 among                Sun                Healthcare Group, Inc. and certain of its subsidiaries as Borrowers,                Capital Source Finance, LLC, as Collateral Agent and certain other                lending                institutions               |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.1.1(15)      |   | Joinder                and First Amendment to Amended and Restated Loan and Security Agreement                dated December 9, 2005 among Sun Healthcare Group, Inc. and certain                of its                subsidiaries as Borrowers and CapitalSource Finance, LLC as Collateral                Agent                                     |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.1.2(21)      |   | Second                Amendment to Amended and Restated Loan and Security Agreement dated                February 24, 2006 among Sun Healthcare Group, Inc. and certain of                its                subsidiaries as Borrowers and CapitalSource Finance, LLC as Collateral                Agent                                               |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.2(4)+        |   | Amended                and Restated 2002 Non-Employee Director Equity Incentive Plan of                Sun                Healthcare Group, Inc.                                                                                                                                                                                                       |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.3(13)+       |   | 2004                Equity Incentive Plan of Sun Healthcare Group, Inc.                                                                                                                                                                                                                                                                                |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.4(16)+       |   | Peak                Medical Corporation 1998 Stock Incentive Plan                                                                                                                                                                                                                                                                                      |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.5(25)+       |   | Employment                Agreement dated as of October 12, 2006 by and between Sun Healthcare                Group, Inc. and Richard Matros.                                                                                                                                                                                                          |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.6(17)+       |   | Employment                Agreement with L. Bryan Shaul dated as of February 14,                2005                                                                                                                                                                                                                                                   |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.6.1(25)+     |   | Amendment                No. 1 to Employment Agreement dated as of October 12, 2006 by and                between                Sun Healthcare Group, Inc. and L. Bryan Shaul.                                                                                                                                                                        |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.7(4)+        |   | Employment                Agreement with William A. Mathies dated February 28,                2002                                                                                                                                                                                                                                                     |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.7.1(25)+     |   | Amendment                No. 1 to Employment Agreement dated as of October 12, 2006 by and                between                Sun Health Specialty Services, Inc. and William A.                Mathies.                                                                                                                                            |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.8(20)+       |   | Employment                Agreement with Michael Newman dated March 22, 2005                                                                                                                                                                                                                                                                           |
|            |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.8.1(25)+     |   | Amendment                No. 1 to Employment Agreement dated as of October 12, 2006 by                and                                                                                                                                                                                                                                              |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

|             |   | between                Sun Healthcare Group, Inc. and Michael Newman.                                                                                                                                                                                                                                                                                                                                            |
|-------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.9(25)+   |   | Employment                Agreement dated as of October 12, 2006 by and between Sun Healthcare                Group, Inc. and Heidi J. Fisher.                                                                                                                                                                                                                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.10(25)+  |   | Employment                Agreement dated as of October 12, 2006 by and between Sun Healthcare                Group, Inc. and Chauncey J. Hunker.                                                                                                                                                                                                                                                                |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.11(11)+  |   | Severance                Agreement with Richard L. Peranton dated as of November 1,                2004                                                                                                                                                                                                                                                                                                          |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.12*+     |   | Form                of Stock Option Agreement                                                                                                                                                                                                                                                                                                                                                                    |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.13*+     |   | Form                of Stock Unit Agreement                                                                                                                                                                                                                                                                                                                                                                      |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.14(22)   |   | Financing                Commitment Letter dated October 19, 2006 by and among Sun Healthcare                Group, Inc., Credit Suisse Securities (USA) LLC, Credit Suisse, Cayman                Islands Branch, CIBC World Markets Corp., and CIBC Inc.                                                                                                                                                       |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.15(9)    |   | Amended                and Restated Master Lease Agreement among Sun Healthcare Group, Inc.                and                certain of its subsidiaries (as Lessees) and Omega Healthcare Investors,                Inc. and certain of its affiliates (as Lessors) dated March 1,                2004                                                                                                         |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.15.1(26) |   | First                Amendment to Amended and Restated Master Lease Agreement, Amended                and                Restated Security Agreement and Amended and Restated                Guaranty                                                                                                                                                                                                            |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.15.2(26) |   | Second                Amendment to Amended and Restated Master Lease Agreement, Amended                and                Restated Security Agreement and Amended and Restated                Guaranty                                                                                                                                                                                                           |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.15.3(26) |   | Third                Amendment to Amended and Restated Master Lease Agreement, Amended                and                Restated Security Agreement and Amended and Restated                Guaranty                                                                                                                                                                                                            |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.15.3(24) |   | Fourth                Amendment to the Amended and Restated Master Lease Agreement, Amended                and                Restated Security Agreement, Amended and Restated Letter of Credit                Agreement and Amended and Restated Guaranty dated as of March 27,                2006 by                and among Sun Healthcare Group, Inc. and Omega Healthcare Investors,                Inc. |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.16(18)   |   | Stockholders                Agreement dated as of May 16, 2005, by and among Sun Healthcare Group,                Inc., the stockholders of Peak Medical Corporation named therein                and James                A. Parsons, as Stockholders Agent                                                                                                                                                     |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.16.1(19) |   | Amendment                No. 1, dated as of July 7, 2005, to the Stockholders Agreement, dated                as                of May 16, 2005, by and among Sun Healthcare Group, Inc., the stockholders                of Peak Medical Corporation named therein and James A. Parsons, as                Stockholders Agent                                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.16.2(19) |   | Amendment                No. 2, dated as of September 16, 2005, to the Stockholders Agreement,                dated as of May 16, 2005, by and among Sun Healthcare Group, Inc.,                the                stockholders of Peak Medical Corporation named therein and James                A.                Parsons, as Stockholders Agent                                                              |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 14.1(10)    |   | Code                of Ethics for Chief Executive Officer, Financial Officers and Financial                Personnel                                                                                                                                                                                                                                                                                             |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 21.1*       |   | Subsidiaries                of Sun Healthcare Group, Inc.                                                                                                                                                                                                                                                                                                                                                        |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

| 23.1*  |   | Consent                of Ernst & Young LLP                                                                                                                                     |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                |
| 31.1*  |   | Section                302 Sarbanes-Oxley Certifications by Principal Executive Officer                and                Principal Financial and Accounting Officer                |
|   |   |                                                                                                                                                                                |
| 32.1*  |   | Section                906 Sarbanes-Oxley Certifications by Principal Executive Officer                and                Principal Financial and Accounting                Officer |

| (1)    | Incorporated                by reference from exhibits to our Form 8-A filed on March 6,                2002                                           |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    | Incorporated                by reference from exhibits to our Form 10-K filed on March 29,                2002                                         |
| (3)    | Incorporated                by reference from exhibits to our Form 8-K filed on February 20,                2004                                       |
| (4)    | Incorporated                by reference from exhibits to our Form 10-Q filed on August 16,                2002                                        |
| (5)    | Incorporated                by reference from exhibits to our Form 10-Q filed on August 14,                2003                                        |
| (6)    | Incorporated                by reference from exhibits to our Form 8-K dated February 28, 2002,                as                amended on Form 8-K/A |
| (7)    | Incorporated                by reference from exhibits to our Form 10-K filed on March 28,                2003                                         |
| (8)    | Incorporated                by reference from exhibits to our Form 10-Q filed on May 14,                2003                                           |
| (9)    | Incorporated                by reference from exhibits to our Form 10-K filed on March 5,                2004                                          |
| (10)   | Incorporated                by reference from exhibits to our Form 10-Q filed on May 7,                2004                                            |
| (11)   | Incorporated                by reference from exhibits to our Form 8-K filed on November 18,                2004                                       |
| (12)   | Incorporated                by reference from exhibits to our Form 8-K filed on December 9,                2004                                        |
| (13)   | Incorporated                by reference from Appendix B to our Proxy Statement filed on April                8,                2004                   |
| (14)   | Incorporated                by reference from exhibits to our Form 8-K filed on December 7,                2005                                        |
| (15)   | Incorporated                by reference from exhibits to our Form 8-K filed on December 15,                2005                                       |
| (16)   | Incorporated                by reference from exhibits to our Form S-8 filed on January 9,                2006                                         |
| (17)   | Incorporated                by reference from exhibits to our Form 10-K filed on March 3,                2005                                          |
| (18)   | Incorporated                by reference from exhibits to our Form 8-K filed on May 19,                2005                                            |
| (19)   | Incorporated                by reference from exhibits to our Form 10-Q filed on November 1,                2005                                       |
| (20)   | Incorporated                by reference from exhibits to our Form 8-K filed on November 30,                2005                                       |
| (21)   | Incorporated                by reference from exhibits to our Form 8-K filed on March 2,                2006                                           |
| (22)   | Incorporated                by reference from exhibits to our Form 8-K filed on October 25,                2006.                                       |
| (23)   | Incorporated                by reference from exhibits to our Form 8-K filed on March 2,                2006.                                          |
| (24)   | Incorporated                by reference from exhibits to our Form 8-K filed on March 31,                2006.                                         |
| (25)   | Incorporated                by reference from exhibits to our Form 8-K filed on October 16,                2006.                                       |
| (26)   | Incorporated                by reference from exhibits to our Form 10-K filed on March 10,                2006.                                        |
| (27)   | Incorporated                by reference from exhibits to our Form 8-K filed on January 18,                2007.                                       |
|   |                                                                                                                                                   |

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**SIGNATURES**

|   | SUN                HEALTHCARE GROUP, INC.                                                                                                                                                                                                              |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                   |
|   | By:    /s/                Richard K.                Matros                             |
|   |        Richard                K. Matros                                                                                                                                                                             |
|   |        Chairman                of the Board and Chief                                                                                                                                                               |
|   |          Executive                Officer                                                                                                                                                                 |

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

| **Signatures**                                                                                                                                                                                                                                                     |   | **Title**                                                           |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------|
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   | Chairman                of the Board and Chief Executive Officer    |
|   /s/                Richard K.                Matros                                                             |   | (Principal                Executive Officer)                        |
|    Richard                K. Matros                                                                                                                                                                                                                 |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   | Executive                Vice President and Chief Financial         |
|   /s/                L. Bryan                Shaul                                  |   | Officer                (Principal Financial and Accounting Officer) |
|    L.                Bryan Shaul                                                                                                                                                                                                                    |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|   /s/                Gregory S.                Anderson                                                                                    |   | Director                                                            |
|    Gregory                S. Anderson                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|   /s/                Tony M.                Astorga                                                     |   | Director                                                            |
|    Tony                M. Astorga                                                                                                                                                                                                                   |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|   /s/                Christian K.                Bement                                                                               |   | Director                                                            |
|    Christian                K. Bement                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|   /s/                Michael J.                Foster                                                        |   | Director                                                            |
|    Michael                J. Foster                                                                                                                                                                                                                 |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|   /s/                Barbara B.                Kennelly                                                                               |   | Director                                                            |
|    Barbara                B. Kennelly                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|   /s/                Steven M.                Looney                                                                   |   | Director                                                            |
|    Steven                M. Looney                                                                                                                                                                                                                  |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|   /s/                Milton J.                Walters                                                        |   | Director                                                            |
|    Milton                J. Walters                                                                                                                                                                                                                 |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |
|                                                                                                                                                                                                                                                               |   |                                                                |

----

**SUN      HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**Index      to Consolidated Financial Statements**

**December      31, 2006**

|                                                                                                          | **Page**                    |
|---------------------------------------------------------------------------------------------------------------|-----------------------------|
|                                                                                                          |                        |
| Reports                of Ernst & Young LLP, Independent Registered Public Accounting                Firm | F-2                to F-4   |
|                                                                                                          |                        |
| Consolidated                Balance Sheets                                                                    |                        |
|      As                of December 31, 2006 and 2005                                 | F-5                to F-6   |
|                                                                                                          |                        |
| Consolidated                Statements of Operations                                                          |                        |
|      For                the years ended December 31, 2006, 2005 and 2004             | F-7                         |
|                                                                                                          |                        |
| Consolidated                Statements of Stockholders' Equity (Deficit)                                      |                        |
|      For                the years ended December 31, 2006, 2005 and 2004             | F-8                         |
|                                                                                                          |                        |
| Consolidated                Statements of Cash Flows                                                          |                        |
|      For                the years ended December 31, 2006, 2005 and 2004             | F-9                         |
|                                                                                                          |                        |
| Notes                to Consolidated Financial Statements                                                     | F-10                to F-42 |
|                                                                                                          |                        |
| Supplementary                Data (Unaudited) - Quarterly Financial Data                                      | 1-3                         |

----

**Report        of Ernst & Young LLP, Independent Registered Public Accounting        Firm**

----

**Report        of Ernst & Young LLP, Independent Registered Public Accounting        Firm**

----

----

**SUN      HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED      BALANCE SHEETS**

**ASSETS**

**(in      thousands)**

|                                                                                                             |   | **December                31, 2006** |    |  **December                31, 2005** |   |
|------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|--------------------------------------------|--------|
|                                                                                                             |   |                                 |    |                                       |   |   |   |
| Current                assets:                                                                                   |   |                                 |    |                                       |   |   |   |
|   Cash                and cash equivalents                                                             |   | $                                    | 131,935 |                                       | $      | 16,641 |   |
|   Restricted                cash                                                                       |   |                                 | 32,752  |                                       |   | 25,142 |   |
|   Accounts                receivable, net of allowance for doubtful accounts of                $24,866 |   |                                 |    |                                       |   |   |   |
|    and                $29,384 at December 31, 2006 and 2005, respectively                    |   |                                 | 117,091 |                                       |   | 123,639 |   |
|   Other                receivables, net of allowance of $3,064 and $2,909 at December 31,              |   |                                 |    |                                       |   |   |   |
|    2006                and 2005, respectively                                                     |   |                                 | 2,211   |                                       |   | 2,429 |   |
|   Inventories,                net                                                                      |   |                                 | 4,808   |                                       |   | 5,055 |   |
|   Prepaid                expenses                                                                      |   |                                 | 3,305   |                                       |   | 6,414 |   |
|   Assets                held for sale                                                                  |   |                                 | 7,172   |                                       |   | 1,897 |   |
|                                                                                                             |   |                                 |    |                                       |   |   |   |
| Total                current assets                                                                              |   |                                 | 299,274 |                                       |   | 181,217 |   |
|                                                                                                             |   |                                 |    |                                       |   |   |   |
| Property                and equipment, net of accumulated depreciation and                amortization           |   |                                 |    |                                       |   |   |   |
|   of                $48,233 and $75,999 at December 31, 2006 and 2005,                respectively     |   |                                 | 217,544 |                                       |   | 187,734 |   |
| Intangible                assets, net of accumulated amortization of $6,799 and $8,262                           |   |                                 |    |                                       |   |   |   |
|   December                31, 2006 and 2005, respectively                                              |   |                                 | 13,691  |                                       |   | 19,335 |   |
| Goodwill                                                                                                         |   |                                 | 55,092  |                                       |   | 81,265 |   |
| Restricted                cash, non-current                                                                      |   |                                 | 29,083  |                                       |   | 35,517 |   |
| Other                assets, net                                                                                 |   |                                 | 6,739   |                                       |   | 7,238 |   |
| Total                assets                                                                                      |   | $                                    | 621,423 |                                       | $      | 512,306 |   |

----

**SUN      HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED      BALANCE SHEETS (Continued)**

**LIABILITIES      AND STOCKHOLDERS' EQUITY (DEFICIT)**

**(in      thousands, except share data)**

|                                                                                                           |   | **December                31, 2006** |     |  **December                31, 2005** |   |
|----------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|----------|--------------------------------------------|--------|
| Current                liabilities:                                                                            |   |                                 |     |                                       |   |   |   |
|   Accounts                payable                                                                    |   | $                                    | 43,400   |                                       | $      | 45,115 |   |
|   Accrued                compensation and benefits                                                   |   |                                 | 42,723   |                                       |   | 42,393 |   |
|   Accrued                self-insurance obligations, current                                         |   |                                 | 48,689   |                                       |   | 37,238 |   |
|   Income                taxes payable                                                                |   |                                 | 8,799    |                                       |   | 10,493 |   |
|   Liabilities                held for sale                                                           |   |                                 | 1,672    |                                       |   | - |   |
|   Other                accrued liabilities                                                           |   |                                 | 33,736   |                                       |   | 41,908 |   |
|   Current                portion of long-term debt:                                                  |   |                                 |     |                                       |   |   |   |
|     Company                obligations                                                     |   |                                 | 22,780   |                                       |   | 21,237 |   |
|     Clipper                partnerships                                                    |   |                                 | 736      |                                       |   | 34,415 |   |
|   Capital                leases, current                                                             |   |                                 | 494      |                                       |   | 11,204 |   |
|                                                                                                           |   |                                 |     |                                       |   |   |   |
| Total                current liabilities                                                                       |   |                                 | 203,029  |                                       |   | 244,003 |   |
|                                                                                                           |   |                                 |     |                                       |   |   |   |
| Accrued                self-insurance obligations, net of current                                              |   |                                 | 81,559   |                                       |   | 109,953 |   |
| Long-term                debt, net of current:                                                                 |   |                                 |     |                                       |   |   |   |
|   Company                obligations                                                                 |   |                                 | 100,067  |                                       |   | 115,094 |   |
|   Clipper                partnerships                                                                |   |                                 | 49,392   |                                       |   | 15,829 |   |
| Capital                leases, net of current                                                                  |   |                                 | 696      |                                       |   | - |   |
| Unfavorable                lease obligations, net of accumulated amortization of                               |   |                                 |     |                                       |   |   |   |
|   $13,558                and $11,166 at December 31, 2006 and 2005, respectively                     |   |                                 | 13,423   |                                       |   | 11,454 |   |
| Other                long-term liabilities                                                                     |   |                                 | 29,124   |                                       |   | 18,868 |   |
|                                                                                                           |   |                                 |     |                                       |   |   |   |
| Total                liabilities                                                                               |   |                                 | 477,290  |                                       |   | 515,201 |   |
|                                                                                                           |   |                                 |     |                                       |   |   |   |
| Commitments                and contingencies                                                                   |   |                                 |     |                                       |   |   |   |
|                                                                                                           |   |                                 |     |                                       |   |   |   |
| Stockholders'                equity (deficit):                                                                 |   |                                 |     |                                       |   |   |   |
|    Preferred                stock of $.01 par value, authorized                                 |   |                                 |     |                                       |   |   |   |
|      10,000,000                shares, zero shares issued and outstanding as of       |   |                                 |     |                                       |   |   |   |
|      December                31, 2006 and 2005                                        |   |                                 | -        |                                       |   | - |   |
|    Common                stock of $.01 par value, authorized                                    |   |                                 |     |                                       |   |   |   |
|      50,000,000                shares, 42,889,918 shares issued and 42,879,736 shares |   |                                 |     |                                       |   |   |   |
|      outstanding                as of December 31, 2006 and 31,143,728 shares issued  |   |                                 |     |                                       |   |   |   |
|      and                31,133,546 shares outstanding as of December 31, 2005         |   |                                 | 429      |                                       |   | 311 |   |
|   Additional                paid-in capital                                                          |   |                                 | 553,275  |                                       |   | 428,383 |   |
|   Accumulated                deficit                                                                 |   |                                 | (409,480 | )                                          |   | (431,498 | ) |
|                                                                                                           |   |                                 | 144,224  |                                       |   | (2,804 | ) |
|   Less:                                                                                              |   |                                 |     |                                       |   |   |   |
|     Common                stock held in treasury, at cost, 10,182 shares                   |   |                                 |     |                                       |   |   |   |
|       as                of December 31, 2006 and 2005                            |   |                                 | (91      | )                                          |   | (91 | ) |
|   Total                stockholders' equity (deficit)                                                |   |                                 | 144,133  |                                       |   | (2,895 | ) |
|   Total                liabilities and stockholders' equity (deficit)                                |   | $                                    | 621,423  |                                       | $      | 512,306 |   |

----

**SUN      HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED      STATEMENTS OF OPERATIONS**

**(in      thousands, except per share data)**

|                                                                                                               |   | **For                the Year Ended** |      |
|--------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|-----------|
|                                                                                                               |   | **December                31,**       |      |
|                                                                                                               |   | **2006**                              |      |  **2005** |   |  **2004** |   |
|                                                                                                               |   |                                  |      |   |   |   |   |   |   |   |
| Total                net revenues                                                                                  |   | $                                     | 1,045,637 |   | $ | 765,782 |   | $ | 700,863 |   |
| Costs                and expenses:                                                                                 |   |                                  |      |   |   |   |   |   |   |   |
|   Operating                salaries and benefits                                                         |   |                                  | 598,516   |   |   | 461,425 |   |   | 418,626 |   |
|   Self-insurance                for workers' compensation and general                                    |   |                                  |      |   |   |   |   |   |   |   |
|      and                professional liability insurance                                  |   |                                  | 32,694    |   |   | 26,061 |   |   | 20,725 |   |
|   Operating                administrative expenses                                                       |   |                                  | 27,986    |   |   | 23,552 |   |   | 21,433 |   |
|   Other                operating costs                                                                   |   |                                  | 218,789   |   |   | 147,311 |   |   | 136,780 |   |
|   Facility                rent expense                                                                   |   |                                  | 56,734    |   |   | 38,130 |   |   | 36,278 |   |
|   General                and administrative expenses                                                     |   |                                  | 49,856    |   |   | 47,195 |   |   | 44,104 |   |
|   Depreciation                and amortization                                                           |   |                                  | 14,866    |   |   | 8,389 |   |   | 8,192 |   |
|   Provision                for losses on accounts receivable                                             |   |                                  | 11,124    |   |   | 3,369 |   |   | 4,264 |   |
|   Interest,                net                                                                           |   |                                  | 18,506    |   |   | 11,837 |   |   | 8,671 |   |
|   Loss                on asset impairment                                                                |   |                                  | -         |   |   | 361 |   |   | 1,028 |   |
|   Restructuring                costs, net                                                                |   |                                  | -         |   |   | 122 |   |   | 1,972 |   |
|   Loss                on contract or lease termination                                                   |   |                                  | 975       |   |   | - |   |   | 150 |   |
|   Loss                on sale of assets, net                                                             |   |                                  | 172       |   |   | 383 |   |   | 1,494 |   |
|   Loss                (gain) on extinguishment of debt, net                                              |   |                                  | -         |   |   | 408 |   |   | (3,394 | ) |
| Total                costs and expenses                                                                            |   |                                  | 1,030,218 |   |   | 768,543 |   |   | 700,323 |   |
|                                                                                                               |   |                                  |      |   |   |   |   |   |   |   |
| Income                (loss) before income taxes and discontinued operations                                       |   |                                  | 15,419    |   |   | (2,761 | ) |   | 540 |   |
| Income                tax expense (benefit)                                                                        |   |                                  | 731       |   |   | (786 | ) |   | (1,158 | ) |
| Income                (loss) from continuing operations                                                            |   |                                  | 14,688    |   |   | (1,975 | ) |   | 1,698 |   |
|                                                                                                               |   |                                  |      |   |   |   |   |   |   |   |
| Discontinued                operations:                                                                            |   |                                  |      |   |   |   |   |   |   |   |
|    Income                (loss) from discontinued operations                                        |   |                                  | 5,226     |   |   | 17,847 |   |   | (15,005 | ) |
|    Gain                (loss) on disposal of discontinued operations, net of                related |   |                                  |      |   |   |   |   |   |   |   |
|     tax                expense of $785 for the year ended December 31, 2006                    |   |                                  | 7,204     |   |   | 8,889 |   |   | (5,320 | ) |
| Income                (loss) from discontinued operations                                                          |   |                                  | 12,430    |   |   | 26,736 |   |   | (20,325 | ) |
|                                                                                                               |   |                                  |      |   |   |   |   |   |   |   |
| Net                income (loss)                                                                                   |   | $                                     | 27,118    |   | $ | 24,761 |   | $ | (18,627 | ) |
|                                                                                                               |   |                                  |      |   |   |   |   |   |   |   |
| Basic                earnings per common and common equivalent share:                                              |   |                                  |      |   |   |   |   |   |   |   |
|    Income                (loss) from continuing operations                                          |   | $                                     | 0.46      |   | $ | (0.12 | ) | $ | 0.12 |   |
|    Income                (loss) from discontinued operations, net of tax                            |   |                                  | 0.40      |   |   | 1.67 |   |   | (1.41 | ) |
|    Net                income (loss)                                                                 |   | $                                     | 0.86      |   | $ | 1.55 |   | $ | (1.29 | ) |
|                                                                                                               |   |                                  |      |   |   |   |   |   |   |   |
| Diluted                earnings per common and common equivalent share:                                            |   |                                  |      |   |   |   |   |   |   |   |
|    Income                (loss) from continuing operations                                          |   | $                                     | 0.46      |   | $ | (0.12 | ) | $ | 0.12 |   |
|    Income                (loss) from discontinued operations, net of tax                            |   |                                  | 0.39      |   |   | 1.67 |   |   | (1.40 | ) |
|    Net                income (loss)                                                                 |   | $                                     | 0.85      |   | $ | 1.55 |   | $ | (1.28 | ) |
|                                                                                                               |   |                                  |      |   |   |   |   |   |   |   |
| Weighted                average number of common and common equivalent                                             |   |                                  |      |   |   |   |   |   |   |   |
|    shares                outstanding:                                                               |   |                                  |      |   |   |   |   |   |   |   |
|    Basic                                                                                            |   |                                  | 31,638    |   |   | 16,003 |   |   | 14,456 |   |
|    Diluted                                                                                          |   |                                  | 31,788    |   |   | 16,003 |   |   | 14,548 |   |

----

**SUN      HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED      STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)**

**(in      thousands)**

|                                                                                                       |   | **For                the Year Ended** |   | **For                the Year Ended** |   | **For                the Year Ended** |   |
|------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|---------------------------------------|--------|---------------------------------------|--------|
|                                                                                                       |   | **December                31, 2006**  |   | **December                31, 2005**  |   | **December                31, 2004**  |   |
|                                                                                                       |   | **Shares**                            |   |  **Amount**                      |   | **Shares**                            |   |  **Amount** |   | **Shares** |   |  **Amount** |   |
| **Common                stock**                                                                            |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issued                and outstanding at beginning of period                                               | 31,144 |                                  | $      | 311                                   |   |                                  | 15,325 |   | $ | 153 |   |   | 10,044 |   | $ | 100 |   |
| Retirement                of common stock                                                                  |   |                                  | -      |                                  |   | -                                     |   |   | (5 | ) |   |   |   |   | - |   |   | - |   |
| Cancellation                of restricted stock awards                                                     |   |                                  | -      |                                  |   | -                                     |   |   | - |   |   |   |   |   | (4 | ) |   | - |   |
| Issuance                of common stock                                                                    |   |                                  | 11,746 |                                  |   | 118                                   |   |   | 6,900 |   |   | 69 |   |   | 5,285 |   |   | 53 |   |
| Issuance                of common stock in connection with         |   |                                  |   |                                  |   |                                  |   |   |   |   |   |
| **   **Peak** **transaction                                                            |   |                                  | -      |                                  |   | -                                     |   |   | 8,924 |   |   | 89 |   |   | - |   |   | - |   |
| **Common                stock issued and outstanding at**                                                  |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |
| **   end                of period**                                                         |   |                                  | 42,890 |                                  |   | 429                                   |   |   | 31,144 |   |   | 311 |   |   | 15,325 |   |   | 153 |   |
|                                                                                                       |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Additional                paid-in capital**                                                              |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance                at beginning of period                                                              |   |                                  |   |                                  |   | 428,383                               |   |   |   |   |   | 332,726 |   |   |   |   |   | 271,134 |   |
| Issuance                of common stock in excess of par value                                             |   |                                  |   | 2,235                                 |   |                                  |   |   |   | 94,681 |   |   |   |   |   | 61,881 |   |
| Cancellation                of restricted stock awards                                                     |   |                                  |   |                                  |   | -                                     |   |   |   |   |   | (58 | ) |   |   |   |   | (57 | ) |
| Other                                                                                                      |   |                                  |   |                                  |   | 122,657                               |   |   |   |   |   | 1,034 |   |   |   |   |   | (232 | ) |
| **Additional                paid-in capital at end of period**                                             |   |                                  |   |                                  |   | 553,275                               |   |   |   |   |   | 428,383 |   |   |   |   |   | 332,726 |   |
|                                                                                                       |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Accumulated                deficit**                                                                     |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance                at beginning of period                                                              |   |                                  |   |                                  |   | (431,498                              | )      |   |   |   |   | (456,259 | ) |   |   |   |   | (437,632 | ) |
| Cumulative                effect adjustment pursuant                                                       |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   to                adoption of SAB No. 108                                                      |   |                                  |   |                                  |   | (5,100                                | )      |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                income (loss)                                                                           |   |                                  |   |                                  |   | 27,118                                |   |   |   |   |   | 24,761 |   |   |   |   |   | (18,627 | ) |
| **Accumulated                deficit at end of period**                                                    |   |                                  |   | (409,480                              | )      |                                  |   |   |   | (431,498 | ) |   |   |   |   | (456,259 | ) |
|                                                                                                       |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total**                                                                                                  |   |                                  |   |                                  |   | 144,224                               |   |   |   |   |   | (2,804 | ) |   |   |   |   | (123,380 | ) |
|                                                                                                       |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Common                stock in treasury**                                                                |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase                of treasury stock                                                                  |   |                                  | 10     |                                  |   | (91                                   | )      |   | 10 |   |   | (91 | ) |   | - |   |   | - |   |
| **Common                stock in treasury at end of period**                                               | 10     |                                  |   | (91                                   | )      |                                  | 10     |   |   | (91 | ) |   | - |   |   | - |   |
|                                                                                                       |   |                                  |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total                stockholders' equity (deficit)**                                                    |   |                                  |   |                                  | $      | 144,133                               |   |   |   |   | $ | (2,895 | ) |   |   |   | $ | (123,380 | ) |

----

**SUN      HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED      STATEMENTS OF CASH FLOWS**

**(in      thousands)**

|                                                                                                                                               |   | **For                the Year Ended** |    |  **For                the Year Ended** |   |  **For                the Year Ended** |    |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|---------|---------------------------------------------|--------|---------------------------------------------|---------|
|                                                                                                                                               |   | **December                31, 2006**  |    |  **December                31, 2005**  |   |  **December                31, 2004**  |    |
| **Cash                flows from operating activities:**                                                                                           |   |                                  |    |                                        |   |                                        |    |   |   |   |
| Net                income (loss)                                                                                                                   |   | $                                     | 27,118  |                                        | $      | 24,761                                      |    | $ | (18,627 | ) |
| Adjustments                to reconcile net income (loss) to net cash provided by (used for)                                                       |   |                                  |    |                                        |   |
|    operating                activities, including discontinued operations:                                                          |   |                                  |    |                                        |   |                                        |    |   |   |   |
|    Loss                (gain) on extinguishment of debt, net                                                                        |   |                                  | -       |                                        |   | 408                                         |    |   | (3,394 | ) |
|    Loss                on lease termination                                                                                         |   |                                  | -       |                                        |   | -                                           |    |   | 150 |   |
|    Depreciation                                                                                                                     |   |                                  | 9,569   |                                        |   | 4,876                                       |    |   | 5,254 |   |
|    Amortization                                                                                                                     |   |                                  | 6,822   |                                        |   | 5,101                                       |    |   | 4,356 |   |
|    Amortization                of favorable and unfavorable lease intangibles                                                       |   |                                  | (813    | )                                           |   | (1,714                                      | )       |   | (3,265 | ) |
|    Provision                for losses on accounts receivable                                                                       |   |                                  | 12,781  |                                        |   | 5,009                                       |    |   | 11,901 |   |
|    Loss                on sale of assets, net                                                                                       |   |                                  | 172     |                                        |   | 384                                         |    |   | 1,494 |   |
|    (Gain)                loss on disposal of discontinued operations, net                                                           |   |                                  | (7,204  | )                                           |   | (8,889                                      | )       |   | 5,321 |   |
|    Transaction                costs                                                                                                 |   |                                  | -       |                                        |   | 1,100                                       |    |   | - |   |
|    Loss                on asset impairment                                                                                          |   |                                  | -       |                                        |   | 361                                         |    |   | 1,028 |   |
|    Restricted                stock and option compensation expense                                                                  |   |                                  | 2,326   |                                        |   | 1,303                                       |    |   | 1,570 |   |
|    Other,                net                                                                                                        |   |                                  | 69      |                                        |   | 1,010                                       |    |   | 2,045 |   |
| Changes                in operating assets and liabilities, net of acquisitions:                                                                   |   |                                  |    |                                        |   |                                        |    |   |   |   |
|    Accounts                receivable                                                                                               |   |                                  | (17,269 | )                                           |   | (6,530                                      | )       |   | 6,485 |   |
|    Inventories                                                                                                                      |   |                                  | (2      | )                                           |   | 12                                          |    |   | (17 | ) |
|    Other                receivables                                                                                                 |   |                                  | (510    | )                                           |   | (155                                        | )       |   | 558 |   |
|    Restricted                cash                                                                                                   |   |                                  | (1,286  | )                                           |   | 1,231                                       |    |   | 9,006 |   |
|    Prepaid                expenses and other assets                                                                                 |   |                                  | (785    | )                                           |   | 2,698                                       |    |   | (1,658 | ) |
|    Accounts                payable                                                                                                  |   |                                  | (1,148  | )                                           |   | 3,359                                       |    |   | (14,406 | ) |
|    Accrued                compensation and benefits                                                                                 |   |                                  | 1,342   |                                        |   | (588                                        | )       |   | (6,230 | ) |
|    Accrued                self-insurance obligations                                                                                |   |                                  | (16,946 | )                                           |   | (32,552                                     | )       |   | (26,213 | ) |
|    Income                taxes payable                                                                                              |   |                                  | 2,946   |                                        |   | 794                                         |    |   | 1,436 |   |
|    Other                accrued liabilities                                                                                         |   |                                  | (9,096  | )                                           |   | (9,887                                      | )       |   | (4,687 | ) |
|    Other                long-term liabilities                                                                                       |   |                                  | 1,733   |                                        |   | (405                                        | )       |   | 2,151 |   |
|       Net                cash provided by (used for) operating activities before reorganization                costs | 9,819  |                                  |    | (8,313                                      | )      |                                        | (25,742 | ) |
|       Net                cash paid for reorganization costs                                                          |   |                                  | -       |                                        |   | -                                           |    |   | (499 | ) |
|       Net                cash provided by (used for) operating activities                                            |   |                                  | 9,819   |                                        |   | (8,313                                      | )       |   | (26,241 | ) |
|                                                                                                                                               |   |                                  |    |                                        |   |                                        |    |   |   |   |
| **Cash                flows from investing activities:**                                                                                           |   |                                  |    |                                        |   |                                        |    |   |   |   |
|    Capital                expenditures                                                                                              |   |                                  | (22,158 | )                                           |   | (17,416                                     | )       |   | (12,890 | ) |
|    Proceeds                from sale of assets held for sale                                                                        |   |                                  | 22,009  |                                        |   | 10,742                                      |    |   | 1,857 |   |
|    Acquisitions                                                                                                                     |   |                                  | (3,356  | )                                           |   | (17,816                                     | )       |   | (700 | ) |
|    Repayment                of long-term notes receivable                                                                           |   |                                  | -       |                                        |   | 237                                         |    |   | 147 |   |
|    Insurance                proceeds received                                                                                       |   |                                  | 150     |                                        |   | -                                           |    |   | - |   |
|    Net                proceeds from sale leaseback                                                                                  |   |                                  | 838     |                                        |   | -                                           |    |   | - |   |
|       Net                cash used for investing activities                                                          |   |                                  | (2,517  | )                                           |   | (24,253                                     | )       |   | (11,586 | ) |
|                                                                                                                                               |   |                                  |    |                                        |   |                                        |    |   |   |   |
| **Cash                flows from financing activities:**                                                                                           |   |                                  |    |                                        |   |                                        |    |   |   |   |
|    Net                repayments under Revolving Loan Agreement                                                                     |   |                                  | (693    | )                                           |   | (233                                        | )       |   | (12,491 | ) |
|    Long-term                debt borrowings                                                                                         |   |                                  | 45,936  |                                        |   | 11,000                                      |    |   | - |   |
|    Long-term                debt repayments                                                                                         |   |                                  | (58,240 | )                                           |   | (19,495                                     | )       |   | (6,727 | ) |
|    Principal                payments under capital lease obligations                                                                |   |                                  | (1,104  | )                                           |   | -                                           |    |   | - |   |
|    Net                proceeds from issuance of common stock                                                                        |   |                                  | 121,741 |                                        |   | 38,428                                      |    |   | 52,266 |   |
|    Distribution                of partnership equity                                                                                |   |                                  | (147    | )                                           |   | (327                                        | )       |   | (961 | ) |
|    Net                proceeds from the issuance of common stock from the exercise of employee                stock options         | 499    |                                  |    | -                                           |   |                                        | -       |   |
|       Net                cash provided by financing activities                                                       |   |                                  | 107,992 |                                        |   | 29,373                                      |    |   | 32,087 |   |
|                                                                                                                                               |   |                                  |    |                                        |   |                                        |    |   |   |   |
| Net                increase (decrease) in cash and cash equivalents                                                                                |   |                                  | 115,294 |                                        |   | (3,193                                      | )       |   | (5,740 | ) |
| Cash                and cash equivalents at beginning of period                                                                                    |   |                                  | 16,641  |                                        |   | 19,834                                      |    |   | 25,574 |   |
| Cash                and cash equivalents at end of period                                                                                          |   | $                                     | 131,935 |                                        | $      | 16,641                                      |    | $ | 19,834 |   |
| Supplemental                disclosure of cash flow information:                                                                                   |   |                                  |    |                                        |   |                                        |    |   |   |   |
|    Interest                payments                                                                                                 |   | $                                     | 12,316  |                                        | $      | 10,360                                      |    | $ | 9,420 |   |
|    Capitalized                interest                                                                                              |   | $                                     | 202     |                                        | $      | 132                                         |    | $ | 76 |   |
|    Income                taxes refunded, net                                                                                        |   | $                                     | (2,215  | )                                           | $      | (1,580                                      | )       | $ | (2,595 | ) |

**Supplemental      Disclosures:**

**Non-cash      investing and financing activities:**

**See      accompanying notes.**

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**NOTES        TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER        31, 2006**

**(1)  Nature      of Business **

*Business*

*Comparability      of Financial Information*

*Accounting      for the Impairment or Disposal of Long-Lived Assets*

**(2)  **
**Reorganization**

** **

**(3)  Summary      of Significant Accounting Policies **

*  Use      of Estimates*

----

**SUN            HEALTHCARE GROUP, INC. AND            SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

*(b)  Principles      of Consolidation*

*Consolidation      of Variable Interest Entities*

*  Cash      and Cash Equivalents*

*Net      Revenues*

*Accounts      Receivable*

----

**SUN            HEALTHCARE GROUP, INC. AND            SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

*Inventories*

*  Property      and Equipment*

*Intangible      Assets*

*Goodwill      and Other Intangible Assets*

*Stock-Based      Compensation*

*Accounting      for Stock Issued to Employees*
*Accounting      for Stock-*

----

**SUN            HEALTHCARE GROUP, INC. AND            SUBSIDIARIES**

**NOTES              TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER              31, 2006**

*Based      Compensation *
*.      *

*Share-Based      Payment*

*Net      Income (Loss) Per Share*

*Discontinued      Operations and Assets Held for Sale*

*Reclassifications*

*Cumulative      *
*Effect      Adjustment Pursuant to Adoption of SAB No. 108*

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

**(4)  Loan      Agreements**

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

**(5)**
**Long-Term      Debt and Capital Lease Obligations**

|                                                                                                          |   | **December                31, 2006** |    |  **December                31, 2005** |   |
|---------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|--------------------------------------------|--------|
| Revolving                loan agreement                                                                       |   | $                                    | 10,000  |                                       | $      | 10,141 |   |
| Mortgage                notes payable due at various dates through 2037, interest                at           |   |                                 |    |                                       |   |   |   |
|    rates                from 5.5% to 10.8%, collateralized by various facilities(1)(2)(3) |   |                                 | 153,627 |                                       |   | 158,874 |   |
| Capital                leases                (3)                                                              |   |                                 | 1,190   |                                       |   | 11,204 |   |
| Industrial                revenue bonds                                                                       |   |                                 | 4,655   |                                       |   | 6,360 |   |
| Other                long-term debt                                                                           |   |                                 | 4,693   |                                       |   | 11,200 |   |
| Total                long-term obligations(1)                                                                 |   |                                 | 174,165 |                                       |   | 197,779 |   |
|    Less                amounts due within one year                                             |   |                                 | (24,010 | )                                          |   | (66,856 | ) |
| Long-term                obligations, net of current portion                                                  |   | $                                    | 150,155 |                                       | $      | 130,923 |   |

| (1) | Includes                fair value premium of $0.3 million related to the Peak acquisition                (See                "Note 7 - Acquisitions").                                                                                         |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Includes                $50.1 million and $50.2 million related to the consolidation of Clipper                as                of December 31, 2006 and 2005, respectively (See "Note 10 - Variable                Interest Entities”). |
| (3) | Excludes                $0.8 million reclassified to liabilities held for sale (See “Note 9 -                “Discontinued Operations and Assets Held for                Sale”).                                              |

|      2007 |   |   | 24,010  |   |
|------------------------------------|--------|--------|---------|--------|
|      2008 |   |   | 24,796  |   |
|      2009 |   |   | 13,387  |   |
|      2010 |   |   | 11,996  |   |
|      2011 |   |   | 14,635  |   |
| Thereafter                         |   |   | 85,023  |   |
|                               |   | $      | 173,847 |   |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

**(6)  Property            and Equipment**

|                                                               |   | **December                31, 2006** |    |  **December                31, 2005****(1)** |   |
|--------------------------------------------------------------------|--------|--------------------------------------|---------|---------------------------------------------------|--------|
|                                                               |   |                                 |    |                                              |   |   |   |
| Land                                                               |   | $                                    | 26,002  |                                              | $      | 17,979 |   |
| Buildings                and improvements                          |   |                                 | 151,614 |                                              |   | 158,678 |   |
| Equipment                                                          |   |                                 | 45,830  |                                              |   | 51,471 |   |
| Leasehold                improvements                              |   |                                 | 37,251  |                                              |   | 33,158 |   |
| Construction                in process                             |   |                                 | 5,080   |                                              |   | 2,447 |   |
|    Total                                            |   |                                 | 265,777 |                                              |   | 263,733 |   |
| Less                accumulated depreciation                       |   |                                 | (48,233 | )                                                 |   | (75,999 | ) |
|     Property                and equipment, net |   | $                                    | 217,544 |                                              | $      | 187,734 |   |

| (1) | Included                preliminary estimates for the purchase accounting valuation for Peak,                which estimates were refined by a third party valuation during 2006.                See                “Note 7 - Acquisitions.” |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**(7)  Acquisitions      **

*Harborside*

*Peak*

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

| Fair                value of approximately 8.9 million shares of Common Stock                issued |   | $      | 55,538  |   |
|-----------------------------------------------------------------------------------------------------|--------|--------|---------|--------|
| Fair                value of assumed debt obligations                                               |   |   | 95,739  |   |
| Stock                option costs                                                                   |   |   | 320     |   |
| Direct                transaction costs`                                                            |   |   | 12,832  |   |
|                                                                                                |   | $      | 164,429 |   |

| Net                working capital            |   | $      | 8,791   |   |
|-----------------------------------------------|--------|--------|---------|--------|
| Property                and equipment         |   |   | 112,220 |   |
| Identifiable                intangible assets |   |   | 1,246   |   |
| Goodwill                                      |   |   | 46,325  |   |
| Other                long-term assets         |   |   | 4,987   |   |
| Total                assets acquired          |   |   | 173,569 |   |
|                                          |   |   |    |   |
| Debt                                          |   |   | 95,739  |   |
| Other                long-term liabilities    |   |   | 9,140   |   |
| Total                liabilities assumed      |   |   | 104,879 |   |
|                                          |   |   |    |   |
| Net                assets acquired            |   | $      | 68,690  |   |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES              TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER              31, 2006**

*Other      Acquisitions*

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

**(8)  Intangible        and Long-Lived Assets**

*Intangible      Assets*

|                                                             |   | **Gross**    |   |              |   |       |   |
|------------------------------------------------------------------|--------|--------------|--------|------------------------|--------|-----------------|--------|
|                                                             |   | **Carrying** |   |  **Accumulated**  |   |  **Net**   |   |
|                                                             |   | **Amount**   |   |  **Amortization** |   |  **Total** |   |
| ***Finite-lived                Intangibles:***                   |   |         |   |                   |   |            |   |   |   |   |
| Lease                intangibles:                                |   |         |   |                   |   |            |   |   |   |   |
|           2006 |   | $            | 9,714  |                   | $      | 5,226           |   | $ | 4,488 |   |
|           2005 |   |         | 7,940  |                   |   | 4,517           |   |   | 3,423 |   |
| Deferred                financing costs:                         |   |         |   |                   |   |            |   |   |   |   |
|           2006 |   | $            | 4,378  |                   | $      | 1,002           |   | $ | 3,376 |   |
|           2005 |   |         | 6,518  |                   |   | 3,593           |   |   | 2,925 |   |
| Management                and customer contracts                 |   |         |   |                   |   |            |   |   |   |   |
|           2006 |   | $            | 3,334  |                   | $      | 552             |   | $ | 2,782 |   |
|           2005 |   |         | 5,634  |                   |   | 144             |   |   | 5,490 |   |
|                                                             |   |         |   |                   |   |            |   |   |   |   |
| ***Indefinite-lived                Intangibles:***               |   |         |   |                   |   |            |   |   |   |   |
| Trademarks:                                                      |   |         |   |                   |   |            |   |   |   |   |
|           2006 |   | $            | 1,998  |                   | $      | 19              |   | $ | 1,979 |   |
|           2005 |   |         | 5,954  |                   |   | 4               |   |   | 5,950 |   |
| Other                intangible assets:                          |   |         |   |                   |   |            |   |   |   |   |
|           2006 |   | $            | 1,066  |                   | $      | -               |   | $ | 1,066 |   |
|           2005 |   |         | 1,551  |                   |   | 4               |   |   | 1,547 |   |
|                                                             |   |         |   |                   |   |            |   |   |   |   |
| ***Total                intangible assets:***                    |   |         |   |                   |   |            |   |   |   |   |
|           2006 |   | $            | 20,490 |                   | $      | 6,799           |   | $ | 13,691 |   |
|           2005 |   |         | 27,597 |                   |   | 8,262           |   |   | 19,335 |   |
| Unfavorable                lease intangibles:                    |   |         |   |                   |   |            |   |   |   |   |
|           2006 |   | $            | 26,981 |                   | $      | 13,558          |   | $ | 13,423 |   |
|           2005 |   |         | 22,620 |                   |   | 11,166          |   |   | 11,454 |   |

|                                                            |   | **2006** |   |  **2005** |   |  **2004** |   |
|-----------------------------------------------------------------|--------|----------|--------|----------------|--------|----------------|--------|
|                                                            |   |     |   |           |   |           |   |   |   |   |
| Amortization                expense                             |   | $        | 1,117  |           | $      | 622            |   | $ | 1,592 |   |
| Amortization                of unfavorable                      |   |     |   |           |   |           |   |   |   |   |
|   and                favorable lease intangibles, net |   |     | (812   | )              |   | (1,714         | )      |   | (3,265 | ) |
|                                                            |   | $        | 305    |           | $      | (1,092         | )      | $ | (1,673 | ) |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES          TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

|   |   | **Expense** |   |  **Credit** |   |  **Net** |   |
|--------|--------|-------------|--------|------------------|--------|---------------|--------|
|   |   |        |   |             |   |          |   |   |   |   |
| 2007   |   | $           | 2,531  |             | $      | (2,355        | )      | $ | 176 |   |
| 2008   |   |        | 1,895  |             |   | (2,203        | )      |   | (308 | ) |
| 2009   |   |        | 1,511  |             |   | (2,111        | )      |   | (600 | ) |
| 2010   |   |        | 1,382  |             |   | (1,964        | )      |   | (582 | ) |
| 2011   |   |        | 913    |             |   | (1,772        | )      |   | (859 | ) |

*Impairment      of*
*Intangible      Assets*

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

*Impairment      of Long-Lived Assets*

*  *

*Long      Lived Assets to be Disposed Of*

**(9)  Discontinued      Operations and Assets and Liabilities Held for Sale **

*Loss      (Gain) on Sale of Assets, net*

*     2005.  *

*     2004.  *

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

*Discontinued      Operations*

*Inpatient      Services*

*Pharmaceutical      Services*

*Laboratory      and Radiology Services: *

*Home      Health Services*

*Other      Operations*

*  Assets      and Liabilities Held for Sale*

----

**SUN            HEALTHCARE GROUP, INC. AND            SUBSIDIARIES**

**NOTES              TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER              31, 2006**

|                                                                        |   | **For                the Year**      |   |
|-----------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                        |   | **Ended**                            |   |
|                                                                        |   | **December                31, 2006** |   |
|                                                                        |   | **Inpatient**                        |   |  **Pharmaceutical** |   |  **Laboratory/** |   |  **Home** |   |    |   |    |   |
|                                                                        |   | **Services**                         |   |  **Services** |   |  **Radiology** |   |  **Health** |   |  **Other** |   |  **Total** |   |
|                                                                        |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                net                revenues                            |   | $                                    | 17,589 |   | $ | - |   | $ | 15,255 |   | $ | 56,256 |   | $ | 16,587 |   | $ | 105,687 |   |
| Pretax                income                (loss)                          |   | $                                    | 4,889  |   | $ | 7 |   | $ | (28 | ) | $ | 1,526 |   | $ | (1,168 | ) | $ | 5,226 |   |
| (Loss)                gain on disposal of                                   |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|    discontinued                operations                (1) |   |                                 | (3,549 | ) |   | 4,199 |   |   | (211 | ) |   | 6,763 |   |   | 2 |   |   | 7,204 |   |
| Income                (loss) on                discontinued                 |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|    operations                                                |   | $                                    | 1,340  |   | $ | 4,206 |   | $ | (239 | ) | $ | 8,289 |   | $ | (1,166 | ) | $ | 12,430 |   |

|                                                        |   | **For                the Year**      |   |
|-------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                        |   | **Ended**                            |   |
|                                                        |   | **December                31, 2005** |   |
|                                                        |   | **Inpatient**                        |   |  **Pharmaceutical** |   |  **Laboratory/** |   |  **Home** |   |    |   |    |   |
|                                                        |   | **Services**                         |   |  **Services** |   |  **Radiology** |   |  **Health** |   |  **Other** |   |  **Total** |   |
|                                                        |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                net                revenues            |   | $                                    | 23,316 |   | $ | - |   | $ | 16,646 |   | $ | 60,778 |   | $ | 20,663 |   | $ | 121,403 |   |
| Pretax                income                (loss)          |   | $                                    | 14,769 |   | $ | 22 |   | $ | (2,486 | ) | $ | 2,490 |   | $ | 3,052 |   | $ | 17,847 |   |
| Gain                (loss) on disposal of                   |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|    discontinued                operations    |   |                                 | 725    |   |   | 7,614 |   |   | 674 |   |   | - |   |   | (124 | ) |   | 8,889 |   |
| Income                (loss)                on discontinued |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|    operations                                |   | $                                    | 15,494 |   | $ | 7,636 |   | $ | (1,812 | ) | $ | 2,490 |   | $ | 2,928 |   | $ | 26,736 |   |

|                                                           |   | **For                the Year**      |   |
|----------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                           |   | **Ended**                            |   |
|                                                           |   | **December                31, 2004** |   |
|                                                           |   | **Inpatient**                        |   |  **Pharmaceutical** |   |  **Laboratory/** |   |  **Home** |   |    |   |    |   |
|                                                           |   | **Services**                         |   |  **Services** |   |  **Radiology** |   |  **Health** |   |  **Other** |   |  **Total** |   |
|                                                           |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                net                revenues               |   | $                                    | 34,438 |   | $ | - |   | $ | 31,941 |   | $ | 56,702 |   | $ | 22,351 |   | $ | 145,432 |   |
| Pretax                (loss) income                            |   | $                                    | (9,989 | ) | $ | 696 |   | $ | (12,781 | ) | $ | 3,502 |   | $ | 3,567 |   | $ | (15,005 | ) |
| Gain                (loss) on disposal of                      |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|    discontinued                operations  |   |                                 | 4,968  |   |   | (5,008 | ) |   | (5,550 | ) |   | - |   |   | 270 |   |   | (5,320 | ) |
| (Loss)                income on discontinued                   |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|    operations                                   |   | $                                    | (5,021 | ) | $ | (4,312 | ) | $ | (18,331 | ) | $ | 3,502 |   | $ | 3,837 |   | $ | (20,325 | ) |

| (1) | Net                of related tax expense of $785 |
|-----|---------------------------------------------------|

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

**(10)  Variable        Interest Entities**

*Consolidation      of Variable Interest Entities*

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

|                                                                                           |   | **December                31, 2006** |   |  **December                31, 2005** |   |
|------------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|--------------------------------------------|--------|
|                                                                                           |   |                                 |   |                                       |   |   |   |
| Current                assets:                                                                 |   |                                 |   |                                       |   |   |   |
|   Cash                and cash equivalents                                           |   | $                                    | 546    |                                       | $      | 708 |   |
|   Other                receivables                                                   |   |                                 | 565    |                                       |   | 250 |   |
|   Restricted                cash, current                                            |   |                                 | 767    |                                       |   | 1,021 |   |
|   Prepaids                and other assets                                           |   |                                 | 126    |                                       |   | 131 |   |
|       Total                current assets                        |   |                                 | 2,004  |                                       |   | 2,110 |   |
|                                                                                           |   |                                 |   |                                       |   |   |   |
| Property                and equipment, net:                                                    |   |                                 |   |                                       |   |   |   |
|   Land                                                                               |   |                                 | 6,171  |                                       |   | 6,171 |   |
|   Land                improvements                                                   |   |                                 | 34     |                                       |   | 38 |   |
|   Buildings                                                                          |   |                                 | 35,034 |                                       |   | 36,335 |   |
|   Building                improvements                                               |   |                                 | 2,830  |                                       |   | 2,223 |   |
|   Equipment                                                                          |   |                                 | 185    |                                       |   | 89 |   |
|   Construction-in-process                                                            |   |                                 | -      |                                       |   | 165 |   |
|       Total                property and equipment, net           |   |                                 | 44,254 |                                       |   | 45,021 |   |
|                                                                                           |   |                                 |   |                                       |   |   |   |
| Intangible                assets, net                                                          |   |                                 | 9,122  |                                       |   | 9,982 |   |
| Intercompany                                                                                   |   |                                 | 4,836  |                                       |   | 5,240 |   |
|                                                                                           |   |                                 |   |                                       |   |   |   |
|       Total                assets                                |   | $                                    | 60,216 |                                       | $      | 62,353 |   |
| Current                liabilities:                                                            |   |                                 |   |                                       |   |   |   |
|   Mortgages,                current                                                  |   | $                                    | 736    |                                       | $      | 34,415 |   |
|   Other                accrued liabilities                                           |   |                                 | 597    |                                       |   | 551 |   |
|       Total                current liabilities                   |   |                                 | 1,333  |                                       |   | 34,966 |   |
|                                                                                           |   |                                 |   |                                       |   |   |   |
| Mortgages,                net of current                                                       |   |                                 | 49,392 |                                       |   | 15,829 |   |
| Other                long-term liabilities                                                     |   |                                 | 16,464 |                                       |   | 16,421 |   |
|       Total                long-term liabilities                 |   |                                 | 65,856 |                                       |   | 32,250 |   |
|                                                                                           |   |                                 |   |                                       |   |   |   |
|       Total                liabilities                           |   |                                 | 67,189 |                                       |   | 67,216 |   |
|                                                                                           |   |                                 |   |                                       |   |   |   |
| Stockholders'                deficit:                                                          |   |                                 |   |                                       |   |   |   |
|   Accumulated                deficit                                                 |   |                                 | (6,973 | )                                          |   | (4,863 | ) |
|                                                                                           |   |                                 |   |                                       |   |   |   |
|       Total                liabilities and stockholders' deficit |   | $                                    | 60,216 |                                       | $      | 62,353 |   |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

**(11)  Commitments        and Contingencies**

*Lease      Commitments*

|                                                                   |   | **Operating** |    |
|------------------------------------------------------------------------|--------|---------------|---------|
|                                                                   |   | **Leases**    |    |
|                                                                   |   |          |    |   |
|           2007       |   | $             | 65,937  |   |
|           2008       |   |          | 61,795  |   |
|           2009       |   |          | 61,224  |   |
|           2010       |   |          | 58,894  |   |
|           2011       |   |          | 53,543  |   |
|           Thereafter |   |          | 130,282 |   |
| Total                minimum lease payments                            |   | $             | 431,675 |   |

*Purchase      Commitments*

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

*Insurance        *

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

|                                                     |   | **For                the Year Ended** |   |
|----------------------------------------------------------|--------|---------------------------------------|--------|
|                                                     |   | **December                31,**       |   |
|                                                     |   | **2006**                              |   |  **2005** |   |  **2004** |   |
|                                                     |   |                                  |   |   |   |   |   |   |   |   |
| **Professional                Liability:**               |   |                                  |   |   |   |   |   |   |   |   |
|    Continuing                operations   |   | $                                     | 25,858 |   | $ | 19,490 |   | $ | 20,736 |   |
|    Discontinued                operations |   |                                  | 1,041  |   |   | 1,463 |   |   | 3,016 |   |
|                                                     |   | $                                     | 26,899 |   | $ | 20,953 |   | $ | 23,752 |   |
| **Workers'                Compensation:**                |   |                                  |   |   |   |   |   |   |   |   |
|    Continuing                operations   |   | $                                     | 18,489 |   | $ | 13,323 |   | $ | 16,489 |   |
|    Discontinued                operations |   |                                  | 1,906  |   |   | 2,714 |   |   | 4,592 |   |
|                                                     |   | $                                     | 20,395 |   | $ | 16,037 |   | $ | 21,081 |   |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

|                             |   | **December                31, 2006** |   | **|**                  |   |  **December                31, 2005** |   |
|----------------------------------|--------|--------------------------------------|--------|------------------------|--------|--------------------------------------------|--------|
|                             |   | **Professional**                     |   |  **Workers'**     |   |                                  |   | **|** |   |  **Professional** |   |  **Workers'** |   |    |   |
|                             |   | **Liability**                        |   |  **Compensation** |   |  **Total**                            |   | **|** |   |  **Liability** |   |  **Compensation** |   |  **Total** |   |
| **Assets**(1):                   |   |                                 |   |                   |   |                                       |   |   |   |   |   | **|** |   |   |   |   |   |   |   |   |   |   |
| *Restricted                cash* |   |                                 |   |                   |   |                                       |   |   |   |   |   | **|** |   |   |   |   |   |   |   |   |   |   |
| Current                          |   | $                                    | 4,311  |                   | $      | 21,073                                     |   | $ | 25,384 |   |   | **|** |   | $ | 3,626 |   | $ | 13,427 |   | $ | 17,053 |   |
| Non-current                      |   |                                 | -      |                   |   | 25,977                                     |   |   | 25,977 |   |   | **|** |   |   | - |   |   | 32,076 |   |   | 32,076 |   |
| Total                            |   | $                                    | 4,311  |                   | $      | 47,050                                     |   | $ | 51,361 |   |   | **|** |   | $ | 3,626 |   | $ | 45,503 |   | $ | 49,129 |   |
|                             |   |                                 |   |                   |   |                                       |   |   |   |   |   | **|** |   |   |   |   |   |   |   |   |   |   |
| **Liabilities**(2)(3):           |   |                                 |   |                   |   |                                       |   |   |   |   |   | **|** |   |   |   |   |   |   |   |   |   |   |
| *Self-insurance*                 |   |                                 |   |                   |   |                                       |   |   |   |   |   | **|** |   |   |   |   |   |   |   |   |   |   |
| *liabilities*                    |   |                                 |   |                   |   |                                       |   |   |   |   |   | **|** |   |   |   |   |   |   |   |   |   |   |
| Current                          |   | $                                    | 23,967 |                   | $      | 21,073                                     |   | $ | 45,040 |   |   | **|** |   | $ | 19,180 |   | $ | 13,427 |   | $ | 32,607 |   |
| Non-current                      |   |                                 | 51,111 |                   |   | 30,448                                     |   |   | 81,559 |   |   | **|** |   |   | 67,274 |   |   | 42,679 |   |   | 109,953 |   |
| Total                            |   | $                                    | 75,078 |                   | $      | 51,521                                     |   | $ | 126,599 |   |   | **|** |   | $ | 86,454 |   | $ | 56,106 |   | $ | 142,560 |   |

| (1)  | Total                restricted cash excluded $10,474 and $11,530 at December 31, 2006                and                2005, respectively, held for bank collateral, various mortgages,                bond                payments and capital expenditures on HUD buildings.                                                                                                                                                                                                                      |
|-----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (2)  | Total                self-insurance liabilities excluded $3,649 and $4,631 at December                31, 2006                and 2005, respectively, related to our health insurance                liabilities.                                                                                                                                                                                                                                                                                     |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (3)  | Total                self-insurance liabilities are collateralized, in addition to the                restricted cash, by letters of credit of $750 and $10,694 for general                and                professional liability insurance and workers' compensation, respectively,                as of December 31, 2006 and $5,000 and $6,471 for general and professional                liability insurance and workers' compensation, respectively, as of                December 31, 2005. |

*Construction      Commitments*

**(12)  Income      Taxes**

----

**SUN            HEALTHCARE GROUP, INC. AND            SUBSIDIARIES**

**NOTES              TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER              31, 2006**

|                      |   | **For                The Year Ended** |   |
|---------------------------|--------|---------------------------------------|--------|
|                      |   | **December                31, 2006**  |   |  **December                31, 2005** |   |  **December                31, 2004** |   |
| Current:                  |   |                                  |   |   |   |   |   |   |   |   |
|    Federal |   | $                                     | (1,957 | ) | $ | (1,037 | ) | $ | (1,585 | ) |
|    State   |   |                                  | 787    |   |   | 251 |   |   | 427 |   |
|                      |   |                                  | (1,170 | ) |   | (786 | ) |   | (1,158 | ) |
| Deferred:                 |   |                                  |   |   |   |   |   |   |   |   |
|    Federal |   |                                  | 1,536  |   |   | - |   |   | - |   |
|    State   |   |                                  | 365    |   |   | - |   |   | - |   |
|                      |   |                                  | 1,901  |   |   | - |   |   | - |   |
|    Total   |   | $                                     | 731    |   | $ | (786 | ) | $ | (1,158 | ) |

**     **

|                                                                   |   | **For                The Year Ended** |   |
|------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                   |   | **December                31, 2006**  |   |  **December                31, 2005** |   |  **December                31, 2004** |   |
|                                                                   |   |                                  |   |   |   |   |   |   |   |   |
| Computed                expected tax                                   |   |                                  |   |   |   |   |   |   |   |   |
|   expense                (benefit)                           |   | $                                     | 5,397  |   | $ | (966 | ) | $ | 189 |   |
| Adjustments                in income taxes                             |   |                                  |   |   |   |   |   |   |   |   |
|   resulting                from:                             |   |                                  |   |   |   |   |   |   |   |   |
|   Change                in valuation allowance               |   |                                  | (4,879 | ) |   | 567 |   |   | (1,119 | ) |
|   State                income tax expense                    |   |                                  |   |   |   |   |   |   |   |   |
|      (benefit),                net of Federal |   |                                  |   |   |   |   |   |   |   |   |
|      income                tax effect         |   |                                  | 838    |   |   | (35 | ) |   | 171 |   |
|   Refunds                from NOL carrybacks                 |   |                                  | (1,957 | ) |   | (1,037 | ) |   | (1,585 | ) |
|   Nondeductible                compensation                  |   |                                  | 623    |   |   | 399 |   |   | 650 |   |
|   Other                nondeductible expenses                |   |                                  | 709    |   |   | 286 |   |   | 536 |   |
|           Total      |   | $                                     | 731    |   | $ | (786 | ) | $ | (1,158 | ) |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

|                                                                      |   | **2006** |     |  **2005** |   |
|---------------------------------------------------------------------------|--------|----------|----------|----------------|--------|
|                                                                      |   |     |     |      |   |
| Deferred                tax assets:                                       |   |     |     |           |   |   |   |
|    Accounts                and notes receivable            |   | $        | 12,496   |           | $      | 13,265 |   |
|    Accrued                liabilities                      |   |     | 65,994   |           |   | 74,257 |   |
|    Property                and equipment                   |   |     | 10,670   |           |   | 28,963 |   |
|    Intangible                assets                        |   |     | 24,892   |           |   | 27,768 |   |
|    Write-down                of assets held for sale       |   |     | 2,338    |           |   | 3,512 |   |
|    Jobs                and other credit carryforwards      |   |     | -        |           |   | 107 |   |
|    State                net operating loss carryforwards   |   |     | 4,386    |           |   | 1,614 |   |
|    Federal                net operating loss carryforwards |   |     | 64,470   |           |   | 25,917 |   |
|    Other                                                   |   |     | 227      |           |   | 293 |   |
|                                                                      |   |     | 185,473  |           |   | 175,696 |   |
| Less                valuation allowance:                                  |   |     |     |           |   |   |   |
|    Federal                                                 |   |     | (154,928 | )              |   | (146,818 | ) |
|    State                                                   |   |     | (30,545  | )              |   | (28,878 | ) |
|                                                                      |   |     | (185,473 | )              |   | (175,696 | ) |
| Total                deferred tax assets                                  |   |     | -        |           |   | - |   |
|                                                                      |   |     |     |           |   |   |   |
| Total                deferred tax liabilities                             |   |     | -        |           |   | - |   |
| Deferred                taxes, net                                        |   | $        | -        |           | $      | - |   |

**     **

**     **

**     **

----

**SUN        HEALTHCARE GROUP, INC. AND        SUBSIDIARIES**

**NOTES          TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER          31, 2006**

**     **

**     **

**     **

*Accounting      for Uncertainty in Income Taxes, an interpretation of FASB Statement No.      109”*

**     **

**(13)  Fair      Value of Financial Instruments**

|                                                          |   | **2006**     |    | **2005**                      |   |
|---------------------------------------------------------------|--------|--------------|---------|-------------------------------|--------|
|                                                          |   | **Carrying** |    |                          |   | **Carrying** |   |   |   |
|                                                          |   | **Amount**   |    | **Fair                Value** |   | **Amount** |   | **Fair                Value** |   |
|                                                          |   |         |    |                          |   |   |   |   |   |   |   |   |   |
| Cash                and cash equivalents                      |   | $            | 131,935 |                          | $      | 131,935 |   | $ | 16,641 |   | $ | 16,641 |   |
| Restricted                cash                                |   | $            | 61,835  |                          | $      | 61,835 |   | $ | 60,659 |   | $ | 60,659 |   |
| Long-term                debt, including current portion      |   |         |    |                          |   |   |   |   |   |   |   |   |   |
|    and                capital lease obligation |   | $            | 174,165 |                          | $      | 161,442 |   | $ | 197,779 |   | $ | 182,968 |   |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

**(14)  Capital      Stock**

*Common      Stock*

*  Warrants*

*  Equity      Incentive Plan*

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

*Accounting      for Stock Issued to Employees*
*Accounting      for Stock-Based Compensation *
*.      *

|                                            |   | **For                the Year Ended** |   |
|-------------------------------------------------|--------|---------------------------------------|--------|
|                                            |   | **December                31, 2005**  |   |  **December                31, 2004** |   |
|                                            |   |                                  |   |   |   |   |   |
| Net                income (loss) as reported(1) |   | $                                     | 24,761 |   | $ | (18,627 | ) |
| Compensation                expense             |   |                                  | (1,469 | ) |   | (1,568 | ) |
| Net                income (loss) (pro forma)    |   | $                                     | 23,292 | ) | $ | (20,195 | ) |
| Net                income (loss) per share:     |   |                                  |   |   |   |   |   |
| Basic:                                          |   |                                  |   |   |   |   |   |
| Net                income (loss) as reported    |   | $                                     | 1.55   |   | $ | (1.29 | ) |
| Compensation                expense             |   |                                  | (0.09  | ) |   | (0.11 | ) |
| Net                income (loss) pro forma      |   | $                                     | 1.46   |   | $ | (1.40 | ) |
| Diluted:                                        |   |                                  |   |   |   |   |   |
| Net                income (loss) as reported    |   | $                                     | 1.55   |   | $ | (1.28 | ) |
| Compensation                expense             |   |                                  | (0.09  | ) |   | (0.11 | ) |
| Net                income (loss) pro forma      |   | $                                     | 1.46   |   | $ | (1.39 | ) |

| (1) | Includes                total charges to our consolidated statements of income related to                stock-based employee compensation cost of $1.3 million and $1.6 million                for the years ended December 31, 2005 and 2004,                respectively. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Share-Based      Payment*

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

|     **Options**             |   |    **Shares****(in                thousands)** |   |   **Weighted-****Average****Exercise                Price** |   | **Weighted-****Average****Remaining****Contractual****Term** |   |  **Aggregate****Intrinsic****Value****(in                thousands)** |                   |
|-------------------------------------------------|--------|---------------------------------------------------------------|--------|-----------------------------------------------------------------------|--------|--------------------------------------------------------------|--------|----------------------------------------------------------------------------|------------------------|
|                                            |   |                                                          |   |                                                                  |   |                                                         |   |                                                                       |                   |   |   |   |   |
| Outstanding                at January 1, 2006   |   |                                                          | 1,383  |                                                                  | $      | 7.03                                                         |   |                                                                       |                   |   |   |   |   |
| Granted                (1)                      |   |                                                          | 369    |                                                                  |   | 8.17                                                         |   |                                                                       |                   |   |   |   |   |
| Exercised                                       |   |                                                          | (126   | )                                                                     |   | 4.43                                                         |   |                                                                       |                   |   |   |   |   |
| Forfeited                or expired (2)         |   |                                                          | (134   | )                                                                     |   | 7.13                                                         |   |                                                                       |                   |   |   |   |   |
| Outstanding                at December 31, 2006 |   |                                                          | 1,492  |                                                                  | $      | 7.52                                                         |   |                                                                       | 6                years |   | $ | (7,624 | ) |
|                                            |   |                                                          |   |                                                                  |   |                                                         |   |                                                                       |                   |   |   |   |   |
| Exercisable                at December 31, 2006 |   |                                                          | 648    |                                                                  | $      | 7.37                                                         |   |                                                                       | 6                years |   | $ | (3,408 | ) |
|                                            |   |                                                          |   |                                                                  |   |                                                         |   |                                                                       |                   |   |   |   |   |

| (1)   | Includes                340 performance share awards earned during                2006. |
|-----------------|-----------------------------------------------------------------------------------------|

| (2)   | Includes                14 performance share forfeitures. |
|-----------------|-----------------------------------------------------------|

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

|    **Nonvested                Shares** |   |   **Shares****(in                thousands)** |   | **Weighted-****Average****Grant-Date****Fair                Value** |   |
|-------------------------------------------------------|--------|---------------------------------------------------------|--------|---------------------------------------------------------------------|--------|
|                                                  |   |                                                    |   |                                                                |   |   |   |
| Nonvested                at January 1, 2006           |   |                                                    | 370    |                                                                | $      | 9.17 |   |
| Granted                (1)                            |   |                                                    | 357    |                                                                |   | 8.22 |   |
| Vested                                                |   |                                                    | (95    | )                                                                   |   | 14.03 |   |
| Forfeited                (2)                          |   |                                                    | (45    | )                                                                   |   | 7.54 |   |
| Nonvested                at December 31, 2006         |   |                                                    | 587    |                                                                |   | 7.92 |   |
|                                                  |   |                                                    |   |                                                                |   |   |   |

| (1)   | Includes                340 performance shares earned during                2006. |
|-----------------|-----------------------------------------------------------------------------------|

| (2)   | Includes                18 performance share forfeitures. |
|-----------------|-----------------------------------------------------------|

| Expected                volatility         | 57.15%                - 80.62% |
|--------------------------------------------|--------------------------------|
| Weighted-average                volatility | 67.60%                         |
| Expected                term (in years)    | 4.75                           |
| Risk-free                rate              | 3.02%                - 4.66%   |

**(15)  Other      Events**

*Litigation      *

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

*Other      Inquiries*

*Legislation,      Regulations and Market Conditions*

**(16)  Segment      Information**

----

**SUN            HEALTHCARE GROUP, INC. AND            SUBSIDIARIES**

**NOTES              TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER              31, 2006**

*Inpatient      Services:*

*Rehabilitation      Therapy Services:*

*Medical      Staffing Services:*

----

**SUN            HEALTHCARE GROUP, INC. AND            SUBSIDIARIES**

**NOTES              TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER              31, 2006**

| **As                of and for the**                                 |                                               |      |        |            |   |      |   |       |       |               |   |          |   |          |     |
|----------------------------------------------------------------------|----------------------------------------------------|-----------|-------------|----------------------|--------|----------------|--------|-----------------|------------|--------------------|--------|--------------------|--------|--------------------|----------|
| **Year                Ended**                                        |                                               |      |        |            |   |      |   |       |       |               |   |          |   |          |     |
| **December                31, 2006**                                 | Segment                Information (in thousands): |      |
|                                                                 |                                               |      |        |            |   |      |   |       |       |          |   |          |   |          |     |
|                                                                 |                                               |      |        |  Rehabilitation |   |  Medical  |   |       |       |          |   |          |   |          |     |
|                                                                 |                                               | Inpatient |        |  Therapy        |   |  Staffing |   |       |       |  Intersegment |   |          |   |  Discontinued |     |
|                                                                 |                                               | Services  |        |  Services       |   |  Services |   |  Corporate |       |  Eliminations |   |  Consolidated |   |  Operations   |     |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Revenues                from external customers                      |                                               | $         | 879,112     |                 | $      | 80,623         |   | $               | 85,866     |               | $      | 36                 |   | $                  | -        |   | $ | 1,045,637 |   | $ | 105,687 |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Intersegment                revenues                                 |                                               |      | -           |                 |   | 38,663         |   |            | 998        |               |   | -                  |   |               | (39,661  | ) |   | - |   |   | - |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|      **Total                revenues**      |                                               |      | **879,112** |                 |   | **119,286**    |   |            | **86,864** |               |   | **36**             |   |               | (39,661  | ) |   | **1,045,637** |   |   | **105,687** |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Operating                salaries and benefits                       |                                               |      | 428,362     |                 |   | 100,655        |   |            | 69,499     |               |   | -                  |   |               | -        |   |   | 598,516 |   |   | 65,215 |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Self                insurance for workers'                           |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|   compensation                and general and              |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|   professional                liability insurance          |                                               |      | 30,101      |                 |   | 1,390          |   |            | 903        |               |   | 300                |   |               | -        |   |   | 32,694 |   |   | (3,100 | ) |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Other                operating costs                                 |                                               |      | 246,697     |                 |   | 6,778          |   |            | 4,988      |               |   | (13                | )      |               | (39,661  | ) |   | 218,789 |   |   | 31,215 |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| General                and administrative expenses                   |                                               |      | 18,764      |                 |   | 6,696          |   |            | 2,526      |               |   | 49,856             |   |               | -        |   |   | 77,842 |   |   | 1,159 |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Provision                for losses on accounts                      |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|                   receivable                               |                                               |      | 10,721      |                 |   | 156            |   |            | 247        |               |   | -                  |   |               | -        |   |   | 11,124 |   |   | 1,656 |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| **   Segment                operating income (loss)** |                                               | $         | 144,467     |                 | **$**  | **3,611**      |   | **$**           | **8,701**  |               | **$**  | (50,107            | )      | **$**              | **-**    |   | **$** | **106,672** |   | **$** | **9,542** |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Facility                rent expense                                 |                                               |      | 55,702      |                 |   | 219            |   |            | 813        |               |   | -                  |   |               | -        |   |   | 56,734 |   |   | 2,577 |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Depreciation                and amortization                         |                                               |      | 11,893      |                 |   | 365            |   |            | 749        |               |   | 1,859              |   |               | -        |   |   | 14,866 |   |   | 1,525 |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Interest,                net                                         |                                               |      | 13,418      |                 |   | (11            | )      |            | 158        |               |   | 4,941              |   |               | -        |   |   | 18,506 |   |   | 214 |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| **   Net                segment income (loss)**       |                                               | $         | 63,454      |                 | **$**  | **3,038**      |   | **$**           | **6,981**  |               | **$**  | (56,907            | )      | **$**              | **-**    |   | **$** | **16,566** |   | **$** | **5,226** |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Identifiable                segment assets                           |                                               | $         | 383,511     |                 | $      | 12,111         |   | $               | 33,453     |               | $      | 702,429            |   | $                  | (521,040 | ) | $ | 610,464 |   | $ | 10,959 |   |
|                                                                 |                                               |      |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Segment                capital expenditures                          |                                               | $         | 18,299      |                 | $      | 422            |   | $               | 412        |               | $      | 2,857              |   | $                  | -        |   | $ | 21,990 |   | $ | 1,273 |   |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

| **As                of and for the**                                 |   |                                                                                   |        |            |   |      |   |       |       |          |   |          |   |          |     |
|----------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|-------------|----------------------|--------|----------------|--------|-----------------|------------|--------------------|--------|--------------------|--------|--------------------|----------|
| **Year                Ended**                                        |   |                                                                                   |        |            |   |      |   |       |       |          |   |          |   |          |     |
| **December                31, 2005**                                 |   | Segment                Information (in thousands):       |        |
|                                                                 |   |                                                                                   |        |            |   |      |   |       |       |          |   |          |   |          |     |
|                                                                 |   |                                                                                   |        |  Rehabilitation |   |  Medical  |   |       |       |          |   |          |   |          |     |
|                                                                 |   | Inpatient                                                                              |        |  Therapy        |   |  Staffing |   |       |       |  Intersegment |   |          |   |  Discontinued |     |
|                                                                 |   | Services                                                                               |        |  Services       |   |  Services |   |  Corporate |       |  Eliminations |   |  Consolidated |   |  Operations   |     |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Revenues                from external customers                      |   | $                                                                                      | 614,913     |                 | $      | 79,674         |   | $               | 70,534     |               | $      | 661                |   | $                  | -        |   | $ | 765,782 |   | $ | 121,403 |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Intersegment                revenues                                 |   |                                                                                   | -           |                 |   | 36,952         |   |            | 613        |               |   | -                  |   |               | (37,565  | ) |   | - |   |   | - |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| **Total                net revenues**                                |   |                                                                                   | **614,913** |                 |   | **116,626**    |   |            | **71,147** |               |   | **661**            |   |               | (37,565  | ) |   | **765,782** |   |   | **121,403** |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Operating                salaries and benefits                       |   |                                                                                   | 308,769     |                 |   | 95,866         |   |            | 56,791     |               |   | (1                 | )      |               | -        |   |   | 461,425 |   |   | 71,931 |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Self                insurance for workers'                           |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|   compensation                and general and              |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|   professional                liability insurance          |   |                                                                                   | 23,007      |                 |   | 1,736          |   |            | 946        |               |   | 372                |   |               | -        |   |   | 26,061 |   |   | (10,440 | ) |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Other                operating costs (1)                             |   |                                                                                   | 173,277     |                 |   | 7,626          |   |            | 4,371      |               |   | 10                 |   |               | (37,565  | ) |   | 147,719 |   |   | 34,176 |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| General                and administrative expenses                   |   |                                                                                   | 13,453      |                 |   | 7,351          |   |            | 2,748      |               |   | 47,195             |   |               | -        |   |   | 70,747 |   |   | 1,389 |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Provision                (adjustment) for losses on                  |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|   accounts                receivable                       |   |                                                                                   | 3,839       |                 |   | (691           | )      |            | 221        |               |   | -                  |   |               | -        |   |   | 3,369 |   |   | 1,639 |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| **   Segment                operating income (loss)** |   | $                                                                                      | 92,568      |                 | **$**  | **4,738**      |   | **$**           | **6,070**  |               | **$**  | (46,915            | )      | **$**              | **-**    |   | **$** | **56,461** |   | **$** | **22,708** |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Facility                rent expense                                 |   |                                                                                   | 37,056      |                 |   | 336            |   |            | 738        |               |   | -                  |   |               | -        |   |   | 38,130 |   |   | 2,951 |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Depreciation                and amortization                         |   |                                                                                   | 6,813       |                 |   | 234            |   |            | 376        |               |   | 966                |   |               | -        |   |   | 8,389 |   |   | 1,587 |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Interest,                net                                         |   |                                                                                   | 7,344       |                 |   | (17            | )      |            | 49         |               |   | 4,461              |   |               | -        |   |   | 11,837 |   |   | 323 |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| **   Net                segment income (loss)**       |   | $                                                                                      | 41,355      |                 | **$**  | **4,185**      |   | **$**           | **4,907**  |               | **$**  | (52,342            | )      | **$**              | **-**    |   | **$** | (1,895 | ) | **$** | **17,847** |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Identifiable                segment assets                           |   | $                                                                                      | 364,232     |                 | $      | 12,645         |   | $               | 33,773     |               | $      | 591,233            |   | $                  | (520,985 | ) | $ | 480,898 |   | $ | 31,408 |   |
|                                                                 |   |                                                                                   |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Segment                capital expenditures                          |   | $                                                                                      | 10,586      |                 | $      | 706            |   | $               | 309        |               | $      | 3,541              |   | $                  | -        |   | $ | 15,142 |   | $ | 2,274 |   |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

| **As                of and for the**                                 |   |                                                     |        |            |   |      |   |       |       |          |   |          |   |          |     |
|----------------------------------------------------------------------|--------|----------------------------------------------------------|-------------|----------------------|--------|----------------|--------|-----------------|------------|--------------------|--------|--------------------|--------|--------------------|----------|
| **Year                Ended**                                        |   |                                                     |        |            |   |      |   |       |       |          |   |          |   |          |     |
| **December                31, 2004**                                 |   |  Segment                Information (in thousands): |        |
|                                                                 |   |                                                     |        |            |   |      |   |       |       |          |   |          |   |          |     |
|                                                                 |   |                                                     |        |  Rehabilitation |   |  Medical  |   |       |       |          |   |          |   |          |     |
|                                                                 |   | Inpatient                                                |        |  Therapy        |   |  Staffing |   |       |       |  Intersegment |   |          |   |  Discontinued |     |
|                                                                 |   | Services                                                 |        |  Services       |   |  Services |   |  Corporate |       |  Eliminations |   |  Consolidated |   |  Operations   |     |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Revenues                from external customers                      |   | $                                                        | 566,660     |                 | $      | 79,443         |   | $               | 54,713     |               | $      | 47                 |   | $                  | -        |   | $ | 700,863 |   | $ | 145,432 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Intersegment                revenues                                 |   |                                                     | (600        | )                    |   | 33,310         |   |            | 2,103      |               |   | (82                | )      |               | (34,731  | ) |   | - |   |   | - |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| **Total                net revenues**                                |   |                                                     | **566,060** |                 |   | **112,753**    |   |            | **56,816** |               |   | (35                | )      |               | (34,731  | ) |   | **700,863** |   |   | **145,432** |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Operating                salaries and benefits                       |   |                                                     | 285,010     |                 |   | 89,711         |   |            | 43,918     |               |   | (13                | )      |               | -        |   |   | 418,626 |   |   | 88,891 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Self                insurance for workers'                           |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|   compensation                and general and              |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|   professional                liability insurance          |   |                                                     | 18,975      |                 |   | 681            |   |            | 885        |               |   | 184                |   |               | -        |   |   | 20,725 |   |   | 10,908 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Other                operating costs (1)                             |   |                                                     | 156,114     |                 |   | 7,650          |   |            | 4,329      |               |   | 24                 |   |               | (34,731  | ) |   | 133,386 |   |   | 45,929 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| General                and administrative expenses                   |   |                                                     | 11,895      |                 |   | 6,398          |   |            | 3,140      |               |   | 44,104             |   |               | -        |   |   | 65,537 |   |   | 1,687 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Provision                for losses on accounts                      |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
|   Receivable                                               |   |                                                     | 2,526       |                 |   | 1,398          |   |            | 340        |               |   | -                  |   |               | -        |   |   | 4,264 |   |   | 7,637 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| **   Segment                operating income (loss)** |   | $                                                        | 91,540      |                 | **$**  | **6,915**      |   | **$**           | **4,204**  |               | **$**  | (44,334            | )      | **$**              | **-**    |   | **$** | **58,325** |   | **$** | (9,620 | ) |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Facility                rent expense                                 |   |                                                     | 35,071      |                 |   | 372            |   |            | 826        |               |   | 9                  |   |               | -        |   |   | 36,278 |   |   | 3,778 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Depreciation                and amortization                         |   |                                                     | 7,153       |                 |   | 242            |   |            | 183        |               |   | 614                |   |               | -        |   |   | 8,192 |   |   | 1,418 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Interest,                net                                         |   |                                                     | 5,139       |                 |   | 15             |   |            | (10        | )                  |   | 3,527              |   |               | -        |   |   | 8,671 |   |   | 189 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| **   Net                segment income (loss)**       |   | $                                                        | 44,177      |                 | **$**  | **6,286**      |   | **$**           | **3,205**  |               | **$**  | (48,484            | )      | **$**              | **-**    |   | **$** | **5,184** |   | **$** | (15,005 | ) |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Identifiable                segment assets                           |   | $                                                        | 176,133     |                 | $      | 18,444         |   | $               | 10,726     |               | $      | 447,105            |   | $                  | (366,759 | ) | $ | 285,649 |   | $ | 27,504 |   |
|                                                                 |   |                                                     |        |                 |   |           |   |            |       |               |   |               |   |               |     |   |   |   |   |   |   |   |
| Segment                capital expenditures                          |   | $                                                        | 8,373       |                 | $      | 202            |   | $               | 40         |               | $      | 2,738              |   | $                  | -        |   | $ | 11,353 |   | $ | 1,537 |   |

----

**SUN          HEALTHCARE GROUP, INC. AND          SUBSIDIARIES**

**NOTES            TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**DECEMBER            31, 2006**

**Measurement      of Segment Income or Loss**

|                                                          |   | **2006** |   |  **2005** |   |  **2004** |   |
|---------------------------------------------------------------|--------|----------|--------|----------------|--------|----------------|--------|
|                                                          |   |     |   |      |   |      |   |
| Net                segment income (loss)                      |   | $        | 16,566 |           | $      | (1,895         | )      | $ | 5,184 |   |
|    Loss                on asset impairment     |   |     | -      |           |   | (361           | )      |   | (1,028 | ) |
|    Restructuring                costs, net     |   |     | -      |           |   | (122           | )      |   | (1,972 | ) |
|    Loss                on contract termination |   |     | (975   | )              |   | -              |   |   | - |   |
| Loss                on lease termination                      |   |     | -      |           |   | -              |   |   | (150 | ) |
|    Loss                on sale of assets, net  |   |     | (172   | )              |   | (383           | )      |   | (1,494 | ) |
| Income                (loss) before income taxes and          |   |     |   |           |   |           |   |   |   |   |
|    discontinued                operations      |   | $        | 15,419 |           | $      | (2,761         | )      | $ | 540 |   |

**(17)  401(K)      Plan**

----

**SUN      HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**SUPPLEMENTARY      DATA (UNAUDITED)**

**QUARTERLY      FINANCIAL DATA**

|                                                       |   | **For                the Year**          |    |
|------------------------------------------------------------|--------|------------------------------------------|---------|
|                                                       |   | **Ended**                                |    |
|                                                       |   | **December                31, 2006 (1)** |    |
|                                                       |   | **Fourth**                               |    |  **Third** |   |  **Second** |   |  **First** |   |    |   |
|                                                       |   | **Quarter**                              |    |  **Quarter** |   |  **Quarter** |   |  **Quarter** |   |  **Total** |   |
|                                                       |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                net revenues                          |   | $                                        | 268,304 |   | $ | 262,118 |   | $ | 258,458 |   | $ | 256,757 |   | $ | 1,045,637 |   |
|                                                       |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income                (loss) from continuing               |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   operations                (2)                  |   | $                                        | 10,030  |   | $ | (1,053 | ) | $ | 4,889 |   | $ | 822 |   | $ | 14,688 |   |
|                                                       |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income                from discontinued                    |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   operations                                     |   | $                                        | 9,835   |   | $ | (141 | ) | $ | 2,418 |   | $ | 318 |   | $ | 12,430 |   |
|                                                       |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                income (loss)                           |   | $                                        | 19,865  |   | $ | (1,194 | ) | $ | 7,307 |   | $ | 1,140 |   | $ | 27,118 |   |
|                                                       |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                earnings per common and               |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   common                equivalent share:        |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   Income                (loss) from continuing   |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|     operations                         |   | $                                        | 0.31    |   | $ | (0.03 | ) | $ | 0.16 |   | $ | 0.03 |   | $ | 0.46 |   |
|   Income                (loss) from discontinued |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|     operations                         |   |                                     | 0.30    |   |   | (0.01 | ) |   | 0.07 |   |   | 0.01 |   |   | 0.40 |   |
|   Net                income (loss)               |   | $                                        | 0.61    |   | $ | (0.04 | ) | $ | 0.23 |   | $ | 0.04 |   | $ | 0.86 |   |
|                                                       |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Diluted                earnings per common and             |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   common                equivalent share:        |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   Income                (loss) from continuing   |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|     operations                         |   | $                                        | 0.30    |   | $ | (0.03 | ) | $ | 0.16 |   | $ | 0.03 |   | $ | 0.46 |   |
|   Income                (loss) from discontinued |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|     operations                         |   |                                     | 0.30    |   |   | (0.01 | ) |   | 0.07 |   |   | 0.01 |   |   | 0.39 |   |
|   Net                income (loss)               |   | $                                        | 0.60    |   | $ | (0.04 | ) | $ | 0.23 |   | $ | 0.04 |   | $ | 0.85 |   |
|                                                       |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Weighted                average number of                  |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   common                and common equivalent    |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   shares                outstanding:             |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   Basic                                          |   |                                     | 32,750  |   |   | 31,345 |   |   | 31,264 |   |   | 31,174 |   |   | 31,638 |   |
|   Diluted                                        |   |                                     | 33,069  |   |   | 31,345 |   |   | 31,446 |   |   | 31,228 |   |   | 31,788 |   |

| (1) | In                accordance with SFAS No. 144, we have reclassified all activity related                to                the operations of divested entities for the years ended December                31,                2006,                2005 and 2004 to discontinued operations. Therefore, the quarterly                financial data presented above including revenues, income (loss)                before                income taxes and discontinued operations and income (loss) on discontinued                operations will not reflect the amounts filed previously in our Forms                10-Q                with the SEC. However, net income remains the same.                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | We                recorded a loss on contract termination of $0.1 million, and loss                on sale                of assets of $0.1 million. We also recorded a 32% effective tax rate                for                the first three quarters of 2006. During the fourth quarter, we were                able                to record a tax benefit for the realization of post-emergence temporary                differences and refunds from NOL carrybacks which resulted in an                effective                tax rate for the year of approximately 5%. In                addition, we                recognized a $2.5 million non-cash charge to account for certain                lease                rate escalation clauses during the year (see “Note 3 - Significant                Accounting Policies” in our consolidated financial statements). During the                fourth quarter, we recognized an additional $2.8 million in provision                for                accounts receivable that were unbillable at the date of the Peak                acquisition. |

----

|                                                           |   | **For                the Year**          |    |
|----------------------------------------------------------------|--------|------------------------------------------|---------|
|                                                           |   | **Ended**                                |    |
|                                                           |   | **December                31, 2005 (1)** |    |
|                                                           |   | **Fourth**                               |    |  **Third** |   |  **Second** |   |  **First** |   |    |   |
|                                                           |   | **Quarter**                              |    |  **Quarter** |   |  **Quarter** |   |  **Quarter** |   |  **Total** |   |
|                                                           |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                net revenues                              |   | $                                        | 216,539 |   | $ | 186,957 |   | $ | 184,306 |   | $ | 177,980 |   | $ | 765,782 |   |
|                                                           |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income                (loss) from continuing                   |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   operations                (3)                      |   | $                                        | 2,665   |   | $ | (2,109 | ) | $ | 284 |   | $ | (2,815 | ) | $ | (1,975 | ) |
|                                                           |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   Income                from discontinued operations |   | $                                        | 9,001   |   | $ | 9,443 |   | $ | 6,646 |   | $ | 1,646 |   | $ | 26,736 |   |
|                                                           |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                income (loss)                               |   | $                                        | 11,666  |   | $ | 7,334 |   | $ | 6,930 |   | $ | (1,169 | ) | $ | 24,761 |   |
|                                                           |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                and diluted earnings per                  |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   common                and common equivalent        |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   share:                                             |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   Income                (loss) from continuing       |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|     operations                             |   | $                                        | 0.15    |   | $ | (0.14 | ) | $ | 0.02 |   | $ | (0.18 | ) | $ | (0.12 | ) |
|   Income                from discontinued            |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|     operations                             |   |                                     | 0.50    |   |   | 0.62 |   |   | 0.43 |   |   | 0.10 |   |   | 1.67 |   |
|   Net                income (loss)                   |   | $                                        | 0.65    |   | $ | 0.48 |   | $ | 0.45 |   | $ | (0.08 | ) | $ | 1.55 |   |
|                                                           |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Weighted                average number of                      |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   common                and common equivalent        |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   shares                outstanding:                 |   |                                     |    |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   Basic                                              |   |                                     | 17,957  |   |   | 15,365 |   |   | 15,351 |   |   | 15,320 |   |   | 16,003 |   |
|   Diluted                                            |   |                                     | 18,054  |   |   | 15,365 |   |   | 15,352 |   |   | 15,320 |   |   | 16,003 |   |

| (3) | We                recorded a loss on asset impairment of $0.4 million, restructuring                costs                of $0.1 million, loss on sale of assets of $0.4 million and loss                on                extinguishment of debt of $0.4                million. |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

**SCHEDULE      II**

**SUN      HEALTHCARE GROUP, INC. AND SUBSIDIARIES**

**VALUATION      AND QUALIFYING ACCOUNTS**

**(in      thousands)**

|                                                             |   | **Column                A**   |   |  **Column                B**   |   |  **Column                C**       |   |  **Column                D** |   |  **Column                E**   |   |
|------------------------------------------------------------------|--------|-------------------------------|--------|-------------------------------------|--------|-----------------------------------------|--------|-----------------------------------|--------|-------------------------------------|--------|
|                                                             |   | **Balance                at** |   |  **Charged                to** |   |  **Additions**                     |   |                         |   |  **Balance                at** |   |
|                                                             |   | **Beginning**                 |   |  **Costs                and**  |   |  **Charged                to**     |   |  **Deductions**              |   |  **End                of**     |   |
| **Description**                                                  |   | **of                Period**  |   |  **Expenses(1)**               |   |  **Other                Accounts** |   |  **Other  (2)**    |   |  **Period**                    |   |
| Year                ended December 31, 2006                 |   |                          |   |                                |   |                                    |   |                              |   |                                |   |   |   |   |   |   |
|    Allowance                for doubtful accounts |   | $                             | 29,384 |                                | $      | 12,763                                  |   | $                                 | -      |                                | $      | (17,281 | ) | $ | 24,866 |   |
|    Other                receivable reserve        |   | $                             | 2,909  |                                | $      | 17                                      |   | $                                 | 138    |                                | $      | - |   | $ | 3,064 |   |
|                                                             |   |                          |   |                                |   |                                    |   |                              |   |                                |   |   |   |   |   |   |
| Year                ended December 31, 2005:                |   |                          |   |                                |   |                                    |   |                              |   |                                |   |   |   |   |   |   |
|    Allowance                for doubtful accounts |   | $                             | 40,293 |                                | $      | 5,009                                   |   | $                                 | -      |                                | $      | (15,918 | ) | $ | 29,384 |   |
|    Other                receivable reserve        |   | $                             | 5,739  |                                | $      | -                                       |   | $                                 | -      |                                | $      | (2,830 | ) | $ | 2,909 |   |
|                                                             |   |                          |   |                                |   |                                    |   |                              |   |                                |   |   |   |   |   |   |
| Year                ended December 31, 2004:                |   |                          |   |                                |   |                                    |   |                              |   |                                |   |   |   |   |   |   |
|    Allowance                for doubtful accounts |   | $                             | 67,108 |                                | $      | 11,901                                  |   | $                                 | -      |                                | $      | (38,716 | ) | $ | 40,293 |   |
|    Other                receivable reserve (3)    |   | $                             | 7,245  |                                | $      | -                                       |   | $                                 | 4,685  |                                | $      | (6,191 | ) | $ | 5,739 |   |

| (1)    | Charges                included in provision for losses on accounts receivable, of which                $1,656,                $1,640, and $7,637, respectively, for the years ended December 31,                2006,                2005 and 2004, relate to discontinued operations. |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                    |
| (2)    | Column                D primarily represents write offs and recoveries on divested receivables                that have been fully reserved.                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                    |
| (3)    | Includes                reserves on long-term notes receivable of $148 as of December 31,                2004.                                                                                                                                                                          |

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