** **

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549________________

**FORM 10-K**

(Mark One)

| 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,   2005**                                                                                                                                                                                                                                 |
| OR                                                                                                                                                                                                                                                                                        |
| o    Transition  Report Pursuant to Section 13(a) or 15(d) of the Securities Exchange Act  of 1934  For the transition period from             to            |

Commission file number0-49663

**SUN HEALTHCARE GROUP, INC.**(Exact name of registrant as specified in its charter)

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

**18831 VonKarman,****Suite****400********Irvine****,****CA**** ****92612****(949) 255-7100**(Address, including zip code, and telephone number of principal executiveoffices)

Securitiesregistered pursuant to Section 12(b) of the Act:  **None**Securities registered pursuant to Section 12(g) of the Act:  **Common Stock,par value $.01 per share**

     Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act. 

oYes     xNo

     Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Act. 

oYes     xNo

     Indicateby check mark whether the registrant (1) has filed all reports required bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. 

xYes     oNo

**     **Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof the registrant's knowledge, in the definitive proxy statement incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. o

     Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of "acceleratedfiler and large accelerated filer" in Rule 12b-2 of the Exchange Act.(Check one):
| Large  accelerated filero | Accelerated  filerx | Non-accelerated  filero |
|---------------------------|---------------------|-------------------------|

     Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theAct).

oYes     xNo

     The aggregatemarket value of the voting and non-voting common equity held by non-affiliatescomputed by reference to the price at which the common equity was last sold, orthe average bid and asked price of such common equity, as of the last businessday of the registrant's most recently completed second fiscal quarter was $96.0million.

     Indicate by check markwhether the registrant has filed all documents and reports required to be filedby Section 12, 13 or 15(d) ofthe Securities Exchange Act of 1934 subsequent to the distribution ofsecurities under a plan confirmed by a court.

xYes     oNo

     On March 1, 2006, Sun Healthcare Group, Inc. had 31,150,050 outstandingshares of Common Stock, inclusive of 10,182 shares of treasury stock.

     DocumentsIncorporated by Reference:  Part III of this Form 10-K incorporates informationby reference from the Registrant's definitive proxy statement for the 2006Annual Meeting to be filed prior to April 30, 2006.

** **

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** FORM 10-K**

** FOR THE FISCAL YEAR ENDED****DECEMBER 31, 2005 **

**INDEX**

| ** ** | ** **                                                                     | **Page** |
|------------|--------------------------------------------------------------------------------|----------|
| PART I     |                                                                                |          |
|            |                                                                                |          |
|       |                                                                           |     |
| Item 1.    | Business                                                                       |  3  |
| Item 1A.   | Risk Factors                                                                   | 10       |
| Item 1B.   | Unresolved Staff Comments                                                      | 15       |
| Item 2.    | Properties                                                                     | 15       |
| Item 3.    | Legal Proceedings                                                              | 17       |
| Item 4.    | Submission of Matters to a Vote of Security Holders                            | 18       |
|            |                                                                                |          |
|       |                                                                           |     |
| PART II    |                                                                                |          |
|            |                                                                                |          |
| Item 5.    | Market for Registrant's Common Equity, Related Stockholder Matters and  Issuer |          |
|            | Purchases of Equity Securities                                                 | 19       |
| Item 6.    | Selected Financial Data                                                        | 19       |
| Item 7.    | Management's Discussion and Analysis of Financial Condition and  Results of    |          |
|            | Operation                                                                      | 22       |
| Item 7A.   | Quantitative and Qualitative Disclosures About Market Risk                     | 46       |
| Item 8.    | Financial Statements and Supplementary Data                                    | 46       |
| Item 9.    | Changes in and Disagreements With Accountants on Accounting and  Financial     |          |
|            | Disclosure                                                                     | 47       |
| Item 9A.   | Controls and Procedures                                                        | 47       |
| Item 9B.   | Other Information                                                              | 47       |
|            |                                                                                |          |
|       |                                                                           |     |
| PART III   |                                                                                |          |
|            |                                                                                |          |
| Item 10.   | Directors and Executive Officers of the Registrant                             | 48       |
| Item 11.   | Executive Compensation                                                         | 48       |
| Item 12.   | Security Ownership of Certain Beneficial Owners and Management and  Related    |          |
|            | Stockholder Matters                                                            | 48       |
| Item 13.   | Certain Relationships and Related Transactions                                 | 48       |
| Item 14.   | Principal Accounting Fees and Services                                         | 48       |
|       |                                                                           |     |
| PART IV    |                                                                                |          |
|            |                                                                                |          |
| Item 15.   | Exhibits and Financial Statement Schedules                                     | 49       |
|            |                                                                                |          |
| Signatures | ___________________                              | 53       |

     Referencesthroughout this document to the Company, "we," "our," "ours"and "us" refer to Sun Healthcare Group, Inc. and its direct andindirect consolidated subsidiaries and not any other person. 

     SunBridge®,SunDance®, SunPlus®, CareerStaff Unlimited® and related names are registeredtrademarks of Sun Healthcare Group, Inc. and its subsidiaries.

___________________

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** PARTI**

** Item1.  Business**

** Overview**

     We are a nationwide provider of long-term,subacute and related specialty healthcare services primarily to the seniorpopulation in the United States. Our core business is providing inpatientservices, primarily through 134  skilled nursing facilities (10 of whichare managed), 14 assistedand independent living facilities, sevenmental health facilities and three specialty acute care hospitals with 16,910licensed beds located in 19 states at March 1, 2006. We also providerehabilitation therapy services, temporary medical staffing services and homehealth services to adult and pediatric patients.

* *     In February 2002 we emerged from Chapter 11bankruptcy proceedings pursuant to the terms of our Plan of Reorganization.As used in thisForm 10-K, the term "Predecessor Company" refers to our operations for periodsprior to March 1, 2002, while the term "Reorganized Company" is used to describeour operations for periods beginning March 1, 2002 and thereafter. During the bankruptcy proceedings, we divested our international operations andover 100 inpatient facilities. After the bankruptcy proceedings were concluded,our new management team determined that further significant restructuring ofour business was necessary in order to preserve and enhance shareholder value.Our restructuring was substantially completed in December 2004 and involved:(i) the renegotiation of the terms of our leases for skilled nursingfacilities resulting in an approximate 300 basis point reduction in leaseexpense as a percentage of net revenues; (ii) the divestiture of 137 poorperforming inpatient facilities; and (iii) the sale of non-core assets,including our pharmacy business.

     Commencing in 2005, we implemented a business strategy to leverage ourexisting platform, and in August 2005 we acquired ProCare One Nurses, LLC("ProCare"), a leading provider of specialized nurse staffing withapproximately 800 nurses on its roster.  In December 2005, we acquiredPeak Medical Corporation ("Peak"), an Albuquerque, New Mexico-basedoperator of 56 skilled nursing facilities and independent and assistedliving residences and a small hospice operation. These facilities are locatedin New Mexico, Oklahoma, Colorado, Montana, Idaho, Utah and Wyoming. We believe these acquisitions will provide us withcritical mass in new geographic markets, potential synergies from reduction inoverhead, improved purchasing discounts and revenue and margin growthopportunities.

**Industry**

     The demand for long-term healthcare services isbeing driven by the aging population, increased life expectancies and adecrease in the number of senior care facilities. During 2004, there wereapproximately 3.6 million Americans aged 85 or older, or 1.3% of thepopulation, according to the United States Census Bureau. This age group isprojected to grow to over 5.7 million by 2010 and to approximately6.8 million by 2020, or 2.1% of the projected population. Furthermore, theCenters for Medicare and Medicaid Services ("CMS"), a division of theDepartment of Health and Human Services, predicts that government spending onnursing homes will grow from $106.6 billion in 2002 to approximately$194.6 billion in 2014, representing an annual growth rate of 5.1%.Despite this potential rise in demand for senior care, there has been anoticeable, decreasing trend in the number of certified nursing homes.According to the American Health Care Association, the number of nursingfacilities has declined from 17,014 (1,708,500 beds) in 1999 to 16,032(1,676,770 beds) in June 2005. With no net increase in the number of availablebeds, we believe these demographic trends will create growth opportunities forthe most efficient facility operators.

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**Business Segments**

     Weoperate through various direct and indirect subsidiaries that engaged in thefollowing five principal business segments during 2005:
| -      | inpatient services, primarily  skilled nursing facilities; |
|--------|------------------------------------------------------------|
|   |                                                       |
|        |                                                            |
| -      | rehabilitation therapy  services;                          |
|   |                                                       |
|        |                                                            |
| -      | medical staffing services;                                 |
|   |                                                       |
|        |                                                            |
| -      | home health services; and                                  |
|   |                                                       |
|        |                                                            |
| -      | laboratory and radiology  services.                        |

*Inpatient services*.  As of December 31, 2005, we operated158* long-term care facilities (consisting of 134  skilled nursingfacilities (10 of which are managed), 14* assisted and independent livingfacilities,  seven mental healthfacilities and three specialty acute care hospitals) in 19 states with 16,965licensed beds through SunBridge Healthcare Corporation ("SunBridge")and other subsidiaries. Our skilled nursing facilities provide services thatinclude daily nursing, therapeutic rehabilitation, social services,housekeeping, dietary and administrative services for individuals requiringcertain assistance for activities in daily living. Several of our skillednursing facilities also contain wings dedicated to the care of residentsafflicted with Alzheimer's disease. Our assisted living facilities provideservices that include minimal nursing assistance, housekeeping, dietary,laundry and administrative services for individuals requiring minimalassistance for activities in daily living. Our independent living facilitiesprovide services that include security, housekeeping, dietary and limitedlaundry services for individuals requiring no assistance for activities indaily living. Our mental health facilities provide a range of inpatient andoutpatient services for adults and children through specialized treatmentprograms. Our specialty acute care hospitals provide rehabilitation, long termacute care and geriatric behavioral health services. We also provide hospiceservices in three states for individuals facing end of life issues and 72.1% ofour net revenues in 2005 was generated through inpatient services, which included one month of Peakoperations.  If we had operated Peak for the full year ended December 31, 2005, then 77.8% of our total pro forma netrevenues in 2005 would have been generated through inpatient operations.

*Rehabilitation therapy services*.  We provide rehabilitation therapy services through SunDanceRehabilitation Corporation ("SunDance"). SunDance provides a broadarray of rehabilitation therapy services, including speech pathology, physicaltherapy and occupational therapy. As of December 31, 2005, SunDance provided rehabilitation therapyservices to 424 facilities in 34 states, 328 of which were operated bynonaffiliated parties. We also provide rehabilitative and special educationservices to pediatric clients as well as rehabilitation therapy services foradult home healthcare clients in the greater New York City metropolitanarea through HTA of New York, Inc. ("HTA"), a wholly ownedsubsidiary. Net revenues generated through rehabilitation therapy services were11.4% of our net revenues in 2005._____________________*Wepreviously reported that, upon the acquisition of Peak Medical Corporation inDecember 2005, we operated 164 long-term care facilities, including 20 assistedand independent living facilities. Those statistics included six small assistedliving and independent living facilities operated by Peak that are located onthe same campus as skilled nursing facilities, consistent with the mannerpresented by Peak. We now count such facilities that share the same campus asone facility, so the number of independent and assisted living facilitiesdescribed herein is 14 instead of the previously reported 20, and the totalnumber of facilities is 158 instead of 164. The numbers of licensed beds andavailable beds are not affected by this change.

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

*Medical staffing services*. We are a national provider of temporary medical staffing through CareerStaffUnlimited, Inc. ("CareerStaff"). For the year ended December 31, 2005, CareerStaff derived 66%of its revenues from hospitals and other providers, 21% fromskilled nursing facilities, 9% of its revenues from schools and 4% from prisons. CareerStaff provides (i) licensed therapists skilled in the areas ofphysical, occupational and speech therapy, (ii) nurses,(iii) pharmacists, pharmacist technicians and medical imaging technicians,(iv) physicians, and (v) related medical personnel. CareerStaff also placestraveling therapists and nurses on 13-week assignments and, on apermanent basis, places nurses, physicians, therapists and department headswith health care facilities throughout the United States. As of December 31, 2005, CareerStaff provided medical staffing services in major metropolitanareas in 17 states, and also placed temporary traveling therapists in smallercities and rural areas. Medical staffing services generated 8.0% of our netrevenues in 2005.

*Home health services. *Asof December 31, 2005, we provided skilled nursing care, rehabilitationtherapy and home infusion services to adult and pediatric patients in California and Ohio through SunPlus Home Health Services, Inc. ("SunPlus").SunPlus also operates two licensed home infusion pharmacies in California. Home health services generated 6.9% of our net revenues in 2005.

*Laboratory and radiology services. *Through SunAlliance Healthcare Services, Inc.("SunAlliance"), we provide medical laboratory and radiology servicesto skilled nursing facilities in Massachusetts, New  Hampshire and Rhode Island. On November 4, 2005, SunAlliance sold its mobile radiology operationsin Arizona and Colorado. Laboratory and radiology services generated 1.6%of our net revenues in 2005.

**Competition**

     Ourbusiness is competitive. The nature of competition within the inpatientservices industry varies by location. We compete with other inpatient facilitiesbased on key competitive factors such as the number of competing facilities in the local market, the types ofservices available, quality of care, reputation, age and appearance of eachfacility and the cost of care in each locality. Increased competition in thefuture could limit our ability to attract and retain residents or to expand ourbusiness.

     Wealso compete with other companies in providing rehabilitation therapy services,medical staffing services, home health services and other ancillary services,and in employing and retaining qualified nurses, therapists and other medicalpersonnel. The primary competitive factors for the ancillary services marketsare quality of services, charges for services and responsiveness to customerneeds.

**CompetitiveStrengths**

Webelieve that the following competitive strengths will allow us to continue toimprove our operations and profitability: 
| -      | *National  footprint*.  Our core business, providing inpatient services, operated  through 158 facilities in 19 states at December 31, 2005. These  operations, together with our ancillary businesses that operate in many of  those states as well as several other jurisdictions, enable us to realize the  benefits of economies of scale, purchasing power and increased operating  efficiencies relevant to corporate functions. Furthermore, our geographic  diversity mitigates our risk associated with fluctuating state regulatory  changes related to reimbursement and the handling of patient care liability. |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| -      | *Core  inpatient business*.  Our inpatient business has demonstrated  consistent revenue and earnings growth through expansion of its service  offerings and an increase in the percentage of Medicare revenues. In each of  the last eight consecutive quarters, we have increased the percentage of our  revenues derived from Medicare, in both patient count and revenue dollars,  when compared with                                                                                                                                                                                                                        |

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | the same quarter in the prior year, while maintaining inpatient  occupancy rates above industry averages. We expect future growth will come  from both continued expansion of clinical competencies and services along  with continued improvement in referral development within our local medical  communities.                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| -      | *Quality of care and strong brand image*.  We have  implemented industry leading initiatives to provide a high quality of care to  our patients. These steps have resulted in a reduction in the size and number  of liability claims along with improved regulatory outcomes from our state  licensing bodies. Our standard of care has further strengthened our brand  image, allowing us to develop an extensive referral network of patients.                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| -      | *Ancillary  businesses that provide additional opportunities for value creation*.  Our  medical staffing and home health businesses have a proven operating model. We  are making changes to our operating model for our rehabilitation therapy  business to adjust to current trends in that business, and we believe that  the new operating model will improve our results of operations. These  ancillary businesses diversify our revenue base and improve our payor mix.                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| -      | *Experienced  management team with a proven track record.*Our management team, at both  the executive and operating levels, has significant industry knowledge and  operating experience in the long-term care industry. Our chief executive  officer, our chief financial officer and the chief operating officer of our  operating subsidiaries have over 75 years of cumulative experience.  Since 2002, we have acquired Peak and ProCare, completed two common stock  offerings, restructured and expanded our loan agreement, disposed of 137 poor  performing facilities, sold our pharmacy operations and other non-core  assets, reduced our cost structure, and hired experienced executives for key  management positions. |

**Business Strategy**

     Weintend to build on our competitive strengths to grow our business and maintainour position as a nationwide provider of senior services by achieving thefollowing objectives:
| -      | *Continue our inpatient  growth.*  We intend to grow our  inpatient operations by maintaining a high occupancy rate and enhancing our  payor mix. We are currently implementing this strategy by focusing on our  clinical and case management skills to increase our percentage of revenues  derived from Medicare and creating specialty units within our facilities to  meet unique clinical needs within a community. We plan to take advantage of  our marketing infrastructure and brand image to attract new patients and to  expand our customer base. Additionally, we will continue to explore  opportunities to increase our portfolio through acquisition in both existing  states and new states that provide appropriate business opportunities.                             |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| -      | *Execute strategies in our  ancillary businesses.*  We will  continue to develop and grow our ancillary businesses, which provide us with  diversified revenue sources, favorable payor mix and growth opportunities. We  believe strong industry fundamentals in the medical staffing and home health  sectors will provide consistent demand for our services and allow us to be a  leading player in these businesses. We are committed to executing operational  strategies to improve both margins and profitability in our rehabilitation  therapy business to mitigate the labor pressure that has negatively impacted  the business. Our growth strategy will be balanced between organic and  acquisition based growth that leverages our existing footprint and  infrastructure. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| -      | *Increase operational  efficiency and leverage our existing platform.*  We will continue to  focus on improving operating efficiency without compromising our high quality  of care. We plan to reduce                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**
|        |                                                                  |
|--------|------------------------------------------------------------------|
|   | costs and enhance efficiency through various methods, including: |
|   |                                                             |
|        |                                                                  |
|        | -                                                                | reducing overhead through  process improvement and frequent re-examination of costs; |
|   |                                                             |   |
|        |                                                                  |
|        | -                                                                | controlling risks through a  highly structured management process; |
|   |                                                             |   |
|        | -                                                                | reducing our general and  professional liability expenses year-over-year; and |
|   |                                                             |   |
|        |                                                                  |
|        | -                                                                | continued analysis of the  profitability of individual business units. |

**Employees andLabor Relations**

     Asof December 31, 2005, we had approximately 22,000 full-time andpart-time employees. Of this total, there were 15,800 employees in ourlong-term and subacute care operations, 2,500 employees in the rehabilitationtherapy services operations, 2,000 employees in the medical staffing business, 1,200employees in the home health business, 200 employees in the laboratory andradiology business, and 300 employees at the corporate and regional offices.

     Asof December 31, 2005, we operated 17 facilities with union employees. 1,226of our employees (5.6% of all of our employees) who worked in long-term carefacilities in Alabama, California, Georgia, Massachusetts, Montana, Ohio, Tennessee and West  Virginia were covered by collectivebargaining contracts. Collective bargaining agreements covering 560 of theseemployees (2.5% of all our employees) have expired or will expire in 2006 andare, or will be, subject to renegotiation with the unions.

**Federal andState Regulatory Oversight**

     Thehealthcare industry is extensively regulated. In the ordinary course ofbusiness, our operations are continuously subject to federal, state and localregulatory scrutiny, supervision and control. This often includes inquiries,investigations, examinations, audits, site visits and surveys, some of whichare non-routine. Various laws, including anti-kickback, anti-fraud and abuse provisionscodified under the Social Security Act, prohibit certain business practices andrelationships that might affect the provision and cost of healthcare servicesreimbursable under Medicare and Medicaid, as more fully described below.Sanctions for violating these anti-kickback, anti-fraud and abuse provisionsinclude criminal penalties, civil sanctions, fines and possible exclusion fromgovernment programs such as Medicare and Medicaid. If a facility is decertifiedby CMS or a state as a Medicare or Medicaid provider, the facility will notthereafter be reimbursed for caring for residents that are covered by Medicareand Medicaid, and the facility would be forced to care for such residentswithout being reimbursed or to transfer such residents. See Item 7 - "Management'sDiscussion and Analysis of Financial Condition and Results of Operations -Revenues from Medicare, Medicaid and Other Sources" for a discussion ofour Medicare and Medicaid revenues and how changes and proposed changes in suchprograms are expected to affect those revenues.

     Ourskilled nursing facilities and hospital facilities are currently licensed underapplicable state law, and are certified or approved as providers under theMedicare and Medicaid programs. State and local agencies survey all skillednursing facilities on a regular basis to determine whether such facilities arein compliance with governmental operating and health standards and conditionsfor participation in government sponsored third‐party payor programs. Fromtime to time, we receive notice of noncompliance with various requirements forMedicare/Medicaid participation or state licensure. We review such notices forfactual correctness, and based on such reviews, either take appropriatecorrective action and/or challenge the stated basis for the allegation ofnoncompliance. Where corrective action is required, we work with the reviewingagency to create mutually agreeable measures to be taken to bring the facilityor service provider into compliance. Under certain circumstances, the federaland state agencies have the authority to take adverse actions against a facilityor service provider, including the imposition of monetary fines, bans onadmissions, civil monetary penalties and the 

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

decertification of a facility or providerfrom participation in the Medicare and/or Medicaid programs or licensurerevocation. When appropriate, we vigorously contest such sanctions. Challengingand appealing notices or allegations of noncompliance can require significantlegal expenses and management attention.** **

     Variousstates in which we operate facilities have established minimum staffingrequirements or may establish minimum staffing requirements in the future. Ourability to satisfy such staffing requirements depends upon our ability toattract and retain qualified healthcare professionals, including nurses,certified nurse's assistants and other staff. Failure to comply with suchminimum staffing requirements may result in the imposition of fines or othersanctions.

     Moststates in which we operate have statutes which require that, prior to theaddition or construction of new nursing home beds, the addition of new servicesor certain capital expenditures in excess of defined levels, we first mustobtain a Certificate of Need, or CON, which certifies that the state has made adetermination that a need exists for such new or additional beds, new servicesor capital expenditures. The certification process is intended to promotequality health care at the lowest possible cost and to avoid the unnecessaryduplication of services, equipment and facilities.

     Weare subject to federal and state laws that govern financial and otherarrangements between healthcare providers. These laws often prohibit certaindirect and indirect payments or fee-splitting arrangements between healthcareproviders that are designed to induce the referral of patients to, or therecommendation of, a particular provider for medical products and services.These laws include:
| -      | the "anti-kickback"  provisions of the Medicare and Medicaid programs, which prohibit, among other  things, knowingly and willfully soliciting, receiving, offering or paying any  remuneration (including any kickback, bribe or rebate) directly or indirectly  in return for or to induce the referral of an 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 home health services, physical  therapy and occupational therapy, to an entity in which the physician has a  financial interest.                                                                                                                                                                                                                                  |

     Falseclaims are prohibited pursuant to criminal and civil statutes. Criminalprovisions prohibit filing false claims or making false statements to receivepayment or certification under Medicare or Medicaid or failing to refundoverpayments or improper payments. Civil provisions prohibit the knowing filingof a false claim or the knowing use of false statements to obtain payment.Suits alleging false claims can be brought by individuals, including employeesand competitors.

     Weare also subject to regulations under the privacy and security provisions ofthe Health Insurance Portability and Accountability Act of 1996 ("HIPAA").The privacy rules provide for, among other things, (i) giving consumersthe right and control over the release of their medical information,(ii) the establishment of boundaries for the use of medical information,and (iii) civil or criminal penalties for violation of an individual'sprivacy rights. 

     Theseprivacy regulations apply to "protected health information," which isdefined generally as individually identifiable health information transmittedor maintained in any form or medium, excluding certain education records andstudent medical records. The privacy regulations limit a provider's use anddisclosure of most paper, oral and electronic communications regarding apatient's past, present or future physical or mental health or condition, orrelating to the provision of healthcare to the patient or payment for thathealthcare.

     The security regulationsrequire us to ensure the confidentiality, integrity, and availability of allelectronic protected health information that we create, receive, maintain ortransmit. We must protect against reasonably 

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

anticipated threats or hazards to the security of suchinformation and the unauthorized use or disclosure of such information.** **

**Corporate Integrity Agreement, Permanent Injunction andCompliance Process**

* *     ThePredecessor Company entered into aCorporate Integrity Agreement (the "CIA") with the Health and HumanServices/Office of Inspector General ("HHS/OIG") in July 2001and it became effective on February 28, 2002. It implemented furtherinternal controls with respect to our quality of care standards and Medicareand Medicaid billing, reporting and claims submission processes and engaged anindependent third party to act as Quality Monitor and Independent ReviewOrganization under the CIA. A breach of the CIA could subject us to substantialmonetary penalties and exclusion from participation in Medicare and Medicaidprograms.

* *     ThePredecessor Companyalso consented to the terms of a Permanent Injunction and Final Judgmententered in California state court on October 3, 2001, and we consented to a revised Permanent Injunction and FinalJudgment entered on September 14, 2005 ("PIFJ"). The PIFJ,which resulted from investigations by the Bureau of Medi-Cal Fraud and ElderAbuse (the "BMFEA") of the Office of the California Attorney Generaland applies to our California facilities, requires compliance with certain clinicalpractices which are substantially consistent with existing law and our currentpractices, and imposes staffing requirements and specific training obligations.The PIFJ also requires us to issue to the State of California reports similar to those delivered to the HHS/OIG pursuant to the CIA.A breach of the PIFJ could subject us to substantial monetary penalties.

     Ourcompliance program, referred to as the "Compliance Process," wasinitiated in 1996. It has evolved as the requirements of federal and privatehealthcare programs have changed. Significant refinements were initiated in2001 to parallel requirements of the HHS/OIG compliance guidelines, the CIA,and the PIFJ. There are seven principal elements to the Compliance Process,which integrate the CIA and PIFJ requirements:

     *WrittenPolicies, Procedures and Standards of Conduct.*  Our business lines haveextensive policies and procedures ("P&Ps") modeled afterapplicable laws, regulations, government manuals and industry practices andcustoms. The P&Ps govern the clinical, reimbursement, and operationalaspects of each subsidiary. To emphasize adherence to our P&Ps, we publishand distribute a Code of Conduct and an employee handbook.

     *DesignatedCompliance Officer and Compliance Committee.*  We have a CorporateCompliance Officer whose responsibilities include, among other things:(i) overseeing the Compliance Process; (ii) overseeing compliancewith the CIA, PIFJ, and functioning as the liaison with the external monitorsand federal government on matters related to the Compliance Process, CIA, andPIFJ; (iii) reporting to the Board of Directors, the Compliance Committeeof the Board of Directors, and senior corporate managers on the status of theCompliance Process; and (iv) overseeing the coordination of acomprehensive training program which focuses on the elements of the ComplianceProcess and employee background screening process. We also maintain a CorporateCompliance Committee, which includes the Chief Executive Officer, Chief FinancialOfficer, General Counsel, Chief Operating Officer of our operatingsubsidiaries, Senior Vice President of Human Resources, and the CorporateCompliance Officer. This Committee meets regularly to discuss compliance‐relatedissues. Compliance matters are also reported to the Compliance Committee of theBoard of Directors on a regular basis. The Compliance Committee is comprisedsolely of independent directors.

     *EffectiveTraining and Education.*  Every employee, director and officer istrained on the Compliance Process, Code of Conduct, and CIA. All California administrators are trained on the PIFJ, as required. Training alsooccurs for appropriate employees in applicable provisions of the Medicare andMedicaid laws, fraud and abuse prevention, clinical standards, and practices,and claim submission and reimbursement P&Ps.

     *EffectiveLines of Communication.*  Employees are encouraged to report issuesof concern without fear of retaliation using a Four Step Reporting Process,which includes the toll-free "Sun Quality Line." The Four Step 

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES **

Reporting Process encouragesemployees to discuss clinical, ethical, or financial concerns with supervisorsand local management since these individuals will be most familiar with thelaws, regulations, and policies that impact theirconcern. The Sun Quality Line is an always-available option that may beused for anonymous reporting if the employee so chooses. Reported concerns areinternally reviewed and proper follow-up is conducted.

     *InternalMonitoring and Auditing.*  Our Compliance Process, in accordance withthe CIA, puts internal controls in place to meet the following objectiveseffectively: (i) accuracy of claims, reimbursement submissions, costreports and source documents; (ii) provision of patient care, services,and supplies as required by applicable standards and laws; (iii) accuracyof clinical assessment and treatment documentation; and (iv) implementationof the CIA and PIFJ (e.g., background checks, licensing and training). Eachbusiness line monitors and audits compliance with P&Ps and other standardsto ensure that the objectives listed above are met. Data from these internalmonitoring and auditing systems are analyzed and acted upon through a qualityimprovement process. We have designated the subsidiary presidents and eachmember of the operations management team as Compliance Liaisons. EachCompliance Liaison is responsible for making certain that all requirements ofthe Compliance Process are completed at the operational level for which the ComplianceLiaison is responsible.

     *Enforcementof Standards.*  Our policies, the Code of Conduct and the employeehandbook as well as all associated training materials clearly indicate thatemployees who violate our standards will be subjected to discipline. Sanctionsrange from oral warnings to suspensions and/or to termination of employment. Wehave also adopted a proactive approach to offset the need for punitivemeasures. First, we have implemented employee background review practices thatsurpass industry standards. Second, as noted above, we devote significantresources to employee training. Finally, we have adopted a performancemanagement program intended to make certain that all employees are aware ofwhat duties are expected of them and understand that compliance with policies,procedures, standards and laws related to job functions is required.

     *Responsesto Detected Offenses and Development of Corrective Actions.*  Correctionof detected misconduct or a violation of our policies is the responsibility ofevery manager. As appropriate, a manager is expected to develop and implementcorrective action plans and monitor whether such actions are likely to keep asimilar violation from occurring in the future.

**GeneralInformation**

     SunHealthcare Group, Inc. was incorporated in 1993.  Our principal executiveoffices are located at 18831 Von Karman, Suite 400, Irvine, CA 92612, and ourtelephone number is (949) 255-7100.  We maintain a website at www.sunh.com. Through the "About Our Company," "Investor Information" and"SEC Filings" links on our website, we make available free of charge,as soon as reasonably practicable after such information has been filed orfurnished to the SEC, each of our filings with the SEC, including our annualreport on Form 10-K, quarterly reports on Form 10-Q, current reports on Form8-K, and amendments to those reports filed or furnished pursuant to Section13(a) or 15(d) of the Securities Exchange Act.

**Item 1A. RiskFactors**

** **     Informationprovided in this Annual Report on Form 10-K ("Annual Report") contains"forward-looking" information as that term is defined by the Private SecuritiesLitigation Reform Act of 1995 (the "Act").  All statements regarding ourexpected future financial position, results of operations, cash flows,liquidity, financing plans, business strategy, budgets, the impact of changes ingovernment reimbursement programs, projected costs and capital expenditures,competitive position, growth opportunities, plans and objectives of managementfor future operations and words such as "anticipate," "believe," "plan,""estimate," "expect," "intend," "may" and other similar expressions areforward-looking statements.  The forward-looking statements are qualifiedin their entirety by these cautionary statements, which are being made pursuantto the provisions of the Act and with the intention of obtaining the benefits ofthe "safe harbor" provisions of the Act.  We caution 

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

investors that any forward-looking statementsmade by us are not guarantees of future performance and that actual results maydiffer materially from those in the forward-looking statements as a result ofvarious factors, including, but not limited to, those set forth belowand elsewhere herein.  We do not intend, and undertake no obligation, to updateour forward-looking statements to reflect future events or circumstances.

     Forward-lookingstatements involve known and unknown risks and uncertainties that may cause ouractual results in future periods to differ materially from those projected orcontemplated in the forward-looking statements as a result of, but not limitedto, the factors set forth below. You should carefully consider the risksdescribed herein. There may be additional risks of which we are presentlyunaware or that we currently deem immaterial.

*Reductions in the reimbursement rates paid by Medicare and Medicaidagencies, and adverse changes in our payor mix could reduce our net earnings,and future reform legislation may directly impact our business.*

     Forthe year ended December 31, 2005, we derived 78.3% of our inpatientrevenues from continuing operations (including Peak for the month of December)from Medicare and Medicaid. Federal and state governments continue to focus onmethods to curb spending on health care programs such as Medicare and Medicaid,and have implemented or proposed to implement changes that will or couldadversely affect our reimbursements. For example, among other things,(i) two temporary add-on payments wereeliminated, the number of resource utilization group ("RUG")categories was increased from 44 to 53, and the nursing case-mix weight for all53 RUG categories was increased; (ii) "therapy caps" were implementedto limit the amount of Medicare Part B reimbursement we receive for providingrehabilitation therapy, and an exceptions process for Medicare beneficiarieswho require medically necessary services in excess of the therapy caps wasdeveloped; (iii) Medicaid coverage of prescription drugs for Medicarebeneficiaries who are also eligible for Medicaid, referred to as "dualeligibles", was shifted to the new Part D Medicare program; and (iv)President Bush's budget proposal for the federal fiscal year beginning October1, 2006 contains changes that, if enacted as proposed, would materiallyadversely affect our skilled nursing facilities.  See Item 7 - "Management's Discussion and Analysis of FinancialCondition and Results of Operations - Revenues from Medicare, Medicaid andOther Sources" for a discussion of these changes and other changes to ourMedicare and Medicaid reimbursements.

     Inaddition, the amount of our revenues isdetermined by a number of factors, including the mix of residents and patientsand the rates of reimbursement among payors. Changes in the case mix of theresidents and patients as well as payor mix among private pay, Medicare andMedicaid can affect our profitability. For instance, a significant increase inour Medicaid population could have a material adverse effect on our financialposition, results of operations and cash flow, especially if states operatingthese programs continue to limit, or more aggressively seek limits on, reimbursementrates.

     Inrecent years, there have been numerous initiatives on the federal and statelevels for comprehensive reforms affecting the payment for and availability ofhealthcare services. There can be no assurance as to the ultimate content,timing or effect of any healthcare reform legislation, nor is it possible atthis time to estimate the impact of potential legislation on us. That impactmay have an adverse effect on our financial condition and results ofoperations. 

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

** **     Skillednursing facility operators, including SunBridge and our other inpatient servicessubsidiaries, are subject to lawsuits alleging negligence resulting in injury ordeath to residents of the facilities. We currently have numerous patient carelawsuits pending against us, as well as other types of lawsuits, many of whichrelate to facilities that we no longer operate. Adverse determinations in legalproceedings, whether currently asserted or 

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

arising in the future, could have a materialadverse effect on our financial position, results of operations or cash flows.See Item 3 - "Legal Proceedings."

** **     Weself-insure for the majority of our insurable risks, including general andprofessional liability, workers' compensation liability and employee healthinsurance liability, through the use of self-insurance or retrospective andself-funded insurance policies and other hybrid policies, which vary by thestates in which we operate. Since January 2000, we have relied uponself-funded insurance programs for general and professional liability claims upto a base amount per claim and an aggregate per location, which amounts we areresponsible for funding, and we have obtained excess insurance policies forclaims above those amounts. The programs have the following coverages that weare responsible for self-funding: (i) for events occurring fromJanuary 1, 2000 to December 31, 2002, $1.0 million per claim,and $3.0 million aggregate per location; (ii) for claims made in 2003,$10.0 million per claim; and (iii) for claims made in 2004, 2005 and2006, $10.0 million per claim, with a single $5.0 million excess layerthat attaches at $5.0 million of liability. There is a risk that the amountsfunded to our programs of self-insurance and future cash flows may not besufficient to respond to all claims asserted under those programs.

     AtDecember 31, 2005, we had recorded reserves of $86.5 million forgeneral and professional liability risks, but we had only pre-funded $3.6 millionfor such claims. We can give no assurances that a claim in excess of ourinsurance coverage limits will not arise. A claim against us that is notcovered by, or is in excess of, our coverage limits provided by our excessinsurance policies could have a material adverse effect upon us. Furthermore,we cannot give assurance that we will be able to obtain additional adequateliability insurance in the future or that, if such insurance is available, itwill be available on acceptable terms.

*Our healthcare operations are extensively regulated and adversedeterminations against us could result in severe penalties, including loss oflicensure and decertification.*

     Inthe ordinary course of business, we are continuously subject to a wide varietyof federal, state and local laws and regulations and to state and federalregulatory scrutiny, supervision and control in various areas, includingreferral of patients, false claims under Medicare and Medicaid, health andsafety laws and the protection of health information. Such regulatory scrutinyoften includes inquiries, civil and criminal investigations, examinations,audits, site visits and surveys, some of which are non-routine. See Item 1 - "Business- Federal and State Regulatory Oversight" and Item 3 - "LegalProceedings." If we are found to have engaged in improper practices, wecould be subject to civil, administrative or criminal fines, penalties orrestitutionary relief or corporate settlement agreements with federal, state orlocal authorities, and reimbursement authorities could also seek our suspensionor exclusion from participation in their program. The exclusion of a facilityfrom participating in Medicare or Medicaid could have a material adverse effecton our financial position, results of operations and cash flows. 

*We have in the past sustained losses, and may not be able to maintainprofitability or generate sufficient operating cash flow to fund ouroperations.*

     Althoughwe reported net income of $24.8 million for the year ended December 31, 2005, we incurred net losses of $18.6 million for the year ended December 31, 2004. Since emerging from bankruptcy in 2002 and until recently, ouroperations have not generated sufficient cash flow to operate our businesses,and, as a result, we funded operations through a combination of the proceeds ofequity offerings and borrowings under a revolving credit facility. We generatedpositive cash flow from operations during the second half of 2005 and we anticipate positivecash flow from operations for 2006.

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

** **     Thehealthcare industry is highly competitive and subject to continual changes inthe method by which services are provided and the types of companies providingservices. Our ability to compete successfully varies from location to locationdepending on a number of factors, including the number of competing facilitiesin the local 

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

market, thetypes of services available, quality of care, reputation, age and appearance ofeach facility and the cost of care in each locality. In addition, competitionwith other providers of rehabilitation therapy services has constrained ourability to pass through increases in costs of providing such services. 

*We may not be able to successfully identify, complete and integratefuture acquisitions, which could harm our profitability.*

     Ourstrategy includes expanding through strategic acquisitions. Successfulacquisitions require us to correctly identify appropriate acquisitioncandidates and to integrate acquired operations with our own, and a failure ineither of those tasks would likely result in our inability to realize thebenefits we intended to derive from the acquisition. Even if we identifysuitable targets, we may be unable to complete acquisitions on terms favorableto us or obtain the necessary financing for these acquisitions. Further, to theextent we complete acquisitions and expansion initiatives,  we may be unable to realize the anticipated benefits fromacquisitions and expansions because of operational factors or difficulty inintegrating the acquisition or expansion with our existing business.Acquisitions may also divert our management from operating our existingbusiness. We can give no assurance that we will be able successfully toidentify, complete, and integrate strategic acquisitions.

     Also,we are generally required to obtain regulatory approval from one or more stateagencies when making acquisitions. In the case of an acquisition of a businesslocated in a state in which we do not already operate, we are required toobtain the necessary licenses to operate in that state. In addition, althoughwe may already operate in a state in which we acquire a new business, we willbe required to obtain regulatory approval if, as a result of the acquisition,we will operate in an area of the state in which we did not operate previously.We may be unable to comply with these regulatory requirements for anacquisition in a timely manner, or at all.

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

     We,and other providers in the long-term care industry, have had and continue tohave difficulties in retaining qualified personnel to staff our long-term carefacilities, particularly nurses, and in such situations we may be required touse temporary employment agencies to provide additional personnel. The laborcosts are generally higher for temporary employees than for full-timeemployees. In addition, many states in which we operate have increased minimumstaffing standards. As minimum staffing standards are increased, we may berequired to retain additional staffing. In addition, in recent years we haveexperienced increases in our labor costs primarily due to higher wages andgreater benefits required to attract and retain qualified personnel and toincrease staffing levels in our long-term and subacute care facilities.

     Asimilar situation exists in the rehabilitation therapy industry. We, and otherproviders, have had and continue to have difficulties in hiring a sufficientnumber of rehabilitation therapists. Under these circumstances, we and othersin this industry have been required to offer higher compensation to attract andretain these personnel, and we have been forced to rely on independentcontractors, at higher costs, to fulfill our contractual commitments with ourcustomers. Existing contractual commitments, regulatory limitations and themarket for these services have made it difficult for us to pass through theseincreased costs to our customers. Although we have undertaken strategic andstructural initiatives to address these issues, if these initiatives areunsuccessful, our financial condition, results of operations and cash flowscould be adversely affected.

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

     Our future success depends inlarge part upon the leadership and performance of our executive management team,particularly Richard K. Matros, our chief executive officer, and key employeesat the operating level. If we lose the services of one or more of our executiveofficers or key employees, or if one or more of them decides to

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

join a competitor or otherwisecompete directly or indirectly with us, we may not be able to successfullymanage our business or achieve our business objectives. If we lose the servicesof any of our key employees at the operating or regional level, we may not beable to replace them with similarly qualified personnel, which could harm ourbusiness.

*As a result of our acquisition of Peak, certain of Peak's formerstockholders may have substantial influence over us. *

     Asa result of our acquisition of Peak, RFE Investment Partners V. L.P. and RFE VISBIC, L.P. (collectively, "RFE") and DFW Capital Partners, L.P. ("DFW")have substantial ownership interests in our company. RFE and DFW beneficiallyown 19.0% and 6.8%, respectively, of our common stock. In addition, RFE and DFWhave each nominated one of our current directors. So long as RFE, on the onehand, or DFW, on the other hand, owns at least 50% of the shares of our commonstock it acquired in the Peak acquisition, RFE or DFW, as the case may be, willhave the right to nominate successors to its nominee to our Board of Directors.Thus, RFE and DFW, as stockholders, may have the ability to influence ourstrategic direction and may be able to influence the outcome of all matters,transactions and corporate actions that require approval by our stockholders,other than the election of directors (except for the nominees of RFE and DFW),as to which they have agreed to vote their shares of our common stock in thesame proportion as our other stockholders. The interests of RFE and DFW may notalways coincide with our interests or the interests of other stockholders. Thisconcentration of stock ownership may also have the effect of delaying,preventing or deterring a change in control of our company, which could depriveour stockholders of an opportunity to receive a premium for their common stockas part of a sale of our company and might adversely affect the market price ofour common stock. In addition, this concentration of stock ownership mayadversely affect the market price of our common stock because investors may perceivedisadvantages in owning stock in a company with significant stockholders.

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

     Weare currently prohibited by the terms of our Amended and Restated Loan andSecurity Agreement dated December 2, 2005 (the "Revolving Loan Agreement")from paying dividends to holders of our common stock, and do not anticipatethat we will pay any dividends to holders of our common stock in theforeseeable future. Accordingly, investors must rely on sales of their commonstock after price appreciation, which may never occur, as the only way torealize any future gains on their investment. Investors seeking cash dividendsshould not purchase our common stock. 

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

** **     Weare subject to the anti-takeover provisions of Section 203 of the DelawareGeneral Corporation Law. This section prevents any stockholder who owns 15% ormore of our outstanding common stock from engaging in certain businesscombinations with us for a period of three years following the time that thestockholder acquired such stock ownership unless certain approvals were or areobtained from our Board of Directors or the holders of 66-2/3%of our outstanding common stock. Our Restated Certificate of Incorporation andAmended and Restated Bylaws also contain several other provisions that may makeit more difficult for a third party to acquire control of us without theapproval of our Board of Directors. These provisions include, among otherthings, (i) advance notice for raising business or making nominations atmeetings, (ii) an affirmative vote of the holders of 66-2/3% of our outstandingcommon stock for stockholders to remove directors or amend our Amended andRestated Bylaws or certain provisions of our Restated Certificate ofIncorporation, and (iii) the ability to issue "blank check" preferred stock,which our Board of Directors, without stockholder approval, can designate andissue with such dividend, liquidation, conversion, voting or other rights,including the right to issue convertible securities with no limitations onconversion. The issuance of blank check preferred stock may adversely affect thevoting and other rights of the 

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

holders of our common stockas our Board of Directors may designate and issue preferred stock with termsthat are senior to our common stock.

     OurBoard of Directors can use these and other provisions to discourage, delay orprevent a change in the control of our company or a change in our management.Any delay or prevention of a change of control transaction or a change in ourBoard of Directors or management could deter potential acquirors or prevent thecompletion of a transaction in which our stockholders could receive asubstantial premium over the then current market price for their shares. Theseprovisions could also limit the price that investors might be willing to payfor shares of our common stock.

**Item1B.  Unresolved Staff Comments**

**     **Not applicable.

**Item2.  Properties**

**Inpatient Services**

     Asof March 1, 2006, we operated 158 long-term care, subacute care, assistedliving and independent living facilities, of which 56 were acquired inconnection with the Peak transaction. The 158 facilities are comprised of 118 properties that are leased, 30 properties that are ownedand 10 properties that are managed. We hold options to acquire, at fair value orat a set purchase price, ownership of 22 ofthe facilities that we currently lease. We also leased office space foradministrative purposes in three locations in three states. We consider ourproperties in general to be in good operating condition and suitable for thepurposes for which they are being used. Our facilities that are leased aresubject to long-term operating leases or subleases which require us, amongother things, to fund all applicable capital expenditures, taxes, insurance andmaintenance costs. Our facilities that are owned are subject to mortgagefinancing. The annual rent payable under most of the leases generally increasesbased on a fixed percentage or increases in the U.S. Consumer Price Index. Manyof the leases contain renewal options to extend the term.

     Ouraggregate occupancy percentages for all of our long-term care, subacute careand assisted living facilities in the United States, on a same store basis(excluding the Peak facilities), were 90.0%, 90.6% and 89.7% for the yearsended December 31, 2005, 2004 and 2003, respectively. The percentages werecomputed by dividing the average daily number of beds occupied by the totalnumber of available beds for use during the periods indicated. However, we believethat occupancy percentages, either individually or in the aggregate, should notbe relied upon alone to determine the performance of a facility. Other factorsinclude, among other things, the sources of payment, terms of reimbursement andthe acuity level of the patients.

     Thefollowing table sets forth certain information concerning the 158 facilitiesthat we operated as of March 1, 2006, which consisted of 134  skillednursing facilities (10 of which are managed), 14 assisted living and independent living facilities,  seven mental health facilities, and threespecialty acute care hospitals.

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**
| ** **     | ** **                                                                             | ** **                                                          | **                       Number  of Beds/Units(1)                    ** |
|----------------|----------------------------------------------------------------------------------------|---------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **State**      | **Total  Number of  LicensedBeds/Units(1)**                                            | **Total  Number of  Facilities  **              | **SkilledNursing**                                                                                                                                                                                                                                                                             | **Assisted  Living  ** | **Independent  and Senior     Living     ** | **Mental  Health  ** | **Specialty  Acute   Care   ** |
| New Mexico     | 1,967                                                                                  | 22                                                                  | 1,807                                                                                                                                                                                                                                                                                          | 100 | 60 | - | - |
| Oklahoma       | 1,747                                                                                  | 12                                                                  | 1,420                                                                                                                                                                                                                                                                                          | 182 | 85 | 60 | - |
| California     | 1,677                                                                                  | 20                                                                  | 1,034                                                                                                                                                                                                                                                                                          | - | - | 473 | 170 |
| Colorado       | 1,276                                                                                  | 9                                                                   | 1,179                                                                                                                                                                                                                                                                                          | - | 97 | - | - |
| Idaho          | 1,201                                                                                  | 11                                                                  | 1,179                                                                                                                                                                                                                                                                                          | - | - | - | 22 |
| Georgia        | 1,097                                                                                  | 10                                                                  | 1,065                                                                                                                                                                                                                                                                                          | 32 | - | - | - |
| New Hampshire  | 1,068                                                                                  | 9                                                                   | 865                                                                                                                                                                                                                                                                                            | 203 | - | - | - |
| 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     | 608                                                                                    | 7                                                                   | 552                                                                                                                                                                                                                                                                                            | 56 | - | - | - |
| Ohio           | 547                                                                                    | 5                                                                   | 547                                                                                                                                                                                                                                                                                            | - | - | - | - |
| Utah           | 231                                                                                    | 3                                                                   | 204                                                                                                                                                                                                                                                                                            | 27 | - | - | - |
| Maryland       | 177                                                                                    | 1                                                                   | 177                                                                                                                                                                                                                                                                                            | - | - | - | - |
| Arizona        | 161                                                                                    | 1                                                                   | 161                                                                                                                                                                                                                                                                                            | - | - | - | - |
| Wyoming        |               46 |            1 |             46                                                                                                                                                                                                                     |          - |               - |            - |            - |
| **Total**      | 16,910                                                                                 | 158                                                                 | 15,126                                                                                                                                                                                                                                                                                         | 802 | 257 | 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 158 facilities were 16,168.* |
|-------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

* ***RehabilitationTherapy Services**

* *     Asof March 1, 2006,we leased 33 office spaces and patient care deliverysites in 14 states, and five HTA offices to operate our rehabilitation therapybusinesses.

**Medical Staffing Services**

     As of March 1,2006, we leased office space in 34 locations in 17 states to operate ourCareerStaff medical staffing business.

**Home Health Services**

     Asof March 1, 2006, we leased office space in 23 locations in California andOhio to operate our SunPlus home health business.

**Laboratory and Radiology Services**

     Asof March 1, 2006, we leased 10 locations in Massachusetts to operate ourSunAlliance medical laboratory and mobile radiology business.

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**Corporate**

     We lease ourexecutive offices in Irvine, California and we own three corporate office buildings andlease office space in a fourth building in Albuquerque, New Mexico.

**Item3.  Legal Proceedings**

     OnJune 1, 2004, we commenced a declaratory relief action in theOrange County, California Superior Court in which Steadfast Insurance Company,American International Group, Inc. ("AIG") and certain of AIG'ssubsidiaries are parties. The action seeks, among other things, a judicialdetermination that the carrier providing coverage under our excess/umbrellainsurance policy for liability claims made by residents and patients for the2000 through 2002 policy years is obligated to provide first dollar insurancecoverage for those three policy years pursuant to the terms of theexcess/umbrella policy. That policy provides that the excess/umbrella policycontinues in force as underlying insurance upon exhaustion of the underlyingprimary insurance policy. Trial is currently scheduled to commence on August 28, 2006.If we prevail in this action, such a judicial determination would eliminate aportion of our self-insured liabilities for general and professional liabilityclaims and/or require the carrier to reimburse us for certain amounts that wehave paid to dispose of such claims. We can give no assurances that we will infact prevail.

     InSeptember 2005, we resolved allegations by the Bureau of Medi-Cal Fraud andElder Abuse, a division of the Office of the Attorney General of the State ofCalifornia, that we violated the terms of the Permanent Injunction and FinalJudgment entered in October 2001. The alleged violations includedallegations of inadequate staffing, training and supervision at our California inpatient facilities. The resolution of these allegations resulted inthe PIFJ. Among other things, the PIFJ states that it does not constitute afinding of any violation of law. It requires adherence by our facilities inCalifornia to certain clinical practices specified in the PIFJ (such practicesare substantially consistent with existing law and our current practices) and tostaffing requirements, and the payment of $2.5 million over a two yearperiod commencing in October 2005. The requirements set forth in the PIFJwill not materially change our operating costs or the manner in which weoperate.

     Weare a party to various other legal actions and administrative proceedings andare subject to various claims arising in the ordinary course of our business,including claims that our services have resulted in injury or death to theresidents of our facilities, claims relating to employment and commercialmatters. Although we intend to vigorously defend ourselves in these matters,there can be no assurance that the outcomes of these matters will not have amaterial adverse effect on our results of operations and financial condition.In certain states in which we have or have had operations, insurance coverage forthe risk of punitive damages arising from general and professional liabilitylitigation may not be available due to state law public policy prohibitions.There can be no assurance that we will not be liable for punitive damagesawarded in litigation arising in states for which punitive damage insurancecoverage is not available.

     Weoperate in industries that are extensively regulated. As such, in the ordinarycourse of business, we are continuously subject to state and federal regulatoryscrutiny, supervision and control. Such regulatory scrutiny often includesinquiries, investigations, examinations, audits, site visits and surveys, someof which are non-routine. In addition to being subject to direct regulatoryoversight of state and federal regulatory agencies, these industries arefrequently subject to the regulatory supervision of fiscal intermediaries. If aprovider is found by a court of competent jurisdiction to have engaged inimproper practices, it could be subject to civil, administrative or criminalfines, penalties or restitutionary relief, and reimbursement authorities couldalso seek the suspension or exclusion of the provider or individual fromparticipation in their program. We believe that there has been, and willcontinue to be, an increase in governmental investigations of long-term careproviders, particularly in the area of Medicare/Medicaid false claims, as wellas an increase in enforcement actions resulting from these investigations.Adverse determinations in legal proceedings or governmental investigations,whether currently asserted or arising in the future, could have a materialadverse effect on our financial position, results of operations and cash flows.

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** Item4.  Submission of Matters to a Vote of Security Holders**

(a)   Aspecial meeting of our stockholders was held on October 31, 2005.

(b)   Not applicable.

(c)   The matter voted upon at the meetingand the results are as follows:
| 1.     | Approval of the issuance of up to 8,975,724 shares of our  common stock in connection with the acquisition of Peak. |
|--------|---------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                |
|       For       |     Against     |     Abstain     |
|-----------------------------------------------------------------------------|---------------------------------------------------------|---------------------------------------------------------|
| 9,303,240                                                                   | 190,517                                                 | 15,844                                                  |

(d)   Not applicable.

18

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**PART II**

**Item5.  Market for Registrant's Common Equity, Related StockholderMatters and Issuer Purchases of Equity Securities**

     Webegan issuing our common stock on February 28, 2002 as part of our Plan ofReorganization.  Our common stock began trading under the symbol "SUHG.OB"on the Over-the-Counter ("OTC") Bulletin Board on April 2, 2002 andthen under the symbol "SUNH" on the Nasdaq National Market on March10, 2004.  The following table shows the high and low sale prices for thecommon stock as reported by the OTC Bulletin Board and the Nasdaq NationalMarket for the periods indicated:
|           | ** **                                              | **High**          | **Low**           |
|----------------|---------------------------------------------------------|-------------------|-------------------|
| **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 |
|           |                                                    |              |              |
|----------------|---------------------------------------------------------|-------------------|-------------------|
| **2004**       | ** **                                              | ** **        | ** **        |
| Fourth Quarter | . . . . . . . . . . . . . . . . . . . . . . . . . . . . | $  9.35 | $  6.76 |
| Third Quarter  | . . . . . . . . . . . . . . . . . . . . . . . . . . . . | $  9.88 | $  5.66 |
| Second Quarter | . . . . . . . . . . . . . . . . . . . . . . . . . . . . | $12.34            | $  5.03 |
| First Quarter  | . . . . . . . . . . . . . . . . . . . . . . . . . . . . | $14.30            | $  9.90 |

     Therewere 4,478 holders of record of our common stock as of March 1, 2006. We havenever paid nor declared any dividends on our common stock.  Our Revolving LoanAgreement prohibits us from paying any dividends or making any distributions toour stockholders. We did not repurchase any shares of our common stock duringthe fourth quarter of 2005.

**Item6.  Selected Financial Data**

     Thefollowing selected consolidated financial data for the periods indicated havebeen derived from our consolidated financial statements.  The financial dataset forth below should be read in connection with Item 7 - "Management's Discussionand Analysis of Financial Condition and Results of Operations" and withour consolidated financial statements and related notes thereto (in thousands,except per share data):

19

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

| ** **                         | **                                       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 Ten** | ** ** | ** ** | **The Two** | ** ** | **The Year** | ** ** |
| ** **                         | **Ended**                                                                                                                                                                                                                                                                                                                                                                                                                                                 | ** ** | **Ended**                                                                                                | ** **                                                                                                | **Ended**                                                                                                      | ** ** | **Months Ended** | ** ** | ** ** | **Months Ended** | ** ** | **Ended** | ** ** |
| ** **                         | **December 31,**                                                                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **December 31,**                                                                                         | ** **                                                                                                | **December 31,**                                                                                               | ** ** | **December 31,** | ** ** | ** ** | **February 28,** | ** ** | **December 31,** | ** ** |
| ** **                         | **2005(2)**                                                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **2004(3)**                                                                                              | ** **                                                                                                | **2003(4)**                                                                                                    | ** ** | **2002(5)** | ** ** | ** ** | **2002(6)** | ** ** | **2001(7)** | ** ** |
| Total net revenues                 | $       882,109                                                                                                                                                                                                                                                                                                                                                                                                        |            | $       813,290                                                       |                                                                                                           | $       778,438                                                             |  | $      636,061 |  | **|** | $         301,846 |  | $      2,075,234 |  |
| Income (loss) before income        |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
|   taxes and discontinued |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
|   operations             |             2,051                                                                                                                                                                                                                                                                                                                                                                             |       |            8,750                                  |                                                                                                           |         (29,481                                                        | ) |       (297,417 | ) | **|** |      1,493,157 |  |           (69,116 | ) |
| Income (loss) from                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
|   continuing  operations | 2,837                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            | 9,908                                                                                                    |                                                                                                           | (30,146                                                                                                        | ) | (297,410 | ) | **|** | 1,493,010 |  | (69,437 | ) |
| Income (loss) on  discontinued     |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                     |                                                                                                           |                                                                                                           |  |   |  | **|** |   |  |   |  |
|   operations             |           21,924                                                                                                                                                                                                                                                                                                                                                                                        |            |          (28,535                                            | )                                                                                                         |          30,500                                                   |  |        (140,576 | ) | **|** |            (7,639 | ) |                    - |   |
| Net income (loss)                  | $         24,761                                                                                                                                                                                                                                                                                                                                                                                             |            | $       (18,627                                                       | )                                                                                                         | $             354                             |  | $       (437,986 | ) | **|** | $      1,485,371 |  | $         (69,437 | ) |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | =========                                                                                                |                                                                                                           | =========                                                                                                      |  | ========== | ** ** | **|** | ========== |  | ========== |  |
| Basic earnings per                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  | ** ** | **|** |  |  |  |  |
|   common  and common     |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
|   equivalent  share:     |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
| Income (loss) from                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
|   continuing  operations | $            0.18                                                                                                                                                                                                                                                                                                                                                                             |            | $           0.69                                  |                                                                                                           | $            (3.00                                 | ) | $          (29.74 | ) | **|** | $            24.44 |  | $            (1.14 | ) |
| Income (loss) on  discontinued     |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
|   operations             |               1.37                                                                                                                                                                                                                                                                                                                                                                  |            |            (1.98                                  | )                                                                                                         |                3.04                 |  |             (14.06 | ) | **|** |               (0.12 | ) |                    - |  |
| Net income (loss)                  | $            1.55                                                                                                                                                                                                                                                                                                                                                                             |            | $          (1.29                                       | )                                                                                                         | $             0.04                            |  | $          (43.80 | ) | **|** | $            24.32 |  | $            (1.14 | ) |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | =========                                                                                                |                                                                                                           | ==========                                                                                                     |  | ========== | ** ** | **|** | ========== |  | ========== |  |
| Diluted earnings per common        |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  | ** ** | **|** |  |  |  |  |
|   and common equivalent  |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
|   share:                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
| Income (loss) from                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
|   continuing operations  | $            0.18                                                                                                                                                                                                                                                                                                                                                                             |            | $           0.68                                  |                                                                                                           | $             (3.00                           | ) | $          (29.74 | ) | **|** | $           24.44 |  | $            (1.14 | ) |
| Income (loss) on discontinued      |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  |  | **|** |  |  |  |  |
|   operations             |               1.37                                                                                                                                                                                                                                                                                                                                                                  |            |            (1.96                                  | )                                                                                                         |                3.04                 |  |             (14.06 | ) | **|** |              (0.12 | ) |                   - |  |
| Net income (loss)                  | $            1.55                                                                                                                                                                                                                                                                                                                                                                             |            | $          (1.28                                       | )                                                                                                         | $              0.04                      |  | $          (43.80 | ) | **|** | $           24.32 |  | $            (1.14 | ) |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | =========                                                                                                |                                                                                                           | ==========                                                                                                     |  | ========== | ** ** | **|** | ========== |  | ========== |  |
| Weighted average number of         |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  | ** ** | **|** |  |  |  |  |
|   common and common      |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  | ** ** | **|** |  |  |  |  |
|   equivalent shares:     |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  | ** ** | **|** |  |  |  |  |
|   Basic                  | 16,003                                                                                                                                                                                                                                                                                                                                                                                                                                                    |            | 14,456                                                                                                   |                                                                                                           | 10,050                                                                                                         |  | 10,000 | ** ** | **|** | 61,080 |  | 61,096 |  |
|   Diluted                | 16,019                                                                                                                                                                                                                                                                                                                                                                                                                                                    |            | 14,548                                                                                                   |                                                                                                           | 10,050                                                                                                         |  | 10,000 | ** ** | **|** | 61,080 |  | 61,096 |  |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | =========                                                                                                |                                                                                                           | ==========                                                                                                     |  | ========== | ** ** | **|** | ========== |  | ========== |  |
| Working (deficit) capital          | $         (66,825                                                                                                                                                                                                                                                                                                                                                                                            | )          | $        (30,595                                                 | )                                                                                                         | $         (57,377                                                 | ) | $       (66,412 | ) | **|** | $          69,762 |  | $         (13,259 | ) |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | =========                                                                                                |                                                                                                           | ==========                                                                                                     |  | ========== | ** ** | **|** | ========== |  | ========== |  |
| Total Assets                       | $        512,306                                                                                                                                                                                                                                                                                                                                                                                                  |            | $       313,153                                                       |                                                                                                           | $        300,398                                                       |  | $       475,835 | ** ** | **|** | $        828,416 |  | $        649,804 |  |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | =========                                                                                                |                                                                                                           | ==========                                                                                                     |  | ========== | ** ** | **|** | ========== |  | ========== |  |
| Liabilities subject to             |                                                                                                                                                                                                                                                                                                                                                                                                                                                           |            |                                                                                                          |                                                                                                           |                                                                                                                |  |  | ** ** | **|** |  |  |  |  |
|   compromise             | $                  -                                                                                                                                                                                                                                                                                                                                            |            | $                 - |                                                                                                           | $                  - |  | $                 - | ** ** | **|** | $                  - |  | $     1,549,139 |  |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | ==========                                                                                               |                                                                                                           | ==========                                                                                                     |  | ========== | ** ** | **|** | ========== |  | ========== |  |
| Long-term debt                     | $        186,575                                                                                                                                                                                                                                                                                                                                                                                                  |            | $       107,182                                                       |                                                                                                           | $          78,878                                            |  | $       196,223 | ** ** | **|** | $        190,146 |  | $         78,235 |  |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | ==========                                                                                               |                                                                                                           | ==========                                                                                                     |  | ========== | ** ** | **|** | ========== |  | ========== |  |
| Capital leases                     | $          11,204                                                                                                                                                                                                                                                                                                                                                                                       |            | $                 - |                                                                                                           | $                  - |  | $                 - | ** ** | **|** | $                  - |  | $                 - |  |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | ==========                                                                                               |                                                                                                           | ==========                                                                                                     |  | ========== | ** ** | **|** | ========== |  | ========== |  |
| Stockholders' (deficit) equity     | $          (2,895                                                                                                                                                                                                                                                                                                                                                                                       | )          | $       123,380                                                       | )                                                                                                         | $       (166,398                                                            | ) | $      (187,218 | **)** | **|** | $        237,600 |  | $    (1,602,290 | ) |
|                                    | ==========                                                                                                                                                                                                                                                                                                                                                                                                                                                |            | ==========                                                                                               |                                                                                                           | ==========                                                                                                     |  | ========== | ** ** | **|** | ========== |  | ========== |  |

20

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**SUN HEALTHCAREGROUP, 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, 2005 include revenues and expenses for Peak for the month of  December 2005 (See "Note 7 - Acquisitions"), 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 of $13.0 million from discontinued  operations 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.                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (3)    | 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, a net gain on extinguishment of debt of $3.4 million related  to mortgage restructurings, a loss of $23.2 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 Held for Sale" in our consolidated financial  statements).                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (4)    | 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 $25.1 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 Held for Sale" in our consolidated financial  statements). |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (5)    | Results for the ten month period  ended December 31, 2002 include a non-cash charge of $275.4 million  representing an impairment to our carrying values of goodwill and other  long-lived assets for continuing operations (See "Note 8 - Impairment of  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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

** **21

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |  determined not to be  integral to our core business operations and a loss of $140.6 million from  discontinued operations, of which $132.4 million relates to the impairment to  our carrying values of goodwill and other long-lived assets for discontinued  operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (6)    | 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.                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (7)    | Results for the year ended December 31, 2001 include a  non-cash charge of $18.8 million representing an impairment to our carrying  values of goodwill and other long-lived assets, a charge of $11.0 million due  to legal and regulatory matters, a $1.1 million charge related to  restructuring, a non-cash gain on sale of assets of $0.8 million and a $42.9  million charge for reorganization items due to our chapter 11 filings, which  included the losses for discontinued operations due to the prepetition  termination of 45 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'sDiscussion and Analysis of Financial Condition and Results of Operations**

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

**Overview**

     Weare a nationwide provider of long-term, subacute and related specialtyhealthcare services primarily to the senior population in the United States. Weoperate through various direct and indirect subsidiaries that engaged in thefollowing five principal business segments during 2005:
| -      | inpatient services, primarily skilled nursing  facilities; |
|--------|------------------------------------------------------------|
|   |                                                       |
|        |                                                            |
| -      | rehabilitation therapy services;                           |
|   |                                                       |
|        |                                                            |
| -      | medical staffing services;                                 |
|   |                                                       |
|        |                                                            |
| -      | home health services; and                                  |
|   |                                                       |
|        |                                                            |
| -      | laboratory and radiology services.                         |

** **     In February 2002, we emerged from Chapter 11bankruptcy proceedings pursuant to the terms of our Plan of Reorganization.During the bankruptcy proceedings, we divested our international operations andover 100 inpatient facilities. After the bankruptcy proceedings were concluded,our new management team determined that  

22

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

further significant restructuring ofour business was necessary in order to preserve and enhance shareholder value.Our restructuring was substantially completed in December 2004 and involved:(i) the renegotiation of the terms of our leases for skilled nursingfacilities resulting in an approximate 300 basis point reduction in leaseexpense as a percentage of net revenues; (ii) the divestiture of 137 poorperforming inpatient facilities; (iii) the sale of non-core assets, including ourpharmacy business, and (iv) the reduction of corporate overhead expense.

     Commencing in 2005, we implemented a business strategy to leverage ourexisting platform, and in August 2005 we acquired ProCare, a leadingprovider of specialized nurse staffing with approximately 800 nurses on itsroster.  In December 2005, we acquired Peak, an Albuquerque, New Mexico-basedoperator of 56 skilled nursing facilities and independent and assistedliving residences and a small hospice operation. These facilities are locatedin New Mexico, Oklahoma, Colorado, Montana, Idaho, Utah and Wyoming. We believe these acquisitions will provide us withcritical mass in new geographic markets, potential synergies from reduction inoverhead, improved purchasing discounts and revenue and margin growthopportunities.

     Wehave updated our historical financial statements to reflect the divestiture of  one skilled nursing facility and the sale of our Colorado andArizona mobile radiology services operations during the year ended December 31,2005. U.S. generally accepted accounting principles requirethat these operations be reclassified as discontinued operations on aretroactive basis. The financial information in this Annual Report reflectsthat reclassification for all periods since February 28, 2002.

**Revenues fromMedicare, Medicaid and Other Sources**

**Revenue Sources**

     Wereceive revenues from Medicare, Medicaid, private insurance, self-payresidents, other third party payors and long-term care facilities that utilizeour specialty medical services. The sources and amounts of our inpatientservices revenues are determined by a number of factors, including the numberof licensed beds and occupancy rates of our facilities, the acuity level ofpatients and the rates of reimbursement among payors. Federal and stategovernments continue to focus on methods to curb spending on health careprograms such as Medicare and Medicaid. This focus has not been limited toskilled nursing facilities, but includes other services provided by us, such astherapy services and home health services. We cannot at this time predict theextent to which these proposals will be adopted or, if adopted and implemented,what effect, if any, such proposals will have on us. Efforts to impose reducedcoverage, greater discounts and more stringent cost controls by government andother payors are expected to continue.

     Thefollowing table sets forth the total nonaffiliated revenues and percentage ofrevenues by payor source for our continuing operations, on a consolidated andon an inpatient operations only basis, for the periods indicated (includes Peakfor December 2005 only):

| * *              | **For the Year Ended**     |
|-----------------------|----------------------------|
| * *              | **December 31, 2005**      | **December 31, 2004** | **December 31, 2003** |
| * *              | **(dollars in thousands)** |
| *Consolidated:*       |                            |  |  |  |  |  |
| Sources of Revenues   |                            |  |  |  |  |  |
| Medicaid              | $  316,292       | 35.9% | $  296,677 | 36.5% | $  280,903 | 36.1% |
| Medicare              | 243,450                    | 27.6    | 215,000 | 26.4    | 195,259 | 25.1    |
| Private pay and other |    322,367  |     36.5    |    301,613 |     37.1    |    302,276 |     38.8    |
| Total                 | $  882,109       | 100.0% | $  813,290 | 100.0% | $  778,438 | 100.0% |
|                       | =======                    | ====== | ======= | ====== | ======= | ====== |

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

| * *               | **For the Year Ended**     |
|------------------------|----------------------------|
| * *               | **December 31, 2005**      | **December 31, 2004** | **December 31, 2003** |
| * *               | **(dollars in thousands)** |
| *Inpatient Only:*      |                            |  |  |  |  |  |
| Sources of Revenues    |                            |  |  |  |  |  |
| Medicaid               | $  303,403       | 47.7% | $  284,230 | 48.5% | $  267,752 | 48.9% |
| Medicare               | 194,507                    | 30.6    | 173,982 | 29.7    | 156,381 | 28.6    |
| Private  pay and other |    137,720  |     21.7    |    128,200 |    21.8    |    123,088 |    22.5    |
| Total                  | $  635,630       | 100.0% | $  586,413 | 100.0% | $  547,221 | 100.0% |
|                        | =======                    | ====== | ======= | ====== | ======= | ====== |

**Medicare**

     Medicareis available to nearly every United  States citizen 65 years of ageand older. It is a broad program of health insurance designed to help thenation's elderly meet hospital, hospice, home health and other health carecosts. Health insurance coverage extends to certain persons under age 65 whoqualify as disabled and those having end-stage renal disease. Medicare includesfour related health insurance programs: (i) inpatient hospital, skilledlong-term care, home healthcare and certain other types of healthcare services("Part A"); (ii) physicians' services, outpatient services and certainitems and services provided by medical suppliers ("Part B");(iii) a managed care option for beneficiaries who are entitled toPart A and enrolled in Part B ("Medicare Advantage" or "MedicarePart C"); and (iv) a new Medicare Part D ("Part D") benefitthat became effective on January 1, 2006 covering prescription drugs. TheMedicare program is currently administered by fiscal intermediaries (forPart A and some Part B services) carriers (for Part B) andproviders of prescription drug plans and Medicare Advantage plans (for Part D) underthe direction of CMS.

     Medicarereimburses our skilled nursing facilities under a prospective payment system ("PPS")for inpatient Medicare Part A covered services. PPS wasadopted pursuant to the Balanced Budget Act of 1997 (the "1997 Act").Under PPS, facilities are paid a predetermined amount perpatient, per day, based on the anticipated costs of treating patients. Theamount to be paid is determined by classifying each patient into one of 53resource utilization group ("RUG") categories that are based uponeach patient's acuity level.

     Thenursing home industry came under financial pressure as a result of theimplementation of PPS and other 1997 Act provisions. As a result, infiscal years 1999 and 2000 Congress implemented four temporary add-on paymentsto restore some of the Medicare funding to skilled nursing facilities and otherhealthcare providers that was eliminated by the 1997 Act. Two of the temporaryadd-on payments expired in 2002 and the remaining two temporary add-on paymentsexpired on January 1, 2006. The uncertainty surrounding the dates on whichthe add-on payments would expire made financial predictability difficult. Theremoval of the uncertainty regarding these payments will allow us to moreaccurately project our revenues.

     Thefollowing table sets forth the average amounts of inpatient MedicarePart A revenues per patient, per day, recorded by our skilled nursing ("SNF")and hospital facilities for the periods indicated (includes Peak for December2005 only):

|          | **For the Year Ended              December  31,               ** |
|----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          | **   2005  **                                                                                                                                                                            | **   2004   ** | **   2003  ** |
| SNF      | $    325.61                                                                                                                                                                                   | $   314.77 | $  301.61 |
| Hospital | $ 1,063.24                                                                                                                                                                                                   | $1,045.03 | $  910.80 |

     Thefollowing changes have been implemented, are scheduled to be implemented, orare proposed to be implemented in the near future and will, if implemented,affect Medicare reimbursement and, as a result, our revenues and earnings.

24

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

***Skilled nursingfacilities***
| -      | CMS  issued a 2.8% market basket increase effective with the 2005 Federal fiscal  year beginning October 1, 2004, which, when taken into consideration  with the Federal wage index adjustments, resulted in a net 3.0% increase. We  estimate our Medicare revenues increased approximately $3.1 million ($9.62  per Medicare patient day) for the nine months ended September 30, 2005  as a result of these changes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| -      | CMS issued a 3.1% market basket increase effective  with the 2006 Federal fiscal year beginning October 1, 2005, which when  taken into consideration with a revision to the rates paid to nursing homes  depending upon their geographic location that will be phased-in over a  two-year period (October 1, 2005 to September 30, 2007), results in  a net 2.6% increase. We estimate our Medicare revenues increased approximately  $1.1 million ($8.60 per Medicare patient day) for the three months ended December 31, 2005 (including Peak for December 2005 only).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| -      | Effective January 1, 2006, the remaining  two temporary add-on payments expired, the number of RUG categories increased  from 44 to 53, and  the nursing case-mix weight increased for all 53 RUG  categories by 8.5%. The nine new RUG categories provide for higher  reimbursement rates, and as a result our Medicare revenues will increase for  any residents that qualify for the new RUG categories. Based upon our  performance for the month of January 2006, we estimate that the continuation  of the October 1, 2005 market basket increase and geographic location  changes, the expiration of add-on payments, the expansion of the number of  RUG categories and increasing the case mix weights that become effective  January 1, 2006 will collectively be favorable when compared to our  rates prior to the October 1, 2005 rule changes.                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| -      | CMS had previously  proposed a three year phase-in of a reduction to the Medicare reimbursement  for all unpaid Medicare Part A patient co-payments and deductibles by 30%, which we estimated would have decreased  our revenues $3.1 million ($5.02 per Medicare patient day). However, the  Deficit Reduction Act of 2005 ("DRA") modified this phase-in by  requiring immediate implementation of the full 30% reduction, but  limited its impact to Medicare beneficiaries that are not also eligible for  Medicaid. We now estimate that this more limited reduction will decrease our  inpatient revenues by approximately $0.2 million ($0.30 per Medicare patient  day) for calendar year 2006.                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| -      | Effective January 1, 2006, Medicaid coverage of prescription drugs for Medicare beneficiaries  who are also eligible for Medicaid, referred to as "dual eligibles",  were shifted to the new Part D program.  Part D requires new prescription  drug plans and Medicare Advantage Plans that offer prescription drug coverage  to provide convenient access to long-term care pharmacies and to offer standard  contracts to all long-term care pharmacies within the plans' service areas  that meet performance standards specified by CMS. We do not yet know whether  payment rates for the prescription drugs provided by these plans will be  sufficient to cover the costs of the pharmacy needs of skilled nursing  facility residents. Moreover, certain drugs are excluded from coverage under  the new Medicare benefits in Part D, including several drugs that are  commonly prescribed for nursing home and other long-term care residents. As a  result, there is a risk that if these excluded prescription drug costs are  not reimbursed under Medicaid or through Medicare, we will need to bear the  cost of these drugs. |

***Rehabilitationtherapy***
| - | For the calendar year beginning January 1, 2005, Medicare Part B rehabilitation therapy services rates were  decreased 1.5%. We estimate that our Medicare revenues decreased  approximately $0.2 million and $0.7 million for the three and 12 months  ended December 31, 2005, respectively, as a result of these changes. |
|---|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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**SUN HEALTHCAREGROUP, INC. AND SUBSIDIARIES**
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| -      | 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 DRA allowed CMS to grant exceptions to the therapy****caps  for services provided during calendar year 2006 if these services meet  certain qualifications as medically necessary services, which based on our  assessment, will include the majority of our patients. We cannot forecast if the exception process will  continue beyond the 2006 calendar year or to the extent to which the  exception process will ameliorate the impact of the therapy caps.                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| -      | The RUG case mix indexing that became effective  on January 1, 2006 resulted in patients of skilled nursing facilities  being reclassified into lower rehabilitation RUG categories.  Our therapy  nursing home payment rates are based upon the rehabilitation RUG category  into which patients are classified, and a shift to the lower paying  rehabilitation RUG categories has resulted  in decreased revenues.  We are unable to measure the revenue decrease  that is directly due to the change in case mix indexing. We are seeking  to renegotiate customer contracts to change the current pricing rates  to base them upon services provided, and we will terminate  unprofitable contracts that we are unable to revise and reduce  overhead associated with those contracts. |

***Home health***
| -      | Our home health Medicare payment rates increased  2.1% for the 2005 calendar year, which we estimate increased our Medicare  revenues approximately $0.8 million for the year ended December 31,  2005, respectively.                                                                                                                                                                                                                                                                     |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| -      | CMS has made  geographic specific adjustments to the rates paid to  home health agencies for the 2006 calendar year, which we estimate will result in an approximately $0.3 million  increase (0.9%) in revenues.  However, the DRA froze the Medicare home  health reimbursement rates effective January 1, 2006, thereby eliminating a previously announced 2.8% increase in  rates, which we estimate would have resulted in a $1.0 million increase if it  had been implemented. |

**Medicaid**

     Medicaidis a state‐administered program financed by state funds and federalmatching funds. The program provides for medical assistance to the indigent andcertain other eligible persons. Although administered under broad federalregulations, states are given flexibility to construct programs and paymentmethods. Each state in which we operate nursing facilities has its own uniqueMedicaid reimbursement program. State Medicaid programs include systems thatwill reimburse a nursing facility for reasonable costs it incurs in providingcare to its patients, based upon cost from a prior base year, adjusted forinflation and per diems based upon patient acuity.

     Thefollowing table sets forth the average amounts of inpatient Medicaid revenuesper patient, per day (excluding any impact of state-imposed provider taxes),recorded by our SNF and hospital facilities for the periods indicated(including Peak for December 2005 only):

|          | **For the Year Ended              December  31,               ** |
|----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          | **   2005  **                                                                                                                                                                            | **   2004   ** | **   2003  ** |
| SNF      | $     139.38                                                                                                                                                                             | $   132.87 | $   123.76 |
| Hospital | $     839.07                                                                                                                                                                             | $   820.31 | $   819.51 |

26

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

     Medicaidoutlays are a significant component of state budgets, and there have beenincreased cost containment pressures on Medicaid outlays for nursing homes. Itis not certain whether reductions in Medicaid rates would be imposed in thefuture for any states in which we operate.

    Fourteenof the states in which we operate impose a provider tax against nursing homesas a method of increasing federal matching funds paid to those states forMedicaid: Alabama, California, Georgia, Massachusetts, Montana, New Hampshire, NewMexico, North Carolina, Ohio, Oklahoma, Tennessee, Utah, Washington and WestVirginia. In California, we estimate its program increased our net Medicaidrevenues by $1.3 million (4.5%) for August 1, 2004 throughJuly 31, 2005 and will increase our revenues by an additional$2.0 million (6.5%) for August 1, 2005 throughJuly 31, 2006 above July 2004 revenues, for the facilities wecurrently operate. As a result of the implementation of the provider taxprogram in California, we are contractually obligated to utilize some of ourincreased revenues to increase the wages and benefits of certain classes ofemployees in five of our California facilities, in an amount to be negotiated. Those statesthat have imposed the provider tax have used the matching funds to fundMedicaid reimbursement rates paid to nursing homes, although the amount offunding varies by state. Undercurrent rules, the provider tax cannot exceed 6.0% of revenues. 

**Private payors**

     Wecurrently receive approximately 36.5% of our revenues from private insurance,long-term care facilities that utilize our specialty medical services, self-payfacility residents, and other third party payors. These private third party payorsare continuing their efforts to control healthcare costs through directcontracts with healthcare providers, increased utilization review and greaterenrollment in managed care programs and preferred provider organizations. Theseprivate payors increasingly are demanding discounted fee structures and theassumption by healthcare providers of all or a portion of the financial risk.

**Other reimbursementmatters**

     Netrevenues realizable under third-party payor agreements are subject to changedue to examination and retroactive adjustment by payors during the settlementprocess. Under cost-based reimbursement plans, payors may disallow, in whole orin part, requests for reimbursement based on determinations that certain costsare not reimbursable or reasonable or because additional supportingdocumentation is necessary. We recognize revenues from third-party payors andaccrue estimated settlement amounts in the period in which the related servicesare provided. We estimate these settlement balances by making determinationsbased on our prior settlement experience and our understanding of theapplicable reimbursement rules and regulations.

**Results ofOperations**

     Thefollowing table sets forth the amount and percentage of certain elements oftotal net revenues for the following years ended December 31 ($ in thousands):

|                                    | **2005**                                    | **2004** | **2003**               |
|------------------------------------|---------------------------------------------|----------|------------------------|
| Inpatient  Services                | $    635,630            |          | 72.0                   | % | $     585,813 |  | 72.0 | % | $      546,621 |  | 70.3 | % |
| Rehabilitation  Therapy Services   | 137,289                                     |          | 15.6                   | % | 133,118 |  | 16.4 | % | 144,310 |  | 18.5 | % |
| Medical  Staffing Services         | 71,147                                      |          | 8.1                    | % | 56,816 |  | 6.9 | % | 61,824 |  | 7.9 | % |
| Home  Health Services              | 60,778                                      |          | 6.9                    | % | 56,702 |  | 6.9 | % | 55,533 |  | 7.1 | % |
| Laboratory  and Radiology Services | 14,348                                      |          | 1.6                    | % | 15,709 |  | 1.9 | % | 16,023 |  | 2.1 | % |
| Corporate                          | 661                                         |          | 0.1                    | % | 47 |  | 0.0 | % | 73 |  | 0.0 | % |
| Intersegment  eliminations         |       (37,744 | )        |    (4.3 | )% |        (34,915 | ) |    (4.1) | % |        (45,946 | ) |     (5.9) | % |
|   Total net revenues     | $    882,109            |          | 100.0                  | % | $     813,290 |  | 100.0 | % | $     778,438 |  | 100.0 | % |
|                                    | ========                                    |          | ====                   |  | ======== |  | ==== |  | ======== |  | ==== |  |

27

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

     Inpatientservices revenues for long-term care, subacute care and assisted living servicesinclude revenues billed to patients for therapy, medical staffing, andlaboratory and radiology provided by our affiliated operations.  The followingtable sets forth a summary of the intersegment revenues for the years endedDecember 31 (in thousands):

| ** **                            | **2005**                                                                                                 | ** ** | **2004**                                                                                | ** ** | **2003**                                                                                | ** ** |
|---------------------------------------|----------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| Inpatient  Services                   | $                 - |            | $           (600                 | )          | $            (600           | )          |
| Rehabilitation  Therapy Services      | 36,951                                                                                                   |            | 33,228                                                                                  |            | 38,541                                                                                  |            |
| Medical  Staffing Services            | 613                                                                                                      |            | 2,103                                                                                   |            | 7,216                                                                                   |            |
| Laboratory  and Radiology Services    |               180                  |            |               184 |            |               789 |            |
|   Total  affiliated revenue | $        37,744                                                  |            | $        34,915                                 |            | $        45,946                                 |            |
|                                       | =========                                                                                                |            | =========                                                                               |            | =========                                                                               |            |

     Thefollowing table sets forth the amount of net segment income (loss) for thefollowing years ended December 31 (in thousands):

|                                     | **2005**                                                                                             | ** ** | **2004**                                                                                                  | ** ** | **2003**                                                                                        | ** ** |
|-------------------------------------|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
|                                     |                                                                                                      |            |                                                                                                           |            |                                                                                                 |            |
| Inpatient  Services                 | $          41,437                                  |            | $          44,453                                       |            | $           20,393                       |            |
| Rehabilitation  Therapy Services    | 7,291                                                                                                |            | 10,233                                                                                                    |            | 14,720                                                                                          |            |
| Medical  Staffing Services          | 4,907                                                                                                |            | 3,205                                                                                                     |            | 1,285                                                                                           |            |
| Home  Health Services               | 2,489                                                                                                |            | 3,499                                                                                                     |            | 3,765                                                                                           |            |
| Laboratory  and Radiology Services  |                 (867 | )          |                  400 |            |                1,470 |            |
| Net segment income before Corporate | 55,257                                                                                               |            | 61,790                                                                                                    |            | 41,633                                                                                          |            |
| Corporate                           |            (52,339                            | )          |            (48,396                                 | )          |             (57,842                 | )          |
| Net  segment income (loss)          | $            2,918                       |            | $           13,394                                 |            | $          (16,209                            | )          |
|                                     | ==========                                                                                           |            | ==========                                                                                                |            | ===========                                                                                     |            |

     Thefollowing discussion of the "Year Ended December 31, 2005 compared to theYear Ended December 31, 2004" and the "Year Ended December 31, 2004compared to the Year Ended December 31, 2003" is based on the financialinformation presented in "Note 17 - Segment Information" in ourconsolidated financial statements. 

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

     Net revenues increased$68.8 million, or 8.5%, to $882.1 million, of which Peak accountedfor $21.1 million, for 2005 from $813.3 million for 2004. Excluding netrevenues attributable to Peak, which was acquired in December 2005, netrevenues increased $47.7 million, or 5.9%, for 2005 as compared to 2004. 

     We reported net income forthe year ended December 31, 2005 of $24.8 million, of which Peak accountedfor a loss of $1.2 million, compared to a net loss of $18.6 million forthe year ended December 31, 2004. Excluding the net loss attributable toPeak, net income for the year ended December 31, 2005 was $26.0 million. The$1.2 million loss associated with Peak was comprised of $1.1 million of transactioncosts related to conforming the methodologies for inventory and accountsreceivable, $0.5 million of costs related to an accounts receivable contractualreserve recorded at the hospice operations and $0.5 million of costs foroverhead, offset by net income of $1.0 million related to the operations of theinpatient facilities. * *

     The net income of$24.8 million for the year ended December 31, 2005included:
| - | $21.9 million  of income on discontinued operations and the disposal of discontinued operations  comprised primarily of: |
|---|-------------------------------------------------------------------------------------------------------------------------------|
|   | -                                                                                                                             | a  $7.7 million gain from the partial receipt of a holdback associated with  the 2003 sale of our pharmaceutical operations, |
|   | -                                                                                                                             | $15.4 million of  income associated with the divestiture of skilled nursing facilities in our  Inpatient Services segment, comprised primarily of $14.6 million of prior  year self-insurance reserve recoveries related to those facilities, which  included $15.5 million for general and professional reserves offset by an  increase of $0.9 million in workers' compensation reserves, and $0.8 million  of gain on disposal from the sale of one skilled nursing facility; |

28

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**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**
|        |   | professional reserves offset by an  increase of $0.9 million in workers' compensation reserves, and $0.8 million  of gain on disposal from the sale of one skilled nursing facility; |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                 |
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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   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| *offset by*
         
-

$0.9 million  of losses related to our mobile radiology operations that were sold in November  2005;
         
-

a  $6.8 million, net, reduction in general and professional liability and  workers' compensation insurance reserves for prior years due to improvement  in claim trends; and
      
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a net $0.8 million  income tax benefit as a result of federal income tax refunds;

offset by

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$3.2 million in  additional interest charges associated primarily with borrowings on our line  of credit included in interest, net;
      
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$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;
      
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a $0.4 million  loss on extinguishment of debt associated with debt refinancing; and
      
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a $0.4 million  loss on sale of assets, net, related primarily to write-downs for land and  buildings.

     The net loss of$18.6 million for the year ended December 31, 2004included:

-

a  $28.5 million loss on discontinued operations and the disposal of  discontinued operations comprised primarily of $17.6 million of losses  associated with the California clinical laboratory and radiology operations  that were sold in November 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, $5.3 million of losses associated with the  divestiture of six skilled nursing facilities during 2004 and one in 2005 in  our Inpatient Services division, $1.0 million of losses associated with  the reclassification of our mobile radiology operations to assets held for  sale as of September 30, 2005, and $4.3 million of residual costs  associated with the sale of our pharmacy operations during 2003;
      
-

$8.9 million  of interest expense, net;
      
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$2.0 million  of restructuring costs associated with professional fees and one-time  terminations;
      
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a  $1.5 million loss on sale of assets associated with the write-down of  land and a building held for sale; and
      
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a $1.0 million  loss on asset impairment,

offset by

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a  $16.5 million, net, reduction in general and professional liability and  workers' compensation insurance reserves due to improvement in claim trends,  primarily for prior year policies;
      
-

a $3.4 million  gain on extinguishment of debt, net, due to mortgage restructurings; and 
      
29

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

-

a net $1.2 million  income tax benefit, as a result of federal income tax refunds.

***Segment information***

*InpatientServices.*  Totalrevenues from inpatient services increased $49.8 million, or 8.5%, to $635.6million for the year ended December 31, 2005 from $585.8 million for the yearended December 31, 2004. The addition of Peak for the month of December 2005contributed $20.5 million of the increase in net revenues. The remainingincrease in net revenues was primarily comprised of:

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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;
      
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an  increase of $4.5 million in Medicare revenues driven by 2.7% higher Medicare  rates; and
      
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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. 

     Operating salaries and benefits expenses, excluding workers' compensation insurance costs, increased $24.5 million, or 8.3%,to $320.8 million for the year ended December 31, 2005 from $296.3 million for theyear ended December 31, 2004. $10.1million of the increase was due to the addition of Peak for the one month ofDecember 2005.  The remaining increase in salaries and benefits was primarilydue to:

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increases in wages and related benefits of $7.4 million to  remain competitive in local markets;
      
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an increase of $3.4 million driven by higher labor hours  primarily caused by the increase in Medicare revenues;
      
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an increase of $1.9 million in salaries and benefits at two  hospitals in California to meet or exceed new  staffing requirements, and 
      
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a $1.7 million increase in health insurance costs.

     Self-insurancefor workers' compensationand general and professional liability insurance increased $4.0 million, or19.1%, to $24.9 million for the year ended December 31, 2005 as compared to$20.9 million for the year ended December 31, 2004.  The addition of Peak inDecember 2005 contributed $0.9 million of the increase.  The remaining increasewas primarily due to: 

-

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.

** **     Other operating costs increased $17.7 million, or 11.0%, to$179.2 million for the year ended December 31, 2005, from $161.5 million for theyear ended December 31, 2004. Excluding the impact of Peak, which contributed $3.8 million of the increase,the remaining increase was primarily due to: 

-

a $6.9 million increase in  therapy, pharmacy and medical supplies expense attributable to the increase

30

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**
   
in Medicare patient mix; 
      
-

a gain of $3.4 million for extinguishment of debt recorded in  2004;
      
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a  $2.4 million increase in provider taxes; and
      
-

a  $0.9 million increase in utility expense.

** **     Generaland administrative expenses increased $1.6 million, or 13.4%, to $13.5 millionfor the year ended December 31, 2005 from $11.9 millionfor the year ended December 31, 2004. The $1.6 millionincrease was primarily due to salaries and benefits expense for regionaladministrative and office personnel.

     Facility rent expense of $37.5 million for the year endedDecember 31, 2005 increased $1.9 million, or 5.3%, compared to the year endedDecember 31, 2004, primarily due to the addition of the Peak facilities whichhad $1.4 million in rent for the month of December, 2005.  The remainingincrease was due to normally scheduled rent increases. 

The provision for losses on accountsreceivable increased $1.1 million, or 42.3%, to $3.7million for the year ended December 31, 2005, from $2.6 million for year endedDecember 31, 2004, primarily due to the addition for the month of December 2005of the Peak facilities which contributed $0.8 million of the increase.  Theremaining increase was due to the increase in revenues and timing ofcollections.  

     Depreciation and amortizationdecreased $0.3 million, or 4.1%, to $7.0 million for the year ended December 31, 2005, from $7.3 million for theyear ended December 31, 2004. Thedecrease was primarily attributable to the conversion of one facility from acapital lease to an operating lease in 2004, partly offset by additionalcapital expenditures incurred for facility improvements in 2005 and theaddition of the Peak facilities for the month of December 2005.

     Net interest expense for the yearended December 31, 2005 was$7.5 million as compared to $5.3 million for the year ended December 31, 2004.  The increase of $2.2million, or 41.5%, was due to the assumption of Peak indebtedness and consolidationof the indebtedness of the Clipper entities (collectively known as "Clipper")by reason of their status as variable interest entities, which consolidationcommenced in the third quarter of 2004. (See "Note 10 - Variable InterestEntities.") Clipper consists of three partnerships, fivelimited liability companies and one sole proprietorship, each of which own onefacility that we operate in New Hampshire.

*RehabilitationTherapy Services*.  Total revenues from RehabilitationTherapy Services increased $4.2 million, or 3.2%, to $137.3 million for the yearended December 31, 2005, from $133.1 million for the year ended December 31,2004.  Of the $4.2 million increase in total revenues, affiliated revenuesincreased $3.8 million, or 11.4%, and nonaffiliated revenues increased $0.4million, or 0.4%. The increase in 2005 of $0.4 million in nonaffiliatedrevenues was due primarily to the loss of two large chain customers during thesecond and third quarters of 2004 and the replacement during 2005 of thatrevenue stream through the growth of rehabilitation agency activity.

     Operatingsalaries and benefits expenses, excluding workers' compensation insurancecosts, increased $6.4 million, or 7.0%, to $98.1 million for the year ended December 31, 2005 from $91.7 million for the year ended December 31, 2004. The increase was due primarily to an average increase of 7.2% in therapy wages in order torecruit and maintain therapists offset by a $0.9 million reclassification togeneral and administrative expense of salaries, benefits, and other relatedexpenses for overhead staff that were recorded to operating salaries andbenefits in 2004.

31

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

     Self-insurancefor workers' compensation and general and professional liability expensesincreased $1.1 million, or 157.1%, to $1.8 million for the year ended December31, 2005, from $0.7 million for the year ended December 31, 2004. The increasewas due to an increase in workers' compensation claims expense.

     Otheroperating costs, including contract labor expenses, increased $0.8 million, or 3.7%, to $22.6 million for the year ended December31, 2005 from $21.8 million for the yearended December 31, 2004.  The increase was primarily due to increases incontract therapy expense, legal expense as a result of a reversal of a 2004 accrualfor legal fees, and support fees for management information systems.

     Generaland administrative expenses increased $1.0million, or 15.6%, to $7.4 millionfor the year ended December 31, 2005 from $6.4 million for the year ended December 31, 2004.  The increasewas primarily due to a $0.9 million reclassification of overhead salaries,benefits, and other related expenses that were recorded to operating salariesand benefits in 2004 and increases in wages. 

     Theprovision for losses on accounts receivable decreased $2.0 million, or 133.3%,to a credit of $0.5 million for the year ended December 31, 2005 from $1.5 million for the year ended December 31, 2004. The decrease in expense wasprimarily due to improvements in collections in 2005 of older receivables.

** ***Medical Staffing Services.*  Totalrevenues from Medical Staffing Services increased $14.3 million, or 25.2%, to$71.1 million for the year ended December 31, 2005 from $56.8 million for the yearended December 31, 2004. The increase in revenues was primarily the result of:

-

$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.

     Operatingsalaries and benefits expenses, excluding workers' compensation insurancecosts, increased $12.9 million, or 29.4%, to $56.8 million for the year endedDecember 31, 2005 from $43.9 million for the year ended December 31, 2004. Ofthe $12.9 million increase, $8.1 million was directly attributable to theincrease in billable hours and $4.8 million from the acquisitions mentionedabove.

     Otheroperating costs increased $0.1 million, or 2.3%, to $4.4 million for the yearended December 31, 2005 from $4.3 million for the year ended December 31,2004.  The increase was primarily attributable to a $0.5 million increase incontract labor usage by affiliated inpatient services facilities offset by a$0.4 million decrease in various administrative expenses related to travel andmeal stipends.

    Generaland administrative expenses, which include regional costs related to thesupervision of operations and all other non-direct costs, decreased $0.4million, or 12.9%, to $2.7 million for the year ended December 31, 2005 from $3.1 million for the year ended December 31, 2004.  The decrease resultedprimarily from corporate restructure of overhead and resulting loweradministrative expenses. 

     Theprovision for losses on accounts receivable decreased $0.1 million, or 33.3%,to $0.2 million for the year ended December 31, 2005 from $0.3 million for theprior year due to improved management of receivables and the recoveries ofolder, fully-reserved receivables.

32

**SUN HEALTHCAREGROUP, INC. AND SUBSIDIARIES**

* HomeHealth Services.*  Total revenues from Home Health Servicesincreased $4.1 million, or 7.2%, to $60.8 million for the year ended December31, 2005 from $56.7 million for the year ended December 31, 2004.  Theincrease in revenues was comprised primarily of:

-

a $1.9 million increase in  Medicare revenues due to increased patient episodes;
      
-

a $1.7 million increase in  commercial insurance revenues due to increased patient visits; and
      
-

a $0.4 million increase in  Medicaid revenues due to an acquisition in November 2004.

     Operatingsalaries and benefits expenses, excluding workers compensation insurance costs,increased $4.6 million, or 11.4%, to $45.1 million for the year ended December31, 2005 from $40.5 million for the year ended December 31, 2004. The increaseis directly attributable to the increase in revenues, overtime, wage increasesand a greater utilization of higher skilled labor such as registered nurses andtherapists.

     Self-insurancefor workers' compensation and general and professional liability expensesdecreased $0.5 million, or 23.8%, to $1.6 million for the year ended December 31, 2005 from $2.1 million for the year ended December 31, 2004. The decrease was directly attributable to an improvement in workers' compensation claimsexperience.

     Otheroperating costs increased $0.3 million,or 4.5%, to $7.0 million for the yearended December 31, 2005 from $6.7 millionfor the year ended December 31, 2004.  The increase was driven primarilyby higher purchased services, patient medical supplies and other administrativecosts. 

     Generaland administrative expenses increased $0.3 million,or 33.3%, to $1.2 million for the year ended December 31, 2005 from $0.9million for the year ending December 31, 2004. The increase was primarily dueto increased recruitment efforts to fill open positions, use of temporarystaff/outside consultants and severance payouts.

*Laboratory and RadiologyServices.*  Total revenues from Laboratory and RadiologyServices for the year ended December 31, 2005 decreased by $1.4 million, or8.9%, to $14.3 million from $15.7 million for the year ended December 31, 2004,due primarily to a decrease in the number of nonaffiliated contracts and lowervolume per contract. 

    Self-insurancefor workers' compensation and general and professional liability expensesdecreased by $0.1 million, or 16.7%, to $0.5 million for the year ended December 31, 2005 from $0.6 million for the year ended December 31, 2004. The decrease was due to an improvement in workers' compensation claims experience.

     Otheroperating costs decreased $0.1 million,or 2.2%, to $4.5 million for the yearended December 31, 2005 from $4.6 millionfor the year ended December 31, 2004.  The decrease was primarily theresult of lower property costs. 

*Corporate.*  General and administrative costs notdirectly attributed to operating segments increased $3.1 million, or 7.0%,to $47.2 million for the year ended December 31, 2005 from $44.1 million for the year ended December 31, 2004. The increase was primarily due to:

-

$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; 

33

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

-

$0.7  million of travel and meeting expenses;
      
-

$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,

offsetby

-

a $0.6  million decrease in staff salaries and benefits.

***Interest expense***

     Netinterest expense not directly attributed to operating segments increased$1.0 million, or 28.6%, to $4.5 million for the year ended December 31, 2005 from $3.5 million for the year ended December 31, 2004. The increase was primarily due to an increase in borrowings on our creditfacility during 2005.

**Year Ended****December 31, 2004****Compared to Year Ended****December 31, 2003**

     Netrevenues increased $34.9 million to $813.3 million for 2004 from$778.4 million for 2003. We reported a net loss for the year ended December 31, 2004 of $18.6 million compared to net income of $0.4 million forthe year ended December 31, 2003.

     Thenet loss of $18.6 million for the year ended December 31, 2004included:

-

a $28.5 million loss on discontinued  operations and the disposal of discontinued operations comprised primarily of  $17.6 million of losses associated with the California clinical  laboratory and radiology operations that was sold in November 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, $5.3 million of  losses associated with the divestiture of six skilled nursing facilities  during 2004 and one in 2005 in our Inpatient Services division,  $1.0 million of losses associated with the reclassification of our  mobile radiology operations to assets held for sale as of September 30,  2005, and $4.3 million of residual costs associated with the sale of our  pharmacy operations during 2003;
      
-

$8.9 million interest expense, net;
      
-

$2.0 million of restructuring costs  associated with professional fees and one-time terminations;
      
-

a $1.5 million loss on sale of assets  associated with the write-down of land and a building held for sale; and
      
-

$1.0 million loss on asset impairment,

offsetby

-

a $16.5 million, net, reduction in general  and professional liability and workers' compensation insurance reserves due  to improvement in claim trends, primarily for prior year policies;
      
-

a $3.4 million gain on extinguishment on  debt, net due to mortgage restructurings; and
      
34

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

     

-

a net  $1.2 million income tax benefit, as a result of federal income tax refunds.

The net income of $0.4 million forthe year ended December 31, 2003 included:

-

a  $30.5 million gain on discontinued operations primarily driven by income of  $49.5 million related to the sale of our pharmaceutical operations and  $4.2 million of income related to the sale of our software development company that was sold in  November 2003, offset by losses of $21.9 million related to the  divestiture of 127 Inpatient Services facilities in 2003, six in 2004 and one  in 2005; and
      
-

a $4.2 million gain on sale of land and  buildings included in our Other Operations segment,

offsetby

-

$16.9 million of interest expense;
      
-

$14.7 million of restructuring charges; and
      
-

$2.8 million of asset impairment charges.

***Segment information***

*Inpatient Services.*  Net revenues increased $39.2 million, or7.2%, to $585.8 million for year ended December 31, 2004 from $546.6 million for the year ended December 31, 2003. The increase in net revenues for the Inpatient Services segment wasprimarily the result of:

-

an increase of $17.4 million in Medicare  revenues, $9.8 million of which was due to an improvement in overall  facility occupancy to 90.8% from 90.1%, an improvement in Medicare mix to  13.0% from 12.2% of total occupancy, and $7.6 million due to higher per  diem Medicare rates that started in October 2003;
      
-

an increase of $16.5 million in Medicaid  revenues, $19.0 million of which was caused by higher per diem Medicaid  rates driven mainly by provider taxes, offset, in part, by a decrease of  $3.5 million from lower Medicaid occupancy; and
      
-

an increase of $3.9 million in private and  commercial insurance revenues due to rate increases.

     Operatingsalaries and benefits expenses increased $12.9 million, or 4.6%, to$296.3 million for the year ended December 31, 2004 from $283.4 million for the year ended December 31, 2003. The increase was primarily due to wage increases and an increase inlabor hours associated with an increase in Medicare census, offset partly witha $3.7 million decrease in health insurance costs due to improved claimsexperience.

     Self-insurancefor workers' compensation and general and professional liability insurancedecreased $5.6 million, or 21.1%, to $20.9 million for the year endedDecember 31, 2004 as compared to $26.5 million for the year endedDecember 31, 2003. This decrease was comprised primarily of:

-

a $9.1 million decrease  related to patient care liability costs, net of a reduction of  $14.0 million related to improvement in claims and settlement trends for  prior periods;

offsetby

35

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

 

-

a $3.5 million increase  related to workers' compensation insurance costs, net of a reduction of  $3.2 million related to deterioration of claims trends for prior periods  reflected in the twice yearly actuarial study.

     Otheroperating costs increased $8.3 million, or 5.4%, to $161.5 millionfor the year ended December 31, 2004 from $153.2 million forthe year ended December 31, 2003. The increase was primarily due to:

-

a $5.6 million increase in provider taxes for the 2004 year  as compared to the same period in 2003 due, in part, to the implementation of  provider taxes in North Carolina;
      
-

an increase in ancillary  therapy costs of $2.5 million driven primarily by the increase in  Medicare customer base; and
      
-

a net increase of  $0.4 million due to increases in the cost of supplies and other  purchased services related to patient care.

     Facilityrent expense increased $0.5 million to $35.6 million for the yearended December 31, 2004 from $35.1 million for the year endedDecember 31, 2003 due to contractually scheduled rent increases onexisting leases, offset by the favorable effect of the consolidation of theClipper partnerships (see "Note 10-Variable Interest Entities").

     Generaland administrative expenses decreased $1.5 million, or 11.2%, to$11.9 million for year ended December 31, 2004 from $13.4 million for the year ended December 31, 2003. The $1.5 million decrease was primarily due to salaries andbenefits expense for regional administrative and office personnel, utilitiesand supplies that were eliminated as part of the restructuring.

     Depreciationand amortization increased $2.1 million, or 40.4%, to $7.3 millionfor the 2004 year from $5.2 million for the 2003 year. Theincrease was primarily attributable to capital expenditures incurred forfacility improvements and the additional depreciation and amortization expenseassociated with the consolidation of Clipper partnerships. (See "Note 10-VariableInterest Entities.")

     Theprovision for losses on accounts receivable decreased $3.8 million, or59.4%, to $2.6 million for the year ended December 31, 2004from $6.4 million for the year ended December 31, 2003 due to improved monitoring of current receivablesand the collection of older receivables.

     Netinterest expense for the year ended December 31, 2004 was $5.3 million as compared to$3.1 million for the year ended December 31, 2003. The $2.2 million, or 71.0%, increase wasprimarily due to the scheduled increase in expense related to debt amortizationand the additional interest expense related to the consolidation of Clipperpartnerships. (See "Note 10-Variable Interest Entities.")

*Rehabilitation Therapy Services.*  Net revenues for the Rehabilitation Therapy Services segment decreased$11.2 million, or 7.8%, to $133.1 million for the year ended December 31, 2004 from $144.3 million for the year ended December 31, 2003.The decrease was primarily due to the decrease in nonaffiliated sales as aresult of the lingering disruption of the sales cycle in 2004 due to theJanuary 2004 termination of the contemplated sale of substantially all ofthe segment announced in late 2003.

     Operatingsalaries and benefits expenses decreased $7.2 million, or 7.3%, to$91.7 million for the year ended December 31, 2004 from $98.9 million for the same period in2003. The decrease was primarily driven by the reduction of employees and reorganizationof the operating structure as a result of the impact of lower revenues and areclassification to general and administrative expenses.

36

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

     Self-insuranceexpenses for workers' compensation and professional liability insurancesdecreased $1.1 million, or 61.1%, to $0.7 million for the year ended December 31, 2004 from $1.8 million for the year ended December 31, 2003.The decrease was primarily due to costs related to improved claims experiencesduring the year.

     Generaland administrative expenses increased $2.8 million, or 77.8%, to$6.4 million for the year ended December 31, 2004 from $3.6 million for the year ended December 31, 2003. The increase was primarily due to reclassification of expensesincluded in operating expenses.

** **     Depreciationand amortization decreased $0.9 million, or 81.8%, to $0.2 millionfor the year ended December 31, 2004 from $1.1 million for theyear ended December 31, 2003. The decrease was primarily due to the reductionin property carrying values due to closures of administrative office locationsin conjunction with the Inpatient Services divestitures during 2003 and therestructuring of operations in 2004.

     Theprovision for losses on accounts receivable decreased $0.3 million, or16.7%, to $1.5 million for the year ended December 31, 2004from $1.8 million for the year ended December 31, 2003. The decrease in expense was primarily due toimproved collection and customer credit methods.

*Medical Staffing Services.*  Net revenues from the Medical Staffing Services segment decreased$5.0 million, or 8.1%, to $56.8 million for the year ended December 31, 2004 from $61.8 million for the year ended December 31, 2003.The decrease was primarily the result of decreased agency staff usage withinour affiliated skilled nursing facilities and hospitals.

     Operatingsalaries and benefits expenses were $43.9 million for the year ended December 31, 2004 as compared to $45.6 million for the year ended December 31, 2003, a decrease of $1.7 million, or 3.7%. The decrease was directlyattributable to the decrease in revenue.

     Otheroperating expenses, which include contract staffing utilized to staff personnelshortages, decreased $5.8 million, or 57.4%, to $4.3 million for the 2004 yearfrom $10.1 million for the 2003 year. The decrease was primarilyattributable to a decrease of $5.2 million in contract labor expense dueto decreased usage by the affiliated inpatient facilities and a$0.6 million decrease in regional administrative expenses.

     Generaland administrative expenses increased $0.9 million, or 40.9%, to$3.1 million for the year ended December 31, 2004 from $2.2 million for the year ended December 31, 2003. The increase was primarily due to recruiting and retention costsassociated with initiatives to attract new business and retain staff.

*Home Health Services.* Net revenues from the Home Health Services segment increased $1.2 million,or 2.2%, to $56.7 million for the year ended December 31, 2004from $55.5 million for the year ended December 31, 2003. The increase in revenues was due primarily to anincrease in Medicare rates.

     Operatingsalaries and benefits expenses increased $0.2 million, or 0.5%, to$40.5 million for the 2004 year from $40.3 million for the2003 year. The increase was primarily the result of an increase in healthinsurance costs.

     Self-insuranceexpenses for workers' compensation and professional liability insuranceincreased $0.4 million, or 23.5%, to $2.1 million for the year ended December 31, 2004 from $1.7 million for the year ended December 31, 2003.The increase was primarily the result of increased workers' compensation claimsexpenses.

     Theprovision for losses on accounts receivable increased $0.3 million, to$0.5 million for the year ended December 31, 2004 from$0.2 million for the year ended December 31, 2003. The increase wasdue to better than expected collections on account receivables in 2003 that didnot occur in 2004.

37

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

*Laboratory and Radiology Services.*  Net revenues from the Laboratory and Radiology Services segmentdecreased $0.3 million, or 1.9%, to $15.7 million for the year ended December 31, 2004 from $16.0 million for the year ended December 31, 2003,due primarily to a decrease in contracts in our northeast laboratoryoperations.

     Operatingsalaries and benefits expenses decreased $0.1 million, or 1.1%, to$8.9 million for the 2004 year from $8.8 million for the2003 year. The decrease was primarily the result of a reduction inemployees driven by the decrease in revenues.

     Otheroperating costs increased $0.3 million, or 7.0%, to $4.6 million forthe year ended December 31, 2004 from $4.3 million for the year ended December 31, 2003. This increase was due primarily to an increase in purchased andadministrative services.

     Generaland administrative expenses were $0.3 million for the year ended December 31, 2004. These costs were included in operating costs for the same period in2003.

     Theprovision for losses on accounts receivable decreased $0.2 million, or40.0%, to $0.3 million for the year ended December 31, 2004from $0.5 million for the year ended December 31, 2003. The decrease was primarily the result ofimproved collections.

*Corporate.*  Generaland administrative costs not directly attributed to operating segmentsincreased $0.7 million, or 1.6%, to $44.1 million for the year ended December 31, 2004 from $43.4 million for the year ended December 31, 2003.The increase was primarily due to:

-

$2.0 million  of accounts payable vendor settlement payments related to the 2003  restructuring efforts that did not reoccur in 2004;

offsetby

-

$1.1 million  of excess bank service charges due to a recovery in September 2004  associated with the refinancing of our credit line in September 2003.

***Interest expense***

     Netinterest expense not directly attributed to operating segments decreased$10.4 million, or 74.8%, to $3.5 million for the year ended December 31, 2004 from $13.9 million for the year ended December 31, 2003. The decrease was primarily due to the private placement in March 2004 ofour common stock and warrants and the payoff of substantially all of theoutstanding revolving loan balance for which interest was not incurred.

**Liquidity andCapital Resources**

     Forthe year ended and as of December 31, 2005, our net income was $24.8 millionand our working capital deficit was $66.8 million, of which $34.4 millionrelates to the debt on the Clipper partnerships, which is not our directobligation and is expected to be refinanced during 2006, and $11.2 million to a capital lease that we intend to convert to anoperating lease and for which no principal payment will be required. As of December 31,2005, we had cash and cash equivalents of $16.6 million, $10.1 millionin borrowings and $14.4 million in letters of credit outstanding under ourAmended and Restated Loan and Security Agreement dated December 2, 2005 (the"Revolving Loan Agreement") and $61.1 million of funds available forborrowing under our Revolving Loan Agreement, which expires January 31,2009. We believe that our operating cash flows, existing cash reserves, andavailability for borrowing under our Revolving Loan Agreement will providesufficient funds for our operations, capital expenditures and regularlyscheduled debt service payments at least through the next year.

38

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

***Cash flows***

     For the year endedDecember 31, 2005, our net cash used for operating activities was $8.3 million,which was primarily the result of $36.8 million in funding for workers'compensation and general and professional liability insurances. The $38.4million net proceeds from the issuance of our common stock, the $10.1 million inborrowings under our Revolving Loan Agreement and the cash proceeds of$10.7 million from the sale of assets were primarily used to fund $17.4 millionin capital expenditures, $8.5 million in net debt service for the year, and$17.8 million in acquisition costs for the inpatient and medical staffingsegments. The $8.5 million in debt service was the net of$19.5 million in long-term debt repayments and the $11.0 millionborrowing, as a result of the refinance of three facility mortgages.

     OnDecember 2, 2005, we amended and restated our Revolving Loan Agreement, whichresulted in an immediate increase in our liquidity of $19.0 million.  TheRevolving Loan Agreement was subsequently used to, among other things, pay off$8.5 million outstanding under Peak's credit facility upon our acquisition ofPeak on December 9, 2005.

     InDecember 2005, we sold 6.9 million shares of our common stock at $6.00 pershare in a public offering for net proceeds of $38.4 million. We used the netproceeds to repay amounts outstanding under our Revolving Loan Agreement.

     Forthe year ended December 31, 2004, our net cash used for operatingactivities was $26.2 million, which was primarily the result of $37.4 millionin funding for workers' compensation and general and professional liabilityinsurances. On February 20, 2004, we completed a private placement of our commonstock and warrants to purchase common stock to investors. We received netproceeds of $52.3 million in the private placement. We sold4.4 million shares of our common stock, and warrants to purchase2.0 million shares of our common stock (inclusive of warrants paid to theplacement agent). The price paid by investors was $12.70 per unit, except for155,400 units sold at $12.87 per unit. Each unit consisted of one share ofcommon stock and a warrant to purchase 0.4 shares of common stock with awarrant exercise period of five years at an average exercise price of $13.05per share. The $52.3 million net proceeds from the equity offering wereused to fund self-insurance liabilities, pay down the $13.1 millionbalance under our Revolving Loan Agreement, fund $12.9 million in capitalexpenditures, and pay $6.7 million in debt service for the year.

     OnMarch 1, 2004, we entered into an Amended and Restated MasterLease Agreement with Omega Healthcare Investors, Inc. and various of itsaffiliates ("Omega"). Prior to our portfolio restructuring, we leased51 facilities from Omega. Pursuant to the new master lease, we continue tooperate 30 facilities (including 23 long-term care facilities, onerehabilitation and one long-term care hospital, and five behavioralfacilities). The new master lease also settled a combination of(i) accrued past due rent and (ii) future rent obligations that wouldotherwise have become due under the previously existing master leases as ofMarch 1, 2004 by combining those amounts into "deferred base rent."This deferred base rent accrued interest (compounded annually) at a floatingrate of 375 basis points over the applicable LIBOR rate (subject to a floorrate of 6.0%). However, in April 2004, Omega exercised its right toconvert the deferred base rent and accrued interest into 760,000 shares of ourcommon stock and $0.5 million in cash, resulting in a $4.4 millioncharge recorded in loss on disposal of discontinued operations, net, for theyear ended December 31, 2004.

***Revolving Loan Agreement***

     OnDecember 2, 2005, we entered into an Amended and RestatedLoan and Security Agreement with CapitalSource Finance LLC, ascollateral agent, and certain lenders, which amended and restated an existing revolvingcredit facility. The Revolving Loan Agreement, among other things, provides forup to $100 million of borrowing availability and terminates on January 31, 2009. The interest rate on borrowings equals 2.75% (which  

39

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

percentage is subject toadjustment after June 2, 2006 based on our fixed charge coverage ratio) plus thegreater of (i) 4.31% or (ii) (a) afloating rate equal to the London Interbank Offered Rate for one month adjusteddaily or (b), at our option, a rate that is fixed for a period of 30, 60or 90 days equal to the London Interbank Offered Rate two days prior tothe commencement of such period. The Revolving Loan Agreement continues to besecured by almost all of our assets (and the assets of our subsidiaries),including accounts receivable, inventory, stock of our subsidiaries and equipment,but excluding real estate.

     Availability of amounts underthe Revolving Loan Agreement is subject to compliance with financial covenants,including a fixed charge coverage covenant, which requires that the ratio ofOperating Cash Flow (as defined in the Revolving Loan Agreement) to FixedCharges (as defined in the Revolving Loan Agreement) equalor exceed 1.0:1.0. Our borrowing availability under the Revolving LoanAgreement is generally limited to up to eighty-five percent (85%) of the valueof our accounts receivable that are deemed eligible pursuant to the RevolvingLoan Agreement, plus an overadvance facility equal to an additional 15% of thevalue of such receivables, but not to exceed $100.0 million. Under certaincircumstances, the borrowing capacity of the facility may be expanded to up to$150.0 million. The defined borrowing base as of March 1, 2006 was $88.3 million,net of specified reserves of $5.9 million. As of March 1, 2006, we had borrowed$20.3 million and issued $14.6 million in letters of credit, leaving $53.4million available to us for additional borrowing. The Revolving Loan Agreementcontains customary events of default, such as our failure to make payment ofamounts due, defaults under other agreements evidencing indebtedness, certainbankruptcy events and a change of control (as defined in the Revolving LoanAgreement). The agreement also contains customary covenants restricting, amongother things, incurrence of indebtedness, liens, payment of dividends,repurchase of stock, acquisitions and dispositions, mergers and investments. Wehave also agreed to limit our capital expenditures to a maximum of$13.0 million in any six-month period. Failure to comply with a covenantor the occurrence of an event of default could result in the acceleration ofpayment obligations under the Revolving Loan Agreement.

***Acquisitions***

     On August 29,2005, we acquired ProCare, a temporary nurse staffing business, for a totalpurchase price of $8.3 million, of which $4.2 million was paid incash at closing and $4.1 million is payable over three years pursuant totwo promissory notes. The $8.3 million acquisition cost, including$0.1 million in estimated professional fees, was allocated to the assetsacquired and liabilities assumed, based on their fair values of$2.5 million to working capital and $5.9 million to intangibleassets. Of the $5.9 million of acquired intangible assets, $0.1 millionwas assigned to trade names, which are an indefinite-lived intangible asset, and$3.3 million was assigned to customer contracts, which is subject toamortization. The remaining $2.5 million of acquired intangible assets,whichrepresented goodwill, was assigned to the Medical Staffing segment and will besubject to annual impairment tests.

     On December 9, 2005, we acquired Peak, which operated or managed 56 inpatient facilities,in exchange for approximately nine million shares of our common stock. The$164.4 million acquisition cost, which included the fair value of Sun CommonStock issued of $55.6 million and options issued of $0.3 million, $95.7 millionof assumed indebtedness and $12.8 million in estimated direct transaction costs, wasallocated to the assets acquired and liabilities assumed, based on their fairvalues of $12.8 million to working capital, $74.6 million to property andequipment, $6.0 million to other long-term assets, $2.8 million to identifiedintangibles, less $7.7 million to other long-term liabilities. The remaining $75.9million represented goodwill, which was assigned to the Inpatient Servicessegment and will be subject to annual impairment tests. The allocation of thepurchase price was based on preliminary data and could change when finalvaluation of certain tangible and intangible assets is obtained.

40

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

***Assets held for sale***

     During the year endedDecember 31, 2005, we sold one nursing facility for $1.0 million in cash, andland and a building for $0.8 million. On November 4, 2005, we sold PacificMobile, our mobile and radiology services operations located in Arizona andColorado.

     InJuly 2003, we sold the assets of our pharmaceutical services operations toOmnicare, Inc. for $90.0 million. Of the $90.0 million, wereceived cash proceeds of $75.0 million at closing while$15.0 million was not scheduled to be paid until 2005. Of the $15.0million, $7.7 million of the hold back was received inSeptember 2005. Payment of the remainder of the hold back is pending thecompletion of a net asset adjustment reconciliation satisfactory to bothparties to the transaction. The reconciliation, which is not directly relatedto the hold back consideration, and for which provision has previously beenmade, is expected to be completed during the first quarter of 2006.

** **     Asof December 31, 2005, assets held for sale consisted of twoundeveloped parcels of land collectively valued at $1.9 million. We expectto sell them in 2006.

***Debt***

* *     As part of the Peakacquisition, we assumed indebtedness of $84.9 million and repaid another $10.8million of debt through borrowings under our Revolving Loan Agreement.

     Aspart of the ProCare acquisition in August 2005, we issued $4.1 million in promissorynotes payable over three years. As of March 1, 2006, $1.7 million remains outstanding.

     Ofthe $66.9 million current portion of long-term debt, $45.8 million representsdebt which we expect to refinance during 2006, of which Clipper represents $34.4million. A capital lease of $11.2 million,which was acquired in the Peak acquisition and is presented as a currentliability, is expected to be converted to an operating lease during the year andaccounted for as a sale/leaseback, and no principal payment is anticipated.

     DuringAugust 2005, we refinanced three mortgages that were due in 2005 withCapitalSource Finance for $11.0 million. These loans bear interest at8.5%, mature in five years, require monthly principal and interest payments andare secured by the real property of the nursing facilities.

     OnFebruary 28, 2002, we delivered a promissory note to the federalgovernment as part of our settlement agreement pursuant to our Plan ofReorganization. The remaining payment due under the promissory note is$3.0 million on February 28, 2007. Interest under the promissorynote is based upon the weekly average one-year constant maturity treasuryyield. The effective interest rate as of December 31, 2005 was 2.24%.

     As part of the PIFJas described under Item 3 - "Legal Proceedings," we agreed to pay$2.5 million in quarterly payments commencing October 2005 andterminating July 2007.

***Capital expenditures***

     Weincurred total net capital expenditures related to improvements at facilities,as reflected in the segment reporting, of $17.4 million, $12.9 million and $16.6million for the years ended December 31, 2005, 2004 and 2003,respectively. There were no significant capital expenditures for divestedfacilities for the year ended December 31, 2005. We had construction commitments as of December 31, 2005 undervarious contracts of $3.3 million related to improvements at facilities. Weexpect to incur approximately $24.0 million in capital expenditures during2006, related primarily to improvements at existing facilities and informationsystem upgrades.

41

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

***Other***

     Wecontinue to resolve bankruptcy claims for periods prior to October 14,1999 that were filed by various State Medicaid agencies. As of December 31, 2005, we expect to pay $2.5 million to the State Medicaid agencies toresolve these claims. The payments are expected to be made partly in cash,partly with promissory notes and potentially netted against reimbursementspayable to us.

**Obligationsand Commitments**

     Thefollowing table provides information about our contractual obligations andcommitments in future years as of December 31, 2005 (in thousands):

** **

**                                    Payments  Due by  Period                                         **

** **

** **

** **

** **

** **

** **

** **

**After**

** **

**Total**

**2006**

**2007**

**2008**

**2009**

**2010**

**2010**

*Contractual Obligations:*

Debt (1)(2)

$ 200,547

  $  60,011

$ 26,018

$ 25,743

$ 14,516

$  25,928

$   48,331

Capital  lease (3)

12,401

12,401

-

-

-

-

-

Construction  commitments

3,277

3,277

-

-

-

-

-

Purchase  obligations

123,200

42,000

42,000

29,200

10,000

-

-

Operating  leases

417,978

66,160

62,622

56,940

54,344

50,921

126,991

Other  long-term liabilities (4)

      9,747

       404

    2,036

    2,036

    2,036

     3,235

             -

Total 

$ 767,150

$ 184,253

$132,676

$113,919

$ 80,896

$  80,084

$ 175,322

=======

=======

======

======

======

======

=======
                        
** **

** **

**                 Amount  of Commitment Expiration Per  Period                  **

** **

**Total**

** **

** **

** **

** **

** **

** **

** **

**Amounts**

** **

** **

** **

** **

** **

**After**

** **

**Committed**

**2006**

**2007**

**2008**

**2009**

**2010**

**2010**

*Other  Commercial Commitments:*

Letters  of credit

$    15,660

$  15,660

$            -

$            -

$            -

$             -

$               -

Total 

$    15,660

$ 15,660

$            -

$            -

$            -

$             -

$               -

=======

======

======

======

======

=======

========
                        
(1)

Includes total interest  on debt of $14.4 million based on contractual rates, of which $3.2 million is  attributed to variable interest rates determined using the weighted-average  method.

(2)

Includes $54.1 million of debt  related to Clipper, of which $3.9 million is interest. We expect that $34.4  million, which is classified as current debt, will be refinanced during 2006.  (See "Note 10 -  Variable Interest Entities.")

(3)Includes interest of $1.2 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  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.")

**CriticalAccounting Estimates**

     Our discussion and analysisof the financial condition and results of operations are based upon theconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the 

42

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

United States. The preparation ofthese financial statements requires the use of estimates and judgments thataffect the reported amounts and related disclosures of assets and liabilities,the disclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results may differ materially from these estimates. Webelieve the following critical accounting policies, among others, affect themore significant judgments and estimates used in the preparation of theconsolidated financial statements.

*     Net revenues. *Net revenues consist of long-term and subacutecare revenues, rehabilitation therapy revenues, medical staffing servicesrevenues, home health revenues and laboratory and radiology revenues. Netrevenues are recognized as services are provided. Revenues are recorded net ofprovisions for discount arrangements with commercial payors and contractualallowances with third-party payors, primarily Medicare and Medicaid. Netrevenues realizable under third-party payor agreements are subject tochange due to examination and retroactive adjustment. Estimated third-party payorsettlements are recorded in the period the related services are rendered. Themethods of making such estimates are reviewed periodically, and differencesbetween the net amounts accrued and subsequent settlements or estimates ofexpected settlements are reflected in current results of operations, whendetermined.

*     Accounts receivable and related allowance. *Our accounts receivable relate toservices provided by our various operating divisions to a variety of payors andcustomers. The primary payors for services provided in long-term and subacutecare facilities that we operate are the Medicare program and the various stateMedicaid programs. The rehabilitation therapy service operations provideservices to patients in nonaffiliated long-term, rehabilitation and acute carefacilities. The billings for those services are submitted to the nonaffiliatedfacilities. Many of the nonaffiliated long-term care facilities receive a largemajority of their revenues from the Medicare program and the state Medicaidprograms.

     Estimatedprovisions for doubtful accounts are recorded each period as an expense to theconsolidated statements of operations. In evaluating the collectibility ofaccounts receivable, we consider a number of factors, including the age of theaccounts, changes in collection patterns, the financial condition of ourcustomers, the composition of patient accounts by payor type, the status ofongoing disputes with third-party payors and general industry conditions.Any changes in these factors or in the actual collections of accountsreceivable in subsequent periods may require changes in the estimated provisionfor loss. Changes in these estimates are charged or credited to the results ofoperations in the period of the change.

     Theallowance for uncollectible accounts related to facilities that we currentlyoperate is computed by applying a bad debt percentage to the individualaccounts receivable aging categories based on historical collections. Anadjustment is then recorded each month to adjust the allowance based on thisprocedure. In addition, a retrospective collection analysis is performed withineach operating company to test the adequacy of the reserve on a semi-annualbasis.

     Theallowance for uncollectible accounts related to facilities that we havedivested was based on a percentage of outstanding accounts receivable at thetime of divestiture and was recorded in gain or loss on disposal ofdiscontinued operations, net. As collections are recognized, the allowance isadjusted as appropriate. Due to favorable collections, $0.2 million and$6.5 million of the reserve was recovered during the years ended December 31, 2005 and 2004, respectively. As of December 31, 2005, accounts receivablefor divested operations were fully reserved.

*     Insurance. *We self-insure for certain insurable risks, including general and professionalliability, workers' compensation liability and employee health insuranceliability through the use of self-insurance or retrospective and self-fundedinsurance policies and other hybrid policies, which vary by the states in whichwe operate. There is a risk that amounts funded to our self-insurance programsmay not be sufficient to respond to all claims asserted under those programs.Provisions for estimated reserves, including incurred but not reported losses,are provided in 

43

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

the period of the relatedcoverage. An independent actuarial analysis is prepared twice a year todetermine the adequacy of the self-insurance obligations booked as liabilitieson our financial statement. The methods of making such estimates andestablishing the resulting reserves are reviewed periodically and are based onhistorical paid claims information and nationwide nursing home trends. Anyadjustments resulting there from are reflected in current earnings. Claims arepaid over varying periods, and future payments may be different than theestimated reserves. 

     The most recent workers'compensation actuarial analysis completed in December 2005 by our independentactuaries reflected an overall improvement in worker's compensation liabilitycost trends for the current policy year. We have recorded reserves of $56.1million and $62.8 million as of December 31, 2005 and 2004, respectively. Weestimated our range of exposure at December 31, 2005 was $50.5 million to $61.7million. Effective with the policy period beginning January 1, 2002, we discountour workers' compensation reserves based on a 4% discount rate. At December 31,2005, the discounting of these policy periods resulted in a reduction to ourreserves of $11.6 million. Based on the results of the actuarial analysescompleted in June and December 2005, we adjusted our reserves betweencontinuing operations and discontinued operations, recording  increases of $0.9 million relatedto continuing operations for incidents in prior years, and  of $1.0million related to discontinued operations for incidents in prior years. Basedon the results of the actuarial analyses completed in 2004, we recorded a netpre-tax charge of $0.2 million for the year ended December 31, 2004 related to aslight degradation in claim trends primarily for prior year policies fordiscontinued operations for workers' compensation liability costs.

     The most recent actuarialanalysis completed in December 2005 by our independent actuaries reflected animprovement in patient care liability cost trends for the 2002 and 2003 policyyears. We have recorded reserves of $86.5 million and $104.7 million as ofDecember 31, 2005 and 2004, respectively. We estimated our range of exposure atDecember 31, 2005 was $77.8 million to $95.1 million.  Based on the results ofthe actuarial analyses completed in June and December 2005, we reduced ourreserves by $23.2 million, of which $7.7 million was related to continuing operations for incidents inprior years, and $15.5 million related to discontinued operations forincidents in prior years. Based on the results of the actuarial analysescompleted in 2004, we recorded a net pre-tax credit of $17.9 million for theyear ended December 31, 2004 related to improvement in claim trends primarilyfor prior year policies for patient care liability costs.

*Impairment of assets.*

Goodwill and Accounting for Business Combinations

     Goodwillrepresents the excess of the purchase price over the fair value of the netassets of acquired companies.  Our goodwill included in our consolidatedbalance sheets as of December 31, 2005 and 2004 was $81.3 million and $0.4million, respectively.  The increase in our goodwill during 2005 was primarilythe result of the Peak business combination in the Inpatient Services segment andthree acquisitions in our Medical Staffing segment.

     Statementof Financial Accounting Standards No. 142,*Goodwill and OtherIntangible Assets* ("SFASNo. 142") established new rules on the accounting for goodwill andother intangible assets. Under SFAS No. 142, goodwill and intangibleassets with indefinite lives are no longer amortized; however, they are subjectto annual impairment tests as prescribed by the statement. Intangible assetswith definite lives continue to be amortized over their estimated useful lives.

     The purchase price ofacquisitions is allocated to the assets acquired and liabilities assumed basedupon their respective fair values and subject to change during the twelve monthperiod subsequent to the acquisition date.  We engage independentthird-party valuation firms to assist us in determining the fair values ofassets acquired 

44

**SUN HEALTHCAREGROUP, INC. AND SUBSIDIARIES**

and liabilities assumed. Such valuations require us to make significant estimates and assumptions,including projections of future events and operating performance.

     Pursuantto SFAS No. 142, we perform our annual goodwill impairment analysis during thefourth quarter for each reporting unit that constitutes a business for whichdiscrete financial information is produced and reviewed by operating segmentmanagement. We determine impairment by comparing the net assets of eachreporting unit to their respective fair values. We determine the estimated fairvalue of each reporting unit using a discounted cash flow analysis. In the eventa unit's net assets exceed its fair value, an implied fair value of goodwillmust be determined by assigning the unit's fair value to each asset andliability of the unit. The excess of the fair value of the reporting unit overthe amounts assigned to its assets and liabilities is the implied fair value ofgoodwill. An impairment loss is measured by the difference between the goodwillcarrying value and the implied fair value. We did not record a goodwillimpairment for the years ended December 31, 2005, 2004 or 2003.

Indefinite life intangibles

     Pursuantto SFAS No. 142, we evaluate the recoverability of our indefinite lifeintangibles, which are principally trademarks, by comparing the asset'srespective carrying value to estimates of fair value. We determine theestimated fair value of these intangible assets through a discounted cash flowanalysis. We internally prepared animpairment analysis using discounted cash flows in order to estimate the fairvalue of Indefinite Life Intangibles. We did not record an impairment to ourIndefinite Life Intangibles for the years ended December 31, 2005,2004 or 2003.

Finite life intangibles

     Pursuant to SFASNo. 142, we evaluate the recoverability of our finite life intangibles bycomparing an asset's respective carrying value to estimates of undiscountedcash flows over the life of the intangible. If the carrying value of the assetexceeded the undiscounted cash flows, an impairment loss was measured bycomparing the estimated fair value of the asset, based on discounted cashflows, to its carrying value. We didnot record an impairment to our Finite Life Intangibles for the years endedDecember 31, 2005 or 2004. We did record an impairment of $0.5 million forthe year ended December 31, 2003 within our Inpatient Services segment.

Long-lived assets

     TheFinancial Accounting Standards Board ("FASB") issued Statement ofFinancial Accounting Standards No. 144, *Accounting for the Impairmentor Disposal of Long-Lived Assets*("SFAS No. 144"), which addresses financial accounting andreporting for the impairment of long-lived assets (other than goodwill andindefinite lived intangibles) and for long-lived assets to be disposed of. SFASNo. 144 requires impairment losses to be recognized for long-lived assetsused in operations when indicators of impairment are present and the estimatedundiscounted cash flows are not sufficient to recover the assets' carryingamounts at each facility. The impairment loss is measured by comparing theestimated fair value of the asset, usually based on discounted cash flows, toits carrying amount. In accordance with SFAS No. 144, we assess the needfor an impairment write-down when such indicators of impairment are present.

     *2005.*  Duringthe year ended December 31, 2005, we did not record an impairment.

     *2004.*  Duringthe year ended December 31, 2004, we recorded pretax charges totaling$1.0 million for asset impairments. The asset impairment charges relatedto a $1.0 million write-down of property and equipment in our InpatientServices segment for certain nursing facilities whose book value exceededestimated fair value when tested for impairment.

45

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

     *2003.  *During the yearended December 31, 2003, we recorded pretax charges totaling $2.3 million forasset impairments. The asset impairment charges consisted of a $2.3 millionwrite-down of property and equipment in our Inpatient Services segment forcertain nursing facilities whose book value exceeded estimated fair value whentested for impairment.

**Recent Accounting Pronouncements**

*     *OnDecember 16, 2004, the Financial Accounting Standards Board (FASB) issued FASBStatement No. 123 (revised 2004), Share-Based Payment, which is a revision ofFASB Statement No. 123, *Accounting for Stock-Based Compensation*.Statement 123(R) supersedes APB Opinion No. 25, *Accounting for Stock Issuedto**Employees*, and amends FASB Statement No. 95*,Statement of Cash Flows*. Generally, the approach in Statement 123(R) issimilar to the approach described in Statement 123. However, Statement 123(R) *requires*all share-based payments to employees, including grants of employee stockoptions, to be recognized in the statement of operations based on their fairvalues. Pro forma disclosure is no longer an alternative.

     Weadopted Statement 123(R) using the modified-prospective method on January 1,2006, in which compensation cost is recognized beginning with the effectivedate (a) based on the requirements of Statement 123(R) for all share-basedpayments granted after the effective date and (b) based on the requirements ofStatement 123 for all awards granted to employees prior to the effective dateof Statement 123(R) that remain unvested on the effective date. Based on theestimated value of current unvested stock options, we expect wages and relatedexpenses to increase $0.9 million for the year ending December 31, 2006,beginning January 1, 2006.

**Item7A.  Quantitative and Qualitative Disclosures About Market Risk**

     Weare exposed to market risk because we hold debt that is sensitive to changes ininterest rates.  We manage our interest rate risk exposure by maintaining a mixof fixed and variable rates for debt.  The following table provides informationregarding our market sensitive financial instruments and constitutes a forward-lookingstatement.

 

**Fair  Value**

**Fair  Value**

**                                       Expected  Maturity Dates                                     **

**December  31,**

**December  31,**

**2006**

**2007**

**2008**

**2009**

**2010**

**Thereafter**

**Total**

**2005(1)(2)**

**2004(2)**

**(Dollars  in thousands)**

Fixed rate debt (3)

$ 55,036

$    6,714

$  23,382

$    3,349

$ 23,658

$   45,225

$157,364

$   147,783

$     54,497

   Rate

8.8%

5.5%

7.8%

8.4%

9.5%

6.8%

Variable rate debt

$ 11,820

$  17,442

$      512

$  10,154

$       14

$         52

$ 39,994

$     35,185

$     12,990

   Rate

7.7%

8.6%

6.5%

7.2%

5.5%

5.5%

(1)

Total debt increased by $95.7 million in  connection with the Peak acquisition.

(2)

The fair value of fixed and variable rate debt  were determined based on the current rates offered for debt with similar  risks and maturities.

(3)

Fixed rate long-term debt includes $50.2  million related to the consolidation of Clipper as of December 31, 2005 and $51.0 million as  of December   31, 2004.  (See "Note 10 - Variable Interest Entities.")

**Item8.  Financial Statements and Supplementary Data**

     Informationwith respect to Item 8 is contained in our consolidated financial statementsand financial statement schedules and are set forth herein beginning on PageF-1. 

46

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**Item9.  Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure**

  Notapplicable.

**Item9A.  Controls and Procedures**

**Management'sReport on Disclosure Controls and Procedures**

     As of the end ofthe period covered by this report, our management, including our principalexecutive officer (Richard Matros) and principal financial officer (L. BryanShaul), conducted an evaluation of the effectiveness of our disclosure controlsand procedures.  Disclosure controls and procedures are designed to ensurethat information required to be disclosedin our periodic reports filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission's rules and forms.  Based on thatevaluation, our principal executive officer and principal financial officerconcluded that our disclosure controls and procedures are effective.  No changein our internal control over financial reporting occurred during the fourthquarter of 2005 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

**Management'sReport on Internal Control over Financial Reporting**

     Managementis responsible for establishing and maintaining adequate internal control overfinancial reporting. We maintain a system of internal control that is designedto provide reasonable assurance as to the fair and reliable preparation andpresentation of the consolidated financial statements, as well as to safeguardassets from unauthorized use or disposition.

     We acquiredPeak Medical Corporation in December 2005 and excluded it from our assessmentof the effectiveness of our internal control over financial reporting as of December31, 2005. For the year ended December 31, 2005, Peak contributed $21.1 million,or 2.4%, of our total revenues, and, as of December 31, 2005, accounted for $112.6million, or 25.8%, of our total assets, excluding goodwill that was recorded inconnection with the acquisition of Peak of $75.9 million.

    Weconducted an evaluation of the effectiveness of our internal control overfinancial reporting as of December 31, 2005 based on theframework in *Internal Control - Integrated Framework*issued by theCommittee of Sponsoring Organizations of the Treadway Commission ("COSO").This evaluation included reviewing the documentation of controls, evaluatingthe design effectiveness of controls, testing the operating effectiveness ofcontrols and making a conclusion on this evaluation. Although there areinherent limitations in the effectiveness of any system of internal controlover financial reporting, based on our evaluation, we have concluded that ourinternal control over financial reporting was effective as of December 31, 2005.

     Ourassessment of the effectiveness of our internal control over financialreporting as of December 31, 2005 has been audited byErnst & Young LLP, an independent registered public accounting firm, asstated in their attestation report, which is included herein. (See page F-3).

**Item 9B.  Other Information**

Not applicable.

47

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** PART III**

**Item10.  Directors and Executive Officers of the Registrant**

     The information requiredunder Item 10 is incorporated herein by reference to our definitive proxystatement, which we will file pursuant to Exchange Act Regulation 14A within 120days after the end of fiscal 2005.

**Item 11.  ExecutiveCompensation**

     Theinformation required under Item 11 is incorporated herein by reference to ourdefinitive proxy statement, which we will file pursuant to Exchange ActRegulation 14A within 120 days after the end of fiscal 2005.

**Item12.  Security Ownership of Certain Beneficial Owners and Managementand Related Stockholder Matters**

     Theinformation required under Item 12 is incorporated herein by reference to ourdefinitive proxy statement, which we will file pursuant to Exchange ActRegulation 14A within 120 days after the end of fiscal 2005.

**Item13.  Certain Relationships and Related Transactions**

     Theinformation required under Item 13 is incorporated herein by reference to ourdefinitive proxy statement, which we will file pursuant to Exchange ActRegulation 14A within 120 days after the end of fiscal 2005.

**Item14.  Principal Accounting Fees and Services**

     Theinformation required under Item 14 is incorporated herein by reference to ourdefinitive proxy statement, which we will file pursuant to Exchange ActRegulation 14A within 120 days after the end of fiscal 2005.

48

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** PART IV**

**Item15.  Exhibits and Financial Statement 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, 2005 and 2004
         
Consolidated  Statements of Operations for the years ended December 31, 2005,  2004, and 2003
         
Consolidated Statements of Stockholders' (Deficit) Equity  for the years ended December 31, 2005, 2004, and 2003
         
Consolidated Statements of Cash Flows for the years  ended December 31, 2005, 2004, and 2003
         
Notes to Consolidated Financial Statements
         
(2)

Financial schedules  required to be filed by Item 8 of this form, and by Item 15(d) below:
         
Schedule  II Valuation and Qualifying Accounts for the years ended December 31, 2005, 2004, and 2003
         
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(18)

Agreement and Plan of Merger, dated as of May 16, 2005, by and among Sun  Healthcare Group, Inc., Pinnacle Acquisition Corp., Peak Medical Corporation  and the stockholders of Peak Medical Corporation
      
2.1.1(19)

Amendment No. 1, dated as of July 7, 2005, to  the Agreement and Plan of Merger, dated as of May 16, 2005, by and among Sun  Healthcare Group, Inc., Pinnacle Acquisition Corp., Peak Medical Corporation  and the stockholders of Peak Medical Corporation

2.1.2(19)

Amendment No. 2, dated as of September 16,  2005, to the Agreement and Plan of Merger, dated as of May 16, 2005, by and  among Sun Healthcare Group, Inc., Pinnacle Acquisition Corp., Peak Medical  Corporation and the stockholders of Peak Medical Corporation
      
2.2(5)

Asset Purchase Agreement by and among Omnicare, Inc. (as buyer) and  SunScript Pharmacy Corporation, Advantage Health Services, Inc., HoMed  Convalescent, Inc., SunScript Medical Services, Inc. and First Class Pharmacy,  Inc. (as sellers) dated June 15,

49

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES **

**Exhibit**

** **

**Number**

**Description of Exhibits**
           2003      
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
      
4.4(3)

Form of  Subscription Agreement dated February 2004 between Sun Healthcare Group, Inc.  and the purchasers named on the list of purchasers attached thereto
      
4.5(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
      
4.5(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
      
4.6

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(2)

Corporate Integrity Agreement between the  Office of Inspector General of the Department of Health and Human Services  and Sun Healthcare Group, Inc. dated July 12, 2001

50
      
10.6(2)+

Employment Agreement with Richard K. Matros  dated February   28, 2002
      
10.7(17)+

Employment Agreement with L. Bryan Shaul dated as of February 14, 2005
      
10.8(4)+

Employment Agreement with William A.  Mathies  dated February   28, 2002
      
10.9(20)+

Employment Agreement with Michael Newman dated March 22, 2005 
      
10.10(7)+

Employment Agreement with Heidi J. Fisher  dated February   11, 2002
      
10.11(11)+

Severance Agreement with Richard L. Peranton  dated as of November   1, 2004
      
10.12(8)+

Severance Agreement with Tracy A. Gregg dated April 2, 2003
      
10.13(2)+

Form of Severance Agreement with Chauncey J. Hunker  dated March   22, 2002
      
10.14(12)+

Severance Agreement with  Jennifer L. Botter dated August 24, 2004
      
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*

First  Amendment to Amended and Restated Master Lease Agreement, Amended and  Restated Security Agreement and Amended and Restated Guaranty
      
10.15.2*

Second  Amendment to Amended and Restated Master Lease Agreement, Amended and  Restated Security Agreement and Amended and Restated Guaranty
      
10.15.3*

Third  Amendment to Amended and Restated Master Lease Agreement, Amended and  Restated Security Agreement and Amended and Restated Guaranty
      
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.
      
23.1*

Consent of  Ernst & Young LLP
      
31.1*

Section 302  Sarbanes-Oxley Certifications by Principal Executive Officer and Principal  Financial and Accounting Officer

51
      
32.1*

Section 906  Sarbanes-Oxley Certifications by Principal Executive Officer and Principal  Financial and Accounting Officer

_______________

*      Filedherewith.

+      Designatesa management compensation plan, contract or arrangement

(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

52

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** SIGNATURES**

     Pursuantto the requirements of Section 13(a)or 15(d) of the Securities Exchange Actof 1934, the registrant has duly caused this Report to be signed on its behalfby the undersigned, thereunto duly authorized.

SUN HEALTHCARE GROUP, INC.
            
By:    /s/  Richard K. Matros                  

       Richard  K. Matros

       Chairman  of the Board and Chief

         Executive  Officer

March 9, 2006

53

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** **     Pursuantto the requirements of the Securities Exchange Act of 1934, this Report hasbeen signed below by the following persons on behalf of the registrant as ofMarch 9, 2006 in the capacities indicated.

**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/ Bryan Shaul                                       

Officer  (Principal Financial Officer)

   Bryan Shaul

Senior  Vice President and Corporate Controller

 /s/ Jennifer L. Botter                                    

(Principal  Accounting Officer)

   Jennifer  L. Botter
      
/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/ Keith W. Pennell                                      

Director

   Keith  W. Pennell
      
/s/ Milton J. Walters                                      

Director

   Milton  J. Walters

54

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIESIndex to Consolidated FinancialStatements**

**December 31, 2005**

**Page**
      
Reports of  Ernst & Young LLP, Independent Registered Public Accounting

F-2 to F-4

  Firm
      
Consolidated  Balance Sheets

     As  of December 31, 2005 and 2004

F-5 to F-6
      
Consolidated  Statements of Operations

     For  the years ended December   31, 2005, 2004 and 2003

F-7
      
Consolidated  Statements of Stockholders' Deficit

     For  the years ended December   31, 2005, 2004 and 2003

F-8
      
Consolidated  Statements of Cash Flows 

     For  the years ended December   31, 2005, 2004 and 2003

F-9
      
Notes to  Consolidated Financial Statements

F-10 to F-46
      
Supplementary  Data (Unaudited) - Quarterly Financial Data

1-2

F-1

**Report of Ernst & Young LLP, Independent RegisteredPublic Accounting Firm**

The Board of Directors and StockholdersSun Healthcare Group, Inc.

We have audited the accompanyingconsolidated balance sheets of Sun Healthcare Group, Inc. as of December 31, 2005 and 2004 and the related consolidated statements of operations, stockholders'deficit and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in theIndex at Item 15(a). These consolidated financial statements and schedule arethe responsibility of management of Sun Healthcare Group, Inc. (the "Company").Our responsibility is to express an opinion on these financial statements andschedule based on our audits.

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States).  Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, the financialstatements referred to above present fairly, in all material respects, theconsolidated financial position of Sun Healthcare Group, Inc. at December 31, 2005 and 2004 and the consolidated results of their operations and their cashflows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States.Also, in our opinion, the related financial statement schedule, when consideredin relation to the basic consolidated financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

We also haveaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the effectiveness of Sun Healthcare Group,Inc.'s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission and ourreport dated March 6, 2006 expressed an unqualified opinion thereon.

Ernst & Young LLP

Dallas, Texas March 6, 2006

F-2

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

The Board of Directors andShareholders

Sun Healthcare Group, Inc.

We have audited management's assessment, includedin the accompanying Management's Report on Internal Control over FinancialReporting, that Sun Healthcare Group, Inc. maintained effective internalcontrol over financial reporting as of December 31, 2005, based on criteria establishedin Internal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). Sun HealthcareGroup, Inc.'s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management's assessment and an opinion on the effectiveness of thecompany's internal control over financial reporting based on our audit. 

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement's assessment, testing and evaluating the design and operating effectivenessof internal control, and performing such other procedures as we considerednecessary in the circumstances. We believe that our audit provides a reasonablebasis for our opinion.

A company's internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples. A company's internal control over financial reporting includesthose policies and procedures that (1) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company's assets that could have amaterial effect on the financial statements.

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Asindicated in the accompanying Management's Report on Internal Control overFinancial Reporting, management's assessment of and conclusion on theeffectiveness of internal control over financial reporting did not include theinternal controls over financial reporting of Peak Medical Corporation, amaterial business acquired on December 9, 2005, which is included in the December 31, 2005 consolidated financial statements of theCompany and contributed approximately $21.1 million, or 2.4%, of the Company'stotal revenues, and, as of December 31, 2005, accounted for approximately $112.6million, or 25.8%, of the Company's total assets, excluding $75.9 million ofgoodwill that was recorded in connection with the acquisition. Our audit ofinternal control over financial reporting of the Company also did not includean evaluation of the internal control over financial reporting of Peak MedicalCorporation.

F-3

In our opinion, management's assessmentthat Sun Healthcare Group, Inc. maintained effective internal control overfinancial reporting as of December 31, 2005, is fairly stated, in all materialrespects, based on the COSO criteria.  Also, in our opinion, Sun HealthcareGroup, Inc. maintained, in all material respects, effective internal controlover financial reporting as of December 31, 2005, based on****the COSO criteria**.**

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofSun Healthcare Group, Inc. as of December 31, 2005 and 2004 and the related consolidatedstatements of operations, stockholders' deficit and cash flows for each of thethree years in the period ended December 31, 2005. Our audits also included the financialstatement schedule listed in the Index at Item 15(a).  Our report dated March 6, 2006 expressed an unqualified opinion thereon.

Ernst & Young LLP

Dallas, TexasMarch 6, 2006

F-4

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

** ASSETS(in thousands)**

** **

**December 31,   2005**

** **

**December 31,   2004**

** **

Current  assets:

  Cash  and cash equivalents

$             16,641

$             19,834

  Restricted  cash

25,142

26,649

  Accounts receivable, net of allowance for  doubtful accounts of $29,384

    and $40,293 at December 31, 2005  and 2004, respectively

123,639

95,829

  Other receivables, net of allowance of  $2,909 and $5,591 at 

    December 31, 2005 and 2004, respectively

2,429

2,616

  Inventories,  net

5,055

3,514

  Prepaid  expenses

6,414

 

3,232

  Assets  held for sale

                1,897

                4,736

  Total current assets 

181,217

156,410

  Property and equipment, net of accumulated depreciation and amortization

    of $75,999 at December 31, 2005 and $28,965 at December 31, 2004

187,734

105,852

Intangible  assets, net of accumulated amortization of $8,262 at 

  December   31, 2005 and $6,006 at December   31, 2004

19,335

10,299

Goodwill

81,265

405

Restricted  cash, non-current

35,517

34,111

Other  assets, net

                7,238

 

                6,076

 

Total  assets

$           512,306

$           313,153

===========

===========

F-5

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIESCONSOLIDATED BALANCE SHEETS (Continued)**

**LIABILITIES AND STOCKHOLDERS' DEFICIT(in thousands, except share data)**

**December 31,   2005**

** **

**December 31,   2004**

Current  liabilities:

** **

  Accounts  payable

$                 45,115

** **

$                 36,163

** **

  Accrued  compensation and benefits

42,393

** **

35,481

** **

  Accrued  self-insurance obligations, current

37,238

** **

40,236

** **

  Income  taxes payable

10,493

** **

9,752

** **

  Other  accrued liabilities

45,947

** **

47,897

** **

  Current  portion of long-term debt:

** **

** **

    Company  obligations

21,237

** **

16,363

** **

    Clipper  partnerships

34,415

** **

1,113

** **

  Capital  leases, current

                   11,204

** **

                           -

** **

** **

** **

Total  current liabilities

248,042

** **

187,005

** **

** **

** **

Accrued  self-insurance obligations, net of current

109,953

** **

130,686

** **

Long-term  debt, net of current:

** **

** **

  Company  obligations

115,094

** **

39,803

** **

  Clipper  partnerships

15,829

** **

49,903

** **

Unfavorable  lease obligations, net of accumulated amortization of

** **

** **

  $11,166  and $9,395 at December 31, 2005 and 2004, respectively

11,454

** **

13,985

** **

Other  long-term liabilities

                   14,829

** **

                  15,151

** **

** **

** **

Total  liabilities

515,201

** **

436,533

** **

** **

** **

Commitments  and contingencies

** **

** **

** **

** **

Stockholders'  deficit:

** **

** **

   Preferred stock of $.01 par value,  authorized

** **

** **

     10,000,000 shares, zero  shares were issued and outstanding as of

** **

** **

     December   31, 2005 and 2004

-

** **

-

** **

   Common stock of $.01 par value,  authorized

** **

** **

     50,000,000 shares,  31,143,728 shares issued and 31,133,546 shares 

** **

** **

     outstanding as of December   31, 2005 and 15,325,477 shares issued

** **

** **

     and outstanding as of December   31, 2004

311

** **

153

** **

  Additional  paid-in capital

428,771

** **

334,158

** **

  Accumulated  deficit

            (431,498

)

            (456,259

)

(2,416

)

(121,948

)

  Less:

** **

** **

    Unearned compensation

(388

)

(1,432

)

    Common  stock held in treasury, at cost, 10,182 shares

 

 

      as  of December 31, 2005

                     (91

)

                         -

  Total  stockholders' deficit

                (2,895

)

            (123,380

)

  Total  liabilities and stockholders' deficit

$             512,306

** **

$             313,153

** **

  

============

** **

============

** **

See accompanying notes.

F-6

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share data)**

** **

** **

**For  the Year**

** **

**For  the Year**

** **

**For  the Year**

** **

** **

**Ended**

** **

**Ended**

** **

**Ended**

** **

** **

**December  31,**

** **

**December  31,**

** **

**December  31,**

** **

** **

**      2005     **

** **

**      2004      **

** **

**      2003      **

** **
                     
Total  net revenues

$       882,109

$        813,290

$       778,438

Costs  and expenses:

  Operating  salaries and benefits

529,828

481,264

477,180

    Self-insurance for workers' compensation and general 

       and professional liability insurance

30,002

25,360

32,158

  Operating  administrative expenses

24,930

22,642

20,156

  Other  operating costs

179,597

167,431

149,697

  Facility rent expense

40,953

39,107

38,769

  General and administrative expenses

47,194

44,104

43,394

  Depreciation  and amortization

9,874

9,206

7,123

  Provision  for losses on accounts receivable

4,356

5,323

9,278

  Interest,  net

12,049

8,853

16,892

  Loss  on asset impairment

361

1,028

2,774

  Restructuring  costs, net

122

1,972

14,676

  Loss  on lease termination

-

150

-

  Loss  (gain) on sale of assets, net

384

1,494

(4,178

)

  Loss  (gain) on extinguishment of debt, net

               408

            (3,394

)

                    -

 

Total costs and expenses

        880,058

 

         804,540

 

         807,919

 

  Income (loss) before income taxes and discontinued  operations

2,051

8,750

(29,481

)

Income  tax (benefit) expense

             (786

)

            (1,158

)

              665

 

Income  (loss) from continuing operations

           2,837

             9,908

       (30,146

)

Discontinued  operations:

   Income  (loss) from discontinued operations

13,035

(23,214

)

(25,149

)

     Gain (loss) on disposal of discontinued operations, net of related 

 

 

 

 

 

 

      tax expense of $650 for the year ended December 31, 2003

          8,889

  

           (5,321

)

            55,649

 

Income  (loss) on discontinued operations

        21,924

         (28,535

)

            30,500

 

  Net  income (loss)

$       24,761

$       (18,627

)

$               354

========

=========

=========

Basic  earnings per common and common equivalent share:

   Income  (loss) from continuing operations 

$            0.18

$             0.69

$              (3.00

)

   Income  (loss) from discontinued operations, net of tax

            1.37

            (1.98

)

               3.04

   Net  income (loss) 

$            1.55

$            (1.29

)

$               0.04

========

=========

=========

Diluted  earnings per common and common equivalent share:

   Income  (loss) from continuing operations

$            0.18

$             0.68

$              (3.00

)

   Income  (loss) from discontinued operations, net of tax

            1.37

            (1.96

)

               3.04

   Net  income (loss)

$            1.55

$            (1.28

)

$               0.04

========

=========

=========

Weighted  average number of common and common equivalent

   shares  outstanding:

   Basic

16,003

14,456

10,050

   Diluted

16,019

14,548

10,050

See accompanyingnotes.

F-7

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS'DEFICIT(in thousands)**

** **
   
** **

**For  the Year Ended**

** **

**For  the Year Ended**

** **

**For  the Year Ended**

** **
   
** **

**December 31,   2005**

** **

**December 31,   2004**

** **

**December 31,   2003**

** **
   
** **

**Shares**

** **

**Amount**

** **

**Shares**

** **

**Amount**

** **

**Shares**

** **

**Amount**

** **
   
**Common  stock**

** **
   
Issued  and outstanding at beginning of period

15,325

$        153

10,044

$        100

9,321

$            93
   
Retirement  of common stock

(5

)

-

-

-

-
   
Cancellation  of restricted stock awards

-

(4

)

-

-

-
   
Issuance  of common stock

6,900

 

69

 

5,285

 

53

 

723

 

7

 
   
  Issuance of common stock in connection with

 

 

 
   
**   **Peak transaction

       8,924

 

           89

 

             -

 

              -

 

               -

 

               -
   
**Common stock issued and outstanding at**

 

 

 
   
**   end of period**

31,144

         311

15,325

         153

10,044

          100
   
** **

=======

======

=======
   
**Additional paid-in capital**
   
Balance  at beginning of period

334,158

272,889

253,375
   
Issuance  of common stock in excess of par value

94,681

61,881

19,514
   
Cancellation  of restricted stock awards

(58

)

(57

)

-
   
Other

         (10

)

       (555

)

              -

 
   
**Additional  paid-in capital at end of period**

 

 

 428,771

 

 

 

 334,158

 

 

 

   272,889

 
   
** **
   
**Accumulated  deficit**
   
Balance  at beginning of period

(456,259

)

(437,632

)

(437,986

)
   
Net  income (loss)

   24,761

  (18,627

)

          354
   
**Accumulated  deficit at end of period**

 

 

(431,498

)

 

 

  (456,259

)

 

 

  (437,632

)
   
** **
   
**Total**

 

 

    (2,416

)

 

 

  (121,948

)

 

 

  (164,643

)
   
** **
   
**Unearned  compensation**
   
Balance  at beginning of period

(1,432

)

(1,755

)

(2,700

)
   
Restricted  stock awards 

38

(1,013

)

-
   
Restricted  stock vested

 

 

948

1,279

945

 
   
Other

          58

            57

                -

 
   
**Unearned  compensation at end of period**

 

 

       (388

)

 

 

     (1,432

)

 

 

       (1,755

)
      
Common stock in treasury
   
Balance  at beginning of period

-

-

-

-

-

-
   
Purchase  of treasury stock

            10

 

        (91

)

            -

 

              -

 

               -

 

               -

 
   
**Common  stock in treasury at end of period**

10

        (91

)

-

              -

-

 

               -
   
** **

=======

======

=======
   
** **

 

 

 

 
   
**Total  stockholders' deficit**

$   (2,895

)

$(123,380

)

 

$ (166,398

)
   
** **

======

=======

 

=======

See accompanying notes.

F-8

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands) **

**For  the Year Ended**

**For  the Year Ended**

**For  the Year Ended**

**December 31,   2005**

**December 31,   2004**

**December 31,   2003**

**Cash  flows from operating activities:**

Net  income (loss)

$              24,761

$            (18,627

)

$                 354

Adjustments to reconcile net income (loss) to net cash  (used for) provided by

   operating activities, including  discontinued operations:

   Loss (gain) on extinguishment of  debt, net

408

(3,394

)

-

   Loss on lease termination

-

150

-

   Depreciation

4,876

5,254

4,609

   Amortization

5,101

4,356

4,787

   Amortization  of favorable and unfavorable lease intangibles

(1,714

)

(3,265

)

(8,740

)

   Provision  for losses on accounts receivable

5,009

11,901

19,073

   Loss  (gain) on sale of assets, net

384

1,494

(4,178

)

   (Gain)  loss on disposal of discontinued operations, net

(8,889

)

5,321

(55,649

)

   Transaction  costs

1,100

-

-

   Loss  on asset impairment

361

1,028

2,774

   Restricted  stock and option compensation expense

1,303

1,570

945

   Other,  net

1,010

2,045

898

Changes in operating assets and liabilities, net of  acquisitions:

   Accounts  receivable, net

(6,530

)

6,485

74,937

   Inventories,  net

12

(17

)

790

   Other  receivables, net

(155

)

558

4,261

   Restricted  cash

1,231

9,006

12,472

   Prepaids  and other assets

2,698

(1,658

)

4,573

   Accounts  payable

3,359

(14,406

)

3,656

   Accrued  compensation and benefits

(588

)

(6,230

)

(24,141

)

   Accrued  self-insurance obligations

(32,552

)

(26,213

)

11,985

   Income  taxes payable

794

1,436

1,120

   Other  accrued liabilities

(9,887

)

(4,687

)

(18,084

)

   Other  long-term liabilities

(405

)

2,151

467

   Minority  interest

                      -

                       -

                    (120

)

      Net cash (used for)  provided by operating activities before reorganization costs

(8,313

)

(25,742

)

36,789

      Net  cash paid for reorganization costs

                      -

                  (499

)

                (10,225

)

      Net  cash (used for) provided by operating activities

              (8,313

)

             (26,241

)

                 26,564

** **

**Cash  flows from investing activities:**

   Capital  expenditures, net

(17,416

)

(12,890

)

(16,564

)

   Proceeds  from sale of assets held for sale

10,742

1,857

83,616

   Acquisitions

(17,816

)

(700

)

-

   Repayment  of long-term notes receivable

                  237

                    147

                      839

      Net  cash (used for) provided by investing activities

             (24,253

)

               (11,586

)

                  67,891

** **

**Cash flows from financing activities:**

   Net  repayments under Revolving Loan Agreement

(233

)

(12,491

)

(84,274

)

   Long-term  debt borrowings

11,000

-

-

   Long-term  debt repayments

(19,495

)

(6,727

)

(5,620

)

   Net  proceeds from issuance of common stock

38,428

52,266

-

   Distribution  of partnership equity

                 (327

)

                   (961

)

                          -

      Net  cash provided by (used for) financing activities

              29,373

                32,087

                (89,894

)
                     
  Net  (decrease) increase in cash and cash equivalents

(3,193

)

(5,740

)

4,561

Cash  and cash equivalents at beginning of period

             19,834

                25,574

                 21,013

Cash  and cash equivalents at end of period

$            16,641

$               19,834

$                25,574

===========

=============

=============

Supplemental  disclosure of cash flow information:

   Interest  payments

$            10,360

$               9 ,420

$                21,457

   Capitalized  interest

$                 132

$                     76

$                       77

   Income  taxes refunded, net

$             (1,580

)

$               (2,595

)

$                   (455

)

See accompanyingnotes. F-9

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS **

**DECEMBER 31, 2005**

** (1)  Natureof Business**

* *     Referencesthroughout this document to the Company include Sun Healthcare Group, Inc. andour consolidated subsidiaries. In accordance with the Securities and ExchangeCommission's "Plain English" guidelines, this Annual Report has beenwritten in the first person. In this document, the words "we," "our,""ours" and "us" refer to Sun Healthcare Group, Inc. and itsdirect and indirect consolidated subsidiaries and not any other person.

*Business*

     We are a provider of long-term,subacute and related specialty healthcare in the United States.  We operatethrough five principal business segments: (i) inpatient services, (ii)rehabilitation therapy services, (iii) medical staffing services, (iv) homehealth services and (v) laboratory and radiology services.  Inpatient servicesrepresent the most significant portion of our business.  We operated 158long-term care facilities, inclusive of 10 managed facilities, in 19 states asof March 1, 2006.

*Comparability of Financial Information*

     Weadopted the provisions of Statement of Financial Accounting Standard ("FASB"),*Accounting for the Impairment or Disposal of Long-Lived Assets* ("SFASNo. 144") as of January 1, 2002, requiringreclassification of the results of operations of subsequent divestitures forall periods presented to discontinued operations within the Statement ofOperations.

**(2)  Basisof Reporting and Current Operating Environment**

*Restructuring*

     InJanuary 2003, we initiated efforts to restructure the portfolio of leases underwhich we operate most of our long-term care facilities. During the periodJanuary 1, 2003 to December 31, 2005, we divested 137 of our under-performingfacilities by transitioning operations of those facilities to new operators.

** ***Liquidity*

** **     For the yearended and as of December 31, 2005, our net income was $24.8 million and ourworking capital deficit was $66.8 million, of which $34.4 million relates tothe debt on the Clipper partnerships, which is not our direct obligation andis expected to be refinanced during 2006, and $11.2 million relates to a capital lease that we intend toconvert to an operating lease and for which no principal payment will berequired. As of December 31, 2005, we had cash and cash equivalents of $16.6 million,$10.1 million in borrowings and $14.4 million in letters of credit outstandingunder our Revolving Loan Agreement and $61.1 million of funds available forborrowing under our Revolving Loan Agreement, which expires January 31,2009. We believe that our operating cash flows, existing cash reserves, andavailability for borrowing under our Revolving Loan Agreement will providesufficient funds for our operations, capital expenditures and regularlyscheduled debt service payments at least through the next year.

** **F-10

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

*Reorganization*

   On February 6, 2002, the United StatesBankruptcy Court for the District of Delaware (the "Bankruptcy Court")approved our Plan of Reorganization that was filed with the Bankruptcy Court onNovember 7, 2001.On February 28, 2002,we emerged from proceedings under chapter 11 of Title 11 of the United StatesCode (the "Bankruptcy Code") pursuant to the terms of our Plan ofReorganization.

     In connection with our emergence frombankruptcy, we reflected the terms of the Plan of Reorganization in ourconsolidated financial statements by adopting the fresh-start accountingprovisions of SOP 90-7.  Under fresh-start accounting, a new reporting entityis deemed to be created and the recorded amounts of assets and liabilities areadjusted to reflect their estimated fair values. For accounting purposes, thefresh-start adjustments have been recorded in the consolidated financial statementsas of March 1, 2002.****

**(3)  Summaryof Significant Accounting Policies**

(a)*  Useof Estimates*

    Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United  States requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities, the disclosure of contingent assets and liabilities at thedate of the consolidated financial statements and the reported amounts ofrevenues and expenses during the reporting period. Significant estimatesinclude determination of third-party payor settlements, allowances for doubtfulaccounts and notes receivable, self-insurance obligations, goodwill and otherintangible assets and loss accruals.  Actual results could differ from thoseestimates.

*(b)  Principlesof Consolidation*

     Ourconsolidated financial statements include the accounts of our subsidiaries inwhich we own more than 50% of the voting interest. Investments of companies inwhich we own between 20 - 50% of the voting interests and joint ventures wereaccounted for using the equity method, which records as income an ownershippercentage of the reported income of the subsidiary, regardless of whether itwas or was not received by the parent.  Investments in companies in which weown less than 20% of the voting interests are carried at cost. All significantintersegment accounts and transactions have been eliminated in consolidation.

     Inaccordance with FASB Interpretation No. 46, *Consolidation of Variable InterestEntities* ("FIN No. 46R"), we are required to consolidate certainentities when control exists through means other than ownership of voting (orsimilar) interests in variable interest entities commonly referred to asspecial purpose entities, effective for the first reporting period that endsafter March 15, 2004. FIN No. 46R requires consolidation by the majority holderof expected residual gains and losses of the activities of a variable interestentity. (See "Note 10 - Variable Interest Entities.")

(c)*  Cashand Cash Equivalents*

     Weconsider all highly liquid, unrestricted investments with original maturitiesof three months or less to be cash equivalents. Cash equivalents are stated atcost, which approximates fair value. 

F-11

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

(d)  *Net Revenues*

     Net revenues consist of long-term andsubacute care revenues, rehabilitation therapy services revenues, temporarymedical staffing services revenues and other ancillary services revenues. Netrevenues are recognized as services are provided. Revenues are recorded net ofprovisions for discount arrangements with commercial payors and contractualallowances with third-party payors, primarily Medicare and Medicaid. Netrevenues realizable under third-party payor agreements are subject to changedue to examination and retroactive adjustment. Estimated third-party payorsettlements are recorded in the period the related services are rendered. Themethods of making such estimates are reviewed periodically, and differencesbetween the net amounts accrued and subsequent settlements or estimates ofexpected settlements are reflected in the current period results of operations.Laws and regulations governing theMedicare and Medicaid programs are extremely complex and subject tointerpretation.

     Revenuesfrom Medicaid from our continuing operations accounted for 35.9%, 36.5%, and 36.1%,of our net revenue for the years ended December 31, 2005, 2004 and 2003,respectively.  Revenues from Medicare from our continuing operations comprised 27.6%,26.4% and 25.1% of our net revenues for the years ended December 31, 2005,2004 and 2003, respectively.

(e)  *AccountsReceivable*

* *     Ouraccounts receivable relate to services provided by our various operatingdivisions to a variety of payors and customers. The primary payors for servicesprovided in long-term and subacute care facilities that we operate are theMedicare program and the various state Medicaid programs. The rehabilitationtherapy service operations provide services to patients in unaffiliatedlong-term, rehabilitation and acute care facilities. The billings for thoseservices are submitted to the unaffiliated facilities. Many of the unaffiliatedlong-term care facilities receive a large majority of their revenues from theMedicare program and the state Medicaid programs.

     Estimatedprovisions for doubtful accounts are recorded each period as an expense to thestatement of operations.  In evaluating the collectibility of accountsreceivable, we consider a number of factors, including the age of the accounts,changes in collection patterns, the financial condition of our customers, thecomposition of patient accounts by payor type, the status of ongoing disputeswith third-party payors and general industry conditions.  Any changes in thesefactors or in the actual collections of accounts receivable in subsequentperiods may require changes in the estimated provision for loss. Changes inthese estimates are charged or credited to the results of operations in theperiod of change.

     Theallowance for uncollectible accounts related to facilities that we currentlyoperate is computed by applying a bad debt percentage to the individualaccounts receivable aging categories based on historical collections.  Anadjustment is then recorded each month in the results of operations to adjustthe allowance based on the analysis. In addition, a retrospective collectionanalysis is performed within each operating company to test the adequacy of thereserve on a semi-annual basis.

     Theallowance for uncollectible accounts related to facilities that we havedivested was based on a percentage of outstanding accounts receivable at thetime of divestiture and is recorded in gain or loss on disposal of discontinuedoperations, net.  As collections are recognized, the allowance is adjusted asappropriate. Due to favorable collections, $0.2 million and $6.5 million of thereserve was recovered in the years ended December 31, 2005 and 2004. As of December 31, 2005,accounts receivable for divested operations were fully reserved.

F-12

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

(f)  *Inventories*

     Asof December 31, 2005, our inventories relate to the long-term and subacute careoperations and are stated at the lower of cost or market.

(g)*  Propertyand Equipment*

     Propertyand equipment are stated at the lower of carrying value or fair value. Propertyand equipment held under capital lease are stated at the net present value offuture minimum lease payments.  Major renewals or improvements are capitalizedwhereas ordinary maintenance and repairs are expensed as incurred. Depreciationis computed using the straight-line method over the estimated useful lives ofthe assets as follows: buildings and improvements - five toforty years; leasehold improvements - the shorter of the estimated usefullives of the assets or the life of the lease; and equipment - three totwenty years. We capitalize interest directly related to the developmentand construction of new facilities as a cost of the related asset. Under SFASNo. 144, we subject our long-lived assets to an annual impairment test. (See "Note8 - Impairment of Intangible and Long-Lived Assets.")

* *(h)  *IntangibleAssets*

* *     UnderStatement of Financial Accounting Standards No. 142, *Goodwill and OtherIntangible Assets* ("SFAS No. 142"), we no longer amortizegoodwill and intangible assets with indefinite lives. Instead, we subject themto annual impairment tests. Intangible assets with definite lives continue tobe amortized over their estimated useful lives. (See "Note 8 - Impairmentof Intangible and Long-Lived Assets.")

* *(i)  *Stock-BasedCompensation*

* *     In December 2002,the FASB issued Statement of Financial Accounting Standards No. 148, *Accountingfor Stock-Based Compensation-Transition and Disclosure* ("SFAS No. 148"). This statement amends Statement of Financial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation* ("SFAS No. 123"). The provisions ofSFAS No. 123 were effective for interim and annual financial statements forfiscal years ended after December 15, 2002. This statement provides alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation. Also, this statement amendsthe disclosure requirements of SFAS No. 123 to require prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults. We continue to apply the intrinsic value method of AccountingPrinciples Board Opinion No. 25, *Accounting for Stock Issued to*Employees("APB No. 25"). (See "Note 14 - Capital Stock.")

     OnDecember 16, 2004, the Financial Accounting StandardsBoard (FASB) issued FASB Statement No. 123 (revised 2004), Share-Based Payment,which is a revision of FASB Statement No. 123, *Accounting for Stock-BasedCompensation*. Statement 123(R) supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees*, and amends FASB Statement No. 95*,Statement of Cash Flows*. Generally, the approach in Statement 123(R) issimilar to the approach described in Statement 123. However, Statement 123(R) *requires*all share-based payments to employees, including grants of employee stockoptions, to be recognized in the statement of operations based on their fairvalues. Pro forma disclosure is no longer an alternative.

     We adopted Statement 123(R)using the modified-prospective method on January 1, 2006, in which compensationcost is recognized beginning with the effective date (a) based on therequirements of Statement 123(R) for all share-based payments granted after theeffective date and (b) based on the requirements of 

F-13

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

Statement 123 for all awards granted to employees prior to the effective dateof Statement 123(R) that remain unvested on the effective date. Based on theestimated value of current unvested stock options, we expect wages and relatedexpenses to increase $0.9 million for the year ending December 31, 2006,beginning January 1, 2006.

(j)  *NetIncome (Loss) Per Share*

* *     Basic net income (loss) pershare is based upon the weighted average number of common shares outstandingduring the period.  The weighted average number of common shares for the yearended December 31, 2005 includes all the common shares that are presentlyoutstanding, common shares to be issued once the prepetition claims arefinalized, and the common shares issued as common stock awards and excludenon-vested restricted stock.  (See "Note 14 - Capital Stock.")

** **     Thediluted calculation of income (loss) per common share includes the dilutiveeffect of warrants, stock options and non-vested restricted stock, using thetreasury stock method. However, inperiods of losses from continuing operations, diluted net income (loss) percommon share is based upon the weighted average number of common sharesoutstanding.

(k)  *Reclassification*

* *     Certainreclassifications have been made to the prior period financial statements toconform to the 2005 financial statement presentation.

**(4)  LoanAgreements**

     OnDecember 2, 2005, we entered into an Amended and RestatedLoan and Security Agreement (the "Revolving Loan Agreement") with CapitalSource Finance LLC, ascollateral agent, and certain lenders, which amended and restated an existing revolvingcredit facility. The Revolving Loan Agreement, among other things, provides forup to $100 million of borrowing availability and terminates on January 31, 2009. The interest rate on borrowings equals 2.75% (which percentage issubject to adjustment after June 2, 2006 based on our fixed charge coverageratio) plus the greater of (i) 4.31% or  (ii) (a) a floatingrate equal to the London Interbank Offered Rate for one month adjusted daily or(b), at our option, a rate that is fixed for a period of 30, 60 or90 days equal to the London Interbank Offered Rate two days prior to thecommencement of such period. The  Revolving Loan Agreementcontinues to be secured by almost all of our assets (and the assets of oursubsidiaries), including accounts receivable, inventory, stock of oursubsidiaries and equipment, but excluding real estate.

     Availabilityof amounts under the Revolving Loan Agreement is subjectto compliance with financial covenants, including a fixed charge coveragecovenant, which requires that the ratio of Operating Cash Flow (as defined inthe  Revolving Loan Agreement) to Fixed Charges (as defined in theRevolvingLoan Agreement) equal or exceed 1.0:1.0. Our borrowing availability under theRevolving Loan Agreement is generally limited to up to eighty-five percent(85%) of the value of our accounts receivable that are deemed eligible pursuantto the  Revolving Loan Agreement, plus an overadvance facility equal to anadditional 15% of the value of such receivables, but not to exceed$100.0 million. Under certain circumstances, the borrowing capacity of thefacility may be expanded to up to $150.0 million. The defined borrowing base asof December 31, 2005 was $85.6 million, net of specified reserves of $5.9million. As of December 31, 2005, we had $10.1 million in borrowings outstandingand we had issued $14.4 million in letters of credit, leaving $61.1 millionavailable to us for additional borrowing. The Revolving Loan Agreement containscustomary events of default, such as our failure to make payment of amounts due,defaults under other agreements evidencing indebtedness, certain bankruptcyevents and a change of control 

* *F-14

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

(as defined in the Revolving LoanAgreement). The agreement also contains customary covenantsrestricting, among other things, incurrence of indebtedness, liens, payment ofdividends, repurchase of stock, acquisitions and dispositions, mergers andinvestments. We have also agreed to limit our capital expenditures to a maximumof $13.0 million in any six-month period. Failure to comply with acovenant or the occurrence of an event of default could result in theacceleration of payment obligations under the  Revolving Loan Agreement. 

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

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

**December 31, 2005**

**December 31, 2004**
               
Revolving Loan  Agreement

$            10,141

$                     -

Mortgage notes payable due at various dates through 2037, interest at

   rates from 5.5% to 12.0%, collateralized by  various facilities(1)(2) 

158,874

91,239

Capital lease(3)

11,204

-

Industrial Revenue  Bonds

6,360

6,905

Other long-term  debt

             11,200

               9,038

Total long-term  debt(1)

197,779

107,182

   Less  amounts due within one year

            (66,856

)

            (17,476

)

Long-term debt,  net of current portion

$          130,923

$            89,706

===========

===========

(1)

Net of fair value premium  of $0.4 million related to the Peak acquisition (See "Note 7 - Acquisitions.")

(2)

Includes $50.2 million and  $51.0 million related to the consolidation of Clipper as of December   31, 2005 and 2004, respectively (See "Note 10 - Variable  Interest Entities.")

(3)

We expect to convert the  capital lease to an operating lease during 2006, and no principal payment is  anticipated.

     The scheduled or expectedmaturities of long-term debt, excluding premium, as of December 31, 2005, wereas follows (in thousands):

     2006

$           66,856

     2007

24,156

     2008

23,894

     2009

13,503

     2010

23,672

Thereafter

            45,277

$        197,358

==========

     Includedin the expected maturities of long-term debt are the following amounts relatedto the consolidation of Clipper (See "Note 10 - Variable Interest Entities")(in thousands):  $34,415, $276, $293, $310, $328, and $14,622, respectively,for 2006, 2007, 2008, 2009, 2010 and thereafter.

F-15

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

**(6)  Property and Equipment**

     Propertyand equipment consisted of the following as of the periods indicated (inthousands): 

** **

**December 31, 2005**

** **

**December 31, 2004**

** **
               
Land

$                        17,979

$                    10,527

Buildings and improvements

158,678

** **

70,029

** **

Equipment

51,471

28,850

Leasehold improvements

33,158

** **

23,171

** **

Construction in process

                        2,447

                       2,240

   Total

263,733

** **

134,817

** **

Less accumulated depreciation

                     (75,999

)

                   (28,965

)

    Property and equipment, net

$                   187,734

** **

$                  105,852

** **

===============

** **

==============

** **

** (7)  Acquisitions**

    In December 2005, we completed thepurchase of Peak Medical Corporation, which operated or managed 56 inpatientfacilities, by acquiring all of the outstanding stock of Peak in exchange for approximatelynine million shares of our stock.  Peak's results of operations have beenincluded in the consolidated financial statements since the date ofacquisition.

     The following unaudited pro formaresults of operations of Sun for the year ended December 31, 2005 and2004, assume that the Peak acquisition occurred at the beginning of each of theperiods presented. As a result of the Peak acquisition, we recognized anon-recurring pre-tax charge for transaction costs of $1.1 million. Theseunaudited pro forma results are not necessarily indicative of the actualresults of operations that would have been achieved, nor are they necessarilyindicative of future results of operations (in thousands, except per share data):

F-16

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

**For the Year Ended**

**December 31,**

**        2005       **

**      2004       **
               
Revenues

$      1,107,546

$        1,041,727

Costs and  expenses:

  Operating  costs

1,008,409

944,661

  Facility  rent

53,906

52,958

  Depreciation  and amortization

13,931

13,415

  Interest,  net

19,975

17,729

  Non-operating  costs

               1,274

               1,249

Total costs and  expenses

        1,097,495

        1,030,012
               
Income before  income taxes and discontinued operations

10,051

11,715

Income tax benefit

                (786

)

              (1,158

)

Income from  continuing operations

$           10,837

$            12,873

==========

===========

Net income (loss)

$           31,867

$           (16,965

)

==========

===========

Earnings per share:

Basic:

Income from continuing operations

$                0.68

$               0.89

Net income (loss)

$                1.99

$              (1.09

)
               
Diluted:

Income from continuing operations

$                0.68

$               0.88

Net income (loss)

$                1.99

$              (1.17

)

     The total purchase price of the Peakacquisition is as follows (in thousands):

Fair value of 8.9  million shares of Common Stock issued

$             55,538

Fair value of assumed  debt obligations

95,739

Stock option costs

320

Estimated direct  transaction costs

              12,832

$           164,429

===========

     Under the purchase method ofaccounting, the total purchase price as shown in the table above was allocatedto Peak's net tangible and intangible assets based upon their estimated fairvalues as of December 1, 2005. The excess of the purchase price over theestimated fair value of the net tangible and intangible assets is recorded asgoodwill. The estimated fair value of our Common Stock issued was based on the$6.26 historic Sun average share price for the period of May 12 through May 16,2005, which is in accordance with Emerging Issues Task Force Issue Number99-12, "Determination of the Measurement Date for the Market Price ofAcquirer Securities Issued in a Purchase Business Combination" ("EITFNo. 99-12"). As stated in paragraph 4 in EITF No. 99-12, when thenumber of the acquirer's shares or amount of other consideration is not subjectto change pursuant to the existing terms of the acquisition agreement, the valueof the acquirer's marketable equity securities issued to effect a purchasebusiness combination should be determined pursuant to the guidance in paragraph74 of Accounting Principles Board Opinion 16 ("APB No. 16"), BusinessCombinations, based on the market price of the securities over a reasonableperiod of time before and after the terms of the acquisition are agreed to andannounced.  The Task Force members observed that the reasonable period oftime referred to in paragraph 74 of APB No. 16 is intended to be veryshort, such as a few days before and after the acquisition is agreed to andannounced.

F-17

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

     The purchase price allocation forthe Peak acquisition has been prepared on preliminary basis and is subject tochanges as new facts and circumstances emerge. We have engaged a third-partyvaluation firm to complete a valuation of property and equipment. Once thevaluation study is completed, we will adjust the purchase price allocation toreflect the final values along with the final determination of any favorable orunfavorable lease intangibles. In addition, we are also finalizing our insurancereserves for general and professional and workers' compensation liabilities withour third party actuary. Changes in the purchase price allocation may impactdeferred taxes and goodwill.

     The preliminary fair values ofassets acquired and liabilities assumed at the date of acquisition were asfollows (in thousands):

Net working capital

$      12,824

Property and  equipment

74,561

Identifiable intangible  assets

2,820

Goodwill

75,940

Other long-term  assets

         6,024

Total assets acquired

     172,169
      
Debt

95,739

Other long-term  liabilities

         7,740

Total liabilities  assumed

     103,479
      
Net assets acquired

$     68,690

========

     We identified $2.8 million inintangible assets in connection with the Peak acquisition, of which $2.3million represented a management contract and $0.5 million representedoperating licenses. The amortization period for the management contract is sixyears. The $75.9 million in goodwill was assigned to the Inpatient Servicessegment, none of which is expected to be deductible for tax purposes. Netdeferred tax assets of $19.0 million, for which a full valuation allowance wasrecognized, were recorded in the Peak acquisition.

    In connection with the Peak acquisition, werecognized a pretax charge for transaction costs of $1.1 million in theyear ended December 31, 2005 comprisedof the following (in millions):

Adjustment to Peak  acquired accounts receivable

$            0.5

Adjustment to Peak  acquired inventory

              0.6

$            1.1

========

     The adjustment to acquired accountsreceivable reflects the impact of conforming Peak's accounting treatmentregarding the estimation of the net realizable value of accounts receivable to ouraccounting policy. The adjustment to acquired inventory reflects the impact ofconforming Peak's per bed calculation to our per bed calculation.

F-18

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

**Other Acquisitions**

     On August 29,2005, we acquired ProCare, a temporary nurse staffing business, for a totalpurchase price of $8.3 million, of which $4.2 million was paid atclosing and $4.1 million is payable over three years pursuant to two promissorynotes. The $8.3 million acquisition cost, including $0.1 million inestimated professional fees, was allocated to the assets acquired andliabilities assumed, based on their fair values of $2.5 million to workingcapital and $5.9 million to intangible assets. Of the $5.9 million ofacquired intangible assets, $0.1 million was assigned to trade names, anindefinite-lived intangible asset, and $3.3 million was assigned tocustomer contracts, which is subject to amortization. The remaining$2.5 million of acquired intangible assets represented goodwill, wasassigned to the Medical Staffing segment and will be subject to annualimpairment tests.

     In April 2005, weacquired the operations of SingleSource Staffing and Goddard HealthcareConsulting, Inc. for a combined purchase price of $2.4 million, all of whichwas allocated to goodwill.

     InNovember 2004, we acquired one home health agency for $0.7 million in cash andallocated the purchase price to goodwill and licenses of $0.4 million and $0.3million, respectively. We acquired operations of one skilled nursing facilityduring the year ended December 31, 2003 by entering into a new lease agreementin March 2003.

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

(a)  *IntangibleAssets*

     Thefollowing table provides information regarding our intangible assets, which areincluded in the accompanying consolidated balance sheets at December 31, (inthousands):

F-19

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

**Gross  Carrying   Amount   **

**AccumulatedAmortization**

**Net     Total     **

***Finite-lived  Intangibles:***

Lease  intangibles:

          2005

$       7,940

$       4,517

$       3,423

          2004

5,796

3,178

2,618

Deferred financing cost:

          2005

$       6,518

$       3,593

$       2,925

          2004

3,676

2,825

851

Management and customer contracts

          2005

$       5,634

$         144

$       5,490

          2004

-

-

-
            
***Indefinite-lived Intangibles:***

Trademarks:

          2005

$       5,954

$             4

$       5,950

          2004

5,954

-

5,954

Other intangible assets:

          2005

$       1,551

$             4

$       1,547

          2004

879

3

876
            
***Total intangible assets:***

          2005

$     27,597

$      8,262

$     19,335

          2004

16,305

6,006

10,299
            
Unfavorable  lease intangibles:

          2005

$     22,620

$    11,166

$     11,454

          2004

23,380

9,395

13,985

     Thenet credit to amortization expense was a result of the amortization on unfavorablelease intangibles, which recognize a reduction in rent expense in connectionwith a fair market valuation performed on our facility lease agreements.  The net creditrecorded toamortization was as follows for the years ended December 31, (in thousands):

**    2005    **

** **

**    2004    **

** **

**    2003    **

** **
                     
Amortization  expense

$              622

   

$           1,592

$           1,854
Amortization of unfavorable and                  
   favorable lease intangibles,  net

          (1,714

)

          (3,265

)

          (8,740

)

$         (1,092

)

$         (1,673

)

$         (6,886

)

=========

=========

=========

F-20

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

     Total estimatedamortization (credit) expense for our intangible assets for the next five yearsis as follows (in thousands):

**Expense**

**Credit**

** **

**   Net   **

** **
                  
2006

$      857

$     (1,786

)

$       (929

)

2007

924

(1,609

)

(685

)

2008

905

(1,488

)

(583

)

2009

867

(1,431

)

(564

)

2010

769

(1,431

)

(662

)

     The weighted-average amortization period for leaseintangibles is approximately five years at December 31, 2005.

(b)  *Impairmentof**Intangible Assets*

Goodwill

     Pursuantto SFAS No. 142, we performed our annual goodwill impairment analysis duringthe fourth quarter of 2005 for each reporting unit that constitutes a businessfor which discrete financial information is produced and reviewed by operatingsegment management and, with the exception of the long-term care facilities,provides services that are distinct from the other components of the operatingsegment. We determine impairment by comparing the net assets of each reportingunit to their respective fair values. We determine the estimated fair value ofeach reporting unit using a discounted cash flow analysis. In the event a unit'snet assets exceed its fair value, an implied fair value of goodwill must bedetermined by assigning the unit's fair value to each asset and liability ofthe unit. The excess of the fair value of the reporting unit over the amountsassigned to its assets and liabilities is the implied fair value of goodwill.An impairment loss is measured by the difference between the goodwill carryingvalue and the implied fair value.  Based on the analysis performed, we recordedno goodwill impairment for the years ended December 31, 2005,2004 or 2003.

     During2004, we determined that tax losses generated in 2004 were available to offseta liability that originated upon our emergence from bankruptcy. Accordingly, wereduced the remaining goodwill balance created through fresh-start accounting by$3.8 million (See "Note 12 - Income Taxes"). We also recorded $0.4million in goodwill through a small home health acquisition in November 2004(See "Note 7 - Acquisitions"). During 2005, we recognized $4.9million and $75.9 million in goodwill in connection with acquisitions in our MedicalStaffing and Inpatient Services segments, respectively.

Indefinite Life Intangibles

     Weinternally prepared an impairment analysis using discounted cash flows in orderto estimate the fair value of Indefinite Life Intangibles, which principallyconsists of trademarks. The analysis resulted in no impairment charge for theyears ended December 31, 2005, 2004 and 2003.

F-21

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

Finite Life Intangibles

     Weinternally prepared an impairment analysis using discounted cash flows in orderto estimate the fair value of Finite Life Intangibles, which principallyconsists of lease intangibles, customer contracts and a management contract. Theanalysis resulted in no impairment charge for the year ended December 31, 2005or 2004 and an impairment charge of $0.5 million for the year ended December31, 2003.

(c)  *Impairment of Long-Lived Assets*

     SFAS No.144 requires impairment losses to be recognized for long-lived assets used inoperations when indicators of impairment are present and the estimatedundiscounted cash flows are not sufficient to recover the assets' carryingamounts.  In estimating the undiscounted cash flows for our impairmentassessment, we primarily used our internally prepared budgets and forecastinformation including adjustments for the following items: Medicare andMedicaid funding; overhead costs; capital expenditures; and patient careliability costs.  In accordance with SFAS No. 144, we assess the need for animpairment write-down when such indicators of impairment are present.

     *2005*.  Duringthe fourth quarter of 2005, we did not recognize any impairments.

     *2004.  *Duringthe fourth quarter of 2004, we recorded pretax charges totaling $1.0 millionfor asset impairments.  The asset impairment charges consist of a write-down of property and equipment in our Inpatient Services segmentfor certain nursing facilities whose book value exceeded estimated fair valuewhen tested for impairment.

     *2003.*  Duringthe fourth quarter of 2003, we recorded pretax charges totaling $2.3 millionfor asset impairments. The asset impairment charges consist of a write-down of property and equipment in our Inpatient Services segment forcertain nursing facilities whose book value exceeded estimated fair value whentested for impairment.

(d)  *LongLived Assets to be Disposed Of*

* *     SFASNo. 144 requires that long-lived assets to be disposed of be measured at thelower of carrying amount or fair value less cost to sell, whether reported incontinuing operations or in discontinued operations.  Therefore, discontinuedoperations will no longer be measured at net realizable value or includeamounts for operating losses that have not yet occurred.  SFAS No. 144 alsobroadens the reporting of discontinued operations to include all components ofan entity with operations that can be distinguished from the rest of the entityand that will be eliminated from the ongoing operations of the entity in adisposal transaction. Depreciation is discontinued once an asset is classifiedas held for sale.

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

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

*     2005.  *During the year ended December 31, 2005, we recorded a$0.4 million charge primarily related to the write-down of a property held forsale.

*     2004.  *During the year ended December 31, 2004, we recorded a$1.5 million charge primarily related to the write-down of a property held forsale.

 

F-22

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

     *2003.  *Duringthe year ended December 31, 2003, we recorded a gain on sale of assets of $4.2million primarily related to the sale of land and buildings previously reportedin the Other Operations segment.

(b)  *Discontinued Operations*

* *     Inaccordance with the provisions of SFAS No. 144, the results of operations ofthe disposed assets and the gains (losses) related to these divestitures havebeen classified as discontinued operations for all periods presented in theaccompanying consolidated statements of operations.  

     *InpatientServices*: During the first quarter of 2005, we divested one skilled nursingfacility in accordance with our restructuring plan.  During the second quarterof 2005, we sold a skilled nursing facility for $1.0 million.  Thefacility was held for sale with a carrying amount of $0.1 million and werecorded a net gain of $0.8 million as a deferred gain to currentliabilities.  Although the sale of the facility was final, we continuedto operate the facility until the new owner obtained licensure on August1, 2005, at which time the new owner took over operations of the facilityand the gain was recognized.

     *Laboratoryand Radiology Services:*On November 1, 2004, one of our subsidiaries soldits clinical laboratory and radiology operations located in California. Wereceived $1.6 million in cash in connection with this sale, of which $0.9million was received in the first quarter of 2005. In the fourth quarter of2005, our mobile radiology services operations located in Arizona and Coloradowere sold.

     *PharmaceuticalServices*: In July 2003, we sold the assets of our pharmaceutical servicesoperations to Omnicare, Inc. for $90.0 million. Of the $90.0 million, wereceived cash proceeds of $75.0 million at closing while $15.0 million was notscheduled to be paid until 2005. Of the $15.0 million, $7.7 million of the holdback was received during September 2005. Payment of the remainder of the holdback is pending the completion of a net asset adjustment reconciliationsatisfactory to both parties to the transaction. The reconciliation, which isnot directly related to the hold back consideration, and for whichprovision has previously been made, is expected to be completed during thefirst quarter of 2006.

*     OtherOperations*: On December 31, 2004, weclosed our comprehensive outpatient rehabilitation facilities in Colorado. OnNovember 7, 2003, a majority owned subsidiary sold substantially all of itssoftware development assets to a subsidiary of Omnicare, Inc., forapproximately $5.0 million in proceeds at closing and $0.5 million in cash inDecember 2004.

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

F-23

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

** DECEMBER 31, 2005**

** **

**For the Year**

** **

**Ended**

** **

**                                          ****December  31, 2005****                                       **

** **

**Inpatient**

** **

**Pharmaceutical**

** **

**Laboratory/**

** **

** **

** **

** **

** **

** **

**Services**

** **

**Services**

** **

**Radiology**

** **

**Other**

** **

**Total**

** **
                                 
Total net revenues

$         2,599

$                -

$         2,477

$              -

$         5,076

=========

=========

=========

========

=========

Pretax income (loss)

$       14,686

$             22

$        (1,618

)

$          (55

)

$      13,035

Gain (loss) on disposal of

 

 

 

 

 

   discontinued operations

             725

          7,614

             674

        (124

)

         8,889

Income (loss) on discontinued

   operations 

$       15,411

$         7,636

$          (944

)

$       (179

)

$     21,924

=========

=========

** **

=========

=======

========

** **

**For the Year**

** **

**Ended**

** **

**                                                 ****December   31, 2004****                                              **

** **

**Inpatient**

** **

**Pharmaceutical**

** **

**Laboratory/**

** **

** **

** **

** **

** **

** **

**Services**

** **

**Services**

** **

**Radiology**

** **

**Other**

** **

**Total**

** **

Total  net revenues

$       14,685

$               -

$       16,416

$     1,904

$       33,005

** **

=========

========

=========

=======

========

** **

Pretax  (loss) income

$      (10,264

)

$           696

$      (13,182

)

$       (464

)

$     (23,214

)

Gain  (loss) on disposal of

 

 

 

 

 

   discontinued  operations

         4,967

       (5,008

)

       (5,550

)

         270

       (5,321

)

Loss  on discontinued

   operations

$       (5,297

)

$       (4,312

)

$     (18,732

)

$       (194

)

$    (28,535

)

=========

=========

** **

========

=======

========
      
** **

**For the Year**

** **

**Ended**

** **

**                                                 ****December   31, 2003****                                              **

** **

**Inpatient**

** **

**Pharmaceutical**

** **

**Laboratory/**

** **

** **

** **

** **

** **

**Services**

** **

**Services**

** **

**Radiology**

** **

**Other**

** **

**Total**
                                 
Total net revenues

$      465,277

$     116,542

$     27,495

$     3,200

$    612,514

** **

=========

=========

** **

========

=======

========

** **

Pretax (loss) income  (1)

$      (28,117

)

$         5,595

$     (1,267

)

$    (1,360

)

$    (25,149

)

Gain on disposal of

 

 

 

 

 

   discontinued  operations (2)

          6,210

       43,937

           111

      5,391

     55,649

(Loss) income on  discontinued

   operations  

$      (21,907

)

$      49,532

$     (1,156

)

$     4,031

$   30,500

=========

=========

** **

========

=======

========
      
(1)

Net of restructuring costs  of $405

(2)

Net of related tax expense  of $650

F-24

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

** DECEMBER 31, 2005**

(c)*  AssetsHeld for**Sale*

     Asof December 31, 2005, assets held for sale consisted of twoundeveloped parcels of land valued at $1.9 million, within our consolidatedfinancial statements in our Corporate segment, which we expect to sell during2006.

**(10)  VariableInterest Entities**

     InDecember 2003, the FASB issued a revision to Interpretation No. 46, "*Consolidationof Variable Interest Entities*" ("FIN No. 46R"), which wasoriginally issued in January 2003.  FIN No. 46R provides guidance on theconsolidation of certain entities when control exists through means other thanownership of voting (or similar) interests and was effective for publicentities that have interests in variable interest entities commonly referred toas special purpose entities for the first reporting period that ends afterMarch 15, 2004.  FIN No. 46R requires consolidation by the majority holder ofexpected residual gains and losses of the activities of a variable interestentity ("VIE").

     We currently own less than 8%of the voting interest in three partnerships, five limited liability companiesand one sole proprietorship, each of which own one facility that we operate inNew Hampshire (collectively known as "Clipper").Clipper's objective is to achieve rental income from the leasing of skillednursing and assisted living facilities owned by Clipper. In April 2004, weentered into an agreement with the owners of the remaining interests in thosenine entities.  That agreement granted us options, exercisable sequentiallyover a period of seven years, pursuant to which we can acquire 100% of theownership of those nine entities for an aggregate amount of up to $10.3million.  The agreement also provides the owners the right to require us topurchase those ownership interests at the above described option prices.  Theseput rights can be exercised for any options that have come due but which werenot exercised up to that point in time, but no later than December 31, 2010. OnJune 30, 2005, we gave notice of our intent to exercise the secondoption to acquire an additional 4% interest in the nine entities for anaggregate purchase price of $0.4 million. The consummation of the second optionexercise should occur on or around March 31, 2006. 

     Wehave concluded that Clipper, as identified above, meets the definition of a VIEbecause we have agreements with the majority owners granting us the option toacquire, and the right of the owners to put to us, 100% ownership of Clipper.We have recognized $9.7 million of the option value in other long-termliabilities in our consolidated balance sheet.  The remaining $0.4 million isrecorded as current in other accrued liabilities in our consolidated balancesheet.  We have not recorded any minority interest associated with the 92.5%interest in which we do not own since the partnerships' net equity was adeficit and as the primary beneficiary, we would be responsible for all oftheir losses. Pursuant to FIN No. 46(R), we have eliminated facility rentexpense of $3.5 million for the year ended December 31, 2005, and included$50.2 million of mortgage debt of Clipper in our consolidated balance sheet asof December 31, 2005, although we own less than eight percent of the voting interestin the Clipper properties and are not directly obligated on the debt. The debtis collateralized by the fixed assets of the respective partnerships, limitedliability companies and sole proprietorship that own the Clipper properties andnone of our assets.  Creditors do not have any general recourse against us forthe mortgage debt.

     Asthe primary beneficiary of the VIE, we consolidated Clipper beginning in thethird quarter of 2004.  This change had no affect on previously reported netearnings.  We applied Statement of Financial Accounting Standards No. 141, *BusinessCombinations* ("SFAS No. 141") to consolidate Clipper. Thefollowing table summarizes the estimated fair values of the assets andliabilities assumed at the date of consolidation (in thousands):

F-25

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

Current  assets

$         3,397
         
Current  liabilities (includes $0.9 million of current debt)

2,702

Long-term debt

50,949

Other long-term liabilities (option value)

        10,658

    Total  liabilities assumed

        64,309
         
Net assets

$       60,912

=========

     Uponconsolidation in third quarter of 2004, a $12.5 million unfavorable leaseintangible related to the nine entities and recorded on our books prior toconsolidation was allocated against the $60.9 million basis of property, plantand equipment, and provided a consolidation value of $48.4 million. During thefourth quarter of 2004, we refined the allocation of the fair value andrecorded a $2.8 million adjustment to property, plant and equipment due to therefinancing of two mortgages and the $3.5 million write off of a note payableno longer due, leaving a remaining consolidation value of $45.6 million.

     Ourconsolidated assets and liabilities increased approximately $62.4 million and $65.6million, respectively, based upon the fair value of the assets and liabilitiesof Clipper.  Upon consolidation, we eliminated our investment in Clipper. Thefollowing provides a summary of the balance sheet impact of Clipper uponconsolidation as of December 31, 2005 and 2004 (in thousands):

F-26

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

**December   31, 2005**

 

**December   31, 2004**

 

 

 

Current assets:

 

 

 

  Cash  and cash equivalents

$                 708

$                 718

  Other  receivables

250

289

  Restricted cash, current

1,021

1,461

  Prepaids  and other assets

                 131

                 176

      Total  current assets

2,110

2,644
               
Property  and equipment, net:

  Land

6,171

6,171

  Land  improvements

38

  Buildings

36,335

37,173

  Building  improvements

2,223

2,143

  Equipment

89

  Construction-in-process

                 165

                      

 

      Total  property and equipment, net

45,021

 

45,625

 
               
Favorable  lease intangibles, net

9,982

11,979

Intercompany

              5,240

              5,358
               
      Total  assets

$           62,353

$           65,606

==========

==========

Current  liabilities:

 

 

 

 

  Mortgages,  current

$           34,415

$             1,113

  Other accrued liabilities

                 551

                 223

      Total  current liabilities

34,966

1,336
               
Mortgages,  net of current

15,829

49,903

Other  long-term liabilities

           16,421

           16,677

      Total  long-term liabilities

           32,250

           66,580
               
      Total  liabilities

67,216

67,916
               
Stockholders'  deficit:

 

 

  Accumulated  deficit

            (4,863

)

            (2,310

)
               
      Total  liabilities and stockholders' deficit

$          62,353

$          65,606

==========

==========

     Forthe year ended December 31, 2005, the consolidation ofClipper included a net loss of $2.2 million comprised of a $4.0 million chargeto interest expense, a $1.2 million charge to depreciation expense, a $0.4million loss on extinguishment of debt and $0.1 million in administrative andtax expenses, partially offset by a $3.5 million credit to rent expense. Forthe year ended December 31, 2004, the consolidation ofClipper included a net loss of $1.5 million comprised of a $2.2 million chargeto interest expense, a $0.6 million charge to depreciation expense, a $0.4million loss on extinguishment of debt and $0.3 million in administrative andtax expenses, partially offset by a $2.0 million credit to rent expense.

F-27

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

**(11)  Commitmentsand Contingencies**

** **(a)  *LeaseCommitments*

* *     We leasereal estate and equipment under cancelable and noncancelable agreements. Mostof our operating leases have original terms from seven to twelve years andcontain at least one renewal option, (which could extend the terms of theleases by five to ten years), purchase options, escalation clauses (primarilyrelated to inflation) and provisions for payments by us of real estate taxes,insurance and maintenance costs. Leases with a fixed escalation are accountedfor on a straight-line basis. Future minimum lease payments under real estateleases and equipment leases, are as follows (in thousands):

**Operating**
    
**       Leases       **
   
          2006

$               66,160

          2007

62,622

          2008

56,940

          2009

54,344

 

          2010

50,921

 

          Thereafter

              126,991

 

Total minimum  lease payments

$            417,978

============

     Facilityrent expense for continuing operations, totaled $41.0 million, $39.1 millionand $38.8 million for the years ended December 31, 2005,2004 and 2003, respectively. Facility rent expense for discontinued operationsfor the years ended December 31, 2005, 2004 and 2003 was $0.1 million, $1.0 million and $40.3million, respectively. As of March 1, 2006, we have one remaining skillednursing facility identified for divestiture, which is under an operating lease.

     Sunacquired a capital lease of $11.2 million in connection with the Peak acquisition.This amount, which is presented as a current liability, is expected to beconverted to an operating lease during 2006 and no principal payment isanticipated. The net book value of the assets associated with this capitallease is $9.1 million, net of $2.6 million of accumulated amortization.

(b)  *Purchase Commitments*

     Our purchaseobligations have been estimated assuming that we continue to operate the samenumber of facilities in future periods.  The prices that we pay under ourpurchase commitments are subject to market risk.

     We havean agreement establishing Medline Industries, Inc. ("Medline") as the primarymedical supply vendor through January 12, 2010 for all of the long-term carefacilities that we operate.  The agreement provides that the long-term caredivision shall purchase at least 90% of its medical supply products fromMedline.  Additionally, if we choose to terminate the agreement withoutcause or if Medline chooses to terminate the agreement with cause, we may be required topay Medline liquidated damages of $2.0 million if the agreement is terminatedprior to January 11, 2007.

F-28

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

     Wehave an agreement establishing SYSCO Corporation ("SYSCO") as ourprimary foodservice supply vendor through February 29, 2008 for all of our long-term carefacilities.  The agreement provides that the long-term care division shallpurchase at least 80% of its foodservice supply products from SYSCO.  

     Wehave an agreement establishing OmnicarePharmacy Services as the primary pharmacy services vendor throughDecember 31, 2008 for all of the long-term care facilities that we operated asof July 15, 2003.

(c)  *Insurance*

     Weself-insure for certain insurable risks, including general and professionalliability, workers' compensation liability and employee health insuranceliability, through the use of self-insurance or retrospective and self-fundedinsurance policies and other hybrid policies, which vary by the states in whichwe operate. There is a risk that amounts funded to our self-insuranceprograms may not be sufficient to respond to all claims asserted under those programs.Provisions for estimated reserves,including incurred but not reported losses, are provided in the period of therelated coverage. These provisions are based on actuarial analyses, internalevaluations of the merits of individual claims, and industry loss developmentfactors or lag analyses. The methods of making such estimates and establishingthe resulting reserves are reviewed periodically and are based on historicalpaid claims information and nationwide nursing home trends. Any resulting adjustmentsare reflected in current earnings. Claims are paid over varying periods, andfuture payments may be different than the estimated reserves.

     Priorto January 1, 2000, the maximum loss exposure with respectto the third-party insurance policies was $100,000 per claim for general andprofessional liability.  Since January 2000, we have relied upon self-fundedinsurance programs for general and professional liability claims up to a baseamount per claim and an aggregate per location, and have obtained excessinsurance policies for claims above those amounts.  The programs had thefollowing self-insured retentions:  (i) for events occurring from January 1,2000 to December 31, 2002, $1.0 million per claim, and $3.0 million aggregateper location, (ii) for claims made in 2003, $10.0 million per claim with excesscoverage above this level, and (iii) for claims made in 2004, 2005 and 2006,$10.0 million per claim with a single $5.0 million excess layer that attachesat $5.0 million of liability, available for claims made in 2004, 2005 and2006.  An independent actuarial analysis is prepared twice a year to determinethe expected losses and reserves for estimated settlements for general andprofessional liability under the per claim retention level, including incurredbut not reported losses.

     The most recent actuarialanalysis completed in December 2005 by our independent actuaries reflected animprovement in patient care liability cost trends for the 2002 and 2003 policyyears. Based on the results of the actuarial analyses completed in June andDecember 2005, we reduced our reserves by $23.2 million, of which  $7.7 million related to continuingoperations for incidents in prior years, and $15.5 million related todiscontinued operations for incidents in prior years. We have recorded reservesof $86.5 million and $104.7 million, as of December 31, 2005 and 2004,respectively.  Provisions or adjustments forsuch risks were  a credit of $2.2 million for the year endedDecember 31, 2005, and provisions of $9.4 million and $31.5 million for theyears ended December 31, 2004 and 2003, respectively, of which a credit of $15.4million was recorded for the year ended December 31, 2005 and $1.2 million and$20.3 million for the years ended December 31, 2004 and 2003, respectively, wererelated to divested skilled nursing facilities and were included indiscontinued operations.  At December 31, 2005 and 2004, we had $3.6 millionand $3.1 million, respectively, in pre-funded amounts, classified in currentassets, restricted for payment of general and professional liability claims ina revocable trust account. The paid claims for the years ended December 31,2005 and 2004 were $19.4 million and $22.2 million, respectively.

F-29

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

     Themajority of our workers' compensation risks are insured through insurancepolicies with third parties. Our reserves are estimated by independentactuaries beginning with the 2000 policy year and by company analysis using industrydevelopment factors for prior years.  Based on the results of the actuarialanalyses completed in June and December 2005, we adjusted our reserves betweencontinuing operations and discontinued operations, recording increases of $0.9million related to continuing operations for incidents in prior years, and of$1.0 million related to discontinued operations for incidents in prior years. Effective with the policy periodbeginning January 1, 2002, we discount our workers' compensationreserves based on a 4% discount rate. At December 31, 2005, the discounting of these policy periodsresulted in a reduction to our reserves of approximately $11.6 million. Theprovision for such risks, which includes accruals for insurance premiums andclaims costs, for the years ended December 31, 2005, 2004 and 2003 was$17.9 million, $22.3 million and $35.9 million, respectively, of which $1.0million, $5.1 million and $15.0 million, for the years ended December 31,2005, 2004 and 2003, respectively, were related to divested skilled nursingfacilities and included in discontinued operations. We have recorded reservesof $56.1 million and $62.8 million, as of December 31, 2005 and 2004, respectively.  At December 31, 2004, we had $48.4 million in pre-fundedamounts in a revocable trust account restricted for payment of workers'compensation claims, of which $17.4 million was classified in current assetsand $31.0 million was held in non-current assets. At December 31, 2005, we had $45.5 million in pre-funded amounts in a revocabletrust account restricted for payment of workers' compensation claims, of which$13.4 million was classified in current assets and $32.1 million was held innon-current assets. The paid claims for the years ended December 31, 2005 and2004 were $14.3 million and $19.7 million, respectively.

     Theprovision for loss for insurance risks was as indicated (in thousands):

**For  the**

** **

**For  the**

** **

**For  the**

**Year  Ended**

** **

**Year  Ended**

** **

**Year  Ended**

**December 31,   2005**

** **

**December 31,   2004**

** **

**December 31, 2003**

** **

** **

** **

** **

** **

**Professional  Liability:**

   Continuing operations

$             13,160

$               8,187

$               11,201

   Discontinued operations

             (15,407

)

                1,190

 

                20,282

$             (2,247

)

$               9,377

$               31,483

===========

===========

============

**Workers' Compensation:**

   Continuing operations

$            16,842

$             17,173

$               20,957

   Discontinued operations

               1,026

                5,083

                14,988

$            17,868

$             22,256

$               35,945

===========

============

============

     Asummary of the assets and liabilities related to insurance risks at December 31, 2005 and December 31, 2004 were as indicated (in thousands):

F-30

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**
 
**December 31, 2005**

**|**

**December 31, 2004**

** **

**Professional**

**Workers'**

** **

**|**

**Professional**

**Workers'**

** **

** **

**Liability**

**Compensation**

**Total**

**|**

**Liability**

**Compensation**

**Total**

**Assets**(1):

**|**

*Restricted  cash*

**|**

   Current

$             3,626

$          13,427

$          17,053

**|**

$             3,103

$           17,348  

$           20,451

   Non-current

                      -

 

            32,076

 

           32,076

**|**

                      -  

 

            31,003

 

            31,003

          Total

$             3,626

$          45,503

$          49,129

**|**

$             3,103

$           48,351  

$           51,454

==========

==========

==========

**|**

==========

===========

==========

**Liabilities**(2):

**|**

*Self-insurance*

**|**

*liabilities*

**|**

   Current

$           19,180

$          13,427

$           32,607

**|**

$           17,967

$           18,849

$           36,816

   Non-current

            67,274

 

            42,679

 

          109,953

**|**

            86,736

 

            43,950

 

          130,686  

          Total

$           86,454

$          56,106

$         142,560

**|**

$         104,703  

$           62,799

$         167,502  

==========

===========

==========

**|**

===========

===========

==========

** **

(1)

Total restricted cash excluded $11,530 and $9,306 at December 31, 2005 and December 31, 2004, respectively, held for bank collateral,  various mortgages, bond payments and capital expenditures on HUD buildings.

(2)

Total self-insurance liabilities excluded $4,631 and $3,420 at December 31, 2005 and December 31, 2004, respectively, related to our health  insurance liabilities.

(d)  *Construction Commitments*

     As of December 31, 2005, we had construction commitments undervarious contracts of approximately $3.3 million. These items consistedprimarily of contractual commitments to improve existing facilities.

**(12)  IncomeTaxes**

**     **The provision forincome taxes was based upon management's estimate of taxable income or loss foreach respective accounting period.  We recognized an asset or liability for thedeferred tax consequences of temporary differences between the tax bases ofassets and liabilities and their reported amounts in the financial statements. These temporary differences would result in taxable or deductible amounts infuture years when the reported amounts of the assets are recovered orliabilities are settled.  We also recognized as deferred tax assets the future taxbenefits from net operating loss, capital loss, and tax credit carryforwards. A valuation allowance was provided for deferred tax assets as it is more likelythan not that some portion or all of the net deferred tax assets will not berealized.

**     **Income tax expense (benefit) on income (losses) beforediscontinued operations consisted of the following (in thousands): 

F-31

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

** DECEMBER 31, 2005**

**For The Year Ended**

**December 31, 2005**

** **

**December 31, 2004**

**December 31,   2003**

Current:

** **

   Federal

$                  (1,037

)

$                   (1,585

)

$                             -
   State
                        251
   
                        427   
                          665
                       (786

)

                    (1,158

)

                          665

Deferred:

** **

** **

   Federal

-

** **

-

** **

-

   State

                             -

** **

                             -

** **

                              -

                             -

** **

                             -

** **

                              -

   Total

$                         (786

)

$                    (1,158

)

$                        665

===============

** **

==============

** **

==============

**     **Actual tax expense (benefit) differed from theexpected tax expense (benefit) on income (losses) before discontinued operationswhich was computed by applying the U.S. Federal corporate income tax rate of35% to our profit or loss before income taxes as follows (in thousands): 

** **

**For The Year Ended**

** **

** **

**December 31,   2005**

** **

**December 31,   2004**

**December 31,   2003**

** **

Computed expected tax expense

  (benefit)

$                          718

$                          3,063  

$                      (10,271

)
Adjustments in income taxes                    resulting from:                  
  Change in valuation allowance

(2,364

)

(5,936

)

12,333

** **

  State  income tax expense

** **

     (benefit),  net of  Federal

** **

     Income  tax effect

175

529

(1,169

)

  Other

                           685

                           1,186

                            (228

)

          Total

$                         (786

)

$                         (1,158

)

$                            665

===============

================

================

** **

**     **Thechange in the valuation allowance in 2005 and 2004 related principally to thecarryback of Federal net operating losses which generate income tax refunds.Deferred tax assets (liabilities) at December 31consisted of the following (in thousands):

F-32

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

** DECEMBER 31, 2005**

** **

**    2005    **

** **

**    2004    **

** **

Deferred tax assets:

   Accounts and notes receivable

$           13,265

$        16,496

   Accrued liabilities

74,257

81,380

   Property and equipment

28,963

28,634

   Intangible assets

27,768

31,504

   Write-down of assets held for sale

3,512

13,029

   Partnership investments

-

433

   Alternative minimum tax credit

-

3,568

   Jobs and other credit carryforwards

107

7,201

   Capital loss carryforwards

-

92,026

   State net operating loss carryforwards

1,614

39,625

   Federal net operating loss  carryforwards

25,917

385,703

   Other

                 293

 

              344

 

          175,696

 

       699,943

 

Less valuation allowance:

   Federal

(146,818

)

(581,693

)

   State

          (28,878

)

      (118,250

)

        (175,696

)

      (699,943

)

Total deferred tax assets

                    -

 

                   -

 

Total deferred tax liabilities

                    -

                  -

Deferred taxes, net

$                    -

$                 -

==========

=========

**     **In connectionwith the fresh-start accounting adopted in 2002, our assets and liabilitieswere recorded at their respective fair values.  Deferred tax assets andliabilities were then recognized for the tax effects of the differences betweenfair values and tax bases.  In addition, deferred tax assets were recognizedfor future tax benefits of net operating loss ("NOL"), capital lossand tax credit carryforwards, and a valuation allowance was recorded for theoverall net increase in deferred tax assets recognized in connection withfresh-start accounting.

**     **To the extentmanagement believes the pre-emergence net deferred tax assets will more likelythan not be realized, a reduction in the valuation allowance established infresh-start accounting will be recorded.  The reduction in this valuationallowance will first reduce any remaining intangible assets recorded infresh-start accounting, with any excess being treated as an increase to capitalin excess of par value.

**     **During 2004, wedetermined that a portion of the income tax payable balance established infresh-start could be offset by NOL carrybacks.  The payable was reduced by anamount equal to the $3.8 million of goodwill remaining from fresh-startaccounting.

**     **In connectionwith our emergence from bankruptcy on February 28, 2002, we realized a gain onthe extinguishment of debt of approximately $1.5 billion.  This gain was nottaxable since the gain resulted from our reorganization under the BankruptcyCode.  However, pursuant to Section 108 of the Internal Revenue Code, we wererequired as of the beginning of our 2003 taxable year to reduce certain taxattributes, including (a) NOL and capital loss carryforwards, (b) certain taxcredits, and (c) tax bases in assets, in an amount equal to such gain onextinguishment.

**     **Internal RevenueCode Section 382 imposes a limitation on the use of a company's NOLcarryforwards and other losses when the company has an ownership change.  Ingeneral, an ownership change occurs when

F-33

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

** DECEMBER 31, 2005**

shareholders owning 5% or more of a "losscorporation" (a corporation entitled to use NOL or other loss carryovers)have increased their ownership of stock in such corporation by more than 50percentage points during any 3-year testing period beginning on the first dayfollowing the change date for an earlier ownership change.  The annual baseSection 382 limitation is calculated by multiplying the loss corporation'svalue at the time of the ownership change times the greater of the long-termtax-exempt rate determined by the IRS in the month of the ownership change orthe two preceding months.

**     **Ourreorganization under the Bankruptcy Code effective February 28, 2002 constitutedan ownership change under Section 382 of the Internal Revenue Code.  Our acquisitionof Peak on December 9, 2005 resulted in a second ownership change under Section382.  The annual base Section 382 limitation to be applied to our tax attributecarryforwards as a result of this second ownership change is more restrictivethan the Section 382 limitation resulting from our ownership change uponemergence from bankruptcy.  Accordingly, our NOL, capital loss, and tax creditcarryforwards have been reduced to take into account this new limitation andthe respective carryforward periods for these tax attributes.

**     **Theacquisition resulted in an ownership change for Peak as well.  Peak's NOL andtax credit carryforwards are subject to a separate Section 382 limitation basedon its value on the date of the merger.  However, no reduction in Peak's NOL ortax credit carryforwards was required.

**     **During the yearended December 31, 2005, our net deferred tax assets decreased by approximately$524.2 million.  This change resulted from an increase of approximately $19.0million from the preliminary purchase accounting for the acquisition of Peak,offset by a decrease of approximately $543.2 million related primarily to thereduction in our NOL, capital loss, and tax credit carryforwards as a result ofthe Section 382 ownership change from the acquisition.  We also decreased ourvaluation allowance by approximately $524.2 million to match the reduction inour net deferred tax assets.  Our valuation allowance fully offsets our netdeferred tax assets because we have no net operating loss carryback potential,and there is insufficient evidence regarding the generation of future taxableincome to allow for the recognition of deferred tax assets under FAS 109.

**     **Afterconsidering the reduction in tax attributes resulting from the exclusion of thegain on the extinguishment of debt as well as the preliminary calculation ofthe Section 382 limitation resulting from the second ownership change, we haveFederal NOL carryforwards of approximately $74.0 million with expiration datesfrom 2006 through 2025.  Various subsidiaries have state NOL carryforwardstotaling approximately $37.0 million with expiration dates through the year2025.  Our $0.1 million of other tax credit carryforwards will expire in years2020 and 2021.  We expect to finalize the calculation of the Section 382limitation during 2006.

**     **Ourapplication of the rules under Section 382 and Section 108 is subject tochallenge upon IRS review.  A successful challenge could significantly impactour ability to utilize deductions, losses and tax credits generated prior tothe acquisition date.

F-34

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

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

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

** **

**                    2005                     **

**                   2004                     **

** **

**Carrying**

** **

**Carrying**

** **

** **

**   Amount   **

**  Fair Value  **

**   Amount   **

**  Fair Value  **

Cash and cash equivalents

$      16,641

$        16,641

$     19,834

$      19,834

Long-term debt, including current portion

   and capital lease obligation

$    197,779

$      182,968

$   107,182

$      67,487

     Thecash and cash equivalents carrying amount approximates fair value because ofthe short maturity of these instruments.  At December 31, 2005 and 2004, thefair value of our long-term debt, including current maturities, was based onestimates using present value techniques that are significantly affected by theassumptions used concerning the amount and timing of estimated future cashflows and discount rates that reflect varying degrees of risk. The increase inthe carrying amount of debt in 2005 is related to the $95.7 million of debtassumed in connection with the Peak acquisition.

**(14)  CapitalStock**

(a)  *CommonStock*

     As of December 31, 2005,we had issued 31,143,728 shares, inclusive of 10,182 treasury shares.  Theshares issued included (i) 9,931,613 shares pursuant to our Plan ofReorganization as discussed below, (ii) 4,425,232 shares issued in a privateplacement of our common stock in February 2004, (iii) 760,000 shares in paymentof deferred rent as part of our restructuring plan initiated in 2003, (iv)8,871,890 shares in connection with the acquisition of Peak, (v) 6,900,000shares issued in a public offering in December 2005, and (vi) 254,993 in stockawards to our employees and directors. 

     As of December 31, 2005, Sun had issued 9,931,613 shares of common stock inconnection with the extinguishment of liabilities subject to compromise pursuantto our Plan of Reorganization in 2002. As of December 31, 2005, we expected toissue up to an additional 68,387 shares of our common stock to general unsecuredcreditors with claims of more than $50,000 in accordance with the provisions ofthe Plan of Reorganization. The fair value of the additional common stockexpected to be issued is approximately $1.8 million valued at $27 per share byour reorganization plan and was recorded in other long-term liabilities in theDecember 31, 2005 consolidated balance sheet.

(b)*  Warrants*

* *     InFebruary 2004, in conjunction with our private equity offering, we issuedwarrants to purchase 2,017,897 shares of our common stock, of which 1,707,924shares have a strike price of $12.65, 62,160 shares have a strike price of$12.82, and 247,813 shares have a strike price of $15.87.  The warrants have anexercise period of five years.

(c)*  Equity Incentive Plan*

     Our 2004 Equity IncentivePlan (the "2004 Plan") allows for the issuance of up to 2.1 million shares ofour common stock. Pursuant to the 2004 Plan, as of December 31, 2005, ouremployees and directors held options to 

F-35

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

purchase 1,362,750 shares of commonstock, 64,261 shares of restricted common stock, and 300,914 restricted stockunits. Through December 31, 2005, we have issued 180,550 shares of common stockupon the vesting of restricted stock shares, restricted stock units and theexercise of stock options. As of December 31, 2005, 30,000 unvested shares ofrestricted common stock valued at $27.00 per share and 34,261 shares ofrestricted common stock valued at $11.25 per share were held by our executiveofficers and key employees. The restricted common stock vests over a four-yearperiod. Restricted stock awards are outright stock grants.  The issuance ofrestricted stock and other stock awards requires the recognition of compensationexpense measured by the fair value of the stock on the date of grant. As of December 31, 2005, we had 232,589 sharesof nonvested stock granted in 2005 with a weighted-average grant date fairvalue of $7.29 and 102,587 shares of nonvested stock granted in 2004 with aweighted-average grant date fair value of $8.34. We recognized expense relatedto the issuance of these stock awards of $1.3 million, $1.6 million, and $0.9million, respectively, for the years ended December 31, 2005, 2004 and2003.

     Our 2002 Non-employeeDirector Equity Incentive Plan (the "Director Plan") allows for theissuance of up to 40,000 options to purchase shares of our common stock. Uponthe adoption of the 2004 Plan, the grant of further awards under the DirectorPlan was suspended so that no additional awards could be made under theDirector Plan. As of December 31, 2005, our directorsheld options to purchase 20,000 shares under the Director Plan.

**     **As of December 31, 2005, we had outstandingoptions covering an aggregate of 1,382,750 shares of our common stock to ouremployees and directors, of which 345,000 options were granted with an averagestrike price of $7.71 per share and expire in 2009, 360,998 options weregranted with an average strike price of $7.19 per share and expire in 2011, and676,752 options were granted with an average strike price of $6.60 per shareand expire in 2012. The strike prices were equal to the estimated market valueat date of issuance. The options vest over a two- to four-year period.

     Thefollowing is a summary of the status of our Stock Option Plans and changesduring the periods ended (shares in thousands):

F-36

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

** **

**For the Year  Ended**

** **

**December 31, 2005**** **

**December 31, 2004**** **

**December 31, 2003**

** **

** **

** **

**Weighted**

** **

** **

** **

**Weighted**

** **

** **

** **

**Weighted**

** **

** **

** **

** **

**Average**

** **

** **

** **

**Average**

** **

** **

** **

**Average**

** **

** **

**Shares**

** **

**Exercise  Price**

** **

**Shares**

** **

**Exercise Price**

** **

**Shares**

** **

**Exercise Price**

*** ***
                                       
Outstanding at  beginning of period

905

$       8.03

** **

720

$       27.00

** **

800

$      27.00

Granted:

** **

** **

   Price  equals fair value

706

$       6.61

** **

922

7.45

** **

-

-

Exercised/Issued

(30

)

$       6.85

** **

** **

 

 

Cancelled

(198

)

$     10.43

** **

(660

)

27.00

** **

-

 

-

 

Forfeited

            - 

** **

         (77

)

15.83

** **

        (80

)

27.00

 

Outstanding at  period-end

1,383

$       7.03

** **

905

8.03

** **

720

27.00

======

** **

======

** **

======

Options exercisable  at period-end

530

$       6.69

** **

278

8.66

** **

248

27.00

======

** **

======

** **

======

Options available  for future grant

330

** **

908

** **

190

======

** **

======

** **

======

Weighted average fair value of    options  granted during the period

  $     3.37

** **

$      4.20

** **

$     N/A

======

** **

======

** **

======

     We account forstock-based compensation using the intrinsic value method prescribed inAccounting Principles Board Opinion No. 25, *Accounting for Stock Issuedto Employees*("APB No. 25"), and related interpretations.Accordingly, compensation cost for stock options is measured as the excess, ifany, of the quoted market price of our stock at the date of grant over theamount an employee must pay to acquire the stock.  We currently do notrecognize compensation expense for most of our stock option grants, which areissued at fair market value on the date of grant. However, in 2004, wecancelled options with an exercise price of $27.00 per share to eliminatesignificantly out-of-the money options for our employees. New options totaling262,700 with an exercise price of $6.85 were granted within six months of thiscancellation and are accounted for as variable options.

     Statementof Financial Accounting Standards No. 148, *Accounting for Stock-BasedCompensation - Transition and Disclosure* ("SFAS No. 148"), issuedon December 31, 2002, provides companies alternative methods to transitioningto Statement of Financial Accounting Standards No. 123, *Stock-BasedCompensation* ("SFAS No. 123"), fair value method of accountingfor stock-based employee compensation and amends certain disclosure requirements.SFAS No. 148 did not mandate fair value accounting for stock-based employeecompensation but required all companies to meet disclosure provisions.

     Forpurposes of pro forma disclosures, the estimated fair market value of the stockoptions is amortized to expense over their respective vesting periods. The fairvalue of stock options granted in 2005 and 2004 was estimated at the date ofgrant using a Black-Scholes option pricing model with the followingassumptions: volatility (32.5%), expected life (7 years), risk free rate ofreturn (3.86%), dividend yield (0.0%) and weighted average fair value ($3.37 for2005 and $4.20 for 2004). There were no stock options granted in 2003. Thefollowing table summarizes our pro forma basic and diluted net income (loss)per share assuming we accounted for our stock option grants in accordance with SFAS No. 123, for the periods indicated (in thousands, except per shareamounts):

F-37

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

** DECEMBER 31, 2005**

**For The Year  Ended**

**December 31,   2005**

**December 31, 2004**

**December 31, 2003**
                     
Net income (loss) as reported(1)

$                    24,761

$                   (18,627

)

$                          354

Compensation  expense

                      (1,469

)

                       (1,568

)

                          (511

)

   Net  income (loss) (pro forma)

$                    23,292

$                   (20,195

)

$                         (157

)

==============

==============

==============

Net income (loss) per  share:

Basic:

   Net  income (loss) as reported

$                       1.55 

$                       (1.29

)

$                         0.04

   Compensation  expense

                        (0.09

)

                        (0.11

)

                         (0.05

)

   Net income (loss)  pro forma

$                        1.46

$                       (1.40

)

$                        (0.01

)

==============

==============

==============

Diluted:

   Net  income (loss) as reported

$                       1.55 

$                       (1.28

)

$                        0.04

   Compensation  expense

                        (0.09

)

                        (0.11

)

                        (0.05

)

   Net income (loss)  pro forma

$                        1.45

$                       (1.39

)

$                       (0.01

)

==============

==============

==============

(1)

Includes  total charges to our consolidated statements of income related to stock-based  employee compensation cost of $1.3 million, $1.6 million, and $0.9 million  for the years ended December 31, 2005, 2004 and 2003, respectively.

     Theeffects of applying SFAS No. 123 in this pro forma disclosure are notindicative of future amounts. SFAS No. 123 does not apply to options grantedprior to 1995, and additional option grants in future years are anticipated.

     Thefollowing table summarizes information about stock options outstanding as ofDecember 31, 2005 (shares in thousands):

** **

**Options Outstanding**

**       Options  Exercisable        **

** **

** **

**Weighted**

** **

** **

** **

** **

**Number**

**average**

** **

**Number**

**Weighted**

** **

**outstanding**

**remaining**

**Weighted**

**exercisable**

**average**

**Range of**

**at December 31,**

**contractual**

**average**

**at December  31,**

**exercise**

**exercise prices**

**         2005        **

**        life      **

**      price    **

**           2005        **

**     price    **

$3.18

104

7 years

$             3.18

104

$        3.18

$6.04 - $6.84

13

7 years

6.52

-

-

$6.85

301

5 years

6.85

83

6.85

$7.05 - $7.08

368

6 years

7.05

9

7.05

$7.41 - 7.71

538

5 years

7.62

326

7.68

$7.85 - $8.44

39

6 years

8.27

3

7.85

$11.25

                  20

5 years

11.25

                       5

11.25

1,383

6 years

$             7.03

530

$        6.69

==========
   
 

===========
   
     OnDecember 16, 2004, the Financial Accounting Standards Board ("FASB")issued Statement of Financial Accounting Standard No. 123 (revised 2004), *Share-BasedPayment* ("SFAS No. 123(R)"), which is a revision of SFAS No. 123.SFAS No. 123(R) supersedes APB No. 25 and amends Statement of FinancialAccounting Standard No. 95*, Statement of Cash Flows*("SFAS No. 95").Generally, the approach in SFAS No. 123(R) is similar to the approach describedin SFAS No. 123. However, SFAS No. 123(R) *requires* all share-basedpayments to employees, including grants of employee stock options, to be recognizedin the statement of operations based on their fair values. Pro forma disclosureis no longer an alternative.

F-38

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

** NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

     Weadopted SFAS No. 123(R) using the modified-prospective method on January 1, 2006, inwhich compensation cost is recognized beginning with the effective date (a)based on the requirements of SFAS No. 123(R) for all share-based paymentsgranted after the effective date and (b) based on the requirements of SFAS No.123 for all awards granted to employees prior to the effective date of SFAS No.123(R) that remain unvested on the effective date. Based on the estimated valueof current unvested stock options, we expect wages and related expenses toincrease $0.9 million for the year ending December 31, 2006, beginning January 1,2006.

**(15)  Other Events**

** **(a)  *Litigation*

     Weare a party to various other legal actions and administrative proceedings andare subject to various claims arising in the ordinary course of our business,including claims that our services have resulted in injury or death to theresidents of our facilities, claims relating to employment and commercialmatters. Although we intend to vigorously defend ourselves in these matters,there can be no assurance that the outcomes of these matters will not have amaterial adverse effect on our results of operations and financial condition.In certain states in which we have or have had operations, insurance coveragefor the risk of punitive damages arising from general and professionalliability litigation may not be available due to state law public policyprohibitions. There can be no assurance that we will not be liable for punitivedamages awarded in litigation arising in states for which punitive damage insurance coverage is not available.

     Weoperate in industries that are extensively regulated. As such, in the ordinarycourse of business, we are continuously subject to state and federal regulatoryscrutiny, supervision and control. Such regulatory scrutiny often includes inquiries,investigations, examinations, audits, site visits and surveys, some of whichare non-routine. In addition to being subject to direct regulatory oversight ofstate and federal regulatory agencies, these industries are frequently subjectto the regulatory supervision of fiscal intermediaries. If a provider is foundby a court of competent jurisdiction to have engaged in improper practices, itcould be subject to civil, administrative or criminal fines, penalties orrestitutionary relief, and reimbursement authorities could also seek thesuspension or exclusion of the provider or individual from participation intheir program. We believe that there has been, and will continue to be, anincrease in governmental investigations of long-term care providers, particularlyin the area of Medicare/Medicaid false claims, as well as an increase inenforcement actions resulting from these investigations. Adverse determinationsin legal proceedings or governmental investigations, whether currently assertedor arising in the future, could have a material adverse effect on our financialposition, results of operations and cash flows.

(b)  *OtherInquiries*

     Fromtime to time, fiscal intermediaries and Medicaid agencies examine cost reportsfiled by predecessor operators of our skilled nursing facilities. If, as aresult of any such examination, it is concluded that overpayments to apredecessor operator were made, we, as the current operator of such facilities,may be held financially responsible for such overpayments. At this time we areunable to predict the outcome of any existing or future examinations. 

(c)  *Legislation,Regulations and Market Conditions*

* *     Weare subject to extensive federal, state and local government regulationrelating to licensure, conduct of operations, ownership of facilities,expansion of facilities and services and reimbursement for services. As such,in the ordinary course of business, our operations are continuously subject tostate and federal regulatory 

F-39

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

scrutiny, supervision and control. Such regulatoryscrutiny often includes inquiries, investigations, examinations, audits, sitevisits and surveys, some of which may be non-routine. We believe that we are insubstantial compliance with the applicable laws and regulations. However, if weare ever found to have engaged in improper practices, we could be subjected tocivil, administrative or criminal fines, penalties or restitutionary relief,which may have a material adverse impact on our financial position, results ofoperations and cash flows. 

     Weentered into a Corporate Integrity Agreement (the "CIA") with theHHS/OIG in July 2001 and it became effective on February 28, 2002.  Weimplemented further internal controls with respect to our quality of care standards and Medicare and Medicaid billing, reporting and claims submissionprocesses and engaged an independent third party to act as quality monitor andIndependent Review Organization under the CIA.   A breach of the CIA couldsubject us to substantial monetary penalties and exclusion from participationin Medicare and Medicaid programs.  We believe that we are in compliance withthe terms and provisions of the CIA.  Any such sanctions could have a materialadverse effect on our financial position, results of operations, and cashflows.

** (16)  Segment Information**

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

     Thefollowing summarizes the services provided by our reportable and othersegments: 

* Inpatient Services:*  This segment provides, among other services,inpatient skilled nursing and custodial services as well as rehabilitative,restorative and transitional medical services. We provide 24-hour nursing carein these facilities by registered nurses, licensed practical nurses andcertified nursing aids.  At December 31, 2005, we operated 158 long-term carefacilities (consisting of 134 skilled nursing facilities (10 of which aremanaged), 14 assisted livingand independent living facilities, seven mental health facilities, and threespecialty acute care hospitals, which includes 56 facilities acquired in thePeak business combination) with 16,063 licensed beds as compared with 104facilities with 10,659 licensed beds at December 31, 2004.

*Rehabilitation TherapyServices:*  This segment provides,among other services, physical, occupational, speech and respiratory therapysupplies and services to affiliated and nonaffiliated skilled nursingfacilities.  At December 31, 2005, this segment provided services to 424 facilities, 328nonaffiliated and 96 affiliated, as compared to 397 facilities at December 31, 2004, ofwhich 309 were nonaffiliated and 88 were affiliated. At December 31, 2004, weclosed our certified outpatient rehabilitation clinics in Colorado.  InMarch 2002, we sold substantially all of the assets of our respiratory therapyoperation. We also provide rehabilitative and special education services topediatric clients as well as rehabilitation therapy services for adult homehealthcare clients in the greater New  York City metropolitan area through HTAof New York, Inc.

*Medical StaffingServices:*  For the year ended December 31, 2005, thissegment derived 66% of its revenues from hospitals and other providers, 21%from skilled nursing facilities, 9% from schools and 4% from prisons. Weprovide (i) licensed therapists skilled in the areas of physical, occupationaland speech therapy, (ii) nurses, (iii) pharmacists, pharmacist technicians andmedical imaging technicians, (iv) physicians, and (v) related medical personnel. As of December 31, 2005, this segment had 25 division offices, which providedtemporary therapy and nursing staffing services in major metropolitan areas andtwo division offices, which specialize in the placement of temporary travelingtherapists and two division offices specializing in permanent placement ofhealthcare professionals.

F-40

**SUN HEALTHCARE GROUP, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

*Home Health Services*:  As of December 31, 2005,this segment provided skilled nursing care, rehabilitation therapy and homeinfusion services to adult and pediatric patients in California andOhio,and also operated two licensed home infusion pharmacies in California.

*Laboratory andRadiology Services:*This segment providesmedical laboratory and radiology services to skilled nursing facilities in Massachusetts,New Hampshire and Rhode  Island. 

*Other Operations:* We previously provided pharmaceutical productsprimarily to nonaffiliated and affiliated long-term and sub-acute carefacilities through a subsidiary.  In July 2003, we sold substantially all ofits assets to Omnicare, Inc.

     Corporateassets primarily consist of cash and cash equivalents, receivables fromsubsidiary segments, notes receivable, property and equipment and unallocatedintangible assets. Although corporate assetsinclude unallocated intangible assets, the amortization, if applicable, isreflected in the results of operations of the associated segment. 

     Theaccounting policies of the segments are the same as those described in the Note3 - "Summary of Significant Accounting Policies." We primarilyevaluate segment performance based on profit or loss from operations afterallocated expenses and before reorganization and restructuring items, incometaxes and extraordinary items. Gains or losses on sales of assets and certainitems including impairment of assets recorded in connection with SFAS No.144 and No. 142 and restructuring costs are not considered in the evaluation ofsegment performance. Allocated expenses include intersegment charges assessedto segments for management services and asset use based on segment operatingresults and average asset balances, respectively. We account for intersegmentsales and provision of services at estimated market prices. 

     Ourreportable segments are strategic business units that provide differentproducts and services. They are managed separately because each business hasdifferent marketing strategies due to differences in types of customers,distribution channels and capital resource needs.

F-41
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
**DECEMBER 31, 2005**

**As  of and for the**

 

 

 

 

**Year  Ended**

 

 

 

 

**December 31,   2005**

Segment Information (in thousands):

 

 

 

 

** **

Rehabilitation

Medical

Home

Laboratory  and

 

 

 

 

** **

Inpatient

Therapy

Staffing

Health

Radiology

 

Intersegment

 

 

Discontinued

** **

 Services 

  Services  

Services

Services

  Services  

Corporate

Eliminations

Consolidated

 

Operations

Revenues  from external customers

$

635,630

$

100,338

$

70,534

$

60,778

$

14,168

$

661

$

-

$

882,109

$

5,076

Intersegment revenues

                 -

           36,951

             613

                  -

              180

                 -

          (37,744

)

                   -

                    -

     **Total  revenues**

**635,630**

** **

** **

**137,289**

** **

** **

**71,147**

** **

** **

**60,778**

** **

** **

**14,348**

** **

** **

**661**

** **

** **

**(37,744**

**)**

** **

**882,109**

** **

** **

**5,076**

Operating  salaries and benefits

320,819

98,071

56,791

45,143

9,004

-

-

529,828

3,527

Self  insurance for workers'

  compensation  and general and

  professional  liability insurance

24,881

1,759

946

1,557

487

372

-

30,002

(14,381

)

Other  operating costs(1)

179,246

22,568

4,371

7,046

4,509

9

(37,744

)

180,005

1,890

General  and administrative expenses

13,455

7,351

2,748

1,184

193

47,193

-

72,124

12

Provision  (adjustment) for losses on

 

 

 

 

 

 

 

 

 

  accounts  receivable

          3,726

              (509

)

             221

              582

               336

                 -

                    -

            4.356

               652

 

 

 

 

 

 

 

 

 

**   Segment  operating income (loss)**

**$**

**93,503**

** **

**$**

**8,049**

** **

**$**

**6,070**

** **

**$**

**5,266**

** **

**$**

**(181**

**)**

**$**

**(46,913**

**)**

**$**

**-**

** **

**$**

**65,794**

** **

**$**

**13,376**

** **

Facility  rent expense

37,521

513

738

1,866

315

-

-

40,953

128

Depreciation  and amortization

6,999

262

376

901

371

965

-

9,874

102

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest,  net

 

          7,546

 

 

                (17

)

 

               49

 

                10

 

                   -

 

          4,461

 

 

                   -

 

 

          12,049

 

 

               111

**   Net  segment income (loss)**

**$**

**41,437**

** **

**$**

**7,291**

** **

**$**

**4,907**

** **

**$**

**2,489**

** **

**$**

**(867**

**)**

**$**

**(52,339**

**)**

**$**

**-**

** **

**$**

**2,918**

** **

**$**

**13,035**

** **

=========

==========

=========

==========

==========

=========

==========

==========

==========

Identifiable  segment assets

$

371,151

$

19,751

$

33,773

$

12,220

$

2,508

$

591,002

$

(520,985

)

$

509,420

$

2,886

Segment capital expenditures

$

11,045

$

334

$

367

$

520

$

209

$

4,913

$

-

$

17,388

$

28

     

 

 

 

 

 

 

 

 

 

 

 

General and administrative expenses includeoperating administrative expenses.

     The term "segmentoperating income (loss)" is defined as earnings before facility rentexpense, depreciation and amortization, interest, net, loss on assetimpairment, restructuring costs, net, loss (gain) on sale of assets, net,income tax benefit and discontinued operations.

     Theterm "net segment income (loss)" is defined as earnings before losson asset impairment, restructuring costs, net, loss (gain) on sale of assets,net, income tax benefit and discontinued operations.

(1)Includes $408 for loss on extinguishment of debt in Inpatient Services.

F-42
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
**DECEMBER 31, 2005**

**As****of and for the**

 

 

 

 

**Year  Ended**

 

 

 

 

**December 31, 2004**

Segment Information (in thousands):

 

 

 

 

 

 
                                                                                    
 

Rehabilitation

Medical

Home

Laboratory  and

 

 

 

 

Inpatient

Therapy

Staffing

Health

Radiology

 

Intersegment

 

 

Discontinued

 Services 

  Services  

Services

Services

  Services  

Corporate

Eliminations

Consolidated

 

Operations

Revenues  from external customers

$

586,413

$

99,890

$

54,713

$

56,702

$

15,525

$

47

$

-

$

813,290

$

33,005

Intersegment  revenues

         (600

)

           33,228

          2,103

                 -

            184

              -

       (34,915

)

                 -

                  -

**Total  net revenues**

** **

**585,813**

** **

** **

**133,118**

** **

** **

**56,816**

** **

** **

**56,702**

** **

** **

**15,709**

** **

** **

**47**

** **

** **

**(34,915**

**)**

** **

**813,290**

** **

** **

**33,005**

Operating salaries and benefits

296,271

91,693

43,918

40,469

8,926

(13

)

-

481,264

26,252

Self  insurance for workers'

  compensation  and general and

  professional  liability insurance

20,894

693

885

2,097

607

184

-

25,360

6,273

Other  operating costs(1)

161,504

21,779

4,329

6,730

4,590

20

(34,915

)

164,037

15,278

General  and administrative expenses

11,895

6,398

3,140

911

298

44,104

-

66,746

477

Provision  for losses on accounts

 

 

 

 

 

 

 

 

 

  receivable

        2,612

            1,508

              340

             516

             347

               -

                 -

         5,323

          6,578

 

 

 

 

 

 

 

 

 

**   Segment  operating income (loss)**

**$**

**92,637**

** **

**$**

**11,047**

** **

**$**

**4,204**

** **

**$**

**5,979**

** **

**$**

**941**

** **

**$**

**(44,248**

**)**

**$**

**-**

** **

**$**

**70,560**

** **

**$**

**(21,853**

**)**

Facility  rent expense

35,579

551

826

1,852

290

9

-

39,107

950

Depreciation  and amortization

7,320

248

183

592

251

612

-

9,206

404

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest,  net

 

        5,285

 

 

                 15

 

 

              (10

)

 

              36

 

 

                 -

 

        3,527

 

 

                 -

 

 

          8,853

 

 

                 7

**   Net  segment income (loss)**

**$**

**44,453**

** **

**$**

**10,233**

** **

**$**

**3,205**

** **

**$**

**3,499**

** **

**$**

**400**

** **

**$**

**(48,396**

**)**

**$**

**-**

** **

**$**

**13,394**

** **

**$**

**(23,214**

**)**

========

==========

=========

=========

=========

========

=========

=========

=========

Identifiable  segment assets

$

181,598

$

25,352

$

10,726

$

12,674

$

3,203

$

446,875

$

(366,759

)

$

313,669

$

(516

)

Segment capital expenditures

$

8,667

$

231

$

74

$

322

$

162

$

2,710

$

-

$

12,166

$

724

     

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative expenses include operating administrative expenses. 

     The term "segment operating income (loss)" is defined as earnings beforefacility rent expense, depreciation and amortization, interest, loss on assetimpairment, restructuring costs, net, loss on lease termination, loss (gain) onsale of assets, net, income taxes and discontinued operations.

     Theterm "net segment income (loss)" is defined as earnings before losson asset impairment, restructuring costs, net, loss on lease termination, loss(gain) on sale of assets, net, income taxes and discontinued operations. 

(1)  Includes$3.4 million of gain on extinguishment of debt, net, in Inpatient Services.

F-43
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
**DECEMBER 31, 2005**

**As  of and for the**

 

 

 

 

**Year  Ended**

 

 

 

 

**December 31, 2003**

Segment Information (in thousands):

 

 

 

 

 

 
                                                                                    
** **

Rehabilitation

Medical

Home

Laboratory  and

 

 

 

 

** **

Inpatient

Therapy

Staffing

Health

Radiology

 

Intersegment

 

 

Discontinued

** **

 Services 

  Services  

Services

Services

   Services   

Corporate

Eliminations

Consolidated

 

Operations
                                                                                    
Revenues  from external customers

$

547,221

$

105,769

$

54,608

$

55,533

$

15,234

$

73

$

-

$

778,438

$

612,514

Intersegment  revenues

           (600

)

           38,541

           7,216

                 -

             789

                 -

         (45,946

)

                  -

                  -
                                                                                    
**Total  net revenues**

** **

**546,621**

** **

** **

**144,310**

** **

** **

**61,824**

** **

** **

**55,533**

** **

** **

**16,023**

** **

** **

**73**

** **

** **

**(45,946**

**)**

** **

**778,438**

** **

** **

**612,514**
                                                                                    
Operating salaries and benefits

283,360

98,900

45,625

40,255

8,837

203

-

477,180

322,505

Self  insurance for workers'

  compensation  and general and

  professional  liability insurance

26,536

1,767

1,092

1,677

468

618

-

32,158

35,270

Other  operating costs

153,203

21,780

10,069

6,529

4,258

(196

)

(45,946

)

149,697

219,029

General  and administrative expenses

13,393

3,627

2,174

962

-

43,394

-

63,550

7,363

Provision  for losses on accounts

 

 

 

 

 

 

 

 

 

  receivable

          6,389

            1,756

              516

              167

             477

             (27

)

                -

          9,278

           9,795

 

 

 

 

 

 

 

 

 

**   Segment  operating income (loss)**

**$**

**63,740**

** **

**$**

**16,480**

** **

**$**

**2,348**

** **

**$**

**5,943**

** **

**$**

**1,983**

** **

**$**

**(43,919**

**)**

**$**

**-**

** **

**$**

**46,575**

** **

**$**

**18,552**

** **

Facility  rent expense

35,100

664

998

1,699

282

26

-

38,769

40,342

Depreciation  and amortization

5,185

1,125

65

477

231

40

-

7,123

2,272

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest,  net

 

          3,062

 

 

               (29

)

 

                   -

 

 

                 2

 

 

                 -

 

 

       13,857

 

 

                  -

 

 

        16,892

 

 

              682

**   Net  segment income (loss)**

**$**

**20,393**

** **

**$**

**14,720**

** **

**$**

**1,285**

** **

**$**

**3,765**

** **

**$**

**1,470**

** **

**$**

**(57,842**

**)**

**$**

**-**

** **

**$**

**(16,209**

**)**

**$**

**(24,744**

**)**

=========

==========

==========

=========

=========

  ========

=========

=========

=========

Identifiable  segment assets

$

131,614

$

26,877

$

10,412

$

11,396

$

4,242

$

458,714

$

(360,447

)

$

282,808

$

17,590

Segment capital expenditures

$

5,809

$

195

$

140

$

520

$

602

$

4,691

$

-

$

11,957

$

4,607

     

 

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative expenses include operating administrative expenses. 

     Theterm "segment operating income (loss)" is defined as earnings beforefacility rent expense, depreciation and amortization, interest, loss on assetimpairment, restructuring costs, net, loss (gain) on sale of assets, net,income taxes and discontinued operations.

     Theterm "net segment income (loss)" is defined as earnings before losson asset impairment, restructuring costs, net, loss (gain) on sale of assets,net, income taxes and discontinued operations.

F-44

**SUN HEALTHCAREGROUP, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**DECEMBER 31, 2005**

**Measurement of Segment Income or Loss**

     The accounting policies of theoperating segments are the same as those described in the summary of significantaccounting policies (See "Note 3 - Summary of Significant Accounting Policies.") We evaluate financial performance and allocate resources primarily based onincome or loss from operations before income taxes, excluding any unusual items. 

     The following tablereconciles net segment income (loss) to consolidated income (loss) beforeincome taxes and discontinued operations:

** **

**2005**

** **

**2004**

** **

**2003**

** **

Net  segment income (loss)

$          2,918

$        13,394

$      (16,209

)

   Loss  on asset impairment

(361

)

(1,028

)

(2,774

)

   Restructuring  costs, net

(122

)

(1,972

)

(14,676

)

   Loss  on lease termination

-

(150

)

-

   (Loss)  gain on sale of assets, net

             (384

)

          (1,494

)

          4,178

Income  (loss) before income taxes and

   discontinued operations

$          2,051

$          8,750

$     (29,481

)

=========

=========

========

**(17)  RestructuringCosts**

     Wecommenced our restructuring in January 2003, substantially completed it byDecember 31, 2004 and finalized it by December 31, 2005. We adopted *Accountingfor Costs Associated with Exit or Disposal Activities* ("SFAS No. 146")for all divestiture activities initiated after December 31, 2002. Under SFAS No. 146, there are four major types of costs associated with ourrestructuring: (i) one-time termination benefits, (ii) contract termination,(iii) facility consolidation and (iv) professional fees.  We have recognizedthese expenses in the income statement line "restructuring costs" asthey were incurred. All of the costs were under the Corporate reportablesegment.  We had no liability account associated with this restructuringactivity because all of the related expenses were paid when incurred.  Thefollowing table sets forth the costs related to the restructuring activity indetail (in millions).

** **

** **

**Total**

**For the Year**

**Cumulative**

**Expected**

**Major Type of**

**Ended**

**Amount Incurred**

**Restructuring**

**           Restructuring Cost          **

**December 31, 2005**

**        to  Date (1)        **

**           Costs  (2)           **

One-Time  Termination Benefits

$                             -

$                         1.2

$                         1.2

Contract  Terminations (3)

-

5.1

5.1

Facility  Consolidation

-

0.1

0.1

Professional  Fees

                          0.1

                        10.3

                        10.3

     Total

$                         0.1

$                       16.7

$                       16.7

** **

**=============**

**=============**

**=============**

(1)  Cumulative  amount incurred for restructuring period to-date (36 months).

(2)  Aggregate  amount expected to be incurred during entire restructuring.

(3)  Included  costs related to the termination of bank loans.

F-45

**(18)  401(K) Plan**

      We have adefined contribution plan (the "401(k) plan"). Employees who havecompleted three months of service are eligible to participate. Effective January 1, 2004, the401(k) plan allows for a discretionary employer match of contributions made byparticipants for any participants employed on the last day of the year. We may make matchingcontributions under this plan of 25 cents on the dollar up to 3% of theparticipant's compensation. Employer contributions for the 2004 plan wereapproximately $0.6 million in 2005.

 

F-46

**SUN HEALTHCAREGROUP, INC. AND SUBSIDIARIES**

**SUPPLEMENTARY DATA(UNAUDITED)QUARTERLY FINANCIAL DATA**

     Thefollowing tables reflect unaudited quarterly financial data for fiscal years2005 and 2004 (in thousands, except per share data):

** **

**For  the Year**

** **

** **

**Ended**

** **

** **

**December 31,   2005 (1)**

** **

** **

**Fourth**

** **

**Third**

** **

**Second**

** **

**First**

** **

** **

** **

** **

**  Quarte   **

** **

**  Quarter  **

** **

**   Quarter   **

** **

**   Quarter   **

** **

**      Total   **

** **

Total  net revenues

$     245,944

$     216,267

$       213,631

$       206,267

$        882,109

========

========

=========

=========

==========

Income (loss) from continuing

  operations (2) 

$         3,579

$           (937

)

$           1,785

$         (1,590

)

$            2,837

Gain on discontinued

  operations

$         8,087

$         8,271

$           5,145

$             421

$          21,924

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

$           0.20

$         (0.06

)

$            0.12

$           (0.10

)

$              0.18

  Gain on discontinued

 

 

 

 

 

    operations

            0.45

            0.54

             0.33

              0.02

                1.37

  Net income (loss)

$           0.65

$           0.48

$            0.45

$           (0.08

)

$              1.55

========

========

=========

=========

==========

Weighted average number of

  common and common equivalent

  shares outstanding:

  Basic and diluted

17,957

15,365

15,351

15,320

16,003

  Diluted

18,054

15,365

15,352

15,320

16,019

========

========

=========

=========

==========

1

**For  the Year**

** **

** **

**Ended**

** **

** **

**December 31,   2004 (1)**

** **

** **

**Fourth**

** **

**Third**

** **

**Second**

** **

**First**

** **

** **

** **

** **

**  Quarter  **

** **

**  Quarter  **

** **

**  Quarter  **

** **

**  Quarter  **

** **

**     Total  **

** **

Total  net revenues

$      204,633

$       200,897

$       203,965

$      203,795

$    813,290

=========

=========

=========

=========

========

Income (loss) from continuing

  operations (3)

$          5,480

$          (3,248

)

$         11,245

$         (3,569

)

$        9,908

Loss on discontinued

  operations

$         (9,891

)

$          (7,843

)

$          (3,945

)

$         (6,856

)

$     (28,535

)

Net  (loss) income

$         (4,411

)

$        (11,091

)

$           7,300

$       (10,425

)

$     (18,627

)

=========

=========

=========

=========

========

Basic earnings per common and

  common equivalent share:

  Income (loss) from continuing

    operations

$            0.36

$           (0.21

)

$            0.74

$           (0.29

)

$          0.69

  Loss on discontinued operations

            (0.65

)

            (0.52

)

            (0.26

)

            (0.57

)

          (1.98

)

  Net (loss) income

$           (0.29

)

$           (0.73

)

$            0.48

$           (0.86

)

$         (1.29

)

=========

=========

=========

=========

========

Diluted earnings per common and

  common equivalent share:

  Income (loss) before discontinued

      operations

$            0.36

$           (0.21

)

$            0.74

$           (0.29

)

$          0.68

  Loss on discontinued operations

            (0.65

)

            (0.52

)

            (0.26

)

             (0.57

)

          (1.96

)

  Net (loss) income

$           (0.29

)

$           (0.73

)

$            0.48

$           (0.86

)

$         (1.28

)

=========

=========

=========

=========

========

Weighted average number of

  common and common equivalent

  shares outstanding:

  Basic

15,275

15,275

15,142

12,113

14,456

  Diluted

15,335

15,275

15,206

12,113

14,548

=========

=========

=========

=========

========
      
(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, 2005, 2004 and 2003 to discontinued operations.  Therefore,  the quarterly financial data presented above including revenues, income (loss)  before income taxes and discontinued operations and (loss) gain 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 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.
      
(3)

We recorded a loss on asset impairment of $1.0 million,  restructuring costs of $2.0 million, loss on sale of assets of $1.5 million  and gain on extinguishment of debt of $3.4 million.

2

                                                                                                                             **SCHEDULE II**

**SUN HEALTHCAREGROUP, INC. AND SUBSIDIARIES**

** VALUATION ANDQUALIFYING 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  (3)**

** **

**   Period   **

** **

  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 (4)

  $           7,245

  $                 -

  $                4,685

  $       (6,191

)

  $           5,739

 

  =========

  ========

  ===========

  ========

  =========

 

  Year ended December 31, 2003:

     Allowance for doubtful accounts

  $         45,905

  $       18,114

 

  $               23,675

(2)

  $    (20,586

)

  $         67,108

  =========

  ========

  ===========

  ========

  =========

     Other receivable reserve (4)

  $           6,419

  $            959

 

  $                        -

  $         (133

)

  $           7,245

(2)

  =========

  ========

  ===========

  ========

  =========
      (1)
Charges included  in provision for losses on accounts receivable, of which $652, $6,578 and  $9,795, respectively, for the years ended December 31, 2005, 2004 and 2003,  relate to discontinued operations.
   (2)
Provision for  facilities included in discontinued operations recorded in loss on disposal of  discontinued operations.
   (3)
Column D  primarily represents write offs and recoveries on divested receivables that  have been fully  reserved.
      (4)Includes reserves on long-term notes receivable of $148 and  $6,509 as of December 31, 2004 and 2003.
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