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UNITED STATESSECURITIES AND EXCHANGE
COMMISSIONWashington, D.C. 20549___________FORM 10-K

(Mark One)

|[X]    Annual Report Pursuant to
      Section 13 or 15(d) of the Securities Exchange Act of
    1934                                               
|----------------------------------------------------------------------------------------------------------------------------------------------------
|For the fiscal year ended December 31,
    2002                                                                                                     
|OR                                                                                                                                                  
|[  ]    Transition Report
      Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934For the transition period from
       to

Commission file number 0-49663

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

18831 Von Karman, Suite 400Irvine, CA 92612(949)
255-7100(Address and telephone number of Registrant)

Securities registered pursuant to Section 12(b) of the
Act: NoneSecurities registered pursuant to Section 12(g) of the Act:
Title of each classCommon Stock, par value $.01 per
shareWarrants to purchase Common Stock, $.01 par value per share

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

Indicate by check mark whether
the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes [X]     No [ ]



The aggregate market value of such Common
Stock held by nonaffiliates, based on the last sales price of such shares on the
Over-the-Counter Bulletin Board on June 30, 2002, was approximately $109.7
million.

Indicate by check mark whether
the registrant has filed all documents and reports required to be filed by
Section 12, 13 or 15(d) of the Securities Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a court.
Yes  [X]  No  [  ]

Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of the registrant's
knowledge, in the definitive proxy statement incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. [
]

1

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

FORM 10-K



|           |                                                                                                      | Page
|---------- | ---------------------------------------------------------------------------------------------------- | ----
|PART I     |                                                                                                      |     
|           |                                                                                                      |     
|Item 1.    | Business                                                                                             |     
|Item 2.    | Properties                                                                                           |     
|Item 3.    | Legal Proceedings                                                                                    |     
|Item 4.    | Submission of Matters to a Vote of Security Holders                                                  |     
|           |                                                                                                      |     
|PART II    |                                                                                                      |     
|           |                                                                                                      |     
|Item 5.    | Market for Registrant's Common Equity and Related Stockholder
      Matters                          |     
|Item 6.    | Selected Financial Data                                                                              |     
|Item 7.    | Management's Discussion and Analysis of Financial Condition and Results
      of Operations          |     
|Item 7A.   | Quantitative and Qualitative Disclosures About Market
Risk                                           |     
|Item 8.    | Financial Statements and Supplementary Data                                                          |     
|Item 9.    | Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosures          |     
|           |                                                                                                      |     
|PART III   |                                                                                                      |     
|           |                                                                                                      |     
|Item 10.   | Directors and Executive Officers of the Registrant                                                   |     
|Item 11.   | Executive Compensation                                                                               |     
|Item 12.   | Security Ownership of Certain Beneficial Owners and Management and
      Related Stockholder Matters |     
|Item 13.   | Certain Relationships and Related Transactions                                                       |     
|Item 14.   | Controls and Procedures                                                                              |     
|PART IV    |                                                                                                      |     
|           |                                                                                                      |     
|Item 15.   | Exhibits, Financial Statement Schedules, and Reports on
      Form 8-K                               |     
|Signatures |                                                                                                      |     
|           |                                                                                                      |     

SunBridge(R),
SunDance(R), SunScript(R),
SunPlus(R), and CareerStaff
Unlimited(R) and related names are registered trademarks of Sun Healthcare
Group, Inc. and its subsidiaries.

___________________

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

FORWARD LOOKING STATEMENTS

References throughout this
document to the Company include Sun Healthcare Group, Inc. and its consolidated
subsidiaries. In accordance with the Securities and Exchange Commission's "Plain
English" guidelines, this Annual Report on Form 10-K has been written in the
first person. In this document, the words "we," "our," "ours" and "us" refer to
Sun Healthcare Group, Inc. and its direct and indirect consolidated subsidiaries
and not any other person.

Information provided in this Form
10-K contains "forward-looking" information as that term is defined by the
Private Securities Litigation Reform Act of 1995 (the "Act"). All statements
regarding our expected future financial position, results of operations, cash
flows, liquidity, financing plans, lease restructuring initiative, business
strategy, budgets, projected costs and capital expenditures, competitive
position, growth opportunities, plans and objectives of management for future
operations and words such as "anticipate," "believe," "plan," "estimate,"
"expect," "intend," "may" and other similar expressions are forward-looking
statements. The forward-looking statements are qualified in their entirety by
these cautionary statements, which are being made pursuant to the provisions of
the Act and with the intention of obtaining the benefits of the "safe harbor"
provisions of the Act. We caution investors that any forward-looking statements
made by us are not guarantees of future performance and that actual results may
differ materially from those in the forward-looking statements as a result of
various factors, including, but not limited to, those set forth below and
elsewhere herein:

Forward-looking statements
involve known and unknown risks and uncertainties that may cause our actual
results in future periods to differ materially from those projected or
contemplated in the forward-looking statements as a result of, but not limited
to, the following factors:

|- | our borrowing capacity under our Loan Agreements may be insufficient to
      fund our operations;                                                                                                     
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|- | we are in default under our Loan Agreements;                                                                                                                                                           
|- | we recently ceased making payments on leases and mortgages representing
      approximately 56% of our long-term care facilities;                                                                      
|- | our Medicare reimbursements materially and adversely decreased after
      September 30, 2002 and our Medicare and Medicaid reimbursements could
      materially and adversely decrease in the future;
|- | national and local economic conditions, including their effect on the
      availability and cost of labor, utilities and materials;                                                                   
|- | the effect of government regulations and changes in regulations
      governing the healthcare industry, including our compliance with such
      regulations;                                         
|- | liabilities and other claims asserted against us,
      including patient care liabilities (see "Item
      3. Legal
      Proceedings");                                                              
|- | our ability to attract and retain qualified personnel;                                                                                                                                                 
|- | the competitive environment in which we operate; and                                                                                                                                                   
|- | demographic changes.                                                                                                                                                                                   

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

See "Item 1. Business" for a
discussion of various circumstances affecting us in particular, governmental
regulations and other operating factors relating to the healthcare industry and
the risk factors inherent in them. The risks and uncertainties described above
and under "Item 1. Business" are not the only ones facing us. You should
carefully consider the risks described herein before making any investment
decisions in us. There may be additional risks that we do not presently know of
or that we currently deem immaterial. If any of the foregoing risks or the risks
described below actually occurs, our business, financial position, results of
operations and cash flows could be materially adversely affected. In that case,
the trading price of our common stock could decline, and you may lose all or
part of your investment. Given these risks and uncertainties, we can give no
assurances that these forward-looking statements will, in fact, transpire and,
therefore, caution investors not to place undue reliance on
them.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

PART I

Item 1. Business

Operations

We currently are one of the largest
providers of long-term, subacute and related specialty healthcare services in
the United States. We currently operate through three principal business
segments: (i) inpatient services, (ii) rehabilitation therapy services, and
(iii) pharmaceutical services.

The following is a description of
our current business segments and other operations. Financial information for
the business segments is set forth in "Note 16 - Segment Information" in our
consolidated financial statements.

Inpatient Services. Our
long-term and subacute care facilities provide inpatient skilled nursing and
custodial services as well as rehabilitative, restorative and transitional
medical services. We provide 24-hour nursing care in these facilities by
registered nurses, licensed practical nurses and certified nursing aides. As of
March 1, 2003, we operated 233 long-term care facilities (consisting of 215
skilled nursing facilities, nine assisted living facilities and nine
rehabilitation and long-term acute care hospitals) in 25 states with 26,287
licensed beds through our wholly owned subsidiary, SunBridge Healthcare
Corporation and other subsidiaries (collectively, "SunBridge"). As part of our
restructuring efforts, we may divest approximately 56% of our skilled nursing
facilities representing approximately 16,000 licensed beds. We determined that
we must cease operation of those facilities because we cannot operate them
profitably under the current long-term care reimbursement and business
environment. See "Overview of Current Company Financial Condition."

Our acute rehabilitation
hospitals provide a range of inpatient and outpatient services for people with
traumatic brain injuries, strokes, arthritis, and other disabling conditions.
Our assisted living facilities serve the elderly who do not need the level of
nursing care provided by long-term or subacute care facilities, but who do need
some assistance with the activities of daily living.

During the year ended December 31, 2002, we divested 10 skilled
nursing facilities. We did not receive cash consideration from these
divestitures. The aggregate annual net operating losses of the divested skilled
nursing facilities were approximately $4.4 million in 2002. See "Note 7 -
Impairment of Long-Lived Assets and Assets Held for Sale" in our consolidated
financial statements. During the period of January 1, 2003 through March 1,
2003, we divested five skilled nursing facilities and we did not receive cash
for these divestitures.

Rehabilitation Therapy
Services. We provide rehabilitation therapy services primarily through
SunDance Rehabilitation Corporation ("SunDance"). We provide a broad array of
rehabilitation therapy services, including speech pathology, physical therapy
and occupational therapy. As of March 1, 2003, SunDance provided rehabilitation
therapy services to 537 facilities in 40 states, 326 of which were operated
by nonaffiliated parties.

Pharmaceutical Services. We
provide pharmaceutical services primarily through SunScript PharmacyCorporation
("SunScript"). Pharmaceutical services include dispensing pharmaceuticals for
such purposes as infusion therapy, oral medication, pain management, antibiotic
therapy and parenteral nutrition. Additional services include providing
consultant pharmacists. SunScript services are typically provided to
nonaffiliated and affiliated facilities, including subacute and skilled nursing
care facilities, assisted living facilities, group houses, correctional
facilities, mental health facilities and home healthcare companies. As of March
1, 2003, SunScript operated 32 regional pharmacies, two hospital pharmacies,
three specialty disease-state pharmacies and one Part B billing company, which
together provided pharmaceutical products and services to a total of 671
long-term and subacute care facilities in 19 states, 477 of which were operated
by nonaffiliated parties.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Other Operations. We are a
nationwide provider of temporary medical staffing primarily through CareerStaff
Unlimited, Inc. ("CareerStaff"). CareerStaff derives approximately 50% of
its revenues from schools and governmental agencies, 24% from hospitals and
other providers and 26% from skilled nursing facilities. CareerStaff provides
(i) licensed therapists skilled in the areas of physical, occupational and
speech therapy, (ii) nurses, (iii) pharmacists, pharmacist technicians and
medical imaging technicians and (iv) related medical personnel. As of March 1,
2003, CareerStaff had 51 division offices, which provided temporary therapy and
nursing staffing services in major metropolitan areas and one division office,
which specialized in the placement of temporary traveling therapists in smaller
cities and rural areas.

Through SunAlliance Healthcare
Services, Inc. ("SunAlliance") and SunPlus Home Health Services, Inc.
("SunPlus"), we provide mobile radiology, medical laboratory and home healthcare
services in certain locations. Through our majority-owned subsidiary, Shared
Healthcare Systems, Inc., which also does business under the trade name SHS.com,
we develop certain software for use in the long-term care industry.

Prior Operations. During
January 2001, we sold substantially all of the assets of our SunChoice medical
supplies operations to Medline Industries, Inc. We received proceeds of $16.6
million in exchange for the SunChoice assets.

During February 2001, we sold our
operations in the United Kingdom. Those operations included 146 long-term care
facilities with 8,326 licensed beds. We did not receive any material cash
payments in exchange for these operations; however we were released from
approximately $112.9 million of aggregate debt, capital lease obligations, notes
payable and other liabilities upon consummation of the sale. Our operations in
Australia were liquidated in July 2001 and we received liquidation proceeds of
approximately $0.9 million. We divested our long-term care and pharmacy
operations in Germany in February 2001 for approximately $3.5 million. We sold
our long-term care operations in Spain in October 2000 for approximately $7.6
million. At December 31, 2001, we had no operations outside of the U.S.

In March 2002, we divested our
respiratory therapy supplies and equipment business that was operated by our
wholly-owned subsidiary, SunCare Respiratory Services, Inc. We received $0.9
million in cash for these assets.

The approximate number of facilities
that we operated worldwide has decreased from approximately 600 on December 31,
1998 to 233 as of March 1, 2003. The approximate number of our full and
part-time employees worldwide has decreased from approximately 80,700 on
February 20, 1999 to 33,000 on March 1, 2003. We are continuing our
restructuring efforts in 2003.

General Information. Sun
Healthcare Group, Inc. was incorporated in 1993. Our principal executive offices
are located at 18831 Von Karman, Suite 400, Irvine, CA 92612, and our telephone
number is (949) 255-7100. We maintain a web site at

6

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Overview of Current Company Financial Condition

Current Liquidity. Our net
income in 2002 was $1,047.4 million, which includes $1,498.4 million extraordinary
gain on extinguishment of debt and $407.8 million loss on asset impairment, and our cash flow used for operating activities for 2002 was $41.2
million. These negative results are largely due to adverse conditions in the
long-term care industry, including reductions in government support for
long-term care providers, such as the failure of Congress to restore Medicare
funding to the levels existing prior to October 1, 2002. At March 19, 2003, we
had cash and cash equivalents of $6.0 million and borrowing availability under
our Loan Agreements of $28.0 million. That availability resulted, in part, from
our ceasing to pay rent on certain of our facilities as described below. In
addition, the report of our independent auditors as of December 31, 2002 and for
the ten month period then ended is qualified as to our ability to continue as a
going concern.  See report on page F-2 and "Note 2 - Basis of
Reporting and Current Operating Environment."

Defaults under Loan Agreements. We were not in compliance
with certain financial covenants in our Revolving Loan Agreement at December 31,
2002 and we continue not to be in compliance. Pursuant to certain cross-default
provisions, we are also in default under our Term Loan Agreement. The lenders
under the Loan Agreements have continued lending to us in spite of the defaults,
although they have reserved their rights to seek to exercise their remedies
contained in the Loan Agreements. We cannot assure you that the lenders under
those agreements will refrain from seeking to exercise their remedies,
potentially including declaring all loan amounts outstanding to be immediately
due and payable, realizing upon the lenders' security interests, denying us the
right to further borrowings under the Revolving Loan Agreement and other
remedies. It is likely that under those circumstances we would commence
bankruptcy proceedings. We have classified the Loan Agreements as current
obligations at December 31, 2002 and our liquidity remains an ongoing concern
for us.

Defaults under Leases and
Mortgages. In our effort to reduce our costs, in January 2003, we initiated
new restructuring efforts. Our ongoing efforts include an attempt to restructure
the portfolio of leases under which we operate most of our long-term care
facilities. We are seeking to obtain rent concessions with respect to our
under-performing facilities, and if we are unable to get sufficient rent
concessions on a facility lease, or if we determine that it is no longer
advisable to continue operating that facility, then we will seek to transition
operations of that facility to a new operator so that we will no longer be
burdened by the losses generated by that facility. We are currently attempting
to transition approximately 56% of our long-term care facilities to new
operators. As of March 21, 2003, we had withheld payment of approximately $18.9
million in accrued rent and mortgage payments with respect to those facilities.
In addition, we intend to continue withholding certain rent and mortgage
payments until we complete the transition of each affected facility to new
operators. Our restructuring efforts are likely to require nine to 12 months to
complete and we may need to consider selling additional assets during that
period in order to have sufficient liquidity to complete the restructuring. We
cannot predict the extent to which landlords not receiving rent will seek to
assert leasehold or other damages during the nine to 12 month restructuring
period. If the landlords aggressively pursue and obtain such damages, we will
likely be required to commence bankruptcy proceedings prior to the completion of
our restructuring.

2003 Restructuring. Our goal is to restructure our business
so that we can fund our operations and working capital requirements while
remaining a significant provider of skilled nursing and other long-term care
facilities. We will also seek to reduce our overhead and other expenses
significantly, commensurate with reducing the size of our long-term care
facility portfolio. Although we have had encouraging discussions and are making
progress with many landlords from whom we are seeking to obtain rent concessions
or facility lease terminations, and have reached agreements in principle or
final agreements with several of our landlords, no assurance can be given that
we will be successful in our restructuring efforts. In addition, it is not
certain that our available liquidity will provide us with sufficient time to
allow us to reduce our overhead and other expenses as required for us to generate sustainable ongoing positive cash flow from our operations.

7

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Unless we are able to generate
substantial cash flow from operations and/or raise cash from asset sales or
additional financing, our current available cash and borrowing capacity will be
insufficient to fund our ongoing operations. Even if our restructuring allows us
to create a sustainable positive cash flow from our operations, a bankruptcy
filing may, nonetheless, be required to restructure outstanding obligations and
claims against us. Under any circumstance, it is not certain whether we can
create or sustain any value for our common stock.  Due to the uncertainly
of our restructuring efforts we are unable to predict our anticipated cash flows
for the year ended December 31, 2003.

Revenues from Medicare, Medicaid and Other Sources

Revenue Sources.We
receive revenues from Medicare, Medicaid, private insurance, self-pay residents,
other third party payors and long-term care facilities that utilize our
specialty medical services. The sources and amounts of our inpatient services
revenues are determined by a number of factors, including the number of licensed
beds and occupancy rates of our facilities, the acuity level of patients and the
rates of reimbursement among payors. Likewise, payment for ancillary medical
services, including the institutional pharmacy services of SunScript and the
therapy services provided by SunDance, will vary based upon payor and payment
methodologies. The following table sets forth the total revenues and percentage
of revenues by payor source for our U.S. operations for the years indicated (in
thousands):

|                          | Years
      Ended December 31,
|------------------------- | ------------------------------
|Sources of Revenues       | 2002                          
|                          |                               
|Medicaid                  | $870,240                      
|Medicare                  | 481,629                       
|Private pay and other (1) | 548,171                       

|(1) | Includes revenues from the provision of ancillary
      services, which includes payments for rehabilitation and respiratory
      therapy, temporary medical staffing services and pharmaceutical services
      provided to nonaffiliated long-term and subacute facilities and not
      directly charged to Medicaid or Medicare. Nonaffiliated sources may
      themselves derive all or a portion of their revenues from Medicaid and/or
      Medicare.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Changes in the mix of patients among
the Medicaid, Medicare Part A and private pay categories, and among different
types of private pay sources, could significantly affect our revenues and
results of operations. In addition, we cannot be certain that the facilities
operated by us, or the provision of services and products by us, now or in the
future, will initially meet or continue to meet the requirements for
participation in the Medicare and Medicaid programs. A loss of Medicare or
Medicaid certification or a change in our reimbursement under Medicare or
Medicaid could reduce our revenues and adversely affect our results of
operations and cash flows.



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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

The following table sets forth
the approximate average amounts of Medicare Part A revenues per patient per day
recorded by our inpatient and hospital facilities for the years
indicated:

|Fiscal Year EndedDecember 31, | Average Medicare Part ARevenue Per Patient
      Day (1)
|----------------------------- | --------------------------------------------------------
|                              |                                                         
|2002                          | $   382.03                                              
|2001                          | 376.78                                                  
|2000                          | 343.04                                                  
|1999                          | 322.52                                                  
|1998                          | 448.80                                                  

|(1) | The year-to-year comparisons are not on a same-store basis due to
      acquisitions and divestitures.                                                                                           
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | The average Medicare Part A Revenue Per Patient Per Day at our skilled
      nursing facilities (excluding hospital) was approximately $314.41
      subsequent to September 30, 2002. See below.
|(3) | Excludes approximately $52.1 million of excess reserves reversed into
      net patient revenues due to a Settlement Agreement with
  CMS.                                                       
|(4) | Includes estimated adjustments for routine cost limit exception
      revenue.                                                                                                                   
|(5) | Reflects reimbursement rates prior to the implementation of
      PPS.                                                                                                                           

Medicaid is a federal-state
matching program, whereby the federal government, under a needs-based formula,
matches funds provided by the participating states for medical assistance to
"medically indigent" persons. The programs are administered by designated state
agencies following federal and state rules. Although Medicaid programs vary from
state to state, traditionally they have provided for the payment of certain
expenses, up to established limits, at rates determined in accordance with each
state's regulations. For skilled nursing facilities, most states pay
prospectively determined per diem rates, and have some form of acuity
adjustment. In addition to facility-based services, most states cover an array
of medical ancillary services, including those services provided by
institutional pharmacies. Payment methodologies for these services vary based
upon state law and regulations permitted under federal rules.

Reduced Medicare
Reimbursements.Medicare reimburses our skilled nursing facilities under a
prospective payment system ("PPS") for inpatient Medicare Part A covered
services. PPS was adopted pursuant to the Balanced Budget Act of 1997 (the "1997
Act"). Under PPS, facilities are paid a predetermined amount per patient, per
day, based on the anticipated costs of treating patients, and such amount is
determined by classifying each patient into one of 44 resource utilization
groups ("RUG"). The nursing home industry came under financial pressure as a
result of the implementation of PPS and other 1997 Act
provisions.  As a result, Congress enacted The
Balanced Budget Refinement Act of 1999 ("BBRA") and the Medicare, Medicaid
and SCHIP Benefits Improvement Act of 2000 ("BIPA") to provide some relief to
the industry. The BBRA and BIPA required four Medicare "add-on"
payments: a 4% increase in per diem rates; a 16.7% increase in the nursing
component of each RUG; a 20% increase for certain categories of high cost,
medically complex patients; and a 6.7% increase for rehabilitation RUGs.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

On September 30, 2002, two of the
add-on provisions of the Medicare payment regulations expired: the 4% add-on for
all patient categories in the RUG system and the 16.7% add-on for nursing
related costs. We currently estimate that our Medicare revenues decreased by
approximately $8.6 million ($36.98 per patient day) for the period of
October 1, 2002 to December 31, 2002, and we estimate, that based upon the
number of facilities that we currently operate, we will experience a decrease of
approximately $32.9 million for the year ended December 31, 2003 if
these add-ons are not restored, although the decrease could be greater than
anticipated. In addition to the elimination of the add-ons, CMS announced a 2.6%
market basket increase in payments to skilled nursing facilities. For the period
of October 1, 2002 to December 31, 2002, we estimate that the market basket
increase resulted in approximately $2.1 million ($9.49 per patient day) in
revenue, and we estimate, that based upon the number of facilities that we
currently operate we will experience an increase of approximately $8.5 million
in revenue to our inpatient facilities for the year ended December 31,
2003. The net result of the expiration of the add-ons and the market basket
increase is an estimated Medicare revenue decrease of approximately $24.4
million ($27.49 per patient day) for the year ended December 31, 2003.

The remaining two add-on
payments, the 6.7% increase for patients requiring intense rehabilitation and a
20.0% increase for patients requiring complex medical care, are scheduled
to expire on the earlier of September 30, 2003 or at such time as CMS completes
the case mix refinements. The refinements are intended to ensure nursing homes
are fairly and accurately reimbursed for taking care of medically complex
patients. CMS has determined that the research is not sufficiently advanced at
the present time to implement the refinements in the 2003 Federal fiscal year.
Although the add-ons will expire when these refinements are implemented, it is
expected that the add-ons will be replaced by new payment rates that are not
known at this time. If the add-ons expire and are not replaced, we estimate that,
based upon the number of long-term care facilities we currently operate, our per beneficiary per diems would decrease by approximately $27.00, which
would account for $27.5 million annually. The loss of these add-ons would have a
material adverse effect on our financial position, results of operations and
cash flows.

Medicare Part B payments are
generally adjusted annually, effective upon the calendar year beginning January
1 and ending December 31. On December 31, 2002, CMS issued a final rule
providing a 4.4% decrease to the payment fee, effective on March 1, 2003.
However, the recently enacted federal spending bill for fiscal 2003 allowed CMS
to revise the figures used in the statutory formula and increase the update from
a negative 4.4% to a positive 1.6%.

The 1997 Act also implemented
a restriction applicable to Medicare Part B payments that would limit the amount
of reimbursements we receive per patient per day for rehabilitation therapy. BBRA
and BIPA placed a moratorium on that limitation; however, the
moratorium expires on June 30, 2003.  We
estimate the application of the limitation will reduce SunDance's revenue
by approximately $7.2 million and our inpatient services revenue by $0.9 million
for the six months ended December 31, 2003, based upon the number of
long-term care facilities we currently operate.

We also expect our annual revenue
from our home health services to decrease by approximately $2.1 million due to
recent legislation. Additionally, as non-affiliated healthcare providers that
are serviced by our ancillary services operations, including our pharmaceutical,
rehabilitative services, laboratory and radiology operations, are negatively
affected by reduced reimbursements to their operations, we could experience
negative trends in customer credit-worthiness, lengthened payment cycles,
increased exposure to loss on accounts receivable and reductions in our
ancillary services business.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

In a notice of proposed
rulemaking issued on February 10, 2003, CMS proposed a significant change for
the reimbursement of Medicare Part A bad debts. The proposal would subject all
providers to a 30% reduction in Medicare Part A bad debt reimbursement.
CMS proposes to implement the reduction incrementally over a three year period
to mitigate its impact: 10% for cost reporting periods beginning October
1, 2003, 20% for cost reporting periods beginning October 1, 2004, and 30% for cost reporting years beginning October 1, 2005 and thereafter. Based
upon the estimated Medicare bad debts that we will claim on our 2002 cost
reports, we estimate that, based upon the number of long-term care facilities we
currently operate, that our Medicare revenues would decrease by approximately
$0.8 million in 2004, $1.6 million in 2005 and $2.4 million in 2006 if the
proposed changes are implemented.

To summarize, we estimate that
our Medicare revenues will decrease by approximately $34.6 million during the
year ended December 31, 2003 as a result of the known changes to
Medicare and assuming that we continue operating all of our facilities. This
decrease includes: a $32.9 million decrease to inpatient revenues as a result of
the expiration of the add-ons; a $8.5 million increase to inpatient revenues as
a result of the market basket increase; a $7.2 million decrease to therapy
revenues and a $0.9 million decrease in inpatient services revenues as a result
of the expiration of the therapy cap moratorium; and a $2.1 million decrease in
home health revenues as a result of legislative changes.

Reduced Medicaid
Reimbursements. The recent economic downturn has had a detrimental affect on
state revenues. Historically these budget pressures have translated into
reductions in state spending. Given that Medicaid outlays are a significant
component of state budgets, we expect continuing cost containment pressures on
Medicaid outlays for nursing homes and pharmacy services in the states in which
we operate. States that have recently reduced Medicaid reimbursements, or are
considering reducing Medicaid reimbursements, to long-term care facilities
include, but are not limited to, California, Colorado, Idaho, Kentucky, New
Mexico, Washington, Connecticut, Illinois, Massachusetts, Ohio, Georgia,
Louisiana, New Jersey, Tennessee, and Texas.

California's proposed changes would be the most significant to
us because 76 of our facilities, or 33 percent of the facilities that we
operated as of March 1, 2003, were in California. California has proposed a 15%
cut in Medicaid payments to skilled nursing facilities, and we estimate that if
the proposal is implemented then our Medicaid reimbursements at our facilities
in California would decrease by approximately $17.00 per patient per day, which
would result in a decrease of approximately $13.0 million for the period of July
1, 2003 to December 31, 2003 if we continued operating all 76 facilities during
that period.

Reimbursement for
Pharmaceuticals.Most states reimburse pharmacies for drug prescriptions
using an average wholesale price ("AWP") less a percentage discount. The Human
Service Office of the Inspector General ("OIG") has estimated that the
pharmacies' actual acquisition costs for generic drugs averaged 65.9% below AWP.
The OIG and CMS are working to develop a prescription drug reimbursement method
that they believe is more accurate than using AWPs. Likewise, a number of states
have either implemented or proposed cost containment initiatives. Changes in
payment formulas and delivery requirements could materially adversely impact the
SunScript pharmacy operations.

The reimbursement rates for
pharmacy services under Medicaid are determined on a state-by-state basis
subject to review by CMS and applicable federal law. In most states, pharmacy
services are priced at the lower of "usual and customary" charges or cost (which
generally is defined as a function of average wholesale price and may include a
profit percentage) plus a dispensing fee. Certain states have "lowest charge
legislation" or "most favored nation provisions" which require our institutional
pharmacy to charge Medicaid no more than its lowest charge to other consumers in
the state.

Additionally, pharmacy coverage
and cost containment are important policy debates at both the federal and state
levels. Congress has considered proposals to expand Medicare coverage for
outpatient pharmacy services. Enactment of such legislation could affect
institutional pharmacy services. Likewise, a number of states have proposed cost
containment initiatives. Specifically, California, Massachusetts and Washington
have enacted pharmacy rate reductions that, based upon the number of long-term
care facilities we currently operate, will reduce our revenue by
approximately $2.3 million during the year ended December 31, 2003. Changes in payment formulas and delivery
requirements could impact SunScript.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Other Reimbursement Matters.Net revenues realizable under third-party payor agreements are subject to
change due to examination and retroactive adjustment by payors during the
settlement process. Under cost-based reimbursement plans, payors may disallow,
in whole or in part, requests for reimbursement based on determinations that
certain costs are not reimbursable or reasonable or because additional
supporting documentation is necessary. We recognize revenues from third-party
payors and accrue estimated settlement amounts in the period in which the
related services are provided. We estimate these settlement balances by making
determinations based on our prior settlement experience and our understanding of
the applicable reimbursement rules and regulations. The majority of Medicaid
balances are settled two to three years following the provision of
services. There can be no assurance that we will not be required to negatively
adjust future earnings as a result of settlements with payors.

Federal and state governments continue to focus on methods to
curb spending on health care programs such as Medicare and Medicaid. This focus
has not been limited to skilled nursing facilities, but include other services
provided by us, such as pharmacy and therapy services. We cannot at this time
predict the extent 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 reduced coverage, greater discounts and more stringent cost controls by
government and other payors are expected to continue.

Furthermore, government programs are subject to statutory and
regulatory changes, retroactive rate adjustments, administrative rulings and
government funding restrictions, all of which may materially affect the rate of
payment to our facilities and our therapy and pharmaceutical services
businesses. There can be no assurance that payments under governmental programs
will remain at levels comparable to present levels or will be adequate to cover
the costs of providing services to patients eligible for assistance under such
programs. Significant decreases in utilization and changes in reimbursement
could have a material adverse effect on our financial condition, results of
operations, and cash flows including the possible impairment of certain assets.

We receive approximately 28% of our revenues from
private insurance, long-term care facilities that utilize our specialty medical
services, self-pay facility residents, and other third party payors. These
private third party payors are continuing their efforts to control healthcare
costs through direct contracts with healthcare providers, increased utilization
review and greater enrollment in managed care programs and preferred provider
organizations. These private payors increasingly are demanding discounted fee
structures and the assumption by healthcare providers of all or a portion of the
financial risk.

Managed care organizations and other third party payors have
continued to consolidate in order to enhance their ability to influence the
delivery of healthcare services. Consequently, the healthcare needs of a large
percentage of the population are increasingly served by a smaller number of
managed care organizations. These organizations generally enter into service
agreements with a limited number of providers for needed services. To the extent
these organizations terminate us as a preferred provider and/or engage our
competitors as a preferred or exclusive provider, this source of revenues would
be lost. In addition, private payors, including managed care payors,
increasingly are demanding discounted fee structures or the assumption by
healthcare providers of all or a portion of the financial risk through prepaid
capitation (i.e., a fixed amount per person) arrangements.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

For periods prior to the
effective date of PPS for skilled nursing facilities and for all cost reporting
providers, certain Medicare regulations applied to transactions between related
parties, such as between our subsidiaries that operate skilled nursing
facilities or hospitals and subsidiaries that provide ancillary services. These
regulations limit the amount of reimbursement that our facilities are entitled
to receive for certain goods and services provided by our ancillary
subsidiaries. An exception to the related party regulations is available
provided that, among other things, a substantial part of the services of the
relevant subsidiary supplier be transacted with nonaffiliated entities. When
that exception applies, the facility may receive reimbursement for goods and
services provided by our ancillary subsidiaries at the rates applicable to goods
and services provided to nonaffiliated entities. The related party regulations
do not indicate a specific level of services that must be provided to
nonaffiliated entities in order to satisfy the "substantial part" requirement of
this exception. In instances where others have litigated this issue, no
consistent standard has emerged as to the appropriate threshold necessary to
satisfy the "substantial part" requirement.

The implementation of PPS and the
corresponding fee schedules have significantly reduced the Medicare impact of
the related party rule, but the related party rule continues to affect certain
Medicaid cost reports for our skilled nursing facilities and hospitals and will
also affect Medicare cost reports for hospitals for cost reporting years ended
December 31, 2001. Although we have not completed our calculations for the year
ended December 31, 2002, we believe that the percentages discussed below will be
approximately the same as in prior years. Our net revenues from rehabilitation
therapy services, together with net revenues from temporary medical staffing
services, provided to nonaffiliated facilities represented 58% and 56% of total net revenues
for those two operations for the years ended December 31, 2001
and 2000, respectively. Respiratory therapy services provided to nonaffiliated
facilities represented 84% and 67% of total respiratory therapy services net
revenues for the years ended December 31, 2001 and 2000, respectively. Net
revenues from pharmaceutical services billed to nonaffiliated facilities
represented 80% and 79% of total pharmaceutical services revenues for the years
ended December 31, 2001 and 2000, respectively. We use certain variables
such as percent of revenue derived from nonaffiliated parties and associated
service charges to determine whether we have met the requirements. Except for
our software division, we met the related party exception allowing for the
reimbursement of our charges to the inpatient facilities division for cost
reports filed for the years ended December 31, 2000 and December 31, 2001. We
adjusted the 2000 cost reports by decreasing the charges the inpatient
facilities received from the software division to the cost basis of those
services, and we are required to do the same for the 2001 cost reports. We have
determined that the impact of these cost report adjustments in the Medicare
revenues recorded for the years ended December 31, 2000 and December 31, 2001 is
not significant. If we were deemed not to have satisfied these regulations, the
reimbursement that we receive for goods and services provided to our own
facilities could be significantly reduced, which could materially and adversely
affect our financial condition, results of operations and cash flows. If, upon
audit by federal or state reimbursement agencies, such agencies find that the
exception has not been satisfied, and if, after appeal, their findings are
sustained, we could be required to refund some or all of the difference between
our cost of providing these services to any entity found to be subject to the
related party regulations and the fair market value amount actually received.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Federal and State Regulatory Oversight



Long-term care facilities must
comply with certain requirements to participate in Medicare or Medicaid.
Regulations promulgated pursuant to the Omnibus Budget Reconciliation Act of
1987 obligate facilities to demonstrate compliance with requirements relating to
resident rights, resident assessment, quality of care, quality of life,
physician services, nursing services, infection control, physical environment
and administration. Regulations governing survey, certification and enforcement
procedures to be used by state and federal survey agencies to determine
facilities' level of compliance with the participation requirements for Medicare
and Medicaid were adopted in 1995. These regulations require that surveys focus
on residents' outcomes of care and state that all deviations from participation
requirements are considered deficiencies. A facility may have deficiencies and
still be in substantial compliance with the regulations. The regulations
identify alternative remedies for facilities and specify categories of
deficiencies for which they will be applied. The alternative remedies include,
but are not limited to: civil monetary penalties of up to $10,000 per day;
facility closure and/or transfer of residents in emergencies; denial of payment
for new or all admissions; directed plans of correction; and directed in-service
training. Failure to comply with certain standards as a condition to participate
in the Medicare and Medicaid programs may result in termination of the
provider's Medicare and Medicaid provider agreements.

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

The Medicare and Medicaid
anti-kickback statute prohibits the knowing and willful solicitation or receipt
of any remuneration "in return for" referring an individual or for recommending
or arranging for the purchase, lease or ordering of any item or service for
which payment may be made under Medicare or a state healthcare program. In
addition, the statute prohibits the offer or payment of remuneration "to induce"
a person to refer an individual or to recommend or arrange for the purchase,
lease or ordering of any item or service for which payment may be made under the
Medicare or state healthcare programs.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

False claims are prohibited
pursuant to criminal and civil statutes. Criminal provisions prohibit filing
false claims or making false statements to receive payment or certification
under Medicare or Medicaid or failing to refund overpayments or improper
payments; violation of these provisions are felonies punishable by up to five
years imprisonment and/or $25,000 fines. Civil provisions prohibit the knowing
filing of a false claim or the knowing use of false statements to obtain
payment; penalties for violations are fines of not less than $5,000 nor more
than $10,000, plus treble damages, for each claim filed. Suits alleging false
claims can be brought by individuals, including employees and competitors.
Allegations have previously been made under the civil provisions of the statute
in certain qui tam actions that we have filed false claims. We are not
aware of any pending qui tam actions against us.

We believe that our facilities and service providers materially
comply with applicable regulatory requirements. From time to time, however, we
receive notice of noncompliance with various requirements for Medicare/Medicaid
participation or state licensure. We review such notices for factual
correctness, and based on such reviews, either take appropriate corrective
action and/or challenge the stated basis for the allegation of noncompliance. In
most cases, we agree with the reviewing agency upon measures to be taken to
bring the facility or service provider into compliance. Under certain
circumstances, however, such as repeat violations or a high degree of perceived
severity of the violations, the federal and state agencies have the authority to
take adverse actions against a facility or service provider, including the
imposition of monetary fines, the decertification of a facility or provider from
participation in the Medicare and/or Medicaid programs or licensure revocation.
Challenging and appealing notices of noncompliance can require significant legal
expenses and management attention.

We believe that enforcement
activities at both the federal and state levels and qui tam actions
brought by private parties have increased in recent years. In addition, during
our bankruptcy proceedings, we experienced a further increase in regulatory
oversight from both federal and state regulatory bodies. We may be required to
expend substantial amounts to cooperate with, or to defend ourselves against,
any investigations and proceedings. If we are found to have failed to comply
with any of the anti-fraud provisions, including those discussed in the
paragraphs above, we could be materially and adversely affected.

If a nursing facility is
decertified from the Medicare and Medicaid programs, its Medicare and Medicaid
reimbursement is interrupted pending recertification, a process that can take at
least several months. In the interim, the facility may continue to provide care
to its residents without Medicare and Medicaid reimbursement, or the government
may relocate Medicare and Medicaid residents to other facilities. Terminations,
bans on admission and civil monetary penalties can cause material adverse
financial and operational effects on individual facilities. The federal
government has, in the past, decertified some of our facilities from the
Medicare and Medicaid programs. From time to time federal and state survey
agencies have also imposed bans on admissions and civil monetary penalties
against our facilities on the basis of alleged regulatory deficiencies. When
appropriate, we vigorously contest such sanctions and in some cases have sought
and obtained federal court injunctions against proposed sanctions. Such cases
require significant legal expenses and management attention. There can be no
assurance that the federal government will not attempt to decertify additional
facilities of ours from the Medicare and Medicaid programs in the future.

Corporate Integrity Agreement, Permanent Injunction, and
Compliance Process

We entered into a Corporate
Integrity Agreement (the "CIA") with the OIG in July 2001 and it became
effective on February 28, 2002. We implemented further internal controls with
respect to our quality of care standards and Medicare and Medicaid billing,
reporting and claims submission processes and engaged an independent third party
to act as quality monitor and Independent Review Organization under the CIA. A
breach of the CIA could subject us to substantial monetary penalties and
exclusion from participation in Medicare and Medicaid programs. Any such
sanctions could have a material adverse effect on our financial condition,
results of operations, and cash flows.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

We also entered into a Permanent
Injunction and Final Judgment ("PIFJ") with the state of California on October
3, 2001. The PIFJ requires specific staff training, physical plant inspection
and modification, and reporting requirements that are in addition to
requirements of the CIA. The PIFJ also requires us to issue to the State reports
similar to those delivered to the OIG pursuant to the CIA. If California
believes that we have breached the PIFJ, then we could be subject to substantial
monetary penalties. Any such sanctions could have a material adverse effect on
our financial condition, results of operations, and cash flows. See "Item 3.
Legal Proceedings."

Our compliance program, referred
to as the "Compliance Process," was initiated in 1996. It has evolved as the
requirements of federal and private healthcare programs have changed.
Significant refinements were initiated in 2001 to parallel requirements of the
OIG compliance guidelines, the CIA, and the PIFJ. There are seven principle
elements to the Compliance Process, which integrate the CIA and PIFJ
requirements:

Written Policies, Procedures and Standards of Conduct.
 Our subsidiaries have extensive policies and procedures ("P&Ps")
modeled after applicable laws, regulations, government manuals and industry
practices and customs. The P&Ps govern the clinical, reimbursement, and
operational aspects of each subsidiary. To emphasize adherence to our P&Ps,
we publish and distribute a Code of Conduct and each subsidiary publishes and
distributes an employee handbook.Designated Compliance Officer and Compliance Committee.In
August 2000, we appointed a Corporate Compliance Officer. The responsibilities
of the Corporate Compliance Officer include, among other things: (i) overseeing
the Compliance Process; (ii) ensuring compliance with the CIA, PIFJ, and
functioning as the liaison with the external monitors and federal government on
matters related to the Compliance Process, CIA, and PIFJ; (iii) reporting to the
Board of Directors and senior corporate managers on the status of the Compliance
Process; and (iv) overseeing the coordination of a comprehensive education and
training program which focuses on the elements of the Compliance Process.

We also maintain a Corporate
Compliance Committee, which includes the Chief Executive Officer, Chief
Financial Officer, General Counsel, Senior Vice President of Human Resources,
President and Executive Vice President of SunBridge, and the Corporate
Compliance Officer. This Committee meets regularly to discuss compliance-related
issues. Compliance matters are also reported to the Compliance Committee of the
Board of Directors on a regular basis.

Effective Training and Education. We continue to develop
and implement regular training and education programs for all employees. Every
employee, director and officer is trained on the Compliance Process, Code of
Conduct, and CIA. All California administrators are trained on the PIFJ, as
required. Training also occurs for appropriate employees in applicable
provisions of the Medicare and Medicaid laws, fraud and abuse prevention,
clinical standards, and practices, and claim submission and reimbursement
P&Ps. These training sessions explain the consequences both to the
individual and to the Company for failure to comply with any of these
requirements or to report breaches of those requirements.

Effective Lines of Communication. Employees are encouraged
to report issues of concern without fear of retaliation using a Four Step
Reporting Process, which includes the toll-free "Sun Quality Line." The Four
Step Reporting Process encourages employees to discuss clinical, ethical, or
financial concerns with supervisors and local management since these individuals
will be most familiar with the laws, regulations, and policies that impact their
concern. In addition, the Sun Quality Line is promoted as an always-available
option that may be used for anonymous reporting if the employee so chooses. The
telephone number for the Sun Quality Line is posted prominently in places that
are accessible to employees in all of our facilities. Written non-retaliation
and reporting policies have been developed and distributed to all employees to
encourage communication and the reporting of incidents. Reports to the Sun
Quality Line are internally reviewed and proper follow-up is conducted.
Appropriate actions are taken during and following investigations to correct any
non-compliance, including but not limited to, corrective action plans,
government reports and over-payment refunds.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Internal Monitoring and Auditing. Our Compliance Process,
in accordance with the CIA, puts internal controls in place to meet the
following objectives effectively:

|- | Claims, reimbursement submissions, cost reports and
      source documents are accurate.             
|- | -----------------------------------------------------------------------------------------------------
|- | Patient care, services, and supplies are provided as
      required by applicable standards and laws.
|- | Clinical assessments and treatment documentation are
      accurate.                                 
|- | CIA and PIFJ are implemented and obligations are met (e.g., background
      checks, training)       

We have designated the subsidiary
presidents and each member of the operations management team, including
SunBridge facility and hospital administrators, as Compliance Liaisons. Each
Compliance Liaison is responsible for making certain that all requirements of
the Compliance Process and our compliance documents are completed at the
operational level for which the Compliance Liaison is responsible.

Each business line also employs a
number of licensed professionals who monitor and audit compliance with P&Ps
and other standards to ensure that the objectives listed above are met.

Enforcement of Standards. Our policies, the Code of Conduct
and the employee handbook as well as all associated training materials clearly
indicate that employees who violate our standards will be subjected to
discipline. Sanctions range from oral warnings to suspensions, to termination of
employment. Such sanctions have been applied in response to intentionally
wrongful conduct as well as in instances where an employee has failed to
adequately monitor the activities of others. While we have implemented such
disciplinary policies, we have also adopted a pro-active approach to secure the
integrity of our workforce and offset the need for punitive measures.

First, we have implemented employee background
review practices that surpass industry standards. A seven-year historical study
is completed on every prospective employee and includes the OIG/GSA Sanction
List Review, Criminal Record Review, Credentials Verification, and Motor Vehicle
Record Review (as required).

Second, as noted above, we devote significant
resources to employee training. Our employees are required to participate in
compliance training as well as other education endeavors aimed at understanding
policies, procedures, standards, and laws related to job responsibilities. We
believe that understanding these parameters will prevent and provide for early
detection of non-compliance.

Finally, we have adopted a
performance management program intended to make certain that all employees are
aware of what duties are expected of them and understand that compliance with
policies, procedures, standards, and law related to job functions is required.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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

HIPAA

In December 2000, the federal government released the final
privacy rules of the Health Insurance Portability and Accountability Act of 1996
("HIPAA"). The rules provide for, among other things, (i) giving consumers the
right and control over the release of their medical information, (ii) the
establishment of boundaries for the use of medical information, and (iii)
penalties for violation of an individual's privacy rights.

These privacy regulations apply
to "protected health information," which is defined generally as individually
identifiable health information transmitted or maintained in any form or medium,
excluding certain education records and student medical records. The privacy
regulations seek to limit the use and disclosure of most paper, oral and
electronic communications regarding an individual's past, present or future
physical or mental health or condition, or relating to the provision of
healthcare to the individual or payment for that healthcare, if the individual
can or may be identified by such information. HIPAA provides for the imposition
of civil or criminal penalties if protected health information is improperly
disclosed. We are required to comply with the HIPAA privacy rules beginning
April 14, 2003, and we have expended substantial efforts and will require
additional resources for our initial and ongoing compliance with these
rules.

HIPAA's security regulations were
finalized in February 2003. The security regulations specify administrative
procedures, physical safeguards and technical services and mechanisms designed
to ensure the privacy of protected health information. We will be required to
comply with the security regulations beginning on April 21, 2005.

In addition, HIPAA also mandates
the adoption of regulations aimed at standardizing transaction formats and
billing codes for documenting medical services, dealing with claims submissions
and protecting the privacy and security of individually identifiable health
information. HIPAA regulations that standardize transactions and code sets
became final in the fourth quarter of 2000. These regulations do not require
healthcare providers to submit claims electronically, but require standard
formatting for those that do. We currently submit some of our claims
electronically to Medicare and Medicaid through our fiscal intermediary and will
continue to do so. We will be required to comply with HIPAA transaction and code
set standards on October 16, 2003. If we are not able to submit claims
electronically, or the States are not able to receive claims electronically,
then our receipt of our reimbursements could be disrupted.

Additional Business Risks

Impact of 2003 Restructuring on Ancillary Operations.
 Approximately 61% of our rehabilitation therapy services revenue and 20% of our
pharmacy services revenue is derived directly from the provision of services to
our inpatient facilities.  Additionally, another 24% of our pharmacy
services revenue is generated from the provision of services to patients
residing in our inpatient facilities, but are billed to non-affiliated
parties.  Pursuant to our 2003 restructuring, we are seeking to divest
approximately 56% of our inpatient facilities.  The new operators of those
facilities may determine to use alternative providers of pharmaceutical and
therapy services. In the event that SunScript and SunDance no longer provide
services to the divested facilities, we will be required to take appropriate
steps to reduce their costs. We can provide no assurance that SunScript and
SunDance will maintain the divested facilities as customers, or that they will
be able to continue to achieve results of operations comparable to what they
achieved in the past.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Litigation and Insurance Coverage. In recent years,
there has been a dramatic increase in the number and size of lawsuits filed
against nursing home operators alleging negligence resulting in injury or death
to residents of the homes. We currently have numerous patient care lawsuits
pending against us, as well as other types of lawsuits. As a result of
industry-wide trends, general and professional liability costs have increased
and are expected to continue to increase. Beginning in January 2000, we
established a self-funded insurance program for general and professional
liability claims up to a base amount of $1.0 million per claim, and $3.0 million
aggregate per location, and obtained excess insurance for coverage above these
levels. Beginning in January 2003, the self-funded retention under our
liability insurance program increased so that we are responsible for the first
$10.0 million of cost and liability per claim. Our self-funded insurance
reserves may be insufficient to fund the costs of defense, judgments and
settlements resulting during 2003 from litigation against us and if the funding
of those reserves is insufficient, it could have a material adverse impact on
our financial condition, results of operations and cash flows and we could be
forced to seek bankruptcy protection. In addition, in certain states in which we
have significant operations, including California, state law prohibits insurance
coverage for the risk of punitive damages arising from general and professional
liability litigation. There can be no assurance that we will not be liable for
punitive damages awarded in litigation arising in states for which punitive
damage insurance coverage is prohibited by law. See "Note 8 - Commitments and
Contingencies" in our consolidated financial statements.

Collection of Accounts Receivable. Our bad debt expense
for the years ended December 31, 2002, 2001 and 2000 was $15.2 million, $26.0
million and $33.5 million, respectively. Our allowance for doubtful accounts was
$45.9
million and $73.8 million at December 31, 2002 and 2001, respectively. Due to the expiration of certain Medicare
Part A enactments on September 30, 2002 (see above), and other healthcare
reforms adopted which decrease Medicare or Medicaid payments to skilled nursing
facilities, our ancillary services operations may experience a significant
increase in bad debt expense. In addition, as part of our 2003 restructuring, we
are seeking to divest approximately 56% of our inpatient facilities, and we will
retain the rights to all accounts receivable for those facilities that arose
prior to the date of divestiture. Based on our prior experience, we expect that
we will have an increased percentage of bad debts associated with the divested
facilities. Our financial condition, results of operations, and cash flows could
be materially adversely affected by the inability to collect our accounts
receivable.

Shortage of Qualified Facility Personnel and Increasing Labor
Costs.

New Management Team. Our Chief Executive Officer, Chief
Financial Officer, General Counsel, President of SunBridge Healthcare
Corporation, Senior Vice President of Human Resources and our entire Board of
Directors have all joined us since November 2001. As such, there has been a
period of transition in which the new management team has implemented new
business strategies, policies and practices. We believe that the success of the
Company will depend on our ability to retain the members of our management team;
however, there can be no assurance that we will be able to retain those
executive officers and other key employees. The loss of the services of any of
our executive officers or key employees could have a material adverse effect on
our business, financial condition, results of operations, and cash flows.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Shareholder Control. As a group, the four largest
holders of our common stock beneficially hold approximately 37% of our stock. If
these shareholders were to act together, they would be able to significantly
influence all matters that the shareholders vote upon, including the election of
directors or the rejection of a merger or other business combinations that other
shareholders may believe are desirable. See "Item 12 - Security Ownership of
Certain Beneficial Owners and Management and Related Stockholders' Matters."

Competition

The nature of competition within
our industry varies by location. Our facilities generally operate in communities
that are also served by similar facilities operated by others. Some competing
facilities are located in buildings that are newer than those operated by us and
provide services not offered by us, and some are operated by entities having
greater financial and other resources and longer operating histories than us. In
addition, some facilities are operated by nonprofit organizations or government
agencies supported by endowments, charitable contributions, tax revenues and
other resources not available to us. Some hospitals that either currently
provide long-term and subacute care services or are converting their
under-utilized facilities into long-term and subacute care facilities are also a
potential source of competition to us. We compete with other facilities based on
key competitive factors such as our reputation for the quality and
comprehensiveness of care provided; the commitment and expertise of our staff;
the innovativeness of our treatment programs; local physician and hospital
support; marketing programs; charges for services; and the physical appearance,
location and condition of our facilities. The range of specialized services,
together with the price charged for services, are also competitive factors in
attracting patients from large referral sources.

We also compete with other
companies in providing rehabilitation therapy services and pharmaceutical
products and services to the long-term care industry and in employing and
retaining qualified therapists and other medical personnel. Many of these
competing companies have greater financial and other resources than us. We may
encounter increased competition in the future that would adversely affect our
financial condition, results of operations and cash flows.

Employees and Labor Relations

As of March 1, 2003, we had
approximately 33,400 full-time and part-time employees. Of this total, there
were 25,600 employees in our long-term and subacute care facilities, 3,000
employees in the rehabilitation therapy services operations, 1,000 employees in
the pharmaceutical services operations, 1,300 employees in the temporary
staffing business, 700 employees at the corporate and regional offices and 1,800
employees in other health care services. As we divest inpatient facilities
pursuant to our restructuring initiative, the number of employees in our
long-term and subacute care facilities will decrease accordingly and the number
of employees is our ancillary businesses may also be reduced

Certain of our employees in
Alabama, California, Connecticut, Florida, Georgia, Massachusetts, New Jersey,
New Mexico, Ohio, Tennessee and West Virginia are covered by collective
bargaining contracts. The unions representing certain of our employees have from
time to time gone on strike. Due to our financial condition, we did not raise
the pay of certain workers in collective bargaining units in some of our
Connecticut facilities in March 2003, as contemplated under our union contract.
There can be no assurance that the unions will not go on strike in the future or
that such strikes will not have a material adverse effect on our financial
condition, results of operations and cash flows.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Item 2.  Properties

Inpatient Facilities. As
of March 1, 2003, we operated 233 long-term care, subacute care and assisted
living facilities. We operated 223 facilities pursuant to long-term operating
leases or subleases, and we owned 10 facilities. We consider our properties in
general to be in good operating condition and suitable for the purposes for
which they are being used. Our facilities that are leased are subject to
long-term operating leases or subleases which require us, among other things, to
fund all applicable capital expenditures, taxes, insurance and maintenance
costs. The annual rent payable under most of the leases generally increases
based on a fixed percentage or increases in the U.S. Consumer Price Index. Many
of the leases contain renewal options to extend the term. Substantially all of
our leasehold interests serve as collateral for our obligations under our Loan
Agreements.

We calculated our aggregate
occupancy percentages for all of our long-term care, subacute care and assisted
living facilities on a same store basis as 88.6%, 89.3% and 90.0% in the U.S.
for the years ended December 31, 2002, 2001 and 2000, respectively.
However, we believe that occupancy percentages, either individually or in the
aggregate, should not be relied upon alone to determine the performance of a
facility. Other factors include, among other things, the sources of payment,
terms of reimbursement and the acuity level of the patients. We compute
occupancy percentages by dividing the average daily number of beds occupied by
the total number of available beds for use during the periods indicated.

The following table sets forth
certain information concerning the 233 long-term care, subacute care and
assisted living facilities that we operated as of March 1, 2003, which
consisted of 215 skilled nursing facilities, nine assisted living facilities and
nine rehabilitation and long-term acute care hospitals. As part of our
restructuring efforts, we may divest approximately 56% of the facilities in the
table representing approximately 16,000 licensed beds during 2003. See Overview of
Current Company Financial Condition."

|State          | Number of Licensed
    Beds (1) | Number of
      Facilities    Leased         Owned     Total
|-------------- | ------------------------------- | ------------------------------------------------------------
|               |                                 |                                                             
|California     | 7,330                           | 74                                                          
|Massachusetts  | 3,704                           | 28                                                          
|Georgia        | 1,672                           | 12                                                          
|Connecticut    | 1,410                           | 8                                                           
|Texas          | 1,126                           | 8                                                           
|Washington     | 1,101                           | 12                                                          
|New Hampshire  | 1,058                           | 9                                                           
|North Carolina | 1,031                           | 8                                                           
|Arizona        | 1,006                           | 6                                                           
|Tennessee      | 915                             | 8                                                           
|Alabama        | 783                             | 7                                                           
|West Virginia  | 739                             | 7                                                           
|Idaho          | 706                             | 6                                                           
|New Jersey     | 580                             | 4                                                           
|Ohio           | 576                             | 4                                                           
|Illinois       | 470                             | 4                                                           
|Florida        | 470                             | 3                                                           
|Colorado       | 357                             | 2                                                           
|Maryland       | 343                             | 2                                                           
|New Mexico     | 291                             | 4                                                           
|Oklahoma       | 135                             | 2                                                           
|Kentucky       | 134                             | 2                                                           
|Louisiana      | 131                             | 1                                                           
|Virginia       | 120                             | 1                                                           
|Indiana        | 99                              | 1                                                           
|Total          | 26,287                          | 223                                                         
|               | =============                   | =========                                                   

21

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

(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.

Rehabilitation Services. As
of March 1, 2003, we leased office space in 14 locations in 12 states to operate
our rehabilitation therapy business. The number or the location of these
operations could be affected by our restructuring efforts. See "Item 1. Business
- Overview of Current Company Financial Condition."

Pharmaceutical Services. As
of March 1, 2003, we operated 32 regional pharmacies, two in-house long-term
care pharmacies and one pharmaceutical billing and consulting center, which
together provided pharmaceutical products and services in 18 states. All of
these locations were leased. The number or the location of these operations
could be affected by our restructuring efforts. See "Item 1. Business - Overview
of Current Company Financial Condition."

Other Operations.As of March
1, 2003, we leased approximately 76 locations in 23 states to operate our other
businesses, including temporary medical staffing (CareerStaff), home health care
(SunPlus) and medical laboratory and mobile radiology (SunAlliance). We lease
our executive offices in Irvine, California and we lease one and own three
corporate office buildings in Albuquerque, New Mexico.

Item 3. Legal Proceedings

On February 28, 2003, the Bureau
of Medi-Cal Fraud and Elder Abuse (the "BMFEA"), which is a division of the
Office of the Attorney General of the State of California, alleged that we are
violating the terms of the PIFJ. Pursuant to the PIFJ, which was entered in
October 2001, we are enjoined from engaging in violations of federal or state
statutes or regulations governing the operation of health care facilities in the
State of California. Among other things, the BMFEA alleged that our California
facilities have had inadequate staffing, training and supervision. To remedy
these alleged violations, the BMFEA has requested that we pay their costs of the
investigation and to audit our operations in California, and, initially,
requested a significant but unspecified cash penalty. We have commenced a
constructive dialogue with the BMFEA and believe we have made good progress in
demonstrating that we are in fact in compliance with the PIFJ. It is therefore
not clear whether the BMFEA will assert that a material sum is due or payable
and no estimate can be made of any amount that the BMFEA may ultimately seek. An
adverse outcome in this matter could have a material adverse effect on our
financial position, results of operations and cash flows. If the BMFEA does
ultimately assert that we are in violation of the PIFJ, we intend to defend this
matter virgorously

22

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

In March and April 1999, class
action lawsuits were filed against us and three individuals who were at that
time our officers, in the United States District Court for the District of New
Mexico. These actions have been consolidated as In re Sun Healthcare Group, Inc.
Securities and Litigation Master, File No. Civ. 99-269. The lawsuits allege,
among other things, that we did not disclose material facts concerning the
impact that PPS would have on our results of operations. The lawsuits seek
compensatory damages and other relief for stockholders who purchased our common
stock during the class-action period. Pursuant to an agreement among the
parties, we were dismissed without prejudice in December 2000. In January 2002,
the District Court dismissed the lawsuit with prejudice and entered judgment in
favor of the defendants. In February 2002, the plaintiffs filed a Motion to
Amend the Judgment and to File an Amended Complaint and the Motion is pending.
We have responded in opposition to the Motion and we intend to vigorously defend
the individual defendants in this matter, who are indemnified by us and covered
by our insurance.

We are a party to various other
legal actions and administrative proceedings and are subject to various claims
arising in the ordinary course of our business, including claims that our
services have resulted in injury or death to the residents of our facilities,
claims relating to employment and commercial matters. We have experienced an
increasing trend in the number and severity of litigation claims asserted
against us. We believe that this trend is endemic to the long-term care industry
and is a result of the increasing number of large judgments, including large
punitive damage awards, against long-term care providers in recent years
resulting in an increased aggressiveness due to the heightened awareness by
plaintiff's lawyers of potentially large recoveries. In certain states in which
we have significant operations, including California, insurance coverage for the
risk of punitive damages arising from general and professional liability
litigation is generally not available due to state law public policy
prohibitions. There can be no assurance that we will not be liable for punitive
damages awarded in litigation arising in states for which punitive damage
insurance coverage is not available.

We are seeking to restructure our
portfolio of leases and mortgages under which we operates 56% of our long-term
care facilities. In January 2003, we began withholding rent and mortgage
payments with respect to these facilities. We have negotiated and continue to
negotiate with many of our landlords and mortgage holders in an effort to
achieve consensual resolution of these issues. However, several landlords and
mortgage holders have threatened to commence eviction or similar proceedings
against us. Additional actions seeking damages or other leasehold
remedies may also be commenced. See "Item 1. Business - Overview of Current
Company Financial Condition."



23

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Item 4. Submission of Matters to a Vote of Security
Holder

|(a) | The annual meeting of our stockholders was held on
      October 29, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | Directors were appointed to a one-year term as part of
      our emergence from bankruptcy proceedings, and were not elected at the
      annual meeting in 2002. The following directors have terms that expired as
      provided below:                                                                                                                                                                                                                                                                                        
|    | John W. Adams, Gregory S. Anderson, Richard K. Matros,
      Charles W. McQueary, John F. Nickoll, Sanjay H. Patel, Bruce C. Vladeck,
      Steven L. Volla and Milton J. Walters have terms on the Board that expired
      on February 28, 2003; however, pursuant to the Articles and Bylaws of Sun
      Healthcare Group, Inc., those directors will remain in office until their
      successors are duly qualified and elected at the next annual meeting of
      stockholders, anticipated to be scheduled in June 2003.
|(c) | The matters voted at the meeting and the results were as
      follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|    | 1.  Approval of our Amended and Restated 2002 Non-Employee
      Director Equity Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                  
|    | For
      5,841,103                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|    | 2.  Ratification of the appointment of Ernst & Young LLP
      as our independent public accountants for the fiscal year ended December
      31, 2002.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------
|    | For
      5,899,419                                                                                                                                    
|(d) | Not applicable.                                                                                                                                        

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters

We began issuing our new common
stock on February 28, 2002 as part of our Plan of Reorganization. Our new common
stock began trading under the symbol "SUHG.OB" on the Over-the-Counter ("OTC")
Bulletin Board on April 2, 2002. The following table shows the high and low sale
prices for the common stock as reported by the OTC Bulletin Board for the
periods indicated:

|2002   |                                                                            | High   | Low   
|------ | -------------------------------------------------------------------------- | ------ | ------
|First  | Quarter................................................................... | N/A    | N/A   
|Second | Quarter................................................................... | $24.00 | $13.00
|Third  | Quarter................................................................... | $16.50 | $ 5.00
|Fourth | Quarter................................................................... | $ 5.55 | $ 1.00

Our closing stock price on March
14, 2003 was $0.30. There were approximately 670 holders of record of our common
stock as of March 7, 2003. We have never paid nor declared any dividends on our
common stock. Our Loan Agreements restrict our ability to pay dividends.

24

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Item 6. Selected Financial Data

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

|                                                                                                                                                                        | At
      or for the                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                        | ReorganizedCompany                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                        | Ten Months Ended                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                        | December 31, 2002(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Total net revenues                                                                                                                                                      | $1,598,194                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|Loss before income taxes,
         discontinued operations,
         extraordinary
      item and
         cumulative effect of change
         in accounting principle | (437,576                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Loss before discontinued
          operations extraordinary
          item and
      cumulative effect
          of change in accounting
          principle            | (437,986                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Discontinued operations                                                                                                                                                 | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Extraordinary item                                                                                                                                                      | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Cumulative effect of change
          in accounting principle                                                                                                           | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Net (loss) income                                                                                                                                                       | $       (437,986                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                        | ===========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Net loss per common and
          common equivalent share:                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Net loss before  extraordinary item and
         cumulative effect of change
         in
      accounting principle:                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Basic                                                                                                                                                                   | $            (43.80                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                        | ===========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Diluted                                                                                                                                                                 | $            (43.80                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                        | ===========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Net (loss) income:                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Basic                                                                                                                                                                   | $            (43.80                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                        | =========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Diluted                                                                                                                                                                 | $            (43.80                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                        | =========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Weighted average number of
          common and common
          equivalent
      shares:                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Basic                                                                                                                                                                   | 10,000                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                        | =========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Diluted                                                                                                                                                                 | 10,000                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                        | =========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Working Capital (Deficit)                                                                                                                                               | $          (74,244                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                        | =========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Total Assets                                                                                                                                                            | $         475,835                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                        | =========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Liabilities subject to
          compromise                                                                                                                             | $                     -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                        | =========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Long-term debt                                                                                                                                                          | $         196,223                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                        | ======                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Stockholders' (deficit) equity                                                                                                                                          | $       (187,218                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                        | =========                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|25
      SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES                                                                                                                   
|(1)                                                                                                                                                                     | Results for the ten month period ended December 31, 2002
      include a non-cash charge of $407.8 million representing an impairment to
      our carrying values of goodwill and other long-lived assets (see "Note
      7-Impairment of Long-Lived Assets and Assets Held for Sale" in
      our consolidated financial statements), a net non-cash gain on sale of
      assets of $8.7 million due to the prepetition termination of certain
      facility lease agreements, the sale of certain other facilities, and
      reduction of the carrying amount of certain assets that we determined were
      not integral to our core business operations (see "Note 7 - Impairment of
      Long-Lived Assets and Assets Held for Sale" in our consolidated financial
      statements).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(2)                                                                                                                                                                     | Results for the two month period ended February 28, 2002
      include a non-cash charge of $1,498.4 million representing an
      extraordinary gain on extinguishment of debt (see "Note 19-Gain on
      Extinguishment of Debt" in our consolidated financial statements), a net
      non-cash loss on discontinued operations of $7.6 million due to the
      prepetition termination of certain facility lease agreements, the sale of
      certain other facilities, and reduction of the carrying amount of certain
      assets that we determined were not integral to our core business
      operations (see "Note 7 - Impairment of Long-Lived Assets and Assets Held
      for Sale" in our consolidated financial statements) and a $1.4 million
      gain for reorganization items due to our chapter 11 filings (see "Note 17
      - Emergence from Chapter 11 Bankruptcy Proceedings" in our consolidated
      financial statements).                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(3)                                                                                                                                                                     | 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 (see "Note 7-Impairment of Long-Lived Assets and Assets Held for Sale" in our
      consolidated financial statements), a net non-cash gain on sale of assets
      of $0.8 million due to the prepetition termination of certain facility
      lease agreements, the sale of certain other facilities, and reduction of
      the carrying amount of certain assets that we determined were not integral
      to our core business operations (see "Note 7 - Impairment of Long-Lived
      Assets and Assets Held for Sale" in our consolidated financial statements)
      and a $42.9 million charge for reorganization items due to our chapter 11
      filings (see "Note 17 - Emergence from Chapter 11 Bankruptcy Proceedings"
      in our consolidated financial statements).                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(4)                                                                                                                                                                     | Results for the year ended December 31, 2000 include a
      non-cash charge of $191.3 million representing an impairment to our
      carrying values of goodwill and other long-lived assets (see "Note 7-Impairment of Long-Lived Assets and Assets Held for Sale" in our
      consolidated financial statements), a net non-cash gain on sale of assets
      of $21.4 million due to the prepetition termination of certain facility
      lease agreements, the sale of certain other facilities, and reduction of
      the carrying amount of certain assets that we determined were not integral
      to our core business operations (see "Note 7 - Impairment of Long-Lived
      Assets and Assets Held for Sale" in our consolidated financial
      statements), a $1.1 million non-cash recovery of previously recorded cost
      for corporate and financial restructuring, a $2.5 million charge for legal
      and regulatory charges due to our chapter 11 filings (see "Note 17 -
      Emergence from Chapter 11 Bankruptcy Proceedings" in our consolidated
      financial statements) and a $335.9 million charge for reorganization items
      due to our chapter 11 filings (see "Note 17 - Emergence from Chapter 11
      Bankruptcy Proceedings" in our consolidated financial
      statements).
|26
      SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES                                                                                                                   
|(5)                                                                                                                                                                     | Results for the year ended December 31, 1999 include a
      non-cash charge of $457.4 million representing an impairment to our
      carrying values of goodwill and other long-lived assets, a net non-cash
      charge of $78.7 million due to the prepetition termination of certain
      facility lease agreements, the sale of certain other facilities and to
      reduce the carrying amount of certain assets that we determined were not
      integral to our core business operations, a $27.4 million charge for
      corporate and financial restructuring, a $2.5 million loss on the
      termination of the interest rate swaps and a $48.1 million charge for
      reorganization items due to our chapter 11 filings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(6)                                                                                                                                                                     | Results for the year ended December 31, 1998 include a
      non-cash charge of $397.5 million representing an impairment to our
      carrying values of goodwill and other assets, a non-cash charge of
      $206.2 million due to the termination of certain facility lease
      agreements, the sale of certain other facilities and to reduce the
      carrying amount of certain assets that we determined were not integral to
      our core business operations, a $22.5 million charge for legal and
      regulatory matters, a $4.6 million charge for restructuring costs in order
      to more closely align our inpatient, rehabilitation and respiratory
      therapy, and pharmaceutical and medical supplies segments and an
      extraordinary loss of $10.3 million, net of income tax benefit of $3.7
      million, to permanently pay-down $300.0 million of the term loan portion of
      our senior credit facility in addition to the $3.7 million to retire $5.0
      million of the Contour Medical, Inc. convertible debentures purchased by
      us.                                                                                                                                                                                                                                        

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

Overview of Current Company Financial Condition

Current Liquidity. Our net
income in 2002 was $1,047.4
million, which includes $1.498.4million extraordinary gain on extinguishment of
debt and $407.8 million loss on asset impairment, and our cash flow used for operating activities for 2002 was $41.2
million. These negative results are largely due to adverse conditions in the
long-term care industry, including reductions in government support for
long-term care providers, such as the failure of Congress to restore Medicare
funding to the levels existing prior to October 1, 2002. At March 19, 2003, we
had cash and cash equivalents of $6.0 million and borrowing availability under
our Loan Agreements of $28.0 million. That availability resulted, in part, from
our ceasing to pay rent on certain of our facilities as described below.
 In addition, the report of our independent auditors as of December 31,
2002 and for the ten month period then ended is qualified as to our ability to
continue as a going concern.  See report on page F-2 and "Note 2 -
Basis of Reporting and Current Operating Environment."

27

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Defaults under Loan Agreements. We were not in compliance
with certain financial covenants in our Revolving Loan Agreement at December 31,
2002 and we continue not to be in compliance. Pursuant to certain cross-default
provisions, we are also in default under our Term Loan Agreement. The lenders
under the Loan Agreements have continued lending to us in spite of the defaults,
although they have reserved their rights to seek to exercise their remedies
contained in the Loan Agreements. We cannot assure you that the lenders under
those agreements will refrain from seeking to exercise their remedies,
potentially including declaring all loan amounts outstanding to be immediately
due and payable, realizing upon the lenders' security interests, denying us the
right to further borrowing under the Revolving Loan Agreement and other
remedies. It is likely that under those circumstances we would commence
bankruptcy proceedings. We have classified the Loan Agreements as current
obligations at December 31, 2002 and our liquidity remains an ongoing concern
for us.

Defaults under Leases and
Mortgages. In our effort to reduce our costs, in January 2003, we initiated
new restructuring efforts. Our ongoing efforts include an attempt to restructure
the portfolio of leases under which we operate most of our long-term care
facilities. We are seeking to obtain rent concessions with respect to our
under-performing facilities, and if we are unable to get sufficient rent
concessions on a facility lease, then we will seek to transition operations of
that facility to a new operator so that we will no longer be burdened by the
losses generated by that facility. We are currently attempting to transition
approximately 56% of our long-term care facilities to new operators. As of March
21, 2003, we had withheld payment of approximately $18.9 million in accrued rent
and mortgage payments with respect to those facilities. In addition, we intend
to continue withholding certain rent and mortgage payments until we complete the
transition of each affected facility to new operators. Our restructuring efforts
are likely to require nine to 12 months to complete and we may need to consider
selling additional assets during that period in order to have sufficient
liquidity to complete the restructuring. We cannot predict the extent to which
landlords not receiving rent will seek to assert leasehold or other damages
during the nine to 12 month restructuring period. If the landlords aggressively
pursue and obtain such damages, we will likely be required to commence
bankruptcy proceedings prior to the completion of our restructuring.

2003 Restructuring.Our goal is to restructure our business
so that we can fund our operations and working capital requirements while
remaining a significant provider of skilled nursing and other long-term care
facilities. We will also seek to reduce our overhead and other expenses
significantly, commensurate with reducing the size of our long-term care
facility portfolio. Although we have had encouraging discussions and are making
progress with many landlords from whom we are seeking to obtain rent concessions
or facility lease terminations, and have reached agreements in principle or
final agreements with several of our landlords, no assurance can be given that
we will be successful in our restructuring efforts. In addition, it is not
certain that our available liquidity will provide us with sufficient time to
allow us to reduce our overhead and other expenses as required for us
to generate sustainable ongoing positive cash flow from our operations.

Unless we are able to generate
substantial cash flow from operations and/or raise cash from asset sales or
additional financing, our current available cash and borrowing capacity will be
insufficient to fund our ongoing operations. Even if our restructuring allows us
to create a sustainable positive cash flow from our operations, a bankruptcy
filing may, nonetheless, be required to restructure outstanding obligations and
claims against us. Under any circumstance, it is not certain whether we can
create or sustain any value for our common stock.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Emergence from Chapter 11 Bankruptcy
Proceedings

On October 14, 1999 (the "Filing
Date"), we commenced chapter 11 bankruptcy proceedings. On February 6, 2002, the
Bankruptcy Court approved our Plan of Reorganization that was filed with the
Bankruptcy Court on November 7, 2001. On February 28, 2002, we emerged from
proceedings under the Bankruptcy Code pursuant to the terms of our Plan of
Reorganization. See "Note 1 - Nature of Business - Reorganization" in our consolidated financial
statements.

Critical Accounting Policies

Our discussion and analysis of
the financial condition and results of operations are based upon the
consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires the use of estimates and judgments that
affect the reported amounts and related disclosures of assets and liabilities,
the disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results may differ materially from these estimates. We
believe the following critical accounting policies, among others, affect the
more significant judgments and estimates used in the preparation of the
consolidated financial statements.

Our consolidated financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States applicable to a going concern, which
principles, except as otherwise disclosed, assume that our assets will be
realized and our liabilities will be discharged in the normal course of
business.  The report of
our independent auditors as of December 31, 2002 and for the ten month period
then ended is qualified as to our ability to continue as a going concern. 
See report on page F-2 and "Note 2 - Basis of Reporting and Current
Operating Environment."  E&Y has not adjusted
our financial statements to reflect the possible consequences of that
uncertainty. See "Note 2 - Basis of Reporting and Current Operating Environment."

Under the chapter 11 proceedings
commenced in 1999, certain claims against us in existence prior to the Filing
Date were stayed while we continued our operations as a debtor-in-possession.
These claims are reflected in the December 31, 2001 consolidated balance sheet
as "liabilities subject to compromise." The payment of certain prepetition
claims after the Filing Date (principally employee wages and benefits and
payments to critical vendors and utilities) that were approved by the Bankruptcy
Court reduced "liabilities subject to compromise." As part of our emergence from
chapter 11 proceedings, all of the "liabilities subject to compromise" were
discharged, reinstated or paid.

We have determined that,
generally, the fair market value of the collateral was less than the principal
amount of our secured prepetition debt obligations; accordingly, we discontinued
accruing interest on many of those obligations as of the Filing
Date.

(a)  Net Revenues

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

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

(b)  Accounts Receivable

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

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

(c)  Insurance

It is our policy to self-insure
for certain insurable risks, including general and professional liability,
workers' compensation liability and employee health insurance liability
through the use of self-insurance or retrospective and self-funded insurance
policies and other hybrid policies, which vary by the states in which we
operate. There exists a risk that any of the insurance companies we use may
become insolvent and unable to fulfill their obligation to defend, pay or
reimburse us when that obligation becomes due. Although we believe the companies
we have purchased insurance from are solvent, in light of the dramatic changes
occurring in the insurance industry in recent years, we cannot be assured that
they will remain solvent and able to fulfill their obligations. Provisions for
estimated reserves, including incurred but not reported losses, are provided in
the period of the related coverage. These provisions are based on actuarial
analyses, internal evaluations of the merits of individual claims, and industry
loss development factors or lag analyses. The methods of making such estimates
and establishing the resulting reserves are reviewed periodically, and any
adjustments resulting there from are reflected in current earnings. Claims are
paid over varying periods, and future payments may be different than the
estimated reserves.

In January 2000, we established
a self-funded insurance program for general and professional liability claims up
to a base amount of $1.0 million per claim and $3.0 million aggregate per
location and obtained excess insurance for coverage above these levels. This
program expired at the end of 2002. Commencing January 1, 2003, we have
established a self-funded insurance program for general and professional
liability insurance claims up to a base amount of $10.0 million per claim,
obtaining excess insurance above this level on a claims-made basis. Prior to
January 1, 2000, the maximum loss exposure with respect to the third-party
insurance policies was $100,000 per claim for general and professional
liability. An independent actuarial analysis is
prepared twice a year to determine the expected losses and reserves for
estimated settlements for general and professional liability under the per claim
retention level, including incurred but not reported losses. These reserves are
provided on an undiscounted basis in the period that the event occurred. Based
on the results of the actuarial analysis prepared as of September 30, 2002,
we recorded a pre-tax charge of $20.0 million related to an increase in patient
care liability costs for prior policy years and revisions to the current year
estimate based on increasing industry trends. As of December 31, 2002 and
2001, the reserves for such risk were approximately $108.0 million and $81.6
million, respectively. The actuarially determined range of reserves at
December 31, 2002 was $98.8 million to $131.3 million. Provisions for such
risks were approximately $44.1 million, $9.0 million, $58.1 million and $35.3
million for the ten months ended December 31, 2002, two months ended
February 28, 2002 and years ended December 31, 2001 and 2000,
respectively, and are included in operating expenses and corporate general and
administrative expenses. At December 31, 2002 we had $12.0 million in
pre-funded amounts restricted for payment of general and professional liability
claims.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

The majority of our workers'
compensation risks are insured through insurance policies with third parties.
Our reserves are estimated by independent actuaries for the 2000 through 2002
policy years and company analysis using industry development factors for prior
years. We discount our workers' compensation reserves for the policy period
January 1, 2002 through December 31, 2002 based on a 4% discount rate.
The discounting of this policy period resulted in a reduction to our reserves of
$3.7 million. The provision for such risks, which includes accruals for
insurance premiums and claims costs, for the ten months ended December 31,
2002, two months ended February 28, 2002, and the years ended
December 31, 2002 and 2001 was $26.5 million, $3.4 million, $54.9 million
and $27.4 million, respectively. The most recent actuarial analysis completed in
November 2002 by our independent actuaries reflected an improvement in the
claims trends for the 2001 and 2002 policy years. Based upon these results, we
decreased our reserve by $6.0 million at September 30, 2002. We have
recorded reserves of $65.3 million, and $29.5 million, as of December 31,
2002, and 2001, respectively. The range of estimated reserves at
December 31, 2002 was $60.7 million to $71.3 million. At December 31,
2002 we had $57.4 million in pre-funded amounts restricted for payment of
workers' compensation claims.

(d) Intangible Assets

Goodwill

The Reorganized Company recorded
$214.8 million in goodwill under fresh-start accounting based on an independent
valuation of the fair value of our assets and liabilities as of March 1,
2002.In July 2001, Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets ("SFAS No. 142") was issued,
which established new rules on the accounting for goodwill and other intangible
assets. Under SFAS No. 142, goodwill and intangible assets with indefinite
lives are no longer amortized; however, they are subject to annual impairment
tests as prescribed by the statement. Intangible assets with definite lives will
continue to be amortized over their estimated useful lives. With respect to our
goodwill and intangible assets, SFAS No. 142 was effective for us beginning
January 1, 2002. Upon adoption of this statement, amortization of goodwill
and indefinite life intangibles ceased.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Following is a summary of
adjusted operating results reflecting the effects of adopting SFAS 142:

|                                           | ReorganizedCompany                             |   |  | PredecessorCompany                            
|------------------------------------------ | ---------------------------------------------- | - |  | ----------------------------------------------
|                                           | For The TenMonths EndedDecember 31,
      2002 |   |  | For The TwoMonths EndedFebruary 28,
      2002
|                                           |                                                |   |  | (in thousands, except per share data)         
|                                           |                                                |   |  |                                               
|Reported (loss) income                     | $                (437,986                      | ) |  | $           1,485,371                         
|Add back: Goodwill amortization            | -                                              |   |  | -                                             
|Adjusted income                            | $                (437,986                      | ) |  | $           1,485,371                         
|                                           | ===============                                |   |  | ==============                                
|                                           |                                                |   |  |                                               
|Basic and Diluted (loss) income per share: |                                                |   |  |                                               
|Reported income                            | $                   (43.80                     | ) |  | $                24.32                        
|Goodwill amortization                      | -                                              |   |  | -                                             
|Adjusted (loss) income per share           | $                   (43.80                     | ) |  | $                24.32                        
|                                           | ===============                                |   |  | ==============                                

In accordance with SFAS No. 142,
we performed our annual impairment test during the fourth quarter of 2002. We
evaluate goodwill for impairment on an annual basis and whenever events and
circumstances indicate that these assets might be impaired if an event occurs
that would more likely than not reduce the fair value of a reporting unit below
its carrying amount. We determine impairment by comparing the net assets of each
reporting unit to their respective fair values. We determine the estimated fair
value of each reporting unit using a discounted cash flow analysis. In the event
a unit's net assets exceed its fair value, an implied fair value of goodwill
must be determined by assigning the unit's fair value to each asset and
liability of the unit. The excess of the fair value of the reporting unit over
the amounts assigned to its assets and liabilities is the implied fair value of
goodwill. An impairment loss is measured by the difference between the goodwill
carrying value and the implied fair value.

The change in the carrying amount
of goodwill for the ten months ended December 31, 2002 was as follows (in
thousands):

|Reorganized Company                   | Inpatient
        Services |   | Rehabilitationand Respiratory Therapy
      Services |   | Pharmaceutical and Medical Supply
      Services |   | Other Operations          |   | Consolidated                |  
|------------------------------------- | -------------------------- | - | ---------------------------------------------------- | - | ------------------------------------------------ | - | ------------------------- | - | --------------------------- | -
|                                      |                            |   |                                                      |   |                                                  |   |                           |   |                             |  
|Balance as of March 1, 2002           | $             89,335       |   | $             56,660                                 |   | $            
      64,069                       |   | $           
      4,753  |   | $
                  214,817 |  
|Adjustments to fresh-start accounting | 18,981                     |   | 335                                                  |   | 379                                              |   | 449                       |   | 20,144                      |  
|Loss on impairment                    | (104,932                   | ) | (56,995                                              | ) | (64,448                                          | ) | (4,692                    | ) | (231,067                    | )
|Balance as of December 31, 2002       | $               3,384      |   | $                      -                             |   | $                      -                         |   | $              
      510 |   | $                3,894      |  
|                                      | =============              |   | =============                                        |   | ============                                     |   | ==========                |   | =============               |  

During the ten month period ended
December 31, 2002, we finalized our allocation of goodwill related to certain
leased facilities that were purchased through the issuance of mortgages.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Indefinite Life Intangibles

The Reorganized Company recorded $34.6
million in trademarks under fresh-start accounting based on an independent
valuation of the fair value of our assets and liabilities as of March 1,
2002. We evaluate the recoverability of the trademarks by comparing the
asset's respective carrying value to estimates of fair value. We determine the
estimated fair value of each trademark through a discounted cash flow analysis.
The change in the carrying amount of trademarks for the ten months ended
December 31, 2002 is as follows (in thousands):

|Reorganized Company             | Rehabilitation
      and Respiratory
       Therapy
        Services |   | Pharmaceutical
      and Medical
      Supply Services |   | OtherOperations |   | Consolidated    |  
|------------------------------- | -------------------------------------------------------------------- | - | ------------------------------------------------------ | - | --------------- | - | --------------- | -
|                                |                                                                      |   |                                                        |   |                 |   |                 |  
|Balance as of March 1, 2002     | $
                         1,100                                     |   | $             9,900                                    |   | $     23,600    |   | $        34,600 |  
|Loss on impairment              | (668                                                                 | ) | (7,237                                                 | ) | (18,078         | ) | (25,983         | )
|Balance as of December 31, 2002 | $                      432                                           |   | $             2,663                                    |   | $       5,522   |   | $         8,617 |  
|                                | ==============                                                       |   | ============                                           |   | ========        |   | =========       |  

Finite Life Intangibles

The Reorganized Company recorded $28.2
million in favorable lease intangibles under fresh-start accounting based on an
independent valuation of the fair value of our assets and liabilities as of
March 1, 2002. We evaluate the recoverability of the favorable lease
intangibles by comparing an asset's respective carrying value to estimates of
undiscounted cash flows over the life of the lease. If the carrying value of the
asset exceeded the undiscounted cash flows, an impairment loss was measured by
comparing the estimated fair value of the asset, based on discounted cash flows,
to its carrying value.
   The following is a summary of our finite
lived favorable lease intangible assets at December 31, 2002 (in
thousands):

|                                | Inpatient Services |  
|------------------------------- | ------------------ | -
|Balance as of March 1, 2002     | $          28,191  |  
|Loss on impairment              | (24,011            | )
|Balance as of December 31, 2002 | $            4,180 |  
|                                | ==========         |  

The weighted-average amortization period for
favorable lease intangibles is approximately five years at December 31, 2002.
Amortization expense on the favorable lease intangibles totaled $6.8 million for
the ten months ended December 31, 2002.

Impairment of Long-Lived Assets

In August 2001, the FASB issued
Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets("SFAS No. 144"), which
addresses financial accounting and reporting for the impairment of long-lived
assets (other than goodwill and indefinite lived intangibles) and for long-lived
assets to be disposed of. SFAS No. 144 supersedes Statement of Financial
Accounting Standards No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of("SFAS No. 121") and
Accounting Principles Board Opinion No. 30, Reporting the Results of
Operations - Reporting the effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions.
We adopted the provisions of SFAS No. 144 as of January 1, 2002. Similar to SFAS
No. 121, SFAS No. 144 requires impairment losses to be recognized for long-lived
assets used in operations when indicators of impairment are present and the
estimated undiscounted cash flows are not sufficient to recover the assets'
carrying amounts. The impairment loss is measured by comparing the estimated
fair value of the asset, usually based on discounted cash flows, to its carrying
amount. In accordance with SFAS No. 144, we assess the need for an impairment
write-down when such indicators of impairment are present. (See Note 2).

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

During the fourth quarter of
2002, we recorded pretax charges totaling approximately $126.7 million for asset
impairments in accordance with SFAS No. 144. The asset impairment charges
consist of the following:

|-                                                                                                                                                                                                                                                                                                                                                              | $81.6 million write-down of property and equipment in our
      Inpatient Services segment for certain nursing facilities whose book value
      exceeded estimated fair value when tested for impairment.                                                                  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|-                                                                                                                                                                                                                                                                                                                                                              | $42.8 million write-down of property and equipment in our
      Other Operations segment which consisted of $8.7 million for Shared
      Healthcare Systems and $34.1 million for our corporate
      headquarters.                                                        
|-                                                                                                                                                                                                                                                                                                                                                              | $2.3 million write-down of property and equipment in our
      Pharmaceutical and Medical Supply Services segment.                                                                                                                                                          
|The October 1, 2002 elimination of certain funding
      under the Medicare program and the increase in our patient care liability
      costs affected our 2002 and future cash flows, and therefore, the fair
      values of each of our operating segments. This event led to an impairment
      assessment on each of our operating segments, including:
|-                                                                                                                                                                                                                                                                                                                                                              | estimating the undiscounted cash flows to be generated by
      each of the segments over the remaining life of the primary asset;
      and                                                                                                                                
|-                                                                                                                                                                                                                                                                                                                                                              | reducing the carrying value of the asset to estimated
      fair value when the total estimated undiscounted future cash flows were
      less than the current book value of the long-lived assets (excluding
      goodwill and other indefinite lived intangible assets).

In estimating the undiscounted
cash flows for the 2002 impairment assessment, we primarily used our internally
prepared budgets and forecast information including adjustments for the
following items: Medicare and Medicaid funding; overhead costs; capital
expenditures; and patient care liability costs. We also considered our plans to
transition approximately 56% of our under-performing long-term care facilities
to new operators. In order to estimate the fair values of the entities, we used
a discounted cash flow approach. A substantial change in the estimated future
cash flows for these entities could materially change the estimated fair values
of these assets, possibly resulting in an additional impairment.

During the fourth quarter of
2001, we reviewed our projections for the future earnings of our businesses
because actual results did not meet initial forecasts. Upon completion of the
review, we recorded an impairment charge of approximately $18.8 million to
reduce to estimated fair value our investment in goodwill and certain other
long-lived assets within the Inpatient Services segment and software development
division. The write-down of $14.5 million to the Inpatient Services segment was,
primarily as a result of decreased future projections of net operating income
(loss) and net cash flows due to lower revenue projections. The remaining $4.3
million write down to the software development division relates to the longer
than expected time-to-market of certain of our products which adversely impacted
the division's cash flow projections.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

During the fourth quarter of
2000, we identified several factors that adversely impacted the future
projections of net operating income (loss) and net cash flows for certain
facilities, primarily in our Inpatient Services segment. These factors were: (i)
the continuation of the tight labor market that increased our use of contract
and temporary staffing, (ii) additional regulatory pressures within the
healthcare industry, as a whole, including new laws in California that specify
the labor dollars spent on patient care and increased the operating costs at a
significant number of our facilities, and (iii) additional staffing and other
overhead within our long-term care division to respond to survey results. During
2000, the Inpatient Services segment, which operates long-term care facilities,
recognized an impairment of $189.3 million related to 141 of the 303 facilities
it operated in the United States. The impairment was primarily due to the
decrease of revenues as compared with profitability projections for each
facility.

Recent Accounting Pronouncements

In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities." Many
variable interest entities have commonly been referred to as special-purpose
entities or off-balance sheet structures, but this Interpretation applies to a
larger population of entities. In general, a variable interest entity is any
legal structure used for business purposes that either (1) does not have
equity investors with voting rights or (2) has equity investors that do not
provide sufficient financial resources for the entity to support its activities.
A variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. Until now, one company generally has
included another entity in its consolidated financial statements only if it
controlled the entity through voting interests. This Interpretation changes that
by requiring a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. The consolidation requirements of this Interpretation apply to
variable interest entities created after January 31, 2003 and apply to
existing variable interest entities in the first fiscal year or interim period
beginning after June 15, 2003. We do not expect the
adoption of this Interpretation to have a material effect on our consolidated
financial position or results of operations.

In November 2002, the FASB issued
FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and
107 and Rescission of FASB Interpretation No. 34." FIN 45 clarifies the
requirements of SFAS No. 5, "Accounting for Contingencies," relating to the
guarantor's accounting for, and disclosure of, the issuance of certain types of
guarantees. The disclosure provisions of FIN 45 are effective for financial
statements of periods that end after December 15, 2002. However, the provisions
for initial recognition and measurement are effective on a prospective basis for
guarantees that are issued or modified after December 31, 2002. We are
currently assessing the potential impact on our financial condition and results
of operations from the adoption of FIN 45.

In July 2002, the FASB issued
SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS 146"). SFAS 146 replaces Emerging Issues Task Force Issue No. 94-3
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity." SFAS 146 requires the recognition of costs associated with
exit or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS 146 is to be applied prospectively
to exit or disposal activities initiated after December 31, 2002. Many of the
provisions of SFAS No. 146 affect only the timing of when a liability is
recorded and not the amount of the liability. Therefore, we do not expect there
will be a material effect on our consolidated financial position or results of
operations as a result of adopting SFAS No. 146.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

In April 2002, the FASB issued
SFAS No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"). This statement
eliminates extraordinary accounting treatment for reporting most gains or losses
on debt extinguishments, and amends certain other existing accounting
pronouncements. The provision of this Statement will be effective for us
beginning with the first quarter of fiscal year 2003. Debt extinguishment
reported as extraordinary items prior to adoption of this Statement may be
reclassified to an appropriate line item on the statement of operations, however
we are evaluating whether this applies to the extraordinary item recorded in our
emergence from bankruptcy. We do not expect there to be a material effect on our
consolidated financial position or results of operations as a result of adopting
SFAS 145.

Reimbursement Matters

We derive approximately 25% of
our revenues from Medicare and approximately 46% from Medicaid. Medicare
reimburses our skilled nursing facilities under a prospective payment system
("PPS") for inpatient Medicare Part A covered services. PPS was adopted pursuant
to the Balanced Budget Act of 1997 (the "1997 Act"). Under PPS, facilities are
paid a predetermined amount per patient, per day, based on the anticipated costs
of treating patients, and such amount is determined by classifying each patient
into one of 44 resource utilization groups ("RUG"). The nursing home industry
came under financial pressure as a result of the implementation of PPS and
other 1997 Act provisions.  As a result, Congress enacted The
Balanced Budget Refinement Act of 1999 ("BBRA") and the Medicare, Medicaid
and SCHIP Benefits Improvement Act of 2000 ("BIPA") to provide some relief to
the industry. The BBRA and BIPA required four Medicare "add-on"
payments: a 4% increase in per diem rates; a 16.7% increase in the nursing
component of each RUG; a 20% increase for certain categories of high cost,
medically complex patients; and a 6.7% increase for rehabilitation RUGs.

On September 30, 2002, two of the
add-on provisions of the Medicare payment regulations expired: the 4% add-on for
all patient categories in the RUG system and the 16.7% add-on for nursing
related costs. We currently estimate that our Medicare revenues decreased by
approximately $8.6 million ($36.98 per patient day) for the period of
October 1, 2002 to December 31, 2002, and we estimate, that based upon the
number of facilities that we currently operate, we will experience a decrease of
approximately $32.9 million for the year ended December 31, 2003 if
these add-ons are not restored, although the decrease could be greater than
anticipated. In addition to the elimination of the add-ons, CMS announced a 2.6%
market basket increase in payments to skilled nursing facilities. For the period
of October 1, 2002 to December 31, 2002, we estimate that the market basket
increase resulted in approximately $2.1 million ($9.49 per patient day) in
revenue, and we estimate, that based upon the number of facilities that we
currently operate we will experience an increase of approximately $8.5 million
in revenue to our inpatient facilities for the year ended December 31,
2003. The net result of the expiration of the add-ons and the market basket
increase is an estimated Medicare revenue decrease of approximately $24.4
million ($27.49 per patient day) for the year ended December 31, 2003.

The remaining two add-on payments, the
6.7% increase for patients requiring intense rehabilitation and a 20.0% increase for patients requiring complex medical care, are scheduled to
expire on the earlier of September 30, 2003 or at such time as CMS completes the
case mix refinements. The refinements are intended to ensure nursing homes are
fairly and accurately reimbursed for taking care of medically complex patients.
CMS has determined that the research is not sufficiently advanced at the present
time to implement the refinements in the 2003 Federal fiscal year. Although the
add-ons will expire when these refinements are implemented, it is expected that
the add-ons will be replaced by new payment rates that are not known at this
time. If the add-ons expire and are not replaced, we estimate that, based upon
the number of long-term care facilities we currently operate our per
beneficiary per diems would decrease by approximately $27.00, which would
account for $27.5 million annually. The loss of these add-ons would have a
material adverse effect on our financial position, results of operations and
cash flows.

36

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Medicare Part B payments are
generally adjusted annually, effective upon the calendar year beginning January
1 and ending December 31. On December 31, 2002, CMS issued a final rule
providing a 4.4% decrease to the payment fee, effective on March 1, 2003.
However, the recently enacted federal spending bill for fiscal 2003 allowed CMS
to revise the figures used in the statutory formula and increase the update from
a negative 4.4% to a positive 1.6%.

The 1997 Act also implemented
a restriction applicable to Medicare Part B payments that would limit the amount
of reimbursements we receive per patient per day for rehabilitation therapy. BBRA
and BIPA placed a moratorium on that limitation; however, the
moratorium expires on June 30, 2003.  We
estimate the application of the limitation will reduce SunDance's revenue
by approximately $7.2 million and our inpatient services revenue by $0.9 million
for the six months ended December 31, 2003, based upon the number of
long-term care facilities we currently operate.

We also expect our annual revenue from our
home health services to decrease by approximately $2.1 million due to recent
legislation. Additionally, as non-affiliated healthcare providers that are
serviced by our ancillary services operations, including our pharmaceutical,
rehabilitative services, laboratory and radiology operations, are negatively
affected by reduced reimbursements to their operations, we could experience
negative trends in customer credit-worthiness, lengthened payment cycles,
increased exposure to loss on accounts receivable and reductions in our
ancillary services business.

In a notice of proposed
rulemaking issued on February 10, 2003, CMS proposed a significant change with
respect to the reimbursement of Medicare Part A bad debts. The proposal would
subject all providers to a 30% reduction in Medicare Part A bad debt
reimbursement. CMS proposes to implement the reduction incrementally over a
three year period to mitigate its impact: 10% for cost reporting periods
beginning October 1, 2003, 20% for cost reporting periods beginning
October 21, 2004, and 30% for cost reporting years beginning October 1, 2005 and
thereafter. Based upon the estimated Medicare bad debts that we will claim on
our 2002 cost reports, we estimate that our Medicare revenues would decrease by
approximately $0.8 million in 2004, $1.6 million in 2005 and $2.4 million in
2006 if the proposed changes are implemented.

To summarize, we estimate that
our Medicare revenues will decrease by approximately $34.6 million during the
year ended December 31, 2003 as a result of the known changes to
Medicare and assuming that we continue operating all of our facilities. This
decrease includes: a $32.9 million decrease to inpatient revenues as a result of
the expiration of the add-ons; a $8.5 million increase to inpatient revenues as
a result of the market basket increase; a $7.2 million decrease to therapy
revenues and a $0.9 million decrease in inpatient services revenues as a result
of the expiration of the therapy cap moratorium; and a $2.1 million decrease in
home health revenues as a result of legislative changes.

The recent economic downturn has
had a detrimental affect on state revenues. Historically these budget pressures
have translated into reductions in state spending. Given that Medicaid outlays
are a significant component of state budgets, we expect continuing cost
containment pressures on Medicaid outlays for nursing homes and pharmacy
services in the states in which we operate. States that have recently reduced
Medicaid reimbursements, or are considering reducing Medicaid reimbursements, to
long-term care facilities include, but are not limited to, California, Colorado,
Idaho, New Mexico, Washington, Connecticut, Illinois, Massachusetts, Ohio,
Georgia, Louisiana, New Jersey, Tennessee, and Texas. California's proposed
changes would be the most significant to us because 76 of our facilities, or 33%
of the facilities that we operated as of March 1, 2003, were in California.
California has proposed a 15% cut in Medicaid payments to skilled nursing
facilities, and we estimate that if the proposal is implemented then our
Medicaid reimbursements at our facilities in California would decrease by
approximately $17.00 per patient per day, which would result in a decrease of
approximately $13.0 million for the period of July 1, 2003 to December 31, 2003
if we continued operating all 76 facilities during that period.

37

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

We could be affected adversely by the
continuing efforts of governmental and private third-party payors to contain
healthcare costs. There can be no assurance that payments under governmental and
private third-party payor programs will remain at levels comparable to present
levels or will be sufficient to cover the costs allocable to patients eligible
for reimbursement pursuant to such programs. In addition, there can be no
assurance that facilities operated by us, or the provision of services and
supplies by us, will meet the requirements for participation in such programs.

There can be no assurance that future
healthcare legislation or other changes in the administration or interpretation
of governmental healthcare programs will not have a material adverse effect on
our financial position, results of operations and cash flows.

Results of Operations

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

|                                                          | Reorganized  Company
      and Predecessor
       Company
       Combined |   | Predecessor
         Company
|--------------------------------------------------------- | ------------------------------------------------------------------------- | - | ----------------------------
|                                                          | 2002                                                                      |   | 2001                        
|                                                          |                                                                           |   |                             
|Inpatient Services                                        | $    1,452,137                                                            |   | 76.4                        
|Rehabilitation and Respiratory
          Therapy Services | 163,157                                                                   |   | 8.6                         
|Pharmaceutical and Medical Supply
          Services      | 258,898                                                                   |   | 13.6                        
|International Operations                                  | -                                                                         |   | -                           
|Other Operations                                          | 181,637                                                                   |   | 9.6                         
|Corporate                                                 | 222                                                                       |   | -                           
|Intersegment eliminations                                 | (156,011                                                                  | ) | (8.2                        
|Total Net Revenues                                        | $    1,900,040                                                            |   | 100.0                       
|                                                          | =======                                                                   |   | ====                        

Inpatient services revenues
for long-term care, subacute care and assisted living services include revenues
billed to patients for therapy and pharmaceutical services and medical supplies
provided by our affiliated operations. Revenues for rehabilitation and
respiratory therapy services provided to affiliated facilities were
approximately $100.2 million, $99.5 million and $113.3 million for the years
ended December 31, 2002, 2001 and 2000, respectively. Revenues for
pharmaceutical and medical supply services provided to affiliated facilities
were approximately $51.6 million, $62.2 million and $88.3 million for the years
ended December 31, 2002, 2001 and 2000, respectively. Revenues for services
provided by other non-reportable segments to affiliated facilities were
approximately $4.2 million, $8.5 million and $11.6 million for the years ended
December 31, 2002, 2001 and 2000, respectively.

38

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

The following tables set forth the amount of
net segment income (loss) for the years ended December 31 (in
thousands):



|                                                | Reorganized
      Company and
      Predecessor
      CompanyCombined | PredecessorCompany
|----------------------------------------------- | --------------------------------------------------------------------- | ------------------
|                                                | 2002                                                                  |                   
|                                                |                                                                       |                   
|Inpatient Services                              | $         (20,033                                                     | )                 
|Rehabilitation and Respiratory Therapy Services | 21,614                                                                |                   
|Pharmaceutical and Medical Supply Services      | 17,545                                                                |                   
|International Operations                        | -                                                                     |                   
|Other Operations                                | 11,304                                                                |                   
|Net segment loss before Corporate               | 30,430                                                                |                   
|                                                |                                                                       |                   
|Corporate                                       | (75,646                                                               | )                 
|Net segment income (loss)                       | $        (45,216                                                      | )                 
|                                                | ========                                                              |                   

The net segment income (loss)
amounts detailed above do not include the following items: legal and regulatory
matters, net; gain (loss) on sale of assets, net; loss on termination of
interest rate swaps; loss on asset impairment; restructuring costs;
reorganization costs, net; income taxes; loss on discontinued operations, and
extraordinary gain on extinguishment of debt. These amounts totaled
approximately $1,002.1 million, $73.3 million and $507.4 million in 2002, 2001 and
2000, respectively.

Corporate expenses include
amounts for interest and corporate general and overhead expenses including those
related to managing our subsidiaries. In 2001 and 2000, we allocated certain
corporate expenses of $85.1 million and $118.5 million, respectively, to our
other segments through management fees and intersegment interest charges based
on segment net revenues. In 2002, we discontinued this process. In 2001 and
2000, interest was charged based upon average net asset balances at rates
determined by management.

Our subsidiaries which operate
inpatient facilities have historically used and continue to use pharmaceutical
and rehabilitation services that are provided by separate subsidiaries of ours,
SunScript and SunDance, respectively. Effective on January 1, 2002, the rates
charged by SunScript and SunDance to our inpatient facilities were adjusted to
more accurately reflect competitive, national market rates. While the change in
these rates did not impact our consolidated results, we estimate that on a
segment basis the pharmaceutical services and rehabilitation therapy services
segments' net income in 2002 decreased by approximately $7.6 million and $4.3
million, respectively, and the inpatient ancillary services expenses decreased
by approximately $11.9 million.

In accordance with SOP 90-7,
items of expense or income that are incurred or realized by us because we were
in reorganization are classified as reorganization costs in our consolidated
statements of operations. As a result, net segment income (loss) do not include
interest earned subsequent to the Filing Date on cash accumulated because we are
not paying our prepetition obligations. Interest earned prior to the Filing Date
is included in net segment income (loss).  Debt discounts and
deferred issuance costs that were written-off after the Filing Date in
accordance with SOP 90-7 are not included in the net segment income
(loss).  The amortization of debt discounts and deferred issuance costs
prior to the Filing Date are included in net segment income (loss). Gain on sale
of assets and professional fees related to the reorganization incurred
subsequent to the Filing Date are excluded from net segment income (loss) which
is consistent with their treatment prior to the Filing Date.

39

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

The following discussions of the
"Year Ended December 31, 2002 compared to the Year Ended December 31, 2001" and
the "Year Ended December 31, 2001 compared to the Year Ended December 31, 2000"
are based on the financial information presented in "Note 16 - Segment
Information" in our consolidated financial statements.

Year Ended December 31, 2002 Compared to Year Ended December 31,
2001

Results of Operations



|- | an extraordinary gain on extinguishment of debt of
      $1,498.4 million;                                                                                  
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                             
|- | an asset impairment charge of $407.8
    million;                                                                                                           
|  |                                                                                                                                                             
|- | a $20.0 million charge for patient care liability costs
      related to our inpatient services operation;                                                  
|  |                                                                                                                                                             
|- | a favorable adjustment of $6.0 million related to
      workers' compensation insurance costs, primarily related to our inpatient
      services operation; 
|  |                                                                                                                                                             
|- | a $2.8 million increase in reimbursement reserve accounts
      due to the Medicaid reserves related to our inpatient services
      operation;             
|  |                                                                                                                                                             
|- | an $8.7 million gain on sale of assets, net primarily due
      to the reversal of accrued prepetition liabilities related to disposed
      facilities; and
|  |                                                                                                                                                             
|- | a gain from reorganization activities of $1.5
      million.                                                                                                

Net income for the prior year
included $42.9 million for reorganization costs, net, related to our bankruptcy
and restructuring activities, a loss on asset impairments of $18.8 million and a
restructuring charge of $1.1 million. In 2001, we recorded our settlement with
the US government, which resulted in a charge of $11.0 million. In connection
with the settlement, we reversed $52.1 million of net excess reserves related to
routine cost limit exception payments. The reversal of the reserves is reflected
as a component of net patient revenue in the 2001 consolidated statement of
operations.

Net Revenues

Our net revenues were $1,900.0
million during the year ended December 31, 2002 compared to $2,075.2 million for
the prior year. The decrease in net revenues of approximately $175.2 million for
the year ended December 31, 2002, as compared to the prior year, primarily
consisted of the following:

40

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

|- | decreases of $122.4 million, $23.9 million and $17.7
      million due to dispositions in our inpatient, international and ancillary
      operations, respectively;                                                                                     
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                          
|- | a decrease of $34.8 million from facilities in our
      inpatient services operations which we operated during each year ended
      December 31, 2002 and 2001 ("same store operations");                                                              
|  |                                                                                                                                                                                                                                                          
|- | an increase of $14.2 million caused by a decrease in
      intersegment eliminations;                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                          
|- | a net increase of $3.6 million in our other operations
      segment, which is comprised of our temporary medical staffing operations,
      our mobile radiology, medical laboratory and home healthcare services and
      our software subsidiary; and
|  |                                                                                                                                                                                                                                                          
|- | an increase of $1.3 million in our pharmaceutical and
      medical supply services operations.                                                                                                                                                          

The unfavorable $34.8 million variance from
inpatient services on a same store basis, reflects the impact of the
aforementioned favorable adjustment of $52.1 million included in 2001 revenues.
Without this adjustment in 2001, inpatient services' revenue on a same store
basis increased by $17.3 million, primarily as a result of the following:

|- | an increase of $12.2 million in Medicare revenue due to
      slightly higher Medicare rates that existed for all but the last three
      months of 2002;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                           
|- | an increase of $7.1 million in Medicaid revenues driven
      by a slight increase in Medicaid census and rates, offset in part
      by                  
|  |                                                                                                                                                           
|- | a decrease of $2.0 million in private, commercial and
      other revenue caused by a decrease in census.                                                 

Operating Expenses,
Corporate General and Administrative Expenses and Provision for Losses on
Accounts Receivable

We reported operating expenses,
general and administrative expenses, and provision for losses on accounts
receivable of $1,896.3 million during the year ended December 31, 2002 compared
to $2,025.9 million during the prior year. Included in operating expenses,
corporate general and administrative expenses is $155.3 million and $171.5
million of rent expense for the years ended December 31, 2002 and 2001,
respectively. For the year ended December 31, 2002, rent expense for our
inpatient services operations was approximately $143.6 million compared to
$150.3 million for the year ended December 31, 2001. On a same store basis in
the year-to-year comparison, rent expense increased $1.9 million
from $139.2 million to $141.1 million due to scheduled
rent increases for certain leases. The decrease of approximately $129.6 million in total corporate general and administrative expenses and provision for losses
on accounts receivable primarily consisted of the following:

41

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

|-                                       | decreases of $137.6 million, $23.0 million and $20.0
      million due to dispositions in our inpatient, international and ancillary
      operations, respectively; and                                                                  
|--------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                        |                                                                                                                                                                                                                                           
|-                                       | a decrease of $8.7 million in our other segment primarily
      caused by the capitalization of certain costs for our software development
      subsidiary, which has achieved technical feasibility for its main software
      product.
|                                        |                                                                                                                                                                                                                                           
|-                                       | a decrease $8.9 related to our efforts to reduce overhead
      and streamline general and administrative costs, primarily
      salaries.                                                                                                
|                                        |                                                                                                                                                                                                                                           
|These decreases were offset in part by:
|                                        |                                                                                                                                                                                                                                           
|-                                       | an increase of $31.4 million due to same store operations
      in our inpatient services operations;                                                                                                                                     
|                                        |                                                                                                                                                                                                                                           
|-                                       | an increase of $14.2 million caused by a decrease in
      intersegment eliminations related to the sale of our respiratory therapy
      operations, which provided services to our inpatient services operations;
      and             
|                                        |                                                                                                                                                                                                                                           
|-                                       | a higher cost of goods sold of $3.6 million at our
      pharmacy operation caused by a higher mix of branded prescriptions of $9.9
      million                                                                                         
|                                        |                                                                                                                                                                                                                                           
|-                                       | an increase of $3.2 million in our rehabilitation and
      respiratory therapy services operations primarily driven by higher
      salaries expense.                                                                                    
|                                        |                                                                                                                                                                                                                                           

The increase in operating
expenses for same store operations was due to the following items:

|-                                       | an increase of $36.3 million in salaries and wages due to
      an increase in the weighted average wage rate and our efforts to improve
      staffing levels,
|--------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                        |                                                                                                                                                                
|-                                       | an increase in health insurance expense of $9.4
      million;                                                                                                 
|                                        |                                                                                                                                                                
|-                                       | an increase of $5.0 million in purchased services;                                                                                                             
|                                        |                                                                                                                                                                
|-                                       | an increase of $4.9 million in paid time off
      expense;                                                                                                    
|                                        |                                                                                                                                                                
|-                                       | the aforementioned increase of $1.9 million in rent
      expense; and                                                                                         
|                                        |                                                                                                                                                                
|-                                       | an increase of $2.1 million in general
      professional liability insurance expense                                                                          
|                                        |                                                                                                                                                                
|These increases were offset in part by:
|                                        |                                                                                                                                                                
|-                                       | decreased workers' compensation expense of $17.6
      million due to a more favorable history in our claims expense.                                          
|                                        |                                                                                                                                                                
|-                                       | decreased supplies expense of $6.7
  million as a result of more monitoring of our purchasing activity; and                                                    
|                                        |                                                                                                                                                                
|-                                       | lower contract labor of $4.8 million due to more
      effective controls and more competitive
wages.                                                          

Interest Expense, net

Interest expense of $16.1 million
was recorded in the year ended December 31, 2002 compared to $12.6 million in
the prior year. The increase of $3.5 million in interest was due primarily to
the recognition of interest for all of our debt instruments. While we were under
bankruptcy protection we did not record interest expense on essentially all of
our prepetition debt. Had we not been under bankruptcy protection our interest
expense, net for the year 2001 would have been $155.4 million.

42

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Depreciation and Amortization

Depreciation and amortization
expense was flat compared to the prior year with $32.9 million for 2002 compared
to $32.8 million for 2001.

Income Taxes

We recorded a provision for income taxes of
approximately $557,000 for the year ended December 31, 2002, primarily related
to state income taxes. We increased our valuation allowance on our deferred tax
assets by $ 139.4 million during 2002 to $615.5 million as of December 31, 2002.
This valuation allowance is required under the guidance in statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes,"
due to our
historical operating performance and our cumulative net losses. Our realization
of the deferred tax benefits primarily associated with our net operating losses
("NOL") is dependent upon our achieving sufficient future pre-tax
income. Under federal income tax regulations we have up to 20 years to generate
sufficient taxable income to realize the deferred benefits. Given the size of
our pre-tax loss a valuation allowance is considered appropriate under the
accounting standards.

At December 31, 2002, we have Federal NOL
carryforwards of $776.4 million with expiration dates from 2004 through 2022.
Various subsidiaries have state NOL carryforwards totaling $1.06 billion with
expiration dates through the year 2002. In addition, we have capital loss
carryfowards of $11.3 million, of which $10.1 million will expire in 2004 and
$1.2 million will expire in 2006. Our alternative minimum tax credit carryfoward
of $4.3 million has no expiration date. Our $6.2 million of other tax credit
carryforwards will expire in years 2005 through 2019.

Year Ended December 31, 2001 Compared to Year Ended
December 31, 2000

Results of Operations

We reported a net loss for the
year ended December 31, 2001 of $69.4 million compared to a net loss of $545.7
million for the prior year. The net loss for the year ended December 31, 2001
included $42.9 million for reorganization costs, net, related to our bankruptcy
and restructuring activities, a loss on asset impairments of $18.8 million and a
restructuring charge of $1.1 million. In 2001 we recorded our settlement with
the US government, which resulted in a charge of $11.0 million. In connection
with the settlement we reversed $52.1 million of net excess reserves related to
routine cost limit exception payments. The reversal of the reserves is reflected
as a component of net patient revenue in the 2001 consolidated statement of
operations.

The net loss for the year ended
December 31, 2000 included the following:

|- | reorganization costs of $335.9 million, including a
      non-cash charge of $310.1 million to reduce the carrying amount of the
      medical supply operations and certain domestic inpatient facilities which
      were classified as assets held for sale in our consolidated 2000 balance
      sheet;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                             
|- | an impairment charge of $191.3 million primarily in our
      inpatient services operations;                                                                                                                                                                                                                
|  |                                                                                                                                                                                                                                                                                                             
|- | a gain on sale of assets of $21.4 million;
    and                                                                                                                                                                                                                                                          
|  |                                                                                                                                                                                                                                                                                                             
|- | legal expenses of $2.5 million including a $1.2 million
      payment to the US government to allow us to transfer certain of our
      facilities to new operators.                                                                                                                                        

43

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Net Revenues

We had net revenues were $2,075.2
million during the year ended December 31, 2001 compared to $2,458.9 million for
the prior year. The decrease in net revenues of approximately $383.7 million for
the year ended December 31, 2001, as compared to the prior year, primarily
consisted of the following:

|-                                       | decreases of $241.6 million, $230.8 million and $65.3
      million due to dispositions in our international, inpatient and ancillary
      operations, respectively;                                                                
|--------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                        |                                                                                                                                                                                                                                      
|-                                       | a decrease of $19.5 million in our rehabilitation therapy
      services operations primarily due to our termination of certain
      nonaffiliated contracts based on customers' credit-worthiness and contract
      profitability;
|                                        |                                                                                                                                                                                                                                      
|-                                       | a decrease of $7.2 million due to the disposition of
      certain of our assisted living facilities.                                                                                                                                
|                                        |                                                                                                                                                                                                                                      
|These decreases were offset in part by:
|                                        |                                                                                                                                                                                                                                      
|-                                       | an increase of $122.0 million due to facilities in our
      inpatient services operations which we operated during each year ended
      December 31, 2001 and 2000 ("same store operations");                                      
|                                        |                                                                                                                                                                                                                                      
|-                                       | an increase of $43.0 million caused by a decrease in
      intersegment eliminations related to the sale of our medical supply
      operations that had previously serviced many of our inpatient
      facilites;                  
|                                        |                                                                                                                                                                                                                                      
|-                                       | a net increase of $6.6 million in our other segment,
      primarily driven by increases at our temporary staffing operation;
      and                                                                                              
|                                        |                                                                                                                                                                                                                                      
|-                                       | an increase of $4.5 million in our pharmaceutical
      services operations due to our efforts to market the services to our
      inpatient facilities.                                                                             

The increase in net revenues of $122.0 million
from our inpatient services operations on a same store basis for the year ended
December 31, 2002, as compared to the prior year, was primarily due:

|- | an increase of $77.1 million due to higher Medicare
      revenue driven by the favorable adjustment of $52.1 million included in
      2001 revenues; and
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                           
|- | an increase of $42.8 million in Medicaid rates and
      census.                                                                                          

Operating Expenses, Corporate General and Administrative
Expenses and Provision for Losses on Accounts Receivable

We reported operating expenses,
corporate general and administrative expenses and provision for losses on
accounts receivable of $2,025.9 million during the year ended December 31, 2001
compared to $2,417.0 million for the prior year. Included in operating expenses,
corporate general and administrative expenses is $171.5 million and $242.9
million of rent expense for the years ended December 31, 2001 and 2000,
respectively. For the year ended December 31, 2001, rent expense for our
inpatient services operations was approximately $150.3 million compared to
$182.0 million for the prior year. On a same store basis in the year-to-year
comparison, rent expense increased $1.0 million from $142.4 million to $143.4
million, due to scheduled rent increases
in certain markets. The decrease of approximately $391.1 million in total
corporate general and administrative expenses and provision for losses on
accounts receivable primarily consisted of the following:

44

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

|- | decreases of $238.9 million, $228.0 million, and $66.6
      million due to dispositions in our international, inpatient and ancillary
      operations;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                         
|- | a decrease of $12.9 million from our rehabilitation
      therapy services operation due to a reduction in labor minutes; offset in
      part by;      
|  |                                                                                                                                                         
|- | an increase of $139.8 million due to same store
      operations in our inpatient services operations; and                                              
|  |                                                                                                                                                         
|- | an increase of $5.3 million on higher costs of goods sold
      for our pharmaceutical operations.                                                      

The increase in operating and
administrative expenses of $139.8 million from same store operations in our
inpatient services operations for the year ended December 31, 2001, as compared
to the prior year and was due primarily to the following:

|- | an increase of $54.9 million in benefits expense due to
      increased paid time-off costs;                                                                         
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                      
|- | $35.5 million of additional wages and salaries due to an
      increase in our weighted average wage rate and our efforts to improve
      staffing levels;          
|  |                                                                                                                                                                      
|- | an increase in general and professional liability expense
      of $26.1 million driven by incremental increase in reserves for prior and
      current policy years;
|  |                                                                                                                                                                      
|- | an increase of $9.8 million due to higher registry costs;
      and                                                                                                  
|  |                                                                                                                                                                      
|- | an increase of $7.5 million caused by higher supplies
      expense.                                                                                                 

Interest Expense, Net

Interest expense, net, decreased to $12.6 million
for the year ended December 31, 2001, as compared to $34.3 million for the prior
year. The decrease was primarily due to the determination in 2001 that certain
debt obligations which existed prior to our bankruptcy filing were subject to
compromise; as a result, we stopped recording interest expense in 2001. While we
were under bankruptcy protection we did not record interest expense on
essentially all of our prepetition debt. Contractual interest expense not paid
or accrued was $142.8 million and $146.4 million for the years ended December
31, 2001 and December 31, 2000, respectively.

Depreciation and Amortization

Depreciation and amortization expense decreased to
$32.8 million for the year ended December 31, 2001, as compared to $45.9 million
for the same period in 2000 primarily due to the impairment recorded in the
fourth quarter of 2000, which reduced property and equipment balances by $59.7
million. In addition, the divestitures of inpatient facilities, and certain
ancillary operations also contributed to $5.2 million of the variance.

Income Taxes

The income tax provision
relates to the operations of profitable subsidiaries in states that do not allow
combined, consolidated or unitary tax filings. No overall tax benefit was
recorded for this period for federal purposes since the realization of net
operating loss carryforwards is uncertain.

45

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Liquidity and Capital Resources

As of March 12, 2003, we had cash
and cash equivalents of approximately $6.0 million.

In addition, the report of our
independent auditors as of December 31, 2002 and for the ten month period then
ended is qualified as to our ability to continue as a going concern.  See
report on page F-2 and "Note 2 - Basis of Reporting and Current Operating
Environment."

On February 28, 2002,
we entered into a Loan and Security Agreement with certain lenders, led by
Heller Healthcare Finance, Inc. as collateral agent, and Citicorp USA, Inc., as
administrative agent (the "Revolving Loan Agreement"). The Revolving Loan
Agreement is a $150.0 million three-year revolving line of credit that is
secured by our accounts receivable, inventory, equipment and other assets, a
first priority pledge of the stock of our subsidiaries, other than those
subsidiaries providing pharmaceutical services, and a second priority pledge of
the pharmaceutical services subsidiaries. As agreed with the lenders under the
Revolving Loan Agreement, we pay interest (i) for Base Rate Loans at prime (or,
if higher, the federal funds rate plus 0.50%) plus 3.50% (subject to certain
adjustments) and (ii) for LIBOR Loans at the London Interbank Offered Rate plus
4.50% (subject to certain adjustments). The effective interest rate as of
December 31, 2002 on borrowings under the Revolving Loan Agreement was
approximately 6.6%. The weighted average borrowing interest rate for the ten
month period ended December 31, 2002 was 7.37%.  Our borrowing availability under the Revolving Loan
Agreement is limited to up to 85% of our net eligible accounts receivable and up
to 50% of our net eligible inventory, but not to exceed $150.0 million. The
defined borrowing base as of March 19, 2003, was $111.4 million, net of
specified reserves of $22.0 million, which includes a $5.0 million minimum
availability reserve. As of March 19, 2003, we had borrowed approximately $57.3
million and had issued approximately $26.1 million in letters of credit under
the Revolving Loan Agreement, leaving approximately $28.0 million available to
us for additional borrowing.

The Loan Agreements require us to
maintain certain financial ratios and spending limits, including fixed charge
coverage ratios, minimum operating cash flows, tangible net worth and capital
expenditure limits as defined in the Loan Agreements.   For the
quarter ended December 31, 2002, we were not in compliance with the following
covenants: Indebtedness to EBITDA Ratio, tangible net worth, capital expenditure
limits and minimum operating cash flow. As of March 21, 2003, the lenders under
the Revolving Loan Agreement had not waived compliance with those covenants.
Pursuant to certain cross-default provisions, we are also in default under the
Term Loan Agreement. We can give no assurance that the lenders will not seek to
exercise their remedies, including but not limited to declaring amounts
outstanding to be immediately due and payable, realizing upon the lenders'
security interests, and denying us the right to further borrowing under the
Revolving Loan Agreement.

46

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

We have classified the Revolving
Loan Agreement and the Term Loan Agreement as current obligations. The default
interest rates under the Revolving Loan Agreement and the Term Loan Agreement
increase by 2.0% based on the rates in effect which equate to default rates of
8.6% and 11.0%, respectively as of December 31, 2002.

We have initiated restructuring
efforts pursuant to which we are seeking to obtain rent concessions with respect
to certain facilities that we operate, and to transition our operations of
certain underperforming facilities to new operators. To date, we have identified
approximately 56% of our facilities that we would seek to transition to new
operators if we are unable to obtain satisfactory rent concessions on the
facilities. Through March 21, 2003, we withheld approximately $18.9 million in
accrued rent and mortgage payments on these facilities and they are classified
as current obligations. We have also classified three mortgages as current
obligations. We can give no assurance that the landlords and lenders will not
seek to exercise their remedies under their respective leases and mortgages,
including the potential acceleration of the principal and interest and/or
forcing an involuntary bankruptcy. Additionally we will be required to compute
outstanding interest under the mortgages using a rate of 18%, which represents
the default rate of interest.

At December 31, 2002, we had
working capital deficit of $74.2 million and cash and cash equivalents of $21.0
million as compared to working capital deficit of $13.3 million and cash and
cash equivalents of $50.6 million at December 31, 2001. The decrease in working
capital is in large part, the result of reclassifying all amounts due under the
Revolving Loan Agreement as current.

We incurred capital expenditures of $34.7
million, $4.0 million, $30.3 million, and $55.4 million for the ten months ended December 31,
2002, two months ended February 28, 2002 and the twelve months ended December 31,
2001 and 2000, respectively. Expenditures related primarily to improvements
at existing facilities and routine capital expenditures. We had construction
commitments as of December 31, 2002, under various contracts of approximately
$6.1 million.

On February 28, 2002, we
delivered a $10.0 million promissory note to the United States of America as
part of our settlement agreement with the federal government, of which $9.0
million remains outstanding. The remaining principal amount of the promissory
note is payable as follows: $1.0 million on February 28, 2004; $2.0 million on
February 28, 2005; and $3.0 million on each of February 28, 2006 and 2007.
Interest under the promissory note is based upon the weekly average one-year
constant maturity treasury yield. The effective interest rate as of December 31,
2002 was approximately 4.9%

We continue to negotiate
settlements of bankruptcy claims for periods prior to February 28, 2002 that
were filed by various State Medicaid agencies. We expect to pay an aggregate of
approximately $13.5 million to the State Medicaid agencies to resolve these
claims, of which we have paid approximately $7.6 million as of December 31,
2002. The payments are expected to be made partly in cash, partly with
promissory notes and potentially as set-offs against reimbursements payable to
us.

47

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Contractual Obligations. The following table
provides information about our contractual obligations at December 31, 2002 (in
thousands):

|                                                    | Payments
      Due by
      Years
|--------------------------------------------------- | ---------------------------------
|                                                    | Total                            
|Debt (excluding capital    lease
      obligations) | $  195,547                       
|Capital lease obligations                           | 676                              
|Construction Commitments                            | 6,112                            
|Operating leases                                    | 771,256                          
|Total                                               | $973,591                         
|                                                    | =======                          

Effects of Inflation

Healthcare costs have been rising
and are expected to continue to rise at a rate higher than that anticipated for
consumer goods as a whole. Our operations could be adversely affected if we
experience significant delays in receiving reimbursement rate increases from
Medicaid and Medicare sources for our labor and other costs.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Our Revolving Loan Agreement and
Term Loan Agreement entered into on February 28, 2002, are sensitive to changes
in interest rates.



The Term Loan Agreement is comprised of a three-year $20.0
million term loan (the "Term Loan") and a three-year $23.7 million original
issue discount note (the "Discount Note") and together with the Term Loan, the
"Term Debt". Under the Discount Note, our borrowing availability is
approximately $20.0 million. Interest accrues on the Term Loan at the greater of (i) prime (or, if higher,
the federal funds rate plus 0.50%) plus 4.00% and (ii) 9.00%. We will
pay interest on the Discount Note for base rate borrowings a rate of interest
equal to the greater of (i) prime (or, if higher, the federal funds rate plus
0.50%) and (ii) 2.65% and for Eurodollar borrowings a rate of interest equal to
the Adjusted Eurodollar Rate (as defined in the Term Loan Agreement) plus 0.50%.
Under the Term Loan Agreement, interest accrues at the greater of (i) prime plus
4.00% and (ii) 9.00%. For each additional percentage point increase in the prime
rate, assuming an outstanding balance of $40.0 million, we will incur
additional interest expense of approximately $400,000 annually.

48

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

The default interest rates under the
Revolving Loan Agreement and the Term Loan Agreement increase by 2.0% based on
the rates in effect which equate to default rates of 8.6% and 11.8%,
respectively as of December 31, 2002

Item 8. Financial Statements and Supplementary Data

Information with respect to Item
8 is contained in our consolidated financial statements and financial statement
schedules and are set forth herein beginning on Page F-1.

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

On June 8, 2002, we dismissed
Arthur Andersen LLP as our principal independent accountants, and on June 27,
2002 engaged Ernst & Young LLP. Information regarding these events was filed
on Forms 8-K on June 14, 2002 and June 28, 2002,
respectively.

PART III

Item 10. Directors and Executive Officers of the
Registrant

Our directors and executive officers as of March 20, 2003 were:

|Name                | Position with Sun                                                                                     
|------------------- | ------------------------------------------------------------------------------------------------------
|                    |                                                                                                       
|Richard K. Matros   | Chairman of the Board and Chief Executive
      Officer                                               
|Kevin W. Pendergest | Executive Vice President and Chief Financial
      Officer                                            
|Steven A. Roseman   | Executive Vice President, General Counsel and
      Secretary                                         
|Chauncey J. Hunker  | Corporate Compliance Officer                                                                          
|Heidi J. Fisher     | Senior Vice President of Human Resources                                                              
|Jennifer L. Botter  | Vice President and Corporate Controller                                                               
|William A. Mathies  | President of SunBridge Healthcare
    Corporation                                                     
|Tracy A. Gregg      | President of SunDance Rehabilitation
      Corporation                                                
|John W. Driscoll    | President of SunScript Pharmacy
  Corporation                                                         
|Kathryn Gay Kelley  | President of CareerStaff Unlimited, Inc.                                                              
|Jennifer L. Clarke  | President of SunPlus Home Health Services, Inc.
      and    SunAlliance Healthcare Services,
    Inc.
|Mary K. Ousley      | Executive Vice President of SunBridge Healthcare
      Corporation                                    
|John W. Adams       | Director                                                                                              
|Gregory S. Anderson | Director                                                                                              
|Charles W. McQueary | Director                                                                                              
|John F. Nickoll     | Director                                                                                              
|Sanjay H. Patel     | Director                                                                                              
|Bruce C. Vladeck    | Director                                                                                              
|Steven L. Volla     | Director                                                                                              
|Milton J. Walters   | Director                                                                                              

Richard K. Matros, age 49, has
been our Chairman of the Board and Chief Executive Officer since November 2001.
Mr. Matros served as Chief Executive Officer and President of Bright Now! Dental
from 1998 to 2000. He served Regency Health Services, Inc., a publicly held
long-term care operator, as Chief Executive Officer from 1995 to 1997, as
President and a director from 1994 to 1997, and as Chief Operating Officer from
1994 to 1995. He served Care Enterprises, Inc. as Chief Executive Officer during
1994, as President, Chief Operating Officer and a director from 1991 to 1994,
and as Executive Vice President - Operations from 1988 to 1991. Mr. Matros
currently serves on the board of directors of Bright Now! Dental, Geriatrix,
Inc., Meridian Neurocare, LLC and Protocare, Inc.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Kevin W. Pendergest, age 49, has
been our Executive Vice President and the Chief Financial Officer since March
2002. Mr. Pendergest was the President and owner of Strategic Alliance Network,
a healthcare services advisory firm, from 1995 to February 2002. From 1990 to
1995 he was Executive Vice President and Chief Financial Officer of GranCare,
Inc., a publicly held long-term care company. From 1981 to 1989, Mr. Pendergest
held various positions with Deloitte Haskins & Sells, the last of which was
as Partner in Charge of Healthcare Consulting for the Western Region of the
United States.

Steven A. Roseman, age 44, has
been our Executive Vice President, General Counsel and Secretary since May 2002.
>From March 2001 to May 2002, Mr. Roseman was Counsel to the law firm of LeBoeuf
Lamb Greene & MacRae, LLP. From 1997 to 2000, he was Senior Vice President,
General Counsel and Secretary of American Health Properties, Inc., a NYSE-listed
healthcare-oriented real estate investment trust. Previously, Mr. Roseman was
Vice President Business Affairs Worldwide Pay Television for Paramount Pictures
Corporation and, prior to that, was a partner in Ervin, Cohen & Jessup, a
Beverly Hills, California law firm.

Heidi J. Fisher, age 46, has been
our Senior Vice President of Human Resources since February 2002. From 1998 to
2002, Ms. Fisher was Vice President Human Resources of Bright Now! Dental, a
dental practice management company. From 1997 to 1998, she was Corporate
director of Human Resources at Covenant Care, Inc., a long-term care company.
>From 1994 to 1997, Ms. Fisher was with Regency Health Services, Inc., a
long-term care company, most recently with the title Senior Director of Human
Resources. From 1987 to 1994, Ms. Fisher was Senior Manager of Human Resources
with Volt Delta Resources, Inc.

Jennifer L. Botter, age 40, has
been our Vice President and Corporate Controller since 2000. From 1998 to 1999,
Ms. Botter held various positions with us. From 1996 to 1998, she was Director
of Finance for Fulcrum Direct, Inc., a manufacturer and cataloguer of children's
apparel. From 1984 to 1996 she held financial consulting and accounting
positions in the high technology and manufacturing industries.

William A. Mathies, age 43, has
been President of SunBridge Healthcare Corporation, our inpatient services
subsidiary, since March 2002. From 1995 to March 2002, Mr. Mathies served as
Executive Vice President of Beverly Enterprises, Inc., a long-term care company.
Most recently, he was the Executive Vice President of Innovation/Services for
Beverly. He previously served Beverly as President of Beverly Health and
Rehabilitation Services, (the LTC subsidiary of Beverly), from 1995 to 2000,
Vice President of Operations for California from 1988 to 1995, as a Regional
Manager from 1986 to 1988 and as a facility administrator from 1981 to 1986.

Tracy A. Gregg, age 49, has been
the President of SunDance Rehabilitation Corporation, our rehabilitation therapy
services subsidiary, since 2000. From 1987 to 1999, Ms. Gregg was employed by
NovaCare, Inc in various capacities, most recently as Senior Vice President of
Operations of the Long Term Care Division. Ms. Gregg has over 28 years of
experience in the long term care industry.

50

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

John W. Driscoll, age 42, has
served as President of SunScript Pharmacy Corporation since 1996. From 1995 to
1996, Mr. Driscoll was Vice President Business & Administrative Operations
for SunScript. From 1990 to 1995, Mr. Driscoll was employed by Diagnostek, Inc.,
a publicly traded pharmaceutical company, in various capacities, including Vice
President Financial Analysis & Planning, Vice President Finance Pharmacy
Operations, and Executive Vice President Finance. From 1984 to 1990, Mr.
Driscoll was employed by KPMG Peat Marwick as an Audit Manager and prior to that
as a Senior Accountant. From 1982 to 1984, he served as Staff Accountant at
Deloitte Haskins & Sells. Mr. Driscoll was an executive officer of SunScript
when it commenced chapter 11 bankruptcy proceedings in October 1999.
   Kathryn Gay Kelley, age 48, has served as
President of CareerStaff Unlimited, Inc., our temporary medical staffing
subsidiary, since February 2002. From 1993 to 2002, Ms. Kelley was employed by
Nursefinders, Inc. in various capacities, including Branch Manager, Area
Director and Vice President. From 1990 to 1993, Ms. Kelley was employed with
Harris Methodist Health Systems as the Director of Employment and Employee
Relations, and prior to that was employed with Alcon Laboratories as a Senior
Staff Recruiter. Ms. Kelley, who is also a nurse, has worked in human resources
and recruitment for over 20 years and has worked with both domestic and
international recruitment.

Jennifer L. Clarke, age 48, has
served as President of SunPlus Home Health Services, Inc., our home healthcare
services subsidiary, since 1997 and of SunAlliance Healthcare Services, Inc.,
our mobile radiology and laboratory services subsidiary, since 1999. >From 1995
to 1997, Ms. Clarke was Vice-President of the Southern California region home
health services for Regency Health Services, Inc. and from 1990 to 1995 she
served as Vice-President of Operations for LifeCare Solutions, a multi-site
California based home health and home infusion company. From 1983 to 1990, she
was the administrator of a hospital-based home health agency, West HealthCare.
Ms. Clarke was an executive officer of SunAlliance and SunPlus when they
commenced chapter 11 bankruptcy proceedings in October 1999.

Mary K. Ousley, age 57, has
served as Executive Vice President of SunBridge Healthcare Corporation since
2001. From 1999 to 2001, Ms. Ousley was Senior Vice President Health Service for
Marriott International's Senior Living Division. From 1996 to 1999, Ms. Ousley
was employed by Horizon Healthcare Corporation, which was acquired in 1997 by
Integrated Health Services, Inc., as Vice President Clinical Services for
Horizon and as Senior Vice President Government Affairs for Integrated Health
Services. From 1991 to 1996, Ms. Ousley was Corporate Director Professional
Services for the Hillhaven Corporation and from 1980 to 1991 she was Executive
Administrator for EPI Healthcare Corporation. Ms. Ousley has been the Chairman
of the American Health Care Association, the largest trade organization
representing long-term care, since 2001. Over the past fifteen years, Ms. Ousley
has been appointed to, and has made recommendations for, the General Accounting
Office (GAO) and the Joint Commission on Accreditation of Healthcare
Organizations (JCAHO), and has served in various capacities as an advisor to the
Centers for Medicare and Medicaid (CMS). She is currently serving on the CMS and
Quality Improvement Organization's technical expert panel on the development and
implementation of a quality improvement model for long-term
care.

John W. Adams, age 59, has served
as a member of our Board of Directors since February 2002. Mr. Adams has served
as President of Smith Management, LLC, a private investment firm, since 1984.
Mr. Adams has served as Chief Executive Officer and President of Hawaiian
Airlines, Inc., a publicly held airline since 2002. From 1972 to 1983 he was a
partner at the law firm of Dillon, Bitar & Luther. Mr. Adams currently
serves as Chairman of the Board of Hawaiian Airlines, Inc., which commenced
bankruptcy proceedings in March 2003.

51

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Gregory S. Anderson, age 46, has
served as a member of our Board of Directors since November 2001. Mr. Anderson
has served as the President and Chief Executive Officer of Quality Care
Solutions, Inc., a publicly held provider of software and services for the
healthcare industry, since 1998. Prior to 1998 Mr. Anderson was in the venture
capital business. From 1993 to 1998 he was President of Anderson & Wells
Co., the venture capital manager of Sundance Venture Partners and El Dorado
Investment Co. Mr. Anderson currently serves on the board of directors of
Hawaiian Airlines, Inc., a publicly held airline (which commenced bankruptcy
proceedings in March 2003), Glendora Hospital and Valley Commerce Bank.
     Charles W. McQueary, age 50, has
served as a member of our Board of Directors since February 2002. Mr. McQueary
served with ProMedCo, Inc., a national medical practice management company, as
Chief Executive Officer from February 2001 to December 2001 and as Senior Vice
President - Operations from May 1997 to February 2001. Mr. McQueary previously
served as Regional Vice President of Med Partners, Inc. from 1995 to 1997 and as
Chief Operating Officer and Chief Financial Officer of Asthma & Allergy
CareAmerica, Inc. from 1993 to 1995. Prior to that, he held offices with other
health care companies and various positions with independent accounting
firms.  Mr. McQueary currently serves as Chairman of the board of directors
of Corinthian Health Services, Inc.

John F. Nickoll, age 68, has
served as a member of our Board of Directors since February 2002. Mr. Nickoll
has served as President, Chairman and Chief Executive Officer of the Foothill
Group, Inc., a subsidiary of Wells Fargo, since 1970. Mr. Nickoll is also
Managing General Partner of Foothill Partners, L.P., Foothill Partners II, L.P.,
Foothill Partners III, L.P. and Foothill Income Trust II, L.P., each of which
invest in senior bank debt and other types of debt issues. Mr. Nickoll currently
serves as a director of the Foothill Group, Inc. and CIM High Yield Securities,
a closed end high yield bond fund.

Sanjay H. Patel, age 42, has
served as a member of our Board of Directors since February 2002. Mr. Patel has
served as Co-President of GSC Partners, a private equity firm, since 1998. Mr.
Patel served Goldman, Sachs & Co. as Managing Director in the Principal
Investment Area from 1992 to 1998, in the Leveraged Buyout Department from 1987
to 1992 and in the Mergers and Acquisitions Department from 1983 to 1985. Mr.
Patel currently serves on the Board of Directors of Alacrity Services, LLC, R.L.
Winston Rod Company, Project Time & Cost, Inc., eTEC Ventures, Ltd.,
ForcesGroup, Ltd., Waddington North America, Inc., Tracmail (Bermuda) Ltd.,
Atlantic Express Transportation Group and GSCP Recovery, Inc.

Bruce C. Vladeck, Ph.D., age
53, has served as a member of our Board of Directors since November 2001. Dr.
Vladeck has served as Senior Vice President for Policy for Mount Sinai NYU
Health, Director of the Institute for Medicare Practice and Professor of Health
Policy and Geriatrics at the Mount Sinai School of Medicine since 1998. From
1993 to 1997, Dr. Vladeck was Administrator of the Health Care Financing
Administration (HCFA) of the U.S. Department of Health and Human Services. From
1983 to 1993, Dr. Vladeck served as President of United Hospital Fund of New
York. Dr. Vladeck currently serves on the board of directors of Senior Health
Partners, a managed long-term care non-profit organization, and as a Trustee of
Ascension Health, the March of Dimes Birth Defects Foundation and the Medicare
Rights Center.

Steven L. Volla, age 56, has
served as a member of our Board of Directors since November 2001. Mr. Volla has
served as President of Health Equities Management, Inc., an investor in and
advisor to healthcare companies, since 1994. He served as Chairman of Primary
Health Systems, Inc., an acute care hospital management company, from 1994 to
2001. He served as President, Chief Executive Officer and Chairman of the Board
of American Healthcare Management, Inc., a publicly held hospital management
company, from 1989 to 1994. He has also served Universal Health Services, Inc.
as Senior Vice President - Operations and UHS Hospital Company as President. Mr.
Volla currently serves on the board of directors of Pathmark Stores, Inc., a
publicly held operator of supermarkets; Brown Schools, Inc., a privately held
education company; and Specialty Hospital of America, a privately held long-term
acute care hospital management company.

52

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Milton J. Walters, age 60, has
served as a member of our Board of Directors since November 2001. Mr. Walters
has served with investment banking companies for over 30 years, including:
Tri-River Capital since 1999 and from 1988 to 1997, as President; Prudential
Securities from 1997 to 1999, most recently as Managing Director; Smith Barney
from 1984 to 1988, most recently as Senior Vice President and Managing Director;
Warburg Paribas Becker from 1965 to 1984, most recently as Managing Director. He
currently serves on the Board of Directors of Decision One Corporation,
Fredericks of Hollywood, Murray's Discount Auto, Quest Products Corporation and
Chairman of MDHIO Marketing, Inc.
     Pursuant to our Joint Plan of
Reorganization, our Board of Directors consists of nine members. The holders of
the senior lender claims selected eight of the members: Messrs. Adams, Anderson,
McQueary, Nickoll, Patel, Vladeck, Volla and Walters to serve on the Board for a
one-year term ending February 28, 2003; however, each of those directors will
continue to serve until their successors are duly elected and qualified. The
Plan provides that the ninth member is our Chief Executive Officer, Mr. Matros.
Beginning with the annual meeting of stockholders anticipated to be held in June
2003, the holders of Sun's common stock will elect the Board.

Section 16(a) Beneficial Ownership Reporting
Compliance

Section 16(a) of the
Exchange Act and the rules promulgated thereunder require our directors and
executive officers and persons who own more than ten percent of our common stock
to report their ownership and changes in their ownership of common stock to the
Securities and Exchange Commission (the "Commission"). Copies of the reports
must also be furnished to us. Specific due dates for the reports have been
established by the Commission and we are required to report any failure of our
directors, executive officers and more than ten percent stockholders to file by
these dates.

Based solely on a review of the
copies of such forms received by us, or written representations from certain
reporting persons, we believe that during 2002 all Section 16(a) filing
requirements applicable to our directors, executive officers and greater than
10% beneficial owners were met with the exception of: (i) John F.
Nickoll, a member of our Board of Directors, filed two Forms 4 late, (ii)
Jennifer L. Botter, an executive officer, filed a Form 4 late, and (iii)
Highland Capital Management LP, a 10% stockholder at the time of filing, filed a
Form 3 late.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Item 11. Executive Compensation

Summary Compensation Table

The following table provides
information concerning employment compensation for services to us and our
subsidiaries for the fiscal years shown for those persons (the "Named Executive
Officers") who were, during the year ended December 31, 2002, (i) the
individuals who served as chief executive officer, and (ii) the other four
most highly compensated executive officers.

|                                                                                             |              | Annual
      Compensation          | Long-Term        CompensationAwards |                                                   
|-------------------------------------------------------------------------------------------- | ------------ | ---------------------------------- | ----------------------------------- | --------------------------------------------------
|Name
      and
      PrincipalPosition                                                       | Year         | Salary                             | Bonus                               | Restricted
             Stock
          Awards ($)
|Richard K. Matros (1)  Chairman of the
      Board  and Chief
      Executive  Officer       | 200220012000 | $  650,000 85,000-                 | $      54,166
       --             | $4,050,000(2)
      -
      -                     
|Kevin W. Pendergest (1)   Executive
      Vice  President and Chief  Financial
      Officer | 200220012000 | 351,442-
      -                   | 175,000(3)
      --                 | -
      -
      -                                 
|William A. Mathies (1)
         President of SunBridge   Healthcare
      Corporation        | 200220012000 | 326,154
      -
      -            | -
      -
      -                   | -
      -
      -                                 
|Tracy A. Gregg (1)
         President of SunDance    Rehabilitation
         Corporation     | 200220012000 | 275,000
      275,918
      68,750 | 96,25032,083-                       | -
      -
      -                                 
|John W. Driscoll
         President of SunScript   Pharmacy
      Corporation                | 200220012000 | 229,613
      207,309186,604       | 75,25053,90036,750                  | -
      -
      -                                 

______________________

|(1) | Mr. Matros joined us on November 7, 2001, Mr.
      Pendergest and Mr. Mathies joined us on February 28, 2002 and Ms.
      Gregg joined us on September 25, 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(2) | We awarded Mr. Matros with a restricted stock
      grant of 150,000 shares on February 28, 2002 at a then-estimated value of
      $27.00 per share. The restricted stock vests as follows: 60,000 shares on
      February 28, 2003 and 30,000 shares on each of February 28, 2004, 2005 and
      2006. The 150,000 restricted shares had an aggregate value of $208,500,
      based on the last reported sales price of the common stock on the
      Over-The-Counter Bulletin Board at December 31, 2002. To the
      extent we declare any dividends on our common stock, Mr. Matros'
      restricted shares would participate in any such dividends.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(3) | The Company awarded Mr. Pendergest this one-time sign-on
      bonus when he joined us.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Option Grants in Last Fiscal Year

The following table sets forth certain
information concerning individual grants of stock options made to each of the
Named Executive Officers during the year ended December 31, 2002:

|                    | Individual Grants               |                                                        
|------------------- | ------------------------------- | -------------------------------------------------------
|                    | Number of Securities Underlying | % of Total Options Granted to Employees in
      Fiscal
|Name                | Options (1)                     | Year (%)                                               
|Richard K. Matros   | 150,000                         | 19.6%                                                  
|Kevin W. Pendergest | 200,000                         | 26.1                                                   
|William A. Mathies  | 100,000                         | 13.1                                                   
|Tracy A. Gregg      | 20,000                          | 2.6                                                    
|John W. Driscoll    | 20,000                          | 2.6                                                    

__________________________

(2)   All options were granted at an exercise price equal to or greater than the
  fair market value of Common Stock on the option grant date. The closing price
  of our stock on March 7, 2003 was $0.25 per share. The options granted to Mr.
  Matros, Mr. Pendergest and Mr. Mathies will vest and become exercisable at a
  rate of 20% on the date of grant and 20% on the first four anniversaries of
  the date of grant. The options granted to Ms. Gregg and Mr. Driscoll vest and
  become exercisable at a rate of 25% on the first four anniversaries of the
  date of grant. All options become fully exercisable on the occurrence of a
  change in control as described in the plan pursuant to which each option was
  granted.

(3)   The potential realizable value is based on the exercise price of $27.00
  per share. The closing price of our stock on March 7, 2003 was $0.25 per
share.



Set forth in the table below is
information concerning the value of stock options held as of December 31,
2002 by each of the Named Executive Officers. None of the Named Executive
Officers exercised any stock options during the year ended December 31,
2002.

|                    | Number of SecuritiesUnderlying
      UnexercisedOptions-at-Year-End
      (#) | Value of UnexercisedIn-the-Money
      OptionsAt-Year-End
      ($)(1)
|------------------- | ----------------------------------------------------------------------------- | ----------------------------------------------------------------------
|Name                | Exercisable                                                                   | Unexercisable                                                         
|Richard K. Matros   | 30,000                                                                        | 120,000                                                               
|Kevin W. Pendergest | 40,000                                                                        | 160,000                                                               
|William A. Mathies  | 20,000                                                                        | 80,000                                                                
|Tracy A. Gregg      | 0                                                                             | 20,000                                                                
|John W. Driscoll    | 0                                                                             | 20,000                                                                

__________________



55

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Compensation of Directors

Our non-employee directors are
entitled to receive: (i) an annual fee of $24,000, which is payable in four
equal quarterly installments, (ii) $1,750 for each Board of Directors or
Committee meeting attended in person, (iii) an additional $500 for each
subsequent meeting attended that same day, and (iv) $500 for any meetings
attended by telephone. In addition, each Chairperson of a Committee of the Board
of Directors is entitled to receive an additional annual fee of $4,000, payable
in four equal quarterly installments. Each of the non-employee directors is
reimbursed for out-of-pocket expenses for attendance at Board and committee
meetings. In addition, each of the non-employee directors has been awarded stock
options to purchase an aggregate of 10,000 shares of common stock at an exercise
price of $27.00 per share.

Employment Agreements

We entered into employment
agreements with Mr. Matros, Mr. Pendergest and Mr. Mathies. These agreements
represent an annual obligation to us of approximately $1.5 million and they have
various renewal options and expiration terms. In addition to the base salary,
the officers are entitled to annual bonuses for each fiscal year in which we
achieve or exceed certain financial performance targets. If the targets are
achieved, depending upon the individual's agreement and how much the targets are
exceeded, the bonuses range from 50% to 100% of base salary. Pursuant to the
agreements, these officers received options to purchase an aggregate of 450,000
shares of common stock at an exercise price of $27.00 per share. The options
vest over the four-year period ending 2006.

The employment agreements
generally provide that in the event of termination of employment without Good
Cause or by the employee for Good Reason (each as defined in the employment
agreements), then the employee would be entitled to a lump sum severance amount
equal to two years of base salary, unless the event occurred within two years of
a change of control, in which case they would each be entitled to three years of
base salary. Additionally, each employee would be entitled to any earned but
unpaid bonus and certain of the employees would also be entitled to one or two
times the amount of the bonus which would have been earned in the year of
termination (depending upon the terms of the applicable agreement.)

Severance Agreements



Compensation Committee Interlocks and Insider
Participation



56

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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

The following table and footnotes
set forth certain information regarding the beneficial ownership of common stock
as of March 17, 2003 by (i) each director, (ii) the Named Executive
Officers (as defined above) and (iii) all directors and executive officers
of ours as a group.

|Name
      of Beneficial
      Owner                                                                | SharesBeneficially Owned(1) | Percent
      ofClass(1)
|--------------------------------------------------------------------------------------------------- | --------------------------- | ------------------------
|                                                                                                    |                             |                         
|John W. Adams                                                                                       | 750                         | (2)                     
|Gregory S. Anderson                                                                                 | 750                         | (2)                     
|John W. Driscoll                                                                                    | 5,000                       | (2)                     
|Tracy A. Gregg                                                                                      | 5,000                       | (2)                     
|William A. Mathies                                                                                  | 43,000                      | (3)                     
|Richard K. Matros                                                                                   | 220,000                     | (4)                     
|Charles W. McQueary                                                                                 | 750                         | (2)                     
|John F. Nickoll                                                                                     | 1,021,609                   | (5)                     
|Sanjay H. Patel                                                                                     | 1,181,528                   | (6)                     
|Kevin W. Pendergest                                                                                 | 87,500                      | (7)                     
|Bruce C. Vladeck                                                                                    | 750                         | (2)                     
|Steven L. Volla                                                                                     | 750                         | (2)                     
|Milton J. Walters                                                                                   | 5,750                       | (8)                     
|All directors and executive officers as a   group
      (20 persons, including those   named above) | 2,598,012                   | (5)(6)(9)               

_____________________

*        Less than 1.0%

|(1)                                                  | Beneficial ownership is determined in accordance with the
      rules of the Commission and generally includes voting or investment
      power with respect to securities. Options exercisable within 60 days of
      March 17, 2003 are deemed to be currently exercisable. Except as indicated
      in the footnotes to this table and pursuant to applicable community
      property laws, the persons named in the table have sole voting and
      investment power with respect to all shares of common stock beneficially
      owned.
|---------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(2)                                                  | Consists solely of shares that could be purchased
      pursuant to stock options.                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(3)                                                  | Consists of 3,000 shares held by the Mathies Family Trust
      and 40,000 shares that could be purchased pursuant to stock
      options.                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(4)                                                  | Includes (i) 90,000 restricted shares awarded under our
      2002 Management Equity Incentive Plan which remain subject to a risk of
      forfeiture and (ii) 60,000 shares that could be purchased pursuant to
      stock options.                                                                                                                                                                                                                                                                                                           
|57
      SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
|(5)                                                  | Includes1,020,859shares held by The Foothill
      Group, Inc. and its affiliates, of which Mr. Nickoll is an executive
      officer. The shares are subject to shared voting and investment power. See
      table below. Also includes 750 shares that could be purchased pursuant to
      stock options.                                                                                                                                                                                                                                    
|                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(6)                                                  | Includes 1,180,778 shares held by GSC Recovery,
      Inc., and its affiliates. The shares may be subject to shared voting and
      dispositive power. Mr. Patel disclaims beneficial ownership of these
      securities. See table below. Also includes 750 shares that could be
      purchased pursuant to stock options.                                                                                                                                                                                                                   
|                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(7)                                                  | Includes 3,000 shares held by the Pendergest Children's
      Trust of 1991 and 80,000 shares that could be purchased pursuant to stock
      options.                                                                                                                                                                                                                                                                                                                                                                                           
|                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(8)                                                  | Includes 750 shares that could be purchased pursuant to
      stock options.                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(9)                                                  | Includes (i) 90,000 restricted shares awarded under our
      2002 Management Equity Incentive Plan that remain subject to a risk of
      forfeiture, (ii) 217,875 shares that could be purchased pursuant to stock
      options and (iii) 6,000 shares held in family trusts.                                                                                                                                                                                                                                                                 



|Name and Address of Beneficial
      Owner                                                                                                 | SharesBeneficially Owned(1) | Percent of Class(1)
|------------------------------------------------------------------------------------------------------------------------------------------ | --------------------------- | -------------------
|GSC Recovery, Inc.   500 Campus
      Drive   Suite 220   Florham Park, NJ
      07932                                                     | 1,181,528  (2)              | 12.0%              
|The Foothill Group, Inc.   2450 Colorado
      Avenue   Suite 3000   Santa Monica,
      CA 90404                                          | 1,021,609  (3)              | 10.4%              
|James Dondero
         Highland Capital Management, L.P.   Two Galleria
      Tower   13455 Noel Road, Suite
      1300   Dallas, TX 75240 | 943,779  (4)                | 9.6%               
|JP Morgan Chase Bank   1 Chase Manhattan
      Plaza   8th Floor   New
      York, NY 10081                                                | 540,043  (5)                | 5.5%               

|(1)                                                  | Beneficial ownership is determined in accordance with the
      rules of the Commission and generally includes voting or investment
      power with respect to securities. Except as indicated in the footnotes to
      this table and pursuant to applicable community property laws, the persons
      named in the table have shared voting and investment power with respect to
      all shares of Common Stock beneficially owned.                                                                                                      
|---------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|58
      SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
|(2)                                                  | Based on information included in a Form 4 filed with the
      Commission on March 17, 2003. Consists of (i) 1,180,778 shares
      beneficially held by Greenwich Street Capital Partners II, L.P., GSCP
      (NJ), L.P., GSCP (NJ), Inc., Greenwich Street Investments II, L.L.C., GSC
      Recovery II, L.P., GSC Recovery II GP, L.P., GSC Recovery, Inc., GSC
      Recovery IIA, L.P. and GSC Recovery IIA GP, L.P. and (ii) 750 shares that
      could be purchased pursuant to stock options.                                        
|(3)                                                  | Based on information included in a Form 4 filed with the
      Commission on March 13, 2003. Consists of (i) 1,020,859 shares
      beneficially held by The Foothill Group, Inc., Foothills Partners III,
      L.P., Stearns Family Trust 2001, Dennis R. Ascher, Jeffrey T. Nikora
      Family Trust, John F. Nickoll Living Trust, Foothill Income Trust, L.P.,
      FIT GP, LLC, Foothill Partners IV, L.P., and FP IV GP, LLC, and (ii) 750
      sharesthat could
      be purchased pursuant to stock options held by John F. Nickoll.
|(4)                                                  | Based on information included in a Form 3 filed with the
      Commission in January 2003 and the number of shares issued to Highland in
      February 2003 pursuant to our Plan of Reorganization. Consists of shares
      held by Highland Capital Management, L.P. and Highland Crusader Offshore
      Partners, L.P.                                                                                                                                                                                                                     
|(5)                                                  | Based on information included in a schedule 136 filed
      with the Commission in February 2003 and on the number of shares
      subsequently issued to J.P. Morgan Chase Bank in February 2003 pursuant to
      our Plan of Reorganization.                                                                                                                                                                                                                                                                                                 



|Plan
      Category                                                        |  | Number of securities
      to be issued upon 
 exercise ofoutstanding options,warrants and
      rights | Weighted average exercise price of outstanding
      options,warrants and rights | Number of securitiesremaining available forfuture
      issuance under equity compensation plans(excluding
      securitiesreflected in column (a))
|-------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|Equity compensation plans approved
          by security
    holders       |  | 800,000                                                                                                 |                                                                                  | $        27.00                                                                                                                                     
|Equity compensation plans not
          approved by security
      holders |  | -                                                                                                       |                                                                                  | -                                                                                                                                                  
|                                                                           |  |                                                                                                         |                                                                                  |                                                                                                                                                    
|Total                                                                      |  | 800,000                                                                                                 |                                                                                  | $        27.00                                                                                                                                     

Item 13. Certain Relationships and Related Transactions

Prior to Mr. Pendergest joining
us as Executive Vice President and Chief Financial Officer in March 2002, he
served as the court appointed examiner during our chapter 11 bankruptcy
proceedings. Mr. Pendergest provided these services as an independent contractor
of Crossroads, LLC, of which he had no ownership interest. The bankruptcy court
approved all of the payments made to Mr. Pendergest in his capacity as the
examiner. In addition to Mr. Pendergest, Crossroads provided other professionals
and consultants to assist with us. During 2002, we paid Crossroads a total of
approximately $148,709 for services rendered, plus expenses, inclusive of the
amounts paid for Mr. Pendergest's services.

Sanjay H. Patel is a member of
our Board of Directors and the Co-President of GSC Partners. Mr. Patel is a
managing member, executive officer, limited partner or shareholder of certain
entities affiliated with, or related to, other entities which, in the aggregate,
beneficially own more than 10% of our common stock (see "Item 10 - Directors and
Executive Officers of the Registrant" and "Item 12 - Security Ownership of
Certain Beneficial Owners and Management") or hold an aggregate of $10.4
million principal amount of indebtedness outstanding under our Loan
Agreements.

59

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

John F. Nickoll is a member of
our Board of Directors and the President, Chairman and Chief Executive Officer
of The Foothill Group, Inc. and the Managing Member of FIT GP, LLC, the General
Partner of Foothill Income Trust, L.P. Through its affiliates, The Foothill
Group, Inc. beneficially holds more than 10% of our common stock. See "Item 10 -
Directors and Executive Officers of the Registrant" and "Item 12 - Security
Ownership of Certain Beneficial Owners and Management." Foothill Income Trust
L.P. is a party to our Loan Agreements and as of March 12, 2003 we were indebted
to Foothill Income Trust L.P. under those agreements for approximately $13.9
million.

Highland Capital Management LP
beneficially holds approximately 9.6% of our common stock

PART IV

Item 14. Controls and Procedures

Our management, including our
Chief Executive Officer (who also serves as Chairman of the Board) and Chief
Financial Officer, conducted an evaluation of the effectiveness of disclosure
controls and procedures within the 90-day period prior to the filing of this
report pursuant to the Exchange Act Rule 13a-14. Disclosure controls and
procedures are designed to ensure that information required to be disclosed in
our periodic reports filed or submitted under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms. Based on that evaluation,
our Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures are effective. There have been no significant
changes in our internal controls, or in other factors that could significantly
affect internal controls, subsequent to the date we completed this evaluation.
We remain vigilant in our ongoing examination of our internal controls and
continue to make ongoing enhancements.

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a)  Financial Statements and Financial Statement
Schedules

(i) Financial Statements:

Report of
Ernst & Young, LLP, Independent Auditors

Report of
Independent Public Accountants

Report of
Independent Public Accountants

Consolidated
Balance Sheets as of December 31, 2002 and 2001

Consolidated
Statements of Operations for the ten months ended December 31, 2002,
two                months ended February
28, 2002 and years ended December 31, 2001 and 2000

Consolidated
Statements of Stockholders' Equity (Deficit) for the ten months ended December
               
31, 2002, two months ended
February 28, 2002 and years ended December 31, 2001 and
               
2000

Consolidated
Statements of Cash Flows for the ten months ended December 31, 2002,
two
                months ended February
28, 2002 and years ended December 31, 2001 and 2000
           Notes to
Consolidated Financial
Statements

60

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

(ii)  Financial Statement
Schedules:

Report
of Independent Public Accountants

Schedule II
Valuation and Qualifying Accounts for the years ended December
31,
                          2002,
2001 and 2000

(All other financial statement schedules required by
Rule 5-04 of Regulation S-X are not applicable or not
required).

(b)  Reports on Form 8-K

We did not file any Reports on Form 8-K
during the quarter ended December 31, 2002.

(c)  Exhibits

|ExhibitNumber                                        | Description of Exhibits                                                                                                                                                                                                                                                                                                   
|---------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                     |                                                                                                                                                                                                                                                                                                                           
|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(2)                                               | Form of Registration Rights Agreement among Sun
      Healthcare Group, Inc. and the parties named therein dated as of February
      28, 2002                                                                                                                                                                            
|                                                     |                                                                                                                                                                                                                                                                                                                           
|4.2(1)                                               | Warrant Agreement dated February 28, 2002 between Sun
      Healthcare Group, Inc. and American Stock Transfer & Trust
      Company                                                                                                                                                                                      
|                                                     |                                                                                                                                                                                                                                                                                                                           
|4.3(1)                                               | Sample Common Stock Certificate of Sun Healthcare Group,
      Inc.                                                                                                                                                                                                                                                       
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.1(2)                                              | Loan and Security Agreement dated February 28, 2002 among
      Sun Healthcare Group, Inc. and certain of its subsidiaries as Borrowers,
      Heller Healthcare Finance, Inc., as Collateral Agent and Lender, Citicorp,
      USA, Inc., as Administrative Agent and Lender and certain other lending
      institutions
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.2(2)                                              | Term Loan and Note Purchase Agreement dated February 28,
      2002 among Sun Healthcare Group, Inc. and certain of its subsidiaries as
      Borrowers, U.S. Bank as Administrative Agent and certain other lending
      institutions                                                                                   
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.3(2)                                              | 2002 Management Equity Incentive Plan of Sun Healthcare
      Group, Inc.                                                                                                                                                                                                                                                 
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.4(2)                                              | Form of Expense Indemnification Agreement between Sun
      Healthcare Group, Inc. and certain former and current directors and
      officers                                                                                                                                                                            
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.5(2)                                              | Form of Severance Agreement with Chauncey J.
      Hunker                                                                                                                                                                                                                                                                 
|61
      SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
|10.6(3)                                              | Joint Plan of Reorganization dated December 18,
      2001                                                                                                                                                                                                                                                                
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.6.1(3)                                            | Amendments to Joint Plan of
  Reorganization                                                                                                                                                                                                                                                                              
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.7(3)                                              | Disclosure Statement dated December 18,
  2001                                                                                                                                                                                                                                                                            
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.8(2)                                              | Employment Agreement with Richard K. Matros dated
      February 28, 2002                                                                                                                                                                                                                                                 
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.9(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                                                                                                                                       
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.10(4)                                             | Employment Agreement with Kevin W. Pendergest dated
      February 28, 2002                                                                                                                                                                                                                                               
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.11(4)                                             | Employment Agreement with William A. Mathies dated
      February 28, 2002                                                                                                                                                                                                                                                
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.12(4)                                             | Employment Agreement with Steven A. Roseman dated May 22,
      2002                                                                                                                                                                                                                                                      
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.13*                                               | Employment Agreement with Heidi J. Fisher dated February
      11, 2002                                                                                                                                                                                                                                                   
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.14(5)                                             | Intercreditor Agreement dated February 28, 2002 by and
      among Sun Healthcare Group, Inc. and its subsidiaries named therein, US
      Bank, National Association, Citicorp USA, Inc., and Heller Healthcare
      Finance, Inc.                                                                                      
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.15(4)                                             | Amended and Restated 2002 Non-Employee Director Equity
      Incentive Plan of Sun Healthcare Group, Inc.                                                                                                                                                                                                                 
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.16*                                               | Severance Agreement with John W. Driscoll dated January
      8, 2003                                                                                                                                                                                                                                                     
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.17*                                               | Severance Agreement with Jennifer Clarke dated January
      30, 2003                                                                                                                                                                                                                                                     
|                                                     |                                                                                                                                                                                                                                                                                                                           
|10.18*                                               | Severance Agreement with Mary Ousley dated March 29,
      2002                                                                                                                                                                                                                                                           
|                                                     |                                                                                                                                                                                                                                                                                                                           
|21*                                                  | Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                            
|                                                     |                                                                                                                                                                                                                                                                                                                           
|99.1*                                                | Written Statement of Chief Executive
  Officer                                                                                                                                                                                                                                                                            
|                                                     |                                                                                                                                                                                                                                                                                                                           
|99.2*                                                | Written Statement of Chief Financial
  Officer                                                                                                                                                                                                                                                                            

_______________

*       Filed
herewith.

(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 dated February 28, 2002, as amended on Form
8-K/A.

62

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

(4) Incorporated by reference from exhibits to our Form
10-Q filed on August 15, 2002.

(5) Incorporated by reference from exhibits to our Form 10-Q
filed on May 15, 2002.

63

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

SIGNATURES



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

March 26, 2003

64

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

POWER OF ATTORNEY

Each person whose signature
appears below hereby appoints each of Richard K. Matros and Michael T. Berg as
his attorney-in-fact, to sign this Report on his or her behalf, individually and
in the capacity stated below, and to file all supplements and amendments to this
Report and any and all instruments or documents filed as a part of or in
connection with this Report or any amendment or supplement thereto, and any such
attorney-in-fact may make such changes and additions to this Report as such
attorney-in-fact may deem necessary or appropriate.

Pursuant to the requirements of
the Securities Exchange Act of 1934, this Report has been signed below by the
following persons on behalf of the registrant as of March 26, 2003 in the
capacities indicated.

|Signatures                                                    | Title                                                                                   
|------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|                                                              |                                                                                         
|/s/ Richard K.
      Matros           Richard
      K. Matros | Chairman of the Board and Chief Executive Officer(Principle
      Executive Officer)    
|                                                              |                                                                                         
|/s/ Kevin W. Pendergest   Kevin W. Pendergest                 | Executive Vice President and Chief Financial Officer (Principal
      Financial Officer)
|                                                              |                                                                                         
|/s/ Jennifer L.
      Botter   Jennifer
      L. Botter       | Vice President and Corporate Controller(Principal Accounting
      Officer)             
|                                                              |                                                                                         
|/s/ John W.
      Adams
        John W. Adams                 | Director                                                                                
|                                                              |                                                                                         
|/s/ Gregory S. Anderson
        Gregory S. Anderson           | Director                                                                                
|                                                              |                                                                                         
|/s/ Charles W. McQueary
        Charles W. McQueary           | Director                                                                                
|                                                              |                                                                                         
|/s/ John F. Nickoll
        John F. Nickoll                   | Director                                                                                
|                                                              |                                                                                         
|/s/ Sanjay H.
      Patel
        Sanjay H. Patel             | Director                                                                                
|                                                              |                                                                                         
|/s/ Bruce C.
      Vladek   Bruce
      C. Vladek             | Director                                                                                
|65
      SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES         
|/s/ Steven L.
      Volla   Steven
      L. Volla             | Director                                                                                
|                                                              |                                                                                         
|/s/ Milton J.
      Walters   Milton
      J. Walters         | Director                                                                                
|                                                              |                                                                                         

66

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY
ACT OF 2002

I, Richard K. Matros, certify that:

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

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

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

4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:

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

b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;

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

a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have
indicated in this annual report whether there were significant changes in
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

|Date: March 26, 2003 | /s/ Richard K.
      Matros                    
|-------------------- | -----------------------------------------------
|                     | Richard K. Matros
      Chief Executive Officer

67

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY
ACT OF 2002

I, Kevin W. Pendergest, certify that:

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

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

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

4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:

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

b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;

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

a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have
indicated in this annual report whether there were significant changes in
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.



|Date: March 26, 2003 | /s/ Kevin W. Pendergest                                                             
|-------------------- | ------------------------------------------------------------------------------------
|                     | Kevin W. Pendergest
      Executive Vice President and Chief Financial
      Officer

68

---

SUN HEALTHCARE GROUP, INC.  AND SUBSIDIARIES

Index to Consolidated Financial Statements

December 31, 2002

|                                                                       | Page        
|---------------------------------------------------------------------- | ------------
|                                                                       |             
|Report of Ernst & Young, LLP, Independent Auditors                     | F-2         
|Report of Independent Public Accountants                               | F-3         
|Report of Independent Public Accountants                               | F-4         
|                                                                       |             
|Consolidated Balance Sheets                                            |             
|Reorganized Company - as of December 31,
      2002                    | F-5         
|Predecessor Company - as of December 31,
      2001                    | F-5         
|                                                                       |             
|Consolidated Statements of Operations                                  |             
|Reorganized Company - for the ten months
      ended December 31, 2002 | F-7         
|Predecessor Company - for the two months
      ended February 28, 2002 | F-7         
|Predecessor Company - for the year ended
      December 31, 2001       | F-7         
|Predecessor Company - for the year ended
      December 31, 2000       | F-7         
|                                                                       |             
|Consolidated Statements of Stockholders' Equity (Deficit)              |             
|Reorganized Company - for the ten months
      ended December 31, 2002 | F-8         
|Predecessor Company - for the two months
      ended February 28, 2002 | F-8         
|Predecessor Company - for the year ended
      December 31, 2001       | F-8         
|Predecessor Company - for the year ended
      December 31, 2000       | F-8         
|                                                                       |             
|Consolidated Statements of Cash Flows                                  |             
|Reorganized Company - for the ten months
      ended December 31, 2002 | F-9         
|Predecessor Company - for the two months
      ended February 28, 2002 | F-9         
|Predecessor Company - for the year ended
      December 31, 2001       | F-9         
|Predecessor Company - for the year ended
      December 31, 2000       | F-9         
|                                                                       |             
|Notes to Consolidated Financial Statements                             | F-10 to F-59
|                                                                       |             
|Supplementary Data (Unaudited) - Quarterly Financial Data              | 1           

F-1

---

Report of Ernst & Young LLP, Independent Auditors

Board of Directors and Stockholders
Sun Healthcare Group, Inc.

We have audited the accompanying
consolidated balance sheet of Sun Healthcare Group, Inc. and subsidiaries (the
"Company") as of December 31, 2002, and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for the ten month
period then ended. Our audit also included the financial statement schedule
listed in the Index at Item 15(a) for the ten month period ended December 31, 2002.
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audit. The consolidated financial statements
of the
Company (i) as of December 31, 2001 and for the two year period then ended and
(ii) for the two month period ended February 28, 2002 were audited by other
auditors who have ceased operations and whose reports dated March 18, 2002 and
April 29, 2002, respectively, expressed unqualified opinions on those financial
statements.

We conducted our audit in
accordance with auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.

In our opinion, the December 31,
2002 financial statements referred to above present fairly, in all material
respects, the consolidated financial condition of Sun Healthcare Group, Inc. and
subsidiaries as of December 31, 2002, and the consolidated results of their
operations and their cash flows for the ten month period then ended, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion the related financial statement schedule, when considered
in relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth
therein.

The accompanying consolidated
financial statements of the Company as of December 31, 2002, and for the ten
month period then ended have been prepared assuming that the Company will
continue as a going concern. As more fully described in Note 2 to the
consolidated financial statements, the Company reported a net loss from operations of $438.0
million for the ten month period ended December 31,
2002, and has a negative working capital deficiency of $74.2 million and a net
capital deficiency of $187.2 million at December 31, 2002.   These factors raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also discussed in Note 2. These financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
might result from the outcome of this uncertainty.

/s/ Ernst & Young LLP

Dallas, Texas
March 21, 2003

F-2

---

NOTE: The following report is a copy of a report previously issued by Arthur
Andersen LLP and has not been reissued by Arthur Andersen LLP.

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors of Sun Healthcare
Group, Inc.:

We have audited the accompanying consolidated balance sheets of
Sun Healthcare Group, Inc. (Debtor-in-Possession) (a Delaware corporation) and
subsidiaries as of December 31, 2001 and 2000, and the related consolidated
statements of losses, stockholders' deficit and cash flows for each of the three
years in the period ended December 31, 2001. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards
generally accepted in the United States. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial position of Sun
Healthcare Group, Inc. (Debtor-in-Possession) and subsidiaries as of December
31, 2001 and 2000, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2001, in conformity
with accounting principles generally accepted in the United States.



/s/ Arthur Andersen
LLP         ARTHUR ANDERSEN LLP

Albuquerque, New MexicoMarch 18, 2002

F-3

---

NOTE: The following report is a copy of a report previously issued by Arthur
Andersen LLP and has not been reissued by Arthur Andersen LLP.

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of
Sun Healthcare Group, Inc.:

We have audited the accompanying
consolidated balance sheet of Sun Healthcare Group, Inc. (a Delaware
corporation) and subsidiaries (the "Company") as of March 1, 2002, and the
related consolidated statements of income (loss), stockholders' equity and cash
flows for the two months ended February 28, 2002 (pre-confirmation). These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.

We conducted our audit in
accordance with auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

As discussed in Note 1 to the
consolidated financial statements, effective February 28, 2002, the Company was
reorganized under a plan confirmed by the United States Bankruptcy Court for the
District of Delaware and adopted a new basis of accounting whereby all remaining
assets and liabilities were adjusted to their estimated fair values.
Accordingly, the consolidated financial statements for periods subsequent to the
reorganization are not comparable to the consolidated financial statements
presented for prior periods.

In our opinion, the consolidated
financial statements referred to above present fairly, in all material aspects,
the financial position of Sun Healthcare Group, Inc. and subsidiaries as of
March 1, 2002, and the results of their operations and their cash flows for the
two months ended February 28, 2002, in conformity with accounting principles
generally accepted in the United States.

/s/  Arthur Andersen
LLP         Arthur Andersen
LLP

Albuquerque, New MexicoApril 29, 2002

F-4

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS(in thousands)

|                                                                                                                                                | Reorganized Company | |
      | | Predecessor Company | 
|----------------------------------------------------------------------------------------------------------------------------------------------- | ------------------- | --------- | ------------------- | 
|                                                                                                                                                | December 31, 2002   | |         | December 31, 2001   | 
|                                                                                                                                                |                     | |         |                     | 
|Current assets:                                                                                                                                 |                     | |         |                     | 
|Cash and cash equivalents                                                                                                                       | $            21,013 | |         | $         50,649    | 
|Accounts receivable, net of allowance for doubtful accounts
      of $45,905 and      $73,819 at December 31, 2002 and 2001,
      respectively | 227,929             | |
      | | 204,733             | 
|Inventories, net                                                                                                                                | 21,846              | |         | 20,415              | 
|Other receivables, net of allowance of $1,174 and $2,566 at
      December 31, 2002     and 2001, respectively                                  | 4,762               | |
      | | 9,556               | 
|Assets held for sale                                                                                                                            | 6,333               | |         | -                   | 
|Restricted cash                                                                                                                                 | 76,739              | |         | -                   | 
|Prepaids and other assets                                                                                                                       | 12,437              | |         | 5,653               | 
|                                                                                                                                                |                     | |         |                     | 
|Total current assets                                                                                                                            | 371,059             | |         | 291,006             | 
|                                                                                                                                                |                     | |         |                     | 
|Property and equipment, net                                                                                                                     | 67,714              | |         | 133,216             | 
|Assets held for sale                                                                                                                            | -                   | |         | 18,158              | 
|Notes receivable, net of allowance of $5,245 and $3,650 at December 31,
      2002
          and 2001, respectively                             | 1,506               | |
      | | 4,895               | 
|Goodwill, net                                                                                                                                   | 3,894               | |         | 177,202             | 
|Other assets, net                                                                                                                               | 31,662              | |         | 25,327              | 
|Total assets                                                                                                                                    | $         475,835   | |         | $       649,804     | 
|                                                                                                                                                | =========           | |         | ========            | 

See accompanying notes.

F-

---

SUN HEALTHCARE GROUP, INC. AND
SUBSIDIARIESCONSOLIDATED BALANCE SHEETS (Continued)

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

|                                                                                                                                                                                                              | ReorganizedCompany    |   |     | PredecessorCompany |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------- | - | --- | ------------------ | -
|                                                                                                                                                                                                              | December 31, 2002     |   | |   | December 31, 2001  |  
|Current liabilities:                                                                                                                                                                                          |                       |   | |   |                    |  
|Current portion of long-term debt                                                                                                                                                                             | $             124,183 |   | |   | $          54,975  |  
|Accounts payable                                                                                                                                                                                              | 63,728                |   | |   | 30,335             |  
|Accrued compensation and benefits                                                                                                                                                                             | 66,723                |   | |   | 79,328             |  
|Accrued self-insurance obligations                                                                                                                                                                            | 116,010               |   | |   | 47,097             |  
|Income taxes payable                                                                                                                                                                                          | 12,700                |   | |   | 12,430             |  
|Other accrued liabilities                                                                                                                                                                                     | 61,959                |   | |   | 80,100             |  
|                                                                                                                                                                                                              |                       |   | |   |                    |  
|Total current liabilities                                                                                                                                                                                     | 445,303               |   | |   | 304,265            |  
|                                                                                                                                                                                                              |                       |   | |   |                    |  
|Liabilities subject to compromise                                                                                                                                                                             | -                     |   | |   | 1,549,139          |  
|Accrued self-insurance obligations, net of current
portion                                                                                                                                                    | 65,876                |   | |   | 51,380             |  
|Long-term debt, net of current portion                                                                                                                                                                        | 72,040                |   | |   | 23,260             |  
|Unfavorable lease obligations                                                                                                                                                                                 | 56,526                |   | |   | -                  |  
|Other long-term liabilities                                                                                                                                                                                   | 23,028                |   | |   | 22,544             |  
|                                                                                                                                                                                                              |                       |   | |   |                    |  
|Total liabilities                                                                                                                                                                                             | 662,773               |   | |   | 1,950,588          |  
|                                                                                                                                                                                                              |                       |   | |   |                    |  
|Commitments and contingencies                                                                                                                                                                                 |                       |   | |   |                    |  
|                                                                                                                                                                                                              |                       |   | |   |                    |  
|Minority interest                                                                                                                                                                                             | 280                   |   | |   | 5,405              |  
|                                                                                                                                                                                                              |                       |   | |   |                    |  
|Company-obligated mandatory redeemable convertible preferred securities
         of a subsidiary trust holding solely 7%
      convertible junior subordinated    debentures of
      the Predecessor Company | -                     |   | ||| | 296,101            |  
|                                                                                                                                                                                                              |                       |   | |   |                    |  
|Stockholders' equity (deficit):                                                                                                                                                                               |                       |   | |   |                    |  
|Reorganized Company preferred stock of $.01 par
      value, authorized      10,000,000 shares,
      zero shares were issued and outstanding as of
           December 31, 2002.                             | -                     |   | ||| | -                  |  
|Reorganized Company common stock of $.01 par value,
      authorized      50,000,000 shares, 9,321,020
      shares issued and outstanding as of December 31,
           2002.                                | 93                    |   | ||| | -                  |  
|Predecessor Company common stock of $.01 par value,
      authorized     155,000,000 shares,
      65,209,188  shares issued and     outstanding
      as of December 31, 2001                                | -                     |   | ||| | 652                |  
|Additional paid-in capital                                                                                                                                                                                    | 253,375               |   | |   | 825,099            |  
|Accumulated deficit                                                                                                                                                                                           | (437,986              | ) | |   | (2,400,655         | )
|                                                                                                                                                                                                              | (184,518              | ) | |   | (1,574,904         | )
|Less:                                                                                                                                                                                                         |                       |   | |   |                    |  
|Unearned compensation                                                                                                                                                                                         | (2,700                | ) | |   | -                  |  
|Predecessor Company common stock held in
            treasury, at cost, 2,213,537
      shares as of December 31, 2001                                                                                        | -                     |   | ||  | (27,376            | )
|Predecessor Company grantor stock trust, at
      market, 1,915,935 shares as      of
      December 31, 2001                                                                                                 | -                     |   | ||  | (10                | )
|Total stockholders' deficit                                                                                                                                                                                   | (187,218              | ) | |   | (1,602,290         | )
|Total liabilities and stockholders' equity
      (deficit)                                                                                                                                                    | $           475,835   |   | |   | $        649,804   |  
|                                                                                                                                                                                                              | =============         |   | |   | ===========        |  

See accompanying notes.

F-

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share amounts)



|                                                                                                                                                                                                                                        | ReorganizedCompany                                |   |             | Predecessor Company                               |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------- | - | ----------- | ------------------------------------------------- | -
|                                                                                                                                                                                                                                        | For the Ten Months Ended December 31,

      2002 |   |             | For the Two Months Ended February 28,

      2002 |  
|                                                                                                                                                                                                                                        |                                                   |   | |           |                                                   |  
|Total net revenues                                                                                                                                                                                                                      | $1,598,194                                        |   | |           | $301,846                                          |  
|Costs and expenses:                                                                                                                                                                                                                     |                                                   |   | |           |                                                   |  
|Operating costs                                                                                                                                                                                                                         | 1,499,127                                         |   | |           | 285,116                                           |  
|Corporate general and administrative                                                                                                                                                                                                    | 81,030                                            |   | |           | 15,862                                            |  
|Depreciation and amortization                                                                                                                                                                                                           | 28,405                                            |   | |           | 4,465                                             |  
|Provision for losses on accounts receivable                                                                                                                                                                                             | 14,787                                            |   | |           | 417                                               |  
|Loss on asset impairment                                                                                                                                                                                                                | 407,760                                           |   | |           | -                                                 |  
|Interest, net (contractual interest expense of $23,730 for
      the
          two months ended February 28, 2002, and $142,800 and 
          $146,406 for the twelve months ended December 31, 2001 and
          2000, respectively) | 13,375                                            |   | |||
      | | 2,672                                             |  
|Legal and regulatory matters, net                                                                                                                                                                                                       | -                                                 |   | |           | -                                                 |  
|Restructuring costs (gain), net                                                                                                                                                                                                         | -                                                 |   | |           | -                                                 |  
|Gain on sale of assets, net                                                                                                                                                                                                             | (8,714                                            | ) | |           | -                                                 |  
|Total costs and expenses                                                                                                                                                                                                                | 2,035,770                                         |   | |           | 308,532                                           |  
|Loss before reorganization costs (gain), net, income taxes,
          discontinued operations and extraordinary
      item                                                                                                              | (437,576                                          | ) | ||          | (6,686                                            | )
|Reorganization costs (gain), net                                                                                                                                                                                                        | -                                                 |   | |           | (1,483                                            | )
|Loss before income taxes, discontinued operations and extraordinary
      item                                                                                                                                                          | (437,576                                          | ) | |           | (5,203                                            | )
|Income taxes                                                                                                                                                                                                                            | 410                                               |   | |           | 147                                               |  
|Loss before discontinued operations and extraordinary
item                                                                                                                                                                              | (437,986                                          | ) | |           | (5,350                                            | )
|                                                                                                                                                                                                                                        |                                                   |   | |           |                                                   |  
|Discontinued Operations:                                                                                                                                                                                                                |                                                   |   | |           |                                                   |  
|Loss from discontinued operations                                                                                                                                                                                                       | -                                                 |   | |           | (1,569                                            | )
|Loss on write-down of assets held for
    sale                                                                                                                                                                                          | -                                                 |   | |           | (6,070                                            | )
|Loss on discontinued operations                                                                                                                                                                                                         | -                                                 |   | |           | (7,639                                            | )
|                                                                                                                                                                                                                                        |                                                   |   | |           |                                                   |  
|Loss before extraordinary item                                                                                                                                                                                                          | (437,986                                          | ) | |           | (12,989                                           | )
|Extraordinary gain on extinguishment of debt, net                                                                                                                                                                                       | -                                                 |   | |           | 1,498,360                                         |  
|Net (loss) income                                                                                                                                                                                                                       | $          (437,986                               | ) | |           | $      1,485,371                                  |  
|                                                                                                                                                                                                                                        | ========                                          |   | |           | ========                                          |  
|Net (loss) income per common and common equivalent share:                                                                                                                                                                               |                                                   |   | |           |                                                   |  
|Loss before discontinued operations and extraordinary
      item                                                                                                                                                                        |                                                   |   | |           |                                                   |  
|                                                                                                                                                                                                                                        |                                                   |   | |           |                                                   |  
|Basic and diluted                                                                                                                                                                                                                       | $              (43.80                             | ) | |           | $               (.09                              | )
|                                                                                                                                                                                                                                        | =======                                           |   | |           | =======                                           |  
|Net (loss) income:                                                                                                                                                                                                                      |                                                   |   | |           |                                                   |  
|                                                                                                                                                                                                                                        |                                                   |   | |           |                                                   |  
|Basic and diluted                                                                                                                                                                                                                       | $              (43.80                             | ) | |           | $              24.32                              |  
|                                                                                                                                                                                                                                        | =======                                           |   | |           | =======                                           |  
|Weighted average number of common and common equivalent shares
      outstanding:                                                                                                                                                       |                                                   |   | ||          |                                                   |  
|                                                                                                                                                                                                                                        |                                                   |   | |           |                                                   |  
|Basic and diluted                                                                                                                                                                                                                       | 10,000                                            |   | |           | 61,080                                            |  
|                                                                                                                                                                                                                                        | =======                                           |   | |           | =======                                           |  



F-7

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)(in
thousands)

|                                                                                                                  | Reorganized Company                           | Predecessor Company                           
|----------------------------------------------------------------------------------------------------------------- | --------------------------------------------- | ----------------------------------------------
|                                                                                                                  | For the Ten MonthsEnded December 31,
    2002 | For the Two Months Ended February 28,
    2002
|                                                                                                                  | Shares                                        |                                               
|Common Stock                                                                                                      |                                               |                                               
|Issued and outstanding at
beginning of period                                                                     | 8,800                                         |                                               
|Elimination of common stock                                                                                       | -                                             |                                               
|Conversion of 7%
          Convertible Trust
          Issued Preferred
      Securities                          | -                                             |                                               
|Cancellation of Restricted
          Stock Awards                                                                 | -                                             |                                               
|Issuance of common stock                                                                                          | 521                                           |                                               
|Common Stock Issued
          and outstanding at
          end of period                                          | 9,321                                         |                                               
|                                                                                                                  | =========                                     |                                               
|Additional Paid-in Capital                                                                                        |                                               |                                               
|Balance at beginning of period                                                                                    |                                               |                                               
|Other                                                                                                             |                                               |                                               
|Elimination of additional
          paid-in capital                                                               |                                               |                                               
|Conversion of 7%
          Convertible Trust Issued
          Preferred
      Securities                          |                                               |                                               
|Adjustment to market 
          value of common stock
          held by the Grantor Stock
          Trust         |                                               |                                               
|Issuance of common stock
            in excess of par value                                                       |                                               |                                               
|Cancellation of Restricted
            Stock Awards                                                               |                                               |                                               
|Additional paid-in capital
          at end of period                                                             |                                               |                                               
|                                                                                                                  |                                               |                                               
|Accumulated Deficit                                                                                               |                                               |                                               
|Balance at beginning of
          period                                                                          |                                               |                                               
|Net (loss) income                                                                                                 |                                               |                                               
|Elimination of accumulated
          deficit                                                                      |                                               |                                               
|Accumulated deficit at
         end of period                                                                     |                                               |                                               
|                                                                                                                  |                                               |                                               
|Accumulated OtherComprehensive Loss                                                                               |                                               |                                               
|Balance at beginning of period                                                                                    |                                               |                                               
|Foreign currency translation
  adjustment, net of tax                                                             |                                               |                                               
|Accumulated othercomprehensive loss
         at end of period                                                     |                                               |                                               
|Total                                                                                                             |                                               |                                               
|                                                                                                                  |                                               |                                               
|Unearned Compensation                                                                                             |                                               |                                               
|Balance at beginning of period                                                                                    |                                               |                                               
|Restricted Stock Awards                                                                                           |                                               |                                               
|Restricted stock vested                                                                                           |                                               |                                               
|Unearned compensation

      at end of period                                                                     |                                               |                                               
|                                                                                                                  |                                               |                                               
|Common Stock in

      Treasury                                                                                   |                                               |                                               
|Balance at beginning of period                                                                                    |                                               |                                               
|Elimination of treasury stock                                                                                     |                                               |                                               
|Common stock in

      treasury at end of
           period                                                       |                                               |                                               
|                                                                                                                  |                                               |                                               
|Grantor Stock Trust                                                                                               |                                               |                                               
|Balance at beginning of period                                                                                    |                                               |                                               
|Elimination of grantor stock

      
  trust                                                                      |                                               |                                               
|Adjustment to market value

      
  
      of common stock
          held by the Grantor Stock  
          Trust |                                               |                                               
|Grantor stock trust at

      end of period                                                                       |                                               |                                               
|                                                                                                                  |                                               |                                               
|Total stockholders' equity

      (deficit)                                                                       |                                               |                                               
|                                                                                                                  |                                               |                                               

See accompanying notes.

F-8

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS(in
thousands)



|                                                                                                                   | ReorganizedCompany                               |   |           | Predecessor Company                                  
|------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------ | - | --------- | -----------------------------------------------------
|                                                                                                                   | For the Ten
      Months Ended
 December 31,2002 |   |           | For the Two
      Months Ended
      February 28,2002
|Cash flows from operating activities:                                                                              |                                                  |   | |         |                                                      
|Net (loss) income                                                                                                  | $(437,986                                        | ) | |         | $1,485,371                                           
|Adjustments to reconcile net (loss) income to net cash
         (used for)
      provided by operating activities: |                                                  |   | ||        |                                                      
|Extraordinary gain on extinguishment of debt,
      net                                                            | -                                                |   | |         | (1,498,360                                           
|Reorganization costs (gain), net                                                                                   | -                                                |   | |         | (1,483                                               
|Depreciation and amortization                                                                                      | 28,405                                           |   | |         | 4,465                                                
|Amortization
      of favorable and unfavorable lease
            intangibles                                      | (2,535                                           | ) |           | -                                                    
|Provision for losses on accounts
    receivable                                                                    | 14,787                                           |   | |         | 417                                                  
|Gain on sale of assets, net                                                                                        | (8,714                                           | ) | |         | -                                                    
|Loss on write-down of assets held for
    sale                                                                     | -                                                |   | |         | 6,070                                                
|Loss on asset impairment                                                                                           | 407,760                                          |   | |         | -                                                    
|Legal and regulatory matters, net                                                                                  | -                                                |   | |         | -                                                    
|Restricted
      Stock Compensation                                                                                | 1,350                                            |   | |         | -                                                    
|Other, net                                                                                                         | 1,320                                            |   | |         | 716                                                  
|Changes in operating assets and liabilities:                                                                       |                                                  |   | |         |                                                      
|Accounts receivable, net                                                                                           | (15,797                                          | ) | |         | (7,368                                               
|Inventories, net                                                                                                   | (1,748                                           | ) | |         | (473                                                 
|Other receivables, net                                                                                             | -                                                |   | |         | 819                                                  
|Restricted cash                                                                                                    | (1,373                                           | ) | |         | (4,430                                               
|Prepaids and other assets                                                                                          | (5,575                                           | ) | |         | (2,391                                               
|Accounts payable                                                                                                   | 28,210                                           |   | |         | (8,601                                               
|Accrued compensation and benefits                                                                                  | (6,708                                           | ) | |         | (1,792                                               
|Accrued self-insurance obligations                                                                                 | 13,094                                           |   | |         | (4,094                                               
|Income taxes payable                                                                                               | (498                                             | ) | |         | 693                                                  
|Other accrued liabilities                                                                                          | (20,114                                          | ) | |         | (2,793                                               
|Liabilities subject to compromise                                                                                  | -                                                |   | |         | 10,865                                               
|Accrued self-insurance obligations, net of current
      portion                                                   | -                                                |   | |         | 3,150                                                
|Unfavorable lease obligations                                                                                      | -                                                |   | |         | (101                                                 
|Other long-term liabilities                                                                                        | (408                                             | ) | |         | (2,004                                               
|Minority interest                                                                                                  | (563                                             | ) | |         | 362                                                  
|Net cash (used for) provided by
      operating activities
               before reorganization costs              | (7,093                                           | ) | |
      | | (20,962                                              
|Net cash paid for reorganization
      costs                                                                       | (10,321                                          | ) | |         | (2,781                                               
|Net cash (used for) provided by
      provided by operating
              activities                               | (17,414                                          | ) | |
      | | (23,743                                              
|Cash flows from investing activities:                                                                              |                                                  |   | ||        |                                                      
|Capital expenditures, net                                                                                          | (34,701                                          | ) | |         | (3,971                                               
|Proceeds from sale of assets held for
    sale                                                                     | 17,885                                           |   | |         | -                                                    
|Proceeds from redemption of strategic
      investment                                                             | -                                                |   | |         | -                                                    
|Repayment (issuance) of long-term notes
      receivable                                                           | 1,067                                            |   | |         | 168                                                  
|Other, net                                                                                                         | 798                                              |   | |         | 142                                                  
|Net cash (used for) provided by
      investing activities                                                         | (14,951                                          | ) | |         | (3,661                                               
|Cash flows from financing activities:                                                                              |                                                  |   | ||        |                                                      
|Net (payments) borrowings under Revolving Credit
          Agreement                                               | (10,958                                          | ) | |
      | | -                                                    
|Net
      (payments) borrowings under DIP Financing                                                                | -                                                |   | |         | (55,382                                              
|Long-term debt borrowings                                                                                          | -                                                |   | |         | 112,988                                              
|Long-term debt repayments                                                                                          | (4,396                                           | ) | |         | (13                                                  
|Principal payments on prepetition debt authorized by
           Bankruptcy Court                                   | -                                                |   | |
      | | (7,966                                               
|Other, net                                                                                                         | (412                                             | ) | |         | (3,728                                               
|Net cash (used for) provided by
      financing activities                                                         | (15,766                                          | ) | |         | 45,899                                               
|Effect of exchange rate on cash and cash equivalents                                                               | -                                                |   | |         | -                                                    
|Net (decrease) increase in cash and cash equivalents                                                               | (48,131                                          | ) | |         | 18,495                                               
|Cash and cash equivalents at beginning of period                                                                   | 69,144                                           |   | |         | 50,649                                               
|Cash and cash equivalents at end of period                                                                         | $                    21,013                      |   | |         | $               69,144                               
|                                                                                                                   | ==============                                   |   | |         | ============                                         

See accompanying notes.

F-9

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2002

(1)  Nature of Business

References throughout this
document to the Company include Sun Healthcare Group, Inc. and our consolidated
subsidiaries.

Business



Reorganization

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

We operated our business as a
debtor-in-possession subject to the jurisdiction of the Bankruptcy Court from
October 14, 1999 (the "Filing Date") until February 28, 2002. Accordingly, our
consolidated financial statements prior to March 1, 2002 have been prepared in
accordance with the American Institute of Certified Public Accountants Statement
of Position 90-7, "Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code" (SOP 90-7) and generally accepted accounting principles
applicable to a going concern, which assume that assets will be realized and
liabilities will be discharged in the normal course of business.

In connection with our emergence
from bankruptcy, we reflected the terms of the Plan of Reorganization in our
consolidated financial statements by adopting the fresh-start accounting
provisions of SOP 90-7. Under fresh-start accounting, a new reporting entity is
deemed to be created and the recorded amounts of assets and liabilities are
adjusted to reflect their estimated fair values. For accounting purposes, the
fresh-start adjustments have been recorded in the consolidated financial
statements as of March 1, 2002. Since fresh-start accounting materially changed
the amounts previously recorded in our consolidated financial statements, a
black line separates the post-emergence financial data from the pre-emergence
data to signify the difference in the basis of preparation of the financial
statements for each respective entity. See Notes 17, 18 and 19 for additional
information about our emergence from bankruptcy and fresh-start accounting.

F-10

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

As used in this Form 10-K, the term
"Predecessor Company" refers to our operations for periods prior to March 1,
2002, while the term "Reorganized Company" is used to describe our operations
for periods beginning March 1, 2002 and thereafter.

Comparability of Financial Information

The adoption of fresh-start accounting as of
March 1, 2002 materially changed the amounts previously recorded in the
consolidated financial statements of the Predecessor Company. With respect to
reported operating results, we believe that business segment operating income of
the Predecessor Company is generally comparable to that of the Reorganized
Company. However, capital costs (rent, interest, depreciation and amortization)
of the Predecessor Company that were based on pre-petition contractual
agreements and historical costs are not comparable to those of the Reorganized
Company. In addition, the reported financial position, results of operations and
cash flows of the Predecessor Company for periods prior to March 1, 2002
generally are not comparable to those of the Reorganized Company.

Our consolidated financial
statements as of December 31, 2002, and for the ten month period then ended have
been prepared under accounting principles generally accepted in the United
States assuming that we will continue as a going concern. We recorded a net loss
and had negative cash flows from operations of $438.0 million and $17.4 million,
respectively, for the ten month period ended December 31, 2002. We have negative
working capital and a stockholders' deficit of $74.2 million and $187.2 million,
respectively, at December 31, 2002. Our net loss was primarily the result of a
$407.8 million impairment charge recorded during the fourth quarter of 2002 (See
Note 7). In addition, we are not in compliance with financial covenants on
certain long-term debt obligations totaling $121.7 at December 31, 2002 (See
Notes 4 and 5). Accordingly, we have classified these debt obligations as current
liabilities in the accompanying consolidated balance sheet as of December 31,
2002. We are also in non-compliance with certain financial covenants contained
in certain lease agreements for 32 of our long-term care facilities at December
31, 2002, which gives the lessors the right to require us to relinquish leased
facilities.

We have initiated restructuring
efforts pursuant to which we are seeking to obtain rent concessions with respect
to certain facilities that we operate, and to transition our operations of
certain underperforming facilities to new operators. To date, we have identified
approximately 56% of our facilities that we would seek to transition to new
operators if we are unable to obtain satisfactory rent concessions on the
facilities. Through March 21, 2003, we have withheld approximately $18.9 million
in accrued rent and mortgage payments with respect to those facilities. They are
classified as current obligations in 2003. We have also classified three
mortgages as current obligations at December 31, 2002. We can give no assurance
that the landlords and lenders will not seek to exercise their remedies under
their respective leases and mortgages, including the potential acceleration of
the principal and interest. Additionally we will be required to compute
outstanding interest under the mortgages using an "Advance Rate" of 18%, which
represents the default rate of interest.

We currently do not have adequate
liquidity or available sources of financing to meet our contractual obligations
(including operating lease commitments) and settle our other liabilities in
2003. If we are unable to generate sufficient cash flow levels, there is a
substantial prospect that we and/or one of more of our subsidiaries would be
required to seek protection under the U.S. Bankruptcy Code. These factors raise
substantial doubt about our ability to continue as a going concern.

F-11

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

In addition to our lease
restructuring efforts, we have taken the following actions:

|(a) | evaluated the opportunity to sell assets in order to
      improve our short-term liquidity position;                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | intensified collection efforts on older accounts
      receivable not included in the borrowing base under our Revolving Loan
      Agreement to improve cash flows;
|(c) | implemented stricter controls over operating and overhead
      costs and cost reduction initiatives; and                                                           
|(d) | begun negotiations with third party financial
      institutions in order to secure liquidity availability during the lease
      restructuring initiative.         

No assurance can be given that
the actions discussed above, or any future actions taken by us, will improve our
cash flows, liquidity availability or future operating prospects.

The consolidated financial
statements as of December 31, 2002, and for the ten-month period then ended, do
not include any adjustments to reflect the possible future effects to the
recoverability and classification of assets or the amounts and classification of
liabilities that might result from the outcome of the uncertainty regarding our
ability to continue as a going concern.

(3)  Summary of Significant Accounting Policies

(a)Use of Estimates

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

(b)  Principles of Consolidation

The consolidated financial
statements include the accounts of our greater than 50% owned subsidiaries.
Investments in companies owned less than 20% are carried at cost. All
significant intersegment accounts and transactions have been eliminated in
consolidation.

(c)  Cash and Cash Equivalents

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

F-12

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002



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

Revenues from
Medicaid accounted for approximately 46.0%, 45.3%, 45.3% and 41.7%, of our net
patient revenue for the ten month period ended December 31, 2002, the two month
period ended February 28, 2002 and the years ended December 31, 2001 and 2000,
respectively. Revenues from Medicare comprised approximately 25.3%, 25.7%, 25.8%
and 21.0% of our net patient revenue for the ten month period ended December 31,
2002, the two month period ended February 28, 2002 and the years ended December
31, 2001 and 2000, respectively.

Laws and regulations governing
the Medicare and Medicaid programs are extremely complex and subject to
interpretation. As a result, there is at least a reasonable possibility that
recorded estimates will change by a material amount in the near term. Changes in
estimates related to third party receivables resulted in an increase in net
revenues of approximately $1.1 million and $2.0 million for the ten month and
two month periods ended December 31, 2002 and February 28, 2002, respectively,
and an increase in net revenues of approximately $50.9 million and $2.1 million
for the years ended December 31, 2001 and 2000, respectively.

(e)  Accounts Receivable

Our accounts receivable relate to
services provided by our various operating divisions to a variety of payors and
customers. The primary payors for services provided in long-term and subacute
care facilities that we operate are the Medicare program and the various state
Medicaid programs. Approximately 51.7% and 51.6% of our gross patient accounts
receivable at December 31, 2002 and 2001, respectively, are due from such
programs. The rehabilitation, respiratory therapy service, and pharmaceutical
operations provide services to patients in Company-operated and unaffiliated
long-term, rehabilitation and acute care facilities. The billings for services
to unaffiliated facilities are submitted to those facilities. Many of the
unaffiliated long-term care facilities also receive a large majority of their
revenues from the Medicare program and the state Medicaid programs.

Estimated provisions for doubtful
accounts are recorded each period as an expense to the statement of operations.
In evaluating the collectibility of accounts receivable, we consider a number of
factors, including the age of the accounts, changes in collection patterns, the
financial condition of our customers, the composition of patient accounts by
payor type, the status of ongoing disputes with third-party payors and general
industry conditions. Any changes in these factors or in the actual collections
of accounts receivable in subsequent periods may require changes in the
estimated provision for loss. Changes in these estimates are charged or credited
to the results of operations in the period of the change.

F-13

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(f)  Inventories

Our inventories relate to the long-term and
subacute care operations and pharmaceutical services operations. The long-term
and subacute care operations inventories are stated at the lower of cost or
market. The pharmaceutical services operations inventories are stated at cost,
which is based on average wholesale price.



Property and equipment is stated
at the lower of carrying value or fair value. Property and equipment held under
capital lease is stated at the net present value of future minimum lease
payments. Major renewals or improvements are capitalized whereas ordinary
maintenance and repairs are expensed as incurred. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets as
follows: buildings and improvements - 5 to 40 years; leasehold
improvements-the shorter of the estimated useful lives of the assets or the life
of the lease; and equipment - 3 to 20 years. We capitalize interest
directly related to the development and construction of new facilities as a cost
of the related asset.

(h)Software Development Costs

Through a majority owned
subsidiary, we are internally developing software that we plan to use in our
operations and to market to unaffiliated long-term care providers. In June 2002,
we established technological feasibility, and we have capitalized $2.4 million of
software development costs as of December 31, 2002. The costs are reported at
the lower of unamortized cost or net realizable value. Prior to June 2002,
software development costs were expensed and are included in operating expenses
in the accompanying consolidated statements of operations.

(i)  Reorganization Costs (Gain)

Reorganization costs (gain) under
Chapter 11 are items of expense or income that were incurred or realized by us
because we were in reorganization. These included, but were not limited to,
professional fees and similar types of expenditures incurred directly relating
to the Chapter 11 proceeding, loss accruals or realized gains or losses
resulting from activities of the reorganization process and interest earned on
cash accumulated by us because we were not paying our prepetition liabilities.
See Note 17.

(j)  Stock-Based Compensation

In December 2002, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation--Transition and
Disclosure" ("SFAS No. 148"). This statement amends Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
No. 123"). The provisions of this statement are effective for interim and annual
financial statements for fiscal years ending after December 15, 2002. This
statement provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
Also, this statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. We continue to apply the
intrinsic value method of APB 25, but have complied with the new disclosure
requirements of SFAS No. 148. See Note 12.

F-14

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(k)  Net Income (Loss) Per Share

Basic net income (loss) per share
is based upon the weighted average number of common shares outstanding during
the period. Diluted net income (loss) per share is based upon the weighted
average number of common shares outstanding during the period increased to
include the number of additional common shares that would have been outstanding
if the potentially dilutive common shares had been issued.

(l)  New Accounting Pronouncements

In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities." Many
variable interest entities have commonly been referred to as special-purpose
entities or off-balance sheet structures, but this Interpretation applies to a
larger population of entities. In general, a variable interest entity is any
legal structure used for business purposes that either (1) does not have
equity investors with voting rights or (2) has equity investors that do not
provide sufficient financial resources for the entity to support its activities.
A variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. Until now, one company generally has
included another entity in its consolidated financial statements only if it
controlled the entity through voting interests. This Interpretation changes that
by requiring a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. The consolidation requirements of this Interpretation apply to
variable interest entities created after January 31, 2003 and apply to
existing variable interest entities in the first fiscal year or interim period
beginning after June 15, 2003. We do not expect the
adoption of this Interpretation to have a material affect on our consolidated
financial position or results of operations.

In November 2002, the FASB issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an
interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB
Interpretation No. 34" ("FIN 45"). FIN 45 clarifies the requirements of
Statement of Financial Accounting Standards No. 5, "Accounting for
Contingencies," ("SFAS No. 5") relating to the guarantor's accounting for, and
disclosure of, the issuance of certain types of guarantees. The disclosure
provisions of FIN 45 are effective for financial statements for periods ending
after December 15, 2002. However, the provisions for initial recognition and
measurement are effective on a prospective basis for guarantees that are issued
or modified after December 31, 2002. We are currently assessing the
potential impact on our financial condition and results of operations from the
adoption of FIN 45.

In July 2002, the FASB issued
Statement of Financial Accounting Standards No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146
replaces Emerging Issues Task Force Issue No. 94-3 "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity." SFAS
No. 146 requires the recognition of costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or
disposal activities initiated after December 31, 2002. Many of the provisions of
SFAS No. 146 affect only the timing of when a liability is recorded and not
the amount of the liability. Therefore, we do not expect there will be a
material effect on our consolidated financial position or results of operations
as a result of adopting SFAS No. 146.

F-15

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

In April 2002, the FASB issued
SFAS No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"). This statement
eliminates extraordinary accounting treatment for reporting most gains or losses
on debt extinguishments, and amends certain other existing accounting
pronouncements. The provision of this Statement will be effective for us
beginning with the first quarter of fiscal year 2003. Debt extinguishment
reported as extraordinary items prior to adoption of this Statement may be
reclassified to an appropriate line item on the statement of operations however,
we are evaluating whether this applies to the extraordinary item recorded in our
emergence from bankruptcy. We do not expect there to be a material effect on our
consolidated financial position or results of operations as a result of adopting
SFAS 145.

(m) Reclassifications

Our presentation of our
self-insurance obligations and related funding accounts is presented on a gross
basis at December 31, 2002. Such amounts are shown on a net basis at December
31, 2001.

(4)  Loan Agreements

On February 28, 2002,
we entered into a Loan and Security Agreement with certain lenders, led by
Heller Healthcare Finance, Inc. as collateral agent, and Citicorp USA, Inc., as
administrative agent (the "Revolving Loan Agreement"). The Revolving Loan
Agreement is a $150.0 million three-year revolving line of credit that is
secured by our accounts receivable, inventory, equipment and other assets, a
first priority pledge of the stock of our subsidiaries, other than those
subsidiaries providing pharmaceutical services, and a second priority pledge of
the pharmaceutical services subsidiaries. As agreed with the lenders under the
Revolving Loan Agreement, we are paying interest (i) for Base Rate Loans at
prime (or, if higher, the federal funds rate plus 0.50%) plus 3.50% (subject to
certain adjustments) and (ii) for LIBOR Loans at the London Interbank Offered
Rate plus 4.50% (subject to certain adjustments). The effective interest rate as
of December 31, 2002 on borrowings under the Revolving Loan Agreement was
approximately 6.6%. The weighted average borrowing interest rate for the ten
month period ended December 31, 2002 was 7.37%.  Our borrowing availability under the Revolving Loan
Agreement is limited to up to 85% of our net eligible accounts receivable and up
to 50% of our net eligible inventory, but not to exceed $150.0 million. The
defined borrowing base as of December 31, 2002, was $102.6 million, net of
specified reserves of $26.0 million, which includes a minimum availability
reserve of $10.0 million. As of December 31, 2002, we had borrowed approximately
$62.0 million and had issued approximately $37.7 million in letters of credit
under the Revolving Loan Agreement, leaving approximately $2.9 million available
to us for additional borrowing.

On February 28, 2002, we entered
into a Term Loan and Note Purchase Agreement with certain lenders, led by U.S.
Bank National Association as administrative and collateral agent (the "Term Loan
Agreement," and together with the Revolving Loan Agreement, the "Loan
Agreements"). The Term Loan Agreement is comprised of a three-year $20.0 million
term loan and a three-year $23.7 million original issue discount note (the
"Discount Note") of which our borrowing capacity is limited to $20.0 million.
The Term Loan Agreement is secured primarily by a first security pledge of the
stock of our subsidiaries that provide pharmaceutical services and a second
priority security interest in substantially all of our other assets. Interest
rates under the Term Loan Agreement are variable based upon either the lender's
base rate (as defined) or LIBOR, plus applicable margins. The effective interest
rate as of December 31, 2002 on borrowings under the Term Loan Agreement was
approximately 9.0% inclusive of a rate of 2.7% for the Discount Note. We
borrowed the maximum amount available under the Term Loan Agreement, which was
$40.0 million, and we have made quarterly payments of principal of $0.8 million
plus interest. The principal balance remaining on the Term Loan Agreement was
approximately $37.5 million at December 31, 2002.

F-16

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

As of December 31, 2002, we were
not in compliance with the following covenants: Indebtedness to EBITDA Ratio,
tangible net worth, capital expenditure limits and minimum operating cash flow.
The lenders under the Revolving Loan Agreement had not waived compliance with
those covenants. Pursuant to certain cross-default provisions, we are also in
default under the Term Loan Agreement as well. We can give no assurance that the
lenders will not seek to exercise their remedies, including but not limited to
declaring amounts outstanding to be immediately due and payable, realizing upon
the lenders' security interests, and denying us the right to further borrowing
under the Revolving Loan Agreement.

We have classified the Revolving
Loan Agreement and the Term Loan Agreement totaling $99.5 million as current
obligations as of December 31, 2002. The default interest rates under the
Revolving Loan Agreement and the Term Loan Agreement increase by 2.0% based on
the rates in effect which equate to default rates of 8.6% and 11.0%,
respectively as of December 31, 2002.

In connection with entering into the Loan Agreements, we incurred deferred
financing costs of $3.5 million, which are amortized using the effective
interest method over the lives of the Loan Agreements.Failure to amend and obtain waivers of
the financial covenants may materially and adversely affect our financial
position, results of operations and cash flows.

(5)  Long-Term Debt

As a result of the Chapter 11 filings,
substantially all short and long-term debt at the Filing Date were classified as
"liabilities subject to compromise" in our consolidated balance sheet as of
December 31, 2001 in accordance with SOP 90-7. We did not pay any principal or
accrue any interest on prepetition obligations between October 14, 1999 and
February 28, 2002 except for amounts related to certain Industrial Revenue
Bonds, a fully-secured mortgage, certain capital equipment leases and a nominal
amount related to a promissory note. The total amount of interest that was not
required to be paid is parenthetically disclosed in the consolidated statements
of operations.

We are in default under mortgages for three
skilled nursing facilities, and we have classified the three mortgages totaling
$22.2 million as current obligations as of December 31, 2002. Subsequent to
year-end, the lender has asserted that we are in default of the mortgages. These
facilities are included in the restructuring initiative discussed in Note 2, and
we are currently in discussions with the lender to transition these facilities
to new operators. We can give no assurance that the lender will not seek to
exercise its remedies under the mortgage agreements, including acceleration of
the principal and interest.

F-17

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

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



|                                                                                                                                                                                                                                       | ReorganizedCompany           |   | ||         | PredecessorCompany      |    
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------- | - | ---------- | ----------------------- | ---
|                                                                                                                                                                                                                                       | December 31, 2002            |   | ||         | December 31, 2001       |    
|Senior Credit Facility:                                                                                                                                                                                                                |                              |   | |          |                         |    
|Predecessor Company Revolving Credit                                                                                                                                                                                                   | $                          - |   | |          | $              437,066  | (1)
|Predecessor Company Term Loans                                                                                                                                                                                                         | -                            |   | |          | 358,981                 | (1)
|Revolving Loan Agreement                                                                                                                                                                                                               | 62,030                       |   | |          | -                       |    
|Term Loan Agreement                                                                                                                                                                                                                    | 37,480                       |   | |          | -                       |    
|9 1/2% Senior Subordinated Notes due 2007                                                                                                                                                                                              | -                            |   | |          | 250,000                 | (1)
|9 3/8% Senior Subordinated Notes due 2008                                                                                                                                                                                              | -                            |   | |          | 150,000                 | (1)
|Convertible Subordinated Debentures due 2004, interest at 6.0%  per
      annum                                                                                                                                                        | -                            |   | |
      |  | 83,300                  | (1)
|DIP Financing Agreement                                                                                                                                                                                                                | -                            |   | |          | 54,586                  |    
|Mortgage notes payable due at various dates through 2014, interest
         at
      rates  from 8.0% to 11.4%, collateralized by
      various facilities
         (with a book value of $60.8 million as of December 31,
      2002) | 72,898                       |   | ||
      | | 53,102                  | (2)
|Industrial Revenue Bonds                                                                                                                                                                                                               | 7,915                        |   | |          | 8,365                   | (1)
|Senior Subordinated Notes due 2002, interest at 11-3/4% per
         annum                                                                                                                                                             | -                            |   | |
      |  | 6,161                   | (1)
|Convertible Subordinated Debentures due 2003, interest at 6-1/2%
         per
      annum                                                                                                                                              | -                            |   | ||         | 1,382                   | (1)
|Other long-term debt                                                                                                                                                                                                                   | 15,900                       |   | |          | 30,947                  | (3)
|Total long-term debt                                                                                                                                                                                                                   | 196,223                      |   | |          | 1,433,890               |    
|Less long-term debt subject to compromise                                                                                                                                                                                              | -                            |   | |          | (1,355,655              | )  
|Less amounts due within one year                                                                                                                                                                                                       | (124,183                     | ) | |          | (54,975                 | )  
|Long-term debt, net of current portion                                                                                                                                                                                                 | $                72,040      |   | |          | $                23,260 |    
|                                                                                                                                                                                                                                       | ============                 |   | |          | ============            |    

Long-term debt at December 31, 2002 and
December 31, 2001 includes amounts owed under fully secured mortgage notes
payable, certain Industrial Revenue Bonds and other debt.

|(1) | Classified as "liabilities subject to compromise" in our
      consolidated balance sheet as of December 31, 2001.                                
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                   
|(2) | Approximately $46,023 was classified as "liabilities
      subject to compromise" in our consolidated balance sheet as of December
      31, 2001.
|    |                                                                                                                                                   
|(3) | Approximately $14,377 was classified as "liabilities
      subject to compromise" in our consolidated balance sheet as of December
      31, 2001.

F-18

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

The scheduled maturities of long-term debt as of December 31,
2002 are as follows (in thousands):

|2003       | $                    124,183
|---------- | ----------------------------
|2004       | 25,053                      
|2005       | 19,406                      
|2006       | 5,333                       
|2007       | 4,251                       
|Thereafter | 17,997                      
|           | $                  196,223  
|           | ================            

(6)  Property and Equipment

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



|                              | ReorganizedCompany              |   |   | PredecessorCompany            |  
|----------------------------- | ------------------------------- | - | - | ----------------------------- | -
|                              | December 31, 2002               |   |   | December 31, 2001             |  
|                              |                                 |   |   |                               |  
|Land                          | $                         4,658 |   | | | $                      16,153 |  
|Buildings and improvements    | 29,874                          |   | | | 21,433                        |  
|Equipment                     | 35,906                          |   | | | 94,904                        |  
|Leasehold improvements        | 24,968                          |   | | | 22,496                        |  
|Construction in progress      | 2,451                           |   | | | 6,329                         |  
|Total                         | 97,857                          |   | | | 161,315                       |  
|Less accumulated depreciation | (30,143                         | ) | | | (28,099                       | )
|Property and equipment, net   | $                       67,714  |   | | | $                    133,216  |  
|                              | ============                    |   | | | ===========                   |  

(7)  Impairment of Long-Lived Assets and Assets Held for Sale

Intangible Assets

Goodwill

The Reorganized Company recorded
$214.8 million in goodwill under fresh-start accounting based on an independent
valuation of the fair value of our assets and liabilities as of March 1,
2002.In July 2001, Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets
("SFAS No. 142") was issued,
which established new rules on the accounting for goodwill and other intangible
assets. Under SFAS No. 142, goodwill and intangible assets with indefinite
lives are no longer amortized; however, they are subject to annual impairment
tests as prescribed by the statement. Intangible assets with definite lives will
continue to be amortized over their estimated useful lives. With respect to our
goodwill and intangible assets, SFAS No. 142 was effective for us beginning
January 1, 2002. Upon adoption of this statement, amortization of goodwill
and indefinite life intangibles ceased.

F-19

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

Following is a summary of
adjusted operating results reflecting the effects of adopting SFAS 142:

|                                           | ReorganizedCompany                             |   |  | PredecessorCompany                            
|------------------------------------------ | ---------------------------------------------- | - |  | ----------------------------------------------
|                                           | For The TenMonths EndedDecember 31,
      2002 |   |  | For The TwoMonths EndedFebruary 28,
      2002
|                                           |                                                |   |  | (in thousands, except per share data)         
|                                           |                                                |   |  |                                               
|Reported (loss) income                     | $                (437,986                      | ) |  | $           1,485,371                         
|Add back: Goodwill amortization            | -                                              |   |  | -                                             
|Adjusted income                            | $                (437,986                      | ) |  | $           1,485,367                         
|                                           | ===============                                |   |  | ==============                                
|                                           |                                                |   |  |                                               
|Basic and Diluted (loss) income per share: |                                                |   |  |                                               
|Reported income                            | $                   (43.80                     | ) |  | $                24.32                        
|Goodwill amortization                      | -                                              |   |  | -                                             
|Adjusted (loss) income per share           | $                   (43.80                     | ) |  | $                24.32                        
|                                           | ===============                                |   |  | =============                                 

In accordance with SFAS No. 142,
we performed our annual impairment test during the fourth quarter of 2002. We
evaluate goodwill for impairment on an annual basis and whenever events and
circumstances indicate that these assets might be impaired if an event occurs
that would more likely than not reduce the fair value of a reporting unit below
its carrying amount. We determine impairment by comparing the net assets of each
reporting unit to their respective fair values. We determine the estimated fair
value of each reporting unit using a discounted cash flow analysis. In the event
a unit's net assets exceed its fair value, an implied fair value of goodwill
must be determined by assigning the unit's fair value to each asset and
liability of the unit. The excess of the fair value of the reporting unit over
the amounts assigned to its assets and liabilities is the implied fair value of
goodwill. An impairment loss is measured by the difference between the goodwill
carrying value and the implied fair value.

The change in the carrying amount
of goodwill for the ten months ended December 31, 2002 was as follows (in
thousands):

|Reorganized Company                            | InpatientServices      |   | Rehabilitationand Respiratory
      TherapyServices |   | Pharmaceutical
      and MedicalSupply
      Services |   | OtherOperations          |   | Consolidated                |  
|---------------------------------------------- | ---------------------- | - | --------------------------------------------------- | - | ----------------------------------------------------- | - | ------------------------ | - | --------------------------- | -
|                                               |                        |   |                                                     |   |                                                       |   |                          |   |                             |  
|Balance as of March 1, 2002                    | $              89,335  |   | $           
      56,660                           |   | $             
      64,069                           |   | $          
      4,753  |   | $
                  214,817 |  
|Adjustments to fresh-start
         accounting | 18,981                 |   | 335                                                 |   | 379                                                   |   | 449                      |   | 20,144                      |  
|Loss on impairment                             | (104,932               | ) | (56,995                                             | ) | (64,448                                               | ) | (4,692                   | ) | (231,067                    | )
|Balance as of December 31, 2002                | $                3,384 |   | $                     -                             |   | $                      -                              |   | $             
      510 |   | $                3,894      |  
|                                               | ============           |   | ===========                                         |   | ============                                          |   | ===========              |   | =============               |  



F-20

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

Indefinite Life Intangibles

The Reorganized Company recorded $34.6
million in trademarks under fresh-start accounting based on an independent
valuation of the fair value of our assets and liabilities as of March 1,
2002. We evaluate the recoverability of the trademarks by comparing the
asset's respective carrying value to estimates of fair value. We determine the
estimated fair value of each trademark through a discounted cash flow analysis.

The change in the carrying amount of
trademarks for the ten months ended December 31, 2002 is as follows (in
thousands):

|Reorganized Company             | Rehabilitation
      and Respiratory
      Therapy
        Services | Pharmaceutical
      and MedicalSupply
      Services |                     | OtherOperations |               | Consolidated |                
|------------------------------- | ------------------------------------------------------------------- | ----------------------------------------------------- | ------------------- | --------------- | ------------- | ------------ | ---------------
|                                |                                                                     |                                                       |                     |                 |               |              |                
|Balance as of March 1, 2002     | $
                   1,100                                          |                                                       | $             9,900 |                 | $     23,600  |              | $        34,600
|Loss on impairment              | (668                                                                | )                                                     | (7,237              | )               | (18,078       | )            | (25,983        
|Balance as of December 31, 2002 | $                 432                                               |                                                       | $             2,663 |                 | $       5,522 |              | $         8,617
|                                | ============                                                        |                                                       | ============        |                 | =========     |              | ==========     

Finite Life Intangibles

The Reorganized Company recorded $28.2
million in favorable lease intangibles under fresh-start accounting based on an
independent valuation of the fair value of our assets and liabilities as of
March 1, 2002. We evaluate the recoverability of the favorable lease
intangibles by comparing an asset's respective carrying value to estimates of
undiscounted cash flows over the life of the lease. If the carrying value of the
asset exceeded the undiscounted cash flows, an impairment loss was measured by
comparing the estimated fair value of the asset, based on discounted cash flows,
to its carrying value.

The following is a summary of our finite
lived favorable lease intangible assets at December 31, 2002 (in
thousands):

|                                | Inpatient Services |  
|------------------------------- | ------------------ | -
|Balance as of March 1, 2002     | $          28,191  |  
|Loss on impairment              | (24,011            | )
|Balance as of December 31, 2002 | $            4,180 |  
|                                | ==========         |  



Our estimated aggregate annual
amortization expense for the amortization for each of the next five years is
approximately $0.8 million.

F-21

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

Asset Impairment

Impairment of Long-Lived Assets

In August 2001, the FASB issued
Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets("SFAS No. 144"), which
addresses financial accounting and reporting for the impairment of long-lived
assets (other than goodwill and indefinite lived intangibles) and for long-lived
assets to be disposed of. SFAS No. 144 supersedes Statement of Financial
Accounting Standards No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of("SFAS No. 121") and
Accounting Principles Board Opinion No. 30, Reporting the Results of
Operations - Reporting the effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions.
We adopted the provisions of SFAS No. 144 as of January 1, 2002. Similar to SFAS
No. 121, SFAS No. 144 requires impairment losses to be recognized for long-lived
assets used in operations when indicators of impairment are present and the
estimated undiscounted cash flows are not sufficient to recover the assets'
carrying amounts. The impairment loss is measured by comparing the estimated
fair value of the asset, usually based on discounted cash flows, to its carrying
amount. In accordance with SFAS No. 144, we assess the need for an impairment
write-down when such indicators of impairment are present. (See Note 2).

During the fourth quarter of
2002, we recorded pretax charges totaling approximately $126.7 million for asset
impairments in accordance with SFAS No. 144. The asset impairment charges
consist of the following:

|-                                                                                                                                                                                                                                                                                                                                                              | $81.6 million write-down of property and equipment in our
      Inpatient Services segment for certain nursing facilities whose book value
      exceeded estimated fair value when tested for impairment.                                                                  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|-                                                                                                                                                                                                                                                                                                                                                              | $42.8 million write-down of property and equipment in our
      Other Operations segment which consisted of $8.7 million for Shared
      Healthcare Systems and $34.1 million for our corporate
      headquarters.                                                        
|-                                                                                                                                                                                                                                                                                                                                                              | $2.3 million write-down of property and equipment in our
      Pharmaceutical and Medical Supply Services segment.                                                                                                                                                          
|The October 1, 2002 elimination of certain funding
      under the Medicare program and the increase in our patient care liability
      costs affected our 2002 and future cash flows, and therefore, the fair
      values of each of our operating segments. This event led to an impairment
      assessment on each of our operating segments, including:
|-                                                                                                                                                                                                                                                                                                                                                              | estimating the undiscounted cash flows to be generated by
      each of the segments over the remaining life of the primary asset;
      and                                                                                                                                
|-                                                                                                                                                                                                                                                                                                                                                              | reducing the carrying value of the asset to estimated
      fair value when the total estimated undiscounted future cash flows were
      less than the current book value of the long-lived assets (excluding
      goodwill and other indefinite lived intangible assets).

F-22

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

In estimating the undiscounted
cash flows for the 2002 impairment assessment, we primarily used our internally
prepared budgets and forecast information including adjustments for the
following items: Medicare and Medicaid funding; overhead costs; capital
expenditures; and patient care liability costs. We also considered our plans to
transition approximately 56% of our under-performing long-term care facilities
to new operators. In order to estimate the fair values of the entities, we used
a discounted cash flow approach. A substantial change in the estimated future
cash flows for these entities could materially change the estimated fair values
of these assets, possibly resulting in an additional impairment.

During the fourth quarter of
2001, we reviewed our projections for the future earnings of our businesses
because actual results did not meet initial forecasts. Upon completion of the
review, we recorded an impairment charge of approximately $18.8 million to
reduce to estimated fair value our investment in goodwill and certain other
long-lived assets within the Inpatient Services segment and software development
division. The write-down of $14.5 million to the Inpatient Services segment was,
primarily as a result of decreased future projections of net operating income
(loss) and net cash flows due to lower revenue projections. The remaining $4.3
million write down to the software development division relates to the longer
than expected time-to-market of certain of our products which adversely impacted
the division's cash flow projections.

During the fourth quarter of
2000, we identified several factors that adversely impacted the future
projections of net operating income (loss) and net cash flows for certain
facilities, primarily in our Inpatient Services segment. These factors were: (i)
the continuation of the tight labor market that increased our use of contract
and temporary staffing, (ii) additional regulatory pressures within the
healthcare industry, as a whole, including new laws in California that specify
the labor dollars spent on patient care and increased the operating costs at a
significant number of our facilities, and (iii) additional staffing and other
overhead within our long-term care division to respond to survey results. During
2000, the Inpatient Services segment, which operates long-term care facilities,
recognized an impairment of $189.3 million related to 141 of the 303 facilities
it operated in the United States. The impairment was primarily due to the
decrease of revenues as compared with profitability projections for each
facility.

Long Lived Assets to be Disposed Of

SFAS 144 requires that long-lived
assets to be disposed of be measured at the lower of carrying amount or fair
value less cost to sell, whether reported in continuing operations or in
discontinued operations. Therefore, discontinued operations will no longer be
measured at net realizable value or include amounts for operating losses that
have not yet occurred. SFAS 144 also broadens the reporting of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and that will be eliminated from the
ongoing operations of the entity in a disposal transaction. Depreciation is
discontinued once an asset is classified as held for sale.  During the two month
period ended February 28, 2002, the Predecessor Company presented the operating
results of all facilities identified for sale or disposition in discontinued
operations in the consolidated statement of operations. Subsequent to March 1,
2002, the Reorganized Company has had a limited number of facilities disposed of
or transferred to assets held for sale. These facilities' operating results are
included in continuing operations and are immaterial to our consolidated
financial position and results of operations.

F-23

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

Inpatient Services

During the ten months ended December 31, 2002, we divested 10
skilled nursing facilities. The net revenues and net operating losses for the
ten month period ended December 31, 2002 for these 10 facilities were
approximately $19.5 million and $3.1 million, respectively. The aggregate net
loss on disposal during the ten month period ended December 31, 2002 for these
divestitures was approximately $4.1 million recorded in gain on sale of assets,
net, in our 2002 consolidated statement of operations. Additionally, during
2002, residual divestiture costs associated with prior year divestitures related
to certain skilled nursing facilities were approximately $0.7 million.

During
the year ended December 31, 2001, we divested 43 skilled nursing
facilities. The net revenues and net operating losses for the year ended
December 31, 2001 for these 43 facilities were approximately $85.3 million and
$7.5 million, respectively. The aggregate net loss on disposal during the year
ended December 31, 2001 for these divestitures was approximately $1.4 million
recorded in gain on sale of assets, net, and $23.6 million, which was included
in reorganization costs (gain), net, in our 2001 consolidated statement of
operations.

During the year ended December
31, 2000, we divested 49 skilled nursing facilities and 20 assisted living
facilities. The net revenues and net operating losses for the year ended
December 31, 2000 for these 69 facilities were approximately $132.3 million
and $9.0 million, respectively. The aggregate net loss on disposal during the
year ended December 31, 2000 for these divestitures was approximately $1.7
million recorded in gain on sale of assets, net, and $21.1 million, which was
included in reorganization costs (gain), net, in our 2000 consolidated statement
of operations. In 2000, we decided not to divest 23 skilled nursing facilities
and six outpatient rehabilitation facilities. A reversal of approximately $34.8
million was recorded in reorganization costs (gain), net, in our 2000
consolidated statement of operations.

Of the 20 assisted living
facilities identified above, we sold 16 assisted living facilities for a total
consideration of $67.3 million in 2000. The cash consideration received was
approximately $1.2 million, and we received a note receivable of approximately
$0.5 million. In addition, the aggregate debt, capital leases and other
liabilities assumed by the purchaser totaled approximately $65.6 million. We
previously recorded the anticipated loss on the sale of approximately $71.4
million in 1999. During 2000, we reversed approximately $1.5 million of the loss
recorded in 1999. The reversal of the loss is recorded in gain on sale of
assets, net, in our 2000 consolidated statement of operations. During 2000, we
divested four assisted living facilities. No material cash consideration was
received for these facilities, but we were released from approximately $6.9
million of aggregate debt. We recorded a gain of $4.9 million, net, in gain on
sale of assets, net, in our 2000 consolidated statement of operations. In
addition, we transferred our two remaining assisted living facilities from our
Other Operations segment to our Inpatient Services segment. In December 2000, we
sold a parcel of land for cash consideration of approximately $1.4 million. The
land was received in the sale of the assisted living facilities.

International Operations

During the first quarter of 2000,
we began soliciting offers to purchase our international operations. We recorded
a loss of approximately $168.6 million in 2000 to reduce the carrying value of
our international operations to our estimate of selling value less selling
costs. The charge was recorded in reorganization costs (gain), net, in our 2000
consolidated statement of operations.

F-24

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

Our long-term care operations in
Spain were sold for approximately $7.6 million in October 2000. We also sold 18
pharmacies in the United Kingdom for approximately $14.4 million in the first
and second quarters of 2000.

We sold our remaining operations
in the United Kingdom, consisting of 146 inpatient facilities with 8,326
licensed beds, in February 2001. No material cash consideration was received for
these operations, but we were released from approximately $112.9 million of
aggregate debt, capital lease obligations, notes payable and other liabilities
upon the sale. Our operations in Australia were liquidated in July 2001 and we
received liquidation proceeds of approximately $0.9 million. We sold our
long-term care and pharmacy operations in Germany in April 2001 and received
proceeds of approximately $3.5 million.

Rehabilitation and Respiratory Therapy Services

In 2000, we began pursuing the
disposition of our respiratory therapy business. We recorded losses of
approximately $6.3 million and $0.4 million in 2000 and 2001, respectively, to
reduce the carrying value of our respiratory therapy business to our estimate of
selling value less selling costs. The charges were recorded in reorganization
costs (gain), net, in our consolidated statements of operations. SunCare's net
revenues and net operating loss before management charges for the year ended
December 31, 2001 were $14.8 million and $1.4 million, respectively. In March
2002, we sold certain assets used in our respiratory therapy business for an
aggregate of $0.9 million cash.

Pharmaceutical and Medical Supply Services

During 2000, we decided to sell
our SunChoice medical supplies operations. We recorded losses of approximately
$59.4 million and $2.2 million in 2000 and 2001, respectively, to reduce the
carrying value of our medical supplies operations to our estimate of the selling
value less selling costs. The charges were recorded in reorganization costs
(gain), net, in our consolidated statements of operations. SunChoice's net
revenues and net operating loss before management charges for the year ended
December 31, 2000 were $61.0 million and $3.2 million, respectively. In January
2001, we sold the assets of SunChoice to Medline Industries, Inc. We received
proceeds of $16.6 million in exchange for the SunChoice assets.

Other Operations

In April 2002, we sold two of our
headquarters buildings in Albuquerque, New Mexico for approximately $15.3
million, which approximated their carrying value. The transaction included the
leaseback of one of the buildings and part of an adjacent parking structure for
an initial period of ten years, with an option to extend the lease for two
five-year periods. The commitment under the remaining lease term is
approximately $7.1 million.

In July 2002 we sold our interest
in a joint venture that operated two pharmacies in the Midwest. We recorded a
gain of approximately $1.2 million that is included in gain on sale of assets,
net.

F-25

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

In October 2002, we sold our
interest in a joint venture that operated two skilled nursing facilities in the
Northeast. We recorded a gain of approximately $1.4 million that is including
gain on sale of assets, net.

During 2002, we also recognized
gains for the sale of certain mobile radiology operations for $0.5 million and
the reversal of a rent reserve taken for a closed corporate office for $0.5
million totaling approximately $1.0 million, recorded in gain on sale of assets,
net.

Assets Held for Sale

As of December 31, 2002, assets held for sale
consist of five undeveloped parcels of land were valued at $6.3 million within
our consolidated financial statements in our Other Operations segment, which we
expect to sell during 2003.

As of December 31, 2001, assets
held for sale consist of two buildings at our corporate headquarters $14.8
million and a building formerly used by one of our subsidiaries $2.4 million
within our Other Operations segment, and a portion of our respiratory therapy
business $1.0 million within our Rehabilitation and Respiratory Therapy
Services segment.

(8)  Commitments and Contingencies

(a)Lease Commitments

We lease real estate and
equipment under cancelable and noncancelable agreements. Most of our operating
leases have original terms from seven to twelve years and contain at least one
renewal option, (which could extend the terms of the lease by five to ten
years), purchase options , escalation clauses and provisions for payments by us
of real estate taxes, insurance and maintenance cost.  Future minimum lease
payments under real estate leases and equipment leases, are as follows (in
thousands):



|                                                                           | Capital Leases          |   | OperatingLeases     | 
|-------------------------------------------------------------------------- | ----------------------- | - | ------------------- | 
|                                                                           |                         |   |                     | 
|2003                                                                       | $                   388 |   | $           135,271 | 
|2004                                                                       | 395                     |   | 132,626             | 
|2005                                                                       | -                       |   | 120,686             | 
|2006                                                                       | -                       |   | 92,177              | 
|2007                                                                       | -                       |   | 68,064              | 
|Thereafter                                                                 | -                       |   | 222,432             | 
|Total minimum lease payments                                               | 783                     |   | $           771,256 | 
|Less amount representing interest                                          | (107                    | ) | ==========          | 
|Present value of net minimum lease payments under
          capital leases | $                   676 |   |                     | 
|                                                                           | ==========              |   |                     | 

Rent expense under operating
leases totaled approximately $128.0 million, $166.1 million and $237.6 million
for the ten month period ended December 31, 2002 and the years ended 2001 and
2000, respectively, and $27.3 million for the two month period ended February
28, 2002 and was included in operating costs and corporate general and
administrative expenses in the accompanying consolidated statements of
operations. As of March 1, 2003, we have identified 56% of our skilled nursing
facilities for divestiture, most of which are leased facilities.

F-26

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(b)  Purchase Commitments

Our inpatient services segment
has a contractual agreement through January 31, 2009 establishing Medline
Industries, Inc. ("Medline") as the primary medical supply vendor for all of the
long-term care facilities that we operate. The agreement provides that the
long-term care division shall purchase at least 90% of its medical supply
products from Medline. Additionally, if we choose to terminate the agreement
without cause or if Medline chooses to terminate the agreement with cause, we
may be required to pay Medline liquidated damages of $3.0 million if the
agreement is terminated prior to January 11, 2003, $1.5 million if the agreement
is terminated on or between January 12, 2003 and January 11, 2004 and $0.8
million through January 11, 2005.

(c)Employment and Severance Agreements

We entered into employment
agreements with five of our executive officers. The agreements represent an
annual obligation to us of approximately $2.0 million and they have various
renewal options and expiration terms. In addition to the base salary, the
officers are entitled to annual bonuses for each fiscal year in which we achieve
or exceed certain financial performance targets. If the targets are achieved,
depending upon the individual's agreement and how much the targets are exceeded,
the bonuses range from 33% to 100% of base salary. Pursuant to the agreements,
these officers received options to purchase an aggregate of 495,000 shares of
common stock at exercise prices equal to or greater than the fair market value
of the common stock at the date of grant. The options vest over a four-year
period ending 2006.

We have entered into severance
agreements with five of our executive officers pursuant to which they would
receive severance payments in the event of their Involuntary Termination of
employment (as defined in the agreements). The severance payments would be equal
to 12 to 18 months of their then-current salary. In addition to the severance
payments, they would have the right to participate for a defined period of time
in the medical, dental, health, life and other fringe benefit plans and
arrangements applicable to them immediately prior to termination.

(d)Insurance

It is our policy to self-insure
for certain insurable risks, including general and professional liability,
workers' compensation liability and employee health insurance liability
through the use of self-insurance or retrospective and self-funded insurance
policies and other hybrid policies, which vary by the states in which we
operate. There exists a risk that any of the insurance companies we use may
become insolvent and unable to fulfill their obligation to defend, pay or
reimburse us when that obligation becomes due. Although we believe the companies
we have purchased insurance from are solvent, in light of the dramatic changes
occurring in the insurance industry in recent years, we cannot be assured that
they will remain solvent and able to fulfill their obligations. Provisions for
estimated reserves, including incurred but not reported losses, are provided in
the period of the related coverage. These provisions are based on actuarial
analyses, internal evaluations of the merits of individual claims, and industry
loss development factors or lag analyses. The methods of making such estimates
and establishing the resulting reserves are reviewed periodically, and any
adjustments resulting there from are reflected in current earnings. Claims are
paid over varying periods, and future payments may be different than the
estimated reserves.

F-27

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

In January 2000, we established
a self-funded insurance program for general and professional liability claims up
to a base amount of $1.0 million per claim and $3.0 million aggregate per
location and obtained excess insurance for coverage above these levels. This
program expired at the end of 2002. Commencing January 1, 2003, we have
established a self-funded insurance program for general and professional
liability insurance claims up to a base amount of $10.0 million per claim,
obtaining excess insurance above this level on a claims-made basis. Prior to
January 1, 2000, the maximum loss exposure with respect to the third-party
insurance policies was $100,000 per claim for general and professional
liability. An independent actuarial analysis is
prepared twice a year to determine the expected losses and reserves for
estimated settlements for general and professional liability under the per claim
retention level, including incurred but not reported losses. These reserves are
provided on an undiscounted basis in the period that the event occurred. Based
on the results of the actuarial analysis prepared as of September 30, 2002,
we recorded a pre-tax charge of $20.0 million related to an increase in patient
care liability costs for prior policy years and revisions to the current year
estimate based on increasing industry trends. As of December 31, 2002 and
2001, the reserves for such risk were approximately $108.0 million and $81.6
million, respectively. The actuarially determined range of reserves at
December 31, 2002 was $98.8 million to $131.3 million. Provisions for such
risks were approximately $44.1 million, $9.0 million, $58.1 million and $35.3
million for the ten months ended December 31, 2002, two months ended
February 28, 2002 and years ended December 31, 2001 and 2000,
respectively, and are included in operating expenses and corporate general and
administrative expenses. At December 31, 2002 we had $12.0 million in
pre-funded amounts restricted for payment of general and professional liability
claims.

The majority of our workers'
compensation risks are insured through insurance policies with third parties.
Our reserves are estimated by independent actuaries for the 2000 through 2002
policy years and company analysis using industry development factors for prior
years. We discount our workers' compensation reserves for the policy period
January 1, 2002 through December 31, 2002 based on a 4% discount rate.
The discounting of this policy period resulted in a reduction to our reserves of
$3.7 million. The provision for such risks, which includes accruals for
insurance premiums and claims costs, for the ten months ended December 31,
2002, two months ended February 28, 2002, and the years ended
December 31, 2002 and 2001 was $26.5 million, $3.4 million, $54.9 million
and $27.4 million, respectively. The most recent actuarial analysis completed in
November 2002 by our independent actuaries reflected an improvement in the
claims trends for the 2001 and 2002 policy years. Based upon these results, we
decreased our reserve by $6.0 million at September 30, 2002. We have
recorded reserved of $65.3 million, and $29.5 million, as of December 31,
2002, and 2001, respectively. The range of estimated reserves at
December 31, 2002 was $60.7 million to $71.3 million. At December 31,
2002 we had $57.4 million in pre-funded amounts restricted for payment of
workers' compensation claims.

F-28

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(e)Construction Commitments

As of December 31, 2002, we had
construction commitments under various contracts of approximately $6.1 million.
These items consisted primarily of contractual commitments to improve
existing facilities.

(f)Restricted Cash

Included in restricted cash in
our consolidated balance sheet as of December 31, 2002 is $70.8 million and $5.9 million,
respectively, related to our funding of self-insurance obligations and amounts
to pay U.S Trustee fees. Other Assets, net as of December 31, 2002 and December
31, 2001, respectively, includes $3.6 and $4.1 million of restricted cash
maintained to repay a mortgage.

(9)  Income Taxes

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

Income tax expense (benefit) on
loss before extraordinary loss consists of the following (in thousands):



|          | ReorganizedCompany                             |   | PredecessorCompany                             
|--------- | ---------------------------------------------- | - | -----------------------------------------------
|          | For The TenMonths EndedDecember 31,
      2002 |   | For The TwoMonths Ended February 28,
      2002
|          |                                                |   |                                                
|Current:  |                                                |   |                                                
|Federal   | $                             -                | | | $                             -                
|State     | 410                                            | | | 147                                            
|          | 410                                            | | | 147                                            
|Deferred: |                                                | | |                                                
|Federal   | -                                              | | | -                                              
|State     | -                                              | | | -                                              
|          | -                                              | | | -                                              
|Total     | $                        410                   | | | $                        147                   
|          | ==============                                 | | | ==============                                 

Actual tax expense (benefit) differs from the
expected tax expense (benefit) on loss after discontinued operations and before
extraordinary item which is computed by applying the U.S. Federal corporate
income tax rate of 35% to our loss before income taxes as follows (in
thousands):

F-29

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

|                                                                                                           | ReorganizedCompany                             |             | PredecessorCompany                              |  
|---------------------------------------------------------------------------------------------------------- | ---------------------------------------------- | ----------- | ----------------------------------------------- | -
|                                                                                                           | For The TenMonths EndedDecember 31,
      2002 |             | For The TwoMonths Ended February 28,
      2002 |  
|                                                                                                           |                                                |             |                                                 |  
|Computed expected
         tax benefit                                                                     | $               (153,152)                      | |
      |   | $                       (4,495                  | )
|Adjustments in income
         taxes resulting from:                                                       |                                                | ||          |                                                 |  
|Amortization of
          goodwill                                                                         | -                                              | |
      |   | -                                               |  
|Impairment loss                                                                                            | 27,053                                         | |           | -                                               |  
|Increase in valuation
          allowance                                                                  | 139,354                                        | ||          | 1,685                                           |  
|Legal and regulatory
          matters                                                                     | -                                              | |
      |   | 2,860                                           |  
|(Loss reversal) loss
          on planned asset
          dispositions                                     | -                                              | ||
      |  | -                                               |  
|State income tax
          expense
      (benefit),
           net of Federal     income tax
      benefit | (13,561)                                       | |||
      | | (203                                            | )
|Other                                                                                                      | 716                                            | |           | 300                                             |  
|                                                                                                           | $  
                         410               | |           | $   
                          147              |  
|                                                                                                           | ==============                                 | |           | ===============                                 |  

F-30

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

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



|                                                                                           | 2002                   |   | 2001                    |  
|------------------------------------------------------------------------------------------ | ---------------------- | - | ----------------------- | -
|                                                                                           |                        |   |                         |  
|Deferred tax assets:                                                                       |                        |   |                         |  
|Accounts and notes receivable                                                              | $      20,479          |   | $ 
              28,586 |  
|Accrued liabilities                                                                        | 86,670                 |   | 77,910                  |  
|Property and equipment                                                                     | 76,805                 |   | 49,021                  |  
|Intangible assets                                                                          | 89,900                 |   | 76,499                  |  
|Carryforward of deductions limited by Internal
      Revenue Code
            Section 382  | 6,250                  |   | 6,250                   |  
|Write-down of assets held for sale                                                         | 2,062                  |   | 41,473                  |  
|Partnership investments                                                                    | 4,577                  |   | 2,655                   |  
|Alternative minimum tax credit                                                             | 4,265                  |   | 5,753                   |  
|Jobs and other credit carryforwards                                                        | 6,227                  |   | 6,146                   |  
|Capital loss carryforwards                                                                 | 3,954                  |   | 116,315                 |  
|State net operating loss carryforwards                                                     | 47,450                 |   | 42,181                  |  
|Federal net operating loss
carryforwards                                                   | 266,441                |   | 222,129                 |  
|Other                                                                                      | 469                    |   | 1,992                   |  
|                                                                                           | 615,549                |   | 676,910                 |  
|Less valuation allowance:                                                                  |                        |   |                         |  
|Federal                                                                                    | (511,687               | ) | (561,352                | )
|State                                                                                      | (103,862               | ) | (114,070                | )
|                                                                                           | (615,549               | ) | (675,422                | )
|Total deferred tax assets                                                                  | -                      |   | 1,488                   |  
|                                                                                           |                        |   |                         |  
|Deferred tax liabilities:                                                                  |                        |   |                         |  
|Changes in certain subsidiaries' methods of
      accounting for
             income taxes | -                      |   | (1,488                  | )
|Total deferred tax liability                                                               | -                      |   | (1,488                  | )
|Deferred taxes, net                                                                        | $                    - |   | $                    -  |  
|                                                                                           | ==========             |   | =========               |  

In connection with fresh-start accounting, our assets and
liabilities were recorded at their respective fair values. Deferred tax assets
and liabilities were then recognized for the tax effects of the differences
between fair values and tax bases. In addition, deferred tax assets were
recognized for future tax benefits of net operating loss ("NOL"), capital loss
and tax credit carryforwards, and a valuation allowance was recorded for the
overall net increase in deferred tax assets recognized in connection with
fresh-start accounting.

To the extent management believes the pre-emergence net
deferred tax assets will more likely than not be realized, a reduction in the
valuation allowance established in fresh-start accounting will be recorded. The
reduction in this valuation allowance will first reduce reorganization value in
excess of amounts allocable to identifiable assets recorded in fresh-start
accounting and other intangible assets, with any excess being treated as an
increase to capital in excess of par value.

F-31

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

During the ten months ended December 31, 2002, our net deferred
tax assets increased by approximately $139.4 million. We also increased our
valuation allowance by approximately $139.4 million because we do not believe
that recognition of these deferred tax assets meets the standard for recognition
under FAS 109. We will recognize a tax benefit for these deferred tax assets in
the event that they are realized in a future year. Because we did not decrease
our valuation allowance during the ten months ended December 31, 2002, we did
not reduce the reorganization value in excess of amounts allocable to
identifiable assets recorded in fresh-start accounting and other intangibles
assets.

In connection with our emergence
from bankruptcy, we realized an extraordinary gain on the extinguishment of debt
of approximately $1.5 billion. This gain will not be taxable pursuant to Section
108 of the Internal Revenue Code since the gain resulted from our reorganization
under the Bankruptcy Code. However, we will be required as of the beginning of
our 2003 taxable year to reduce certain tax attributes, including (a) NOL and
capital loss carryforwards, (b) certain tax credits, and (c) tax bases in
assets, in an amount equal to such gain on extinguishment. Our reorganization on
the Effective Date constituted an ownership change under Section 382 of the
Internal Revenue Code, and the use of any of our losses and tax credits
generated prior to the ownership change that are not reduced pursuant to these
provisions will be subject to an overall annual limitation of approximately $14
million.

After considering the reduction
in tax attributes discussed above, we have Federal NOL carryforwards of $776.4
million with expiration dates from 2004 through 2022. Various subsidiaries have
state NOL carryforwards totaling $1.06 billion with expiration dates
through the year 2022. In addition, we have capital loss carryforwards of
$11.3 million, of which $10.1 million will expire in 2004 and
$1.2 million will expire in 2006. Our alternative minimum tax credit
carryforward of $4.3 million has no expiration date. Our $6.2 million
of other tax credit carryforwards will expire in years 2005 through 2019.

(10)  Supplementary Information Relating to Statements of Cash
Flows

Supplementary information for the
consolidated statements of cash flows is set forth below (in thousands):

|                                                                                                                                                                                                                                    | ReorganizedCompany                             |       | Predecessor
      Company                     
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------- | ----- | ----------------------------------------------
|                                                                                                                                                                                                                                    | For The TenMonths EndedDecember 31,
      2002 |       | For The TwoMonths EndedFebruary 28,
      2002
|                                                                                                                                                                                                                                    |                                                | |     |                                               
|Cash paid during the period for:                                                                                                                                                                                                    |                                                | ||    |                                               
|Interest, net of $68, $14, $69 and $82
          capitalized for the ten months ended
          December 31, 2002, two months ended
          February 28, 2002, and years ended 
          December 31, 2001and 2000, respectively | $                     16,232                   | ||||| | $                     2,683                   
|Income taxes paid (refunded)                                                                                                                                                                                                        | 910                                            | |     | (548                                          



---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

We had no acquisitions during the
ten month, two month and twelve month periods ended December 31, 2002, February
28, 2002 and December 31, 2001, respectively. During the ten month period ended
December 31, 2002 we acquired nine skilled nursing facilities by issuing $31.5
million of mortgage notes.  During the year ended December 31, 2000 we
acquired several skilled nursing facilities in the United Kingdom by issuing
$28.5  million of mortgage notes and paying cash of $1.0 million.

(11)  Fair Value of Financial Instruments

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



|                                                                                     | 2002           | 2001            
|------------------------------------------------------------------------------------ | -------------- | ----------------
|                                                                                     | CarryingAmount | Fair
      Value
|                                                                                     |                |                 
|Cash and cash equivalents                                                            | $      21,013  | $      21,013   
|Long-term debt including current portion and
         amounts subject to compromise: |                |                 
|Practicable to estimate fair value                                                   | 196,223        | 160,393         
|                                                                                     |                |                 
|Convertible Trust Issued Preferred Securities
         (CTIPS)                       | -              | -               

The cash and cash equivalents
carrying amount approximates fair value because of the short maturity of these
instruments.

(12)  Capital Stock

As of December 31, 2002, the Reorganized
Company had issued approximately 9,171,000 million shares of its common stock in
connection with the extinguishment of the Predecessor Company's liabilities
subject to compromise. As of December 31, 2002, we expected to issue up to an
additional 829,000 shares of our common stock once certain pre-petition claims
are reconciled. The fair value of the additional common stock expected to be
issued is approximately $22.4 million valued at $27 per share by our
reorganization plan and is recorded in other long-term liabilities in the
December 31, 2002 consolidated balance sheet. Between January 1, 2003 and March
7, 2003, we issued an additional 504,000 shares of common stock.

F-33

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

As of December 31, 2002, the Reorganized
Company had issued 150,000 shares of restricted common stock to its Chairman and
Chief Executive Officer. The restricted common stock vests as follows: 40% vested on February 28, 2003, and 20% vests on each of the second,
third and fourth anniversaries of the restricted stock issuance. Restricted
stock awards are outright stock grants. The issuance of restricted stock and
other stock awards requires the recognition of compensation expense measured by
the fair value of the stock on the date of grant. During the ten months ended
December 31, 2002, we recognized $1.4 million in expense related to the issuance
of these stock awards.

In April 2002, the Reorganized Company issued
warrants to purchase approximately 500,000 shares of its common stock to the
holders of the Predecessor Company's senior subordinated notes. The warrants
have a strike price of $76 per share and are exercisable over a three-year
period. The fair value of the warrants was estimated to be $1.8 million and is
recorded in additional paid in capital in the December 31, 2002 consolidated
balance sheet.

Reorganized Company Stock Option Plan

In February 2002, we adopted the 2002
Management Equity Incentive Plan, which allows for the issuance of up to 900,000 shares of our common
stock, which includes the 150,000 shares of restricted common stock. As of December 31, 2002, our
officers held options to purchase 720,000 shares under this plan.

In March 2002, we adopted the 2002
Non-employee Director Equity Incentive Plan, which, as amended in August 2002,
allows for the issuance of up to 160,000 options to purchase shares of our
common stock. As of December 31, 2002, our directors held options to purchase
80,000 shares under this plan.

We account for stock-based compensation using
the intrinsic value method prescribed in Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. Accordingly, compensation cost for stock options is measured as
the excess, if any, of the quoted market price of our stock at the date of grant
over the amount an employee must pay to acquire the stock.

As of December 31, 2002, we had
outstanding options covering an aggregate of 780,000 shares of our common stock
to our officers and directors at a strike price of $27 per share, which price
was equal to or greater than the estimated market value at date of issuance. Of
those options, 450,000 vest over a four-year period, with 20% vesting
upon issuance and the remaining portion vesting ratably over the first four
anniversary dates. The remaining 330,000 options vest 25% per year on the
first four anniversary dates. All options expire in 2009.

F-34

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

The following is a summary of the
status of our Stock Option Plans and changes during the periods ended (shares in
thousands):

|                                                                                                     | Reorganized Company                              |   | Predecessor
      Company                       
|---------------------------------------------------------------------------------------------------- | ------------------------------------------------ | - | ------------------------------------------------
|                                                                                                     | For the Ten Months Ended December 31,
      2002 |   | For the Two Months Ended February 28,
      2002
|                                                                                                     | Shares                                           |   | WeightedAverageExercise Price                   
|                                                                                                     |                                                  |   |                                                 
|                                                                                                     |                                                  |   |                                                 
|Outstanding at
          beginning of period                                                         | -                                                |   | $             -                                 
|Granted:                                                                                             |                                                  |   |                                                 
|Price equals fair
           value                                                                   | 845                                              |   | 27.00                                           
|Cancelled                                                                                            | -                                                |   | -                                               
|Forfeited                                                                                            | (45                                              | ) | 27.00                                           
|Outstanding at
          period-end                                                                  | 800                                              |   | 27.00                                           
|                                                                                                     | =========                                        |   |                                                 
|Options exercisable
          at period-end                                                          | 90                                               |   | 27.00                                           
|                                                                                                     | =========                                        |   |                                                 
|Options available for
          future grant                                                         | 110                                              |   |                                                 
|                                                                                                     | =========                                        |   |                                                 
|Weighted average fair
          value of options
          granted during
      the
          period | $           3.00                                 |   |                                                 
|                                                                                                     | ========                                         |   |                                                 

SFAS No. 148, issued on December
31, 2002, provides companies alternative methods to transitioning to SFAS's
No. 123's fair value method of accounting for stock-based employee
compensation, and amends certain disclosure requirements. SFAS No. 148 does not
mandate fair value accounting for stock-based employee compensation, but does
require all companies to meet the disclosure provisions. We currently do not
recognize compensation expense for our stock options grants, which are issued at
fair market value on the date of grant, and accounted for under the intrinsic
value method. In order to adopt the recognition provisions of SFAS No. 148 on a
prospective basis, we must make this election during the year ending December
31, 2003 and to change to fair value accounting for stock options. We are
continuing to evaluate the provisions of SFAS No. 148.

The fair value of each option
granted in 2002 is estimated at the date of grant using the Black-Scholes option
pricing model with the following weighted-average assumptions:  (a)
expected life of four years; (b) expected volatility of 62%; (c) risk-free
interest rate of 3.0% and; (d) no dividend yield.   No
options were granted during the two month period ended February 28, 2002 and the
years ended December 31, 2001 and December 31, 2000.

If we determined compensation
cost for our 2002, 2001 and 2000 option grants at a fair value consistent with
SFAS 123 (see "Note 3 - Summary of Significant Accounting and
Financial Reporting Policies", which describes that SFAS 123 establishes fair
value as the measurement basis for stock-based awards), our net losses and net
losses per share for the years ended December 31 would approximate the pro forma
amounts below (in thousands, except per share data):

F-35

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002



|                              | ReorganizedCompany                             |   |   | Predecessor
      Company                      | 
|----------------------------- | ---------------------------------------------- | - | - | ---------------------------------------------- | 
|                              | For The TenMonths EndedDecember 31,
      2002 |   |   | For The TwoMonths EndedFebruary 28,
      2002 | 
|                              |                                                |   | | |                                                | 
|Net (loss) income as reported | $                 (437,986                     | ) | | | $                1,485,371                     | 
|                              |                                                |   | | |                                                | 
|Compensation expense          | (600                                           | ) | | | -                                              | 
|                              |                                                |   | | |                                                | 
|Net (loss) income (pro forma) | $                 (438,586                     | ) | | | $               1,485,371                      | 
|                              | ================                               |   | | | ===============                                | 
|Net (loss) income per share:  |                                                |   | | |                                                | 
|Basic and diluted:            |                                                |   | | |                                                | 
|Net (loss) income as reported | $                    (43.80                    | ) | | | $                       24.32                  | 
|Compensation expense          | (.06                                           | ) | | | -                                              | 
|Net (loss) income pro forma   | $                    (43.86                    | ) | | | $                       24.32                  | 
|                              | ================                               |   | | | ===============                                | 

The effects of applying
SFAS 123 in this pro forma disclosure are not indicative of future amounts.
SFAS 123 does not apply to options granted prior to 1995, and additional
option grants in future years are anticipated although not under the existing
plans. The following table summarizes information about stock options
outstanding as of December 31, 2002 (shares in thousands):

|Options
      Outstanding |                   | Options
      Exercisable
|------------------------- | ----------------- | -------------------------
|Range of Exercise Price   | NumberOutstanding |                          
|                          |                   |                          
|$  27.00                  |                   | $                        
|                          |                   |                          
|                          |                   |                          

(b)  Grantor Stock Trust

In the first quarter of 1996, we
sold 3,050,000 newly issued shares of our common stock to a newly established
Grantor Stock Trust ("Trust") in exchange for a promissory note of approximately
$37.7 million. The Trust was created to fund future obligations under
certain of our benefit plans, including, but not limited to, stock option plans,
a stock purchase plan, and employee compensation. The sale of the shares to the
Trust was recorded as an increase in stockholders' equity with a corresponding
reduction for the value of the shares held by the Trust. As stock was released
from the Trust to satisfy certain employee compensation and benefit plans, the
number and the related fair value of shares held by the Trust was reduced and
stockholders' equity increased correspondingly. The Trust held 1,915,935 shares
of our common stock as of December 31, 2001.

The Trust delivered to us a
promissory note for approximately $37.7 million. The cash portion of the
purchase price of approximately $31,000 represented the par value of the shares
of our common stock sold to the Trust. The consummation of our Plan of
Reorganization on February 28, 2002 cancelled our existing common stock,
including the shares held by the Trust. As a result, the Trust has been
terminated and the debt it owed to us has been forgiven.

F-36

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(13)  Earnings per Share

Basic net income (loss) per share is
based upon the weighted average number of common shares outstanding during the
period. The weighted average number of common shares in the ten months ended
December 31, 2002 include the common shares issued in connection with the
emergence and 829,000 common shares outstanding to be issued once the
prepetition claims are finalized.

Diluted net earnings per share is
based upon the weighted average number of common shares outstanding during the
period plus the number of incremental shares of common stock contingently
issuable upon exercise of stock options and if dilutive, include the assumption
that our convertible securities were converted as of the beginning of the
period. Net earnings are adjusted for the interest on the convertible
securities, net of interest related to additional assumed borrowings to fund the
cash consideration on conversion of certain convertible securities and the
related income tax benefits. In periods of losses, diluted net losses per share
is based upon the weighted average number of common shares outstanding during
the period. As we had a net loss for the ten months ended December 31, 2002 and
for the years ended December 31, 2001 and 2000, our stock options and
convertible debentures were anti-dilutive.

F-37

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(Loss) income per share for the
years ended December 31 is calculated as follows (in thousands, except per
share data):

|                                                                                 | Reorganized
      Company                       |   |           | PredecessorCompany                             
|-------------------------------------------------------------------------------- | ----------------------------------------------- | - | --------- | -----------------------------------------------
|                                                                                 | For the TenMonths Ended December 31,
      2002 |   |           | For the Two Months EndedFebruary 28,
      2002
|                                                                                 |                                                 |   |           |                                                
|Basic:                                                                           |                                                 |   |           |                                                
|(Loss) income before extraordinary item                                          | $            (437,986                           | ) | |         | $               (5,350                         
|Loss on discounted operations                                                    | -                                               |   | |         | (7,639                                         
|Extraordinary item                                                               | -                                               |   | |         | 1,498,360                                      
|Net (loss) income                                                                | $            (437,986                           | ) | |         | $         1,485,371                            
|                                                                                 | =========                                       |   | |         | =========                                      
|Weighted average shares outstanding                                              | 10,000                                          |   | |         | 61,080                                         
|                                                                                 | =========                                       |   | |         | =========                                      
|(Loss) income per share:                                                         |                                                 |   | |         |                                                
|Net (loss) income before discounted operations
           and extraordinary item | $               (43.80                          | ) | ||        | $                  (.09                        
|Loss on discontinued operations                                                  | -                                               |   | |         | (.12                                           
|Extraordinary item                                                               | -                                               |   | |         | 24.53                                          
|Net (loss) income                                                                | $               (43.80                          | ) | |         | $               24.32                          
|                                                                                 | =========                                       |   | |         | =========                                      
|Diluted:                                                                         |                                                 |   | |         |                                                
|(Loss) income before extraordinary item                                          | $           (437,986                            | ) | |         | $              (5,350                          
|Loss on discontinued operations                                                  | -                                               |   | |         | (7,639                                         
|Extraordinary item                                                               | -                                               |   | |         | 1,498,360                                      
|Net (loss) income                                                                | $           (437,986                            | ) | |         | $         1,485,371                            
|                                                                                 | =========                                       |   | |         | =========                                      
|(Loss) income per share:                                                         |                                                 |   | |         |                                                
|(Loss) income before extraordinary item                                          | $               (43.80                          | ) | |         | $                   (.09                       
|Loss on discontinued operations                                                  | -                                               |   | |         | (.12)                                          
|Extraordinary item                                                               | -                                               |   | |         | 24.53                                          
|Net (loss) income                                                                | $               (43.80                          | ) | |         | $                24.32                         
|                                                                                 | =========                                       |   | |         | =========                                      
|Weighted average shares used in basic and
          dilutive calculations        | 10,000                                          |   | |
      | | 61,080                                         
|                                                                                 | =========                                       |   | |         | =========                                      

(14)  Preferred Stock Purchase Rights

On June 2, 1995, the Board
of Directors declared a dividend of one preferred stock purchase right ("Right")
for each outstanding share of the old common stock of ours for stockholders of
record on June 15, 1995 and for all future issuances of the old common
stock. The consummation of our Plan of Reorganization on February 28, 2002
cancelled our old common stock, and the Rights were thereby also cancelled.

F-38

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(15)  Other Events

(a)  Litigation

On February 28, 2003, the Bureau
of Medi-Cal Fraud and Elder Abuse (the "BMFEA"), which is a division of the
Office of the Attorney General of the State of California, alleged that we are
violating the terms of the PIFJ. Pursuant to the PIFJ, which was entered in
October 2001, we are enjoined from engaging in violations of federal or state
statutes or regulations governing the operation of health care facilities in the
State of California. Among other things, the BMFEA alleged that our California
facilities have had inadequate staffing, training and supervision. To remedy
these alleged violations, the BMFEA has requested that we pay their costs of the
investigation and to audit our operations in California, and, initially,
requested a significant but unspecified cash penalty. We have commenced a
constructive dialogue with the BMFEA and believe we have made good progress in
demonstrating that we are in fact in compliance with the PIFJ. It is therefore
not clear whether the BMFEA will assert that a material sum is due or payable
and no estimate can be made of any amount that the BMFEA may ultimately seek. An
adverse outcome in this matter could have a material adverse effect on our
financial position, results of operations and cash flows. If the BMFEA does
ultimately assert that we are in violation of the PIFJ, we intend to defend this
matter virgorously

In March and April 1999, class
action lawsuits were filed against us and three individuals who were at that
time our officers, in the United States District Court for the District of New
Mexico. These actions have been consolidated as In re Sun Healthcare Group, Inc.
Securities and Litigation Master, File No. Civ. 99-269. The lawsuits allege,
among other things, that we did not disclose material facts concerning the
impact that PPS would have on our results of operations. The lawsuits seek
compensatory damages and other relief for stockholders who purchased our common
stock during the class-action period. Pursuant to an agreement among the
parties, we were dismissed without prejudice in December 2000. In January 2002,
the District Court dismissed the lawsuit with prejudice and entered judgment in
favor of the defendants. In February 2002, the plaintiffs filed a Motion to
Amend the Judgment and to File an Amended Complaint and the Motion is pending.
We have responded in opposition to the Motion and we intend to vigorously defend
the individual defendants in this matter, who are indemnified by us and covered
by our insurance.



F-39

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

We are seeking to restructure our
portfolio of leases and mortgages under which we operate 56% of our long-term
care facilities. In January 2003, we began withholding rent and mortgage
payments with respect to these facilities. We have negotiated and continue to
negotiate with many of our landlords and mortgage holders in an effort to
achieve consensual resolution of these issues. However, several landlords and
mortgage holders have threatened to commence eviction or similar proceedings
against us. Additional actions seeking damages or other leasehold
remedies may also be commenced.

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

(b)  Other Inquiries

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

(c)  Legislation, Regulations and Market
Conditions

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

We entered into a Corporate
Integrity Agreement (the "CIA") with the OIG in July 2001 and it became
effective on February 28, 2002. We implemented further internal controls with
respect to our quality of care standards and Medicare and Medicaid billing,
reporting and claims submission processes and engaged an independent third party
to act as quality monitor and Independent Review Organization under the CIA. A
breach of the CIA could subject us to substantial monetary penalties and
exclusion from participation in Medicare and Medicaid programs. Any such
sanctions could have a material adverse effect on our financial position,
results of operations, and cash flows.

F-40

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

In December 2000, the federal
government released the final privacy rules of the Health Insurance Portability
and Accountability Act of 1996 ("HIPAA"). The rules provide for, among other
things, (i) giving consumers the right and control over the release of their
medical information, (ii) the establishment of boundaries for the use of medical
information, and (iii) penalties for violation of an individual's privacy
rights.

These privacy regulations apply
to "protected health information," which is defined generally as individually
identifiable health information transmitted or maintained in any form or medium,
excluding certain education records and student medical records. The privacy
regulations seek to limit the use and disclosure of most paper, oral and
electronic communications regarding an individual's past, present or future
physical or mental health or condition, or relating to the provision of
healthcare to the individual or payment for that healthcare, if the individual
can or may be identified by such information. HIPAA provides for the imposition
of civil or criminal penalties if protected health information is improperly
disclosed. We are required to comply with the HIPAA privacy rules beginning
April 14, 2003, and we will require substantial efforts and resources for
compliance with these rules.

HIPAA's security regulations were
finalized in February 2003. The security regulations specify administrative
procedures, physical safeguards and technical services and mechanisms designed
to ensure the privacy of protected health information. We will be required to
comply with the security regulations beginning in April 2005.

In addition, HIPAA also mandates
the adoption of regulations aimed at standardizing transaction formats and
billing codes for documenting medical services, dealing with claims submissions
and protecting the privacy and security of individually indentifiable health
information. HIPAA regulations that standardize transactions and code sets
became final in the fourth quarter of 2000. These regulations do not require
healthcare providers to submit claims electronically, but require standard
formatting for those that do. We currently submit some of our claims
electronically to Medicare and Medicaid through our fiscal intermediary and will
continue to do so. We will be required to comply with HIPAA transaction and code
set standards in October, 2003. If we are not able to submit claims
electronically, or the States are not able to receive claims electronically,
then our receipt of our reimbursements could be disrupted.



We operate predominantly in the
long-term care segment of the healthcare industry. We are a provider of
long-term, sub-acute and related ancillary care services to nursing home
patients. In addition to services provided in the United States, we previously
provided services in the United Kingdom, Spain, Germany and Australia.

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

Inpatient Services: This segment provides, among other
services, inpatient skilled nursing and custodial services as well as
rehabilitative, restorative and transitional medical services. We provide
24-hour nursing care in these facilities by registered nurses, licensed
practical nurses and certified nursing aids. At December 31, 2002, we operated
237 long-term care facilities with 26,845 licensed beds as compared with 247
facilities with 27,954 licensed beds at December 31, 2001. As part of our
restructuring efforts, we may divest approximately 56% of our skilled nursing
facilities representing approximately 16,000 licensed beds.

F-41

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

Rehabilitation and Respiratory Therapy Services:  This
segment provides, among other services, physical, occupational, speech and
respiratory therapy supplies and services to affiliated and nonaffiliated
skilled nursing facilities. At December 31, 2002, this segment provided services
to 536 facilities, 320 nonaffiliated and 216 affiliated, as compared to 859
facilities at December 31, 2001, of which 622 were nonaffiliated and 237 were
affiliated. In March 2002, we sold substantially all of the assets of our
respiratory therapy operation.

Pharmaceutical and Medical Supply Services: This segment
provides pharmaceutical products primarily to affiliated and nonaffiliated
long-term and sub-acute care facilities for such purposes as infusion therapy,
pain management, antibiotic therapy and parenteral nutrition as well as
providing consultant pharmacist services. This segment provided services to 672
facilities at December 31, 2002 compared with 654 facilities at December 31,
2001. Of the 672 facilities in 2002, 465 were nonaffiliated facilities and 207
were affiliated as compared to 439 nonaffiliated facilities and 215 affiliated
facilities in 2001.  Included in intersegment revenues in the following
tables is revenue billed directly to affiliated homes.

We previously provided medical
supplies to nonaffiliated and affiliated parties through SunChoice Medical
Supply, Inc. ("SunChoice"). In January 2001, we sold substantially all of the
operating assets of SunChoice.

International Operations: We sold our operations in the
United Kingdom, Germany and Australia during 2001 in February, April and July,
respectively. During 2000, we sold 18 pharmacies in the United Kingdom and our
operations in Spain. We did not have any international operations at December
31, 2001 and thereafter.

Other Operations: This segment includes temporary medical
staffing services, assisted living services, home health and hospice, software
development and other ancillary services provided to affiliated and
nonaffiliated facilities.

The accounting policies of the
segments are the same as those described in the Note 3 - "Summary of Significant
Accounting Policies." We primarily evaluate segment
performance based on profit or loss from operations after allocated expenses and
before reorganization items, income taxes and extraordinary items . Gains or
losses on sales of assets and certain items including impairment of assets
recorded in connection with SFAS 144 and 142, legal and regulatory matters
and restructuring costs are not considered in the evaluation of segment
performance. Allocated expenses include intersegment charges assessed to
segments for management services and asset use based on segment operating
results and average asset balances, respectively. We account for intersegment
sales and provision of services at estimated market prices.

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

F-42

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

Our reportable segments are
strategic business units that provide different products and services. They are
managed separately because each business has different marketing strategies due
to differences in types of customers, different distribution channels and
different capital resource needs.The following tables summarize, for the years indicated,
operating results and other financial information, by business segment (in
thousands):

|ReorganizedCompany                                                                                                                                                                                                                                              | InpatientServices    |   | Rehabilitationand
      RespiratoryTherapyServices |   | Pharmaceutical
      and
       Medical
      SupplyServices |   | InternationalOperations   |   | OtherOperations        |   | Corporate              |   | IntersegmentEliminations  |   | Consolidated                |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------- | - | -------------------------------------------------- | - | ------------------------------------------------------------ | - | ------------------------- | - | ---------------------- | - | ---------------------- | - | ------------------------- | - | --------------------------- | -
|For the Ten Months Ended 
         December 31, 2002                                                                                                                                                                                                            |                      |   |                                                    |   |                                                              |   |                           |   |                        |   |                        |   |                          
|Total net revenues                                                                                                                                                                                                                                              | $     1,224,231      |   | $               134,656                            |   | $                  217,797                                   |   | $                      -  |   | $        151,822       |   | $               222    |   | $          (130,534       | ) | $           1,598,194       |  
|Operating expenses, 
         corporate general and
         administrative
         expense and provision
         for  losses on
         accounts receivable                                                                                                 | 1,228,339            |   | 114,851                                            |   | 199,538                                                      |   | -                         |   | 139,232                |   | 43,518                 |   | (130,534                  | ) | 1,594,944                   |  
|Depreciation and
         amortization                                                                                                                                                                                                                          | 12,740               |   | 1,578                                              |   | 3,409                                                        |   | -                         |   | 1,428                  |   | 9,250                  |   | -                         |   | 28,405                      |  
|Interest, net                                                                                                                                                                                                                                                   | 1,853                |   | (12                                                | ) | 24                                                           |   | -                         |   | 666                    |   | 10,844                 |   | -                         |   | 13,375                      |  
|Net segment
          income (loss)                                                                                                                                                                                                                             | $         (18,701    | ) | $                 18,239                           |   | $                    14,826                                  |   | $                      -  |   | $          10,496      |   | $         (63,390      | ) | $                     -   |   | $              (38,530      | )
|                                                                                                                                                                                                                                                                | ========             |   | =========                                          |   | =========                                                    |   | ========                  |   | =======                |   | =======                |   | ========                  |   | =========                   |  
|Intersegment
          revenues                                                                                                                                                                                                                                 | $              (459  | ) | $                 77,813                           |   | $                    43,274                                  |   | $                      -  |   | $            9,906     |   | $                    - |   | $          (130,534       | ) | $                        -  |  
|Identifiable segment
          assets                                                                                                                                                                                                                           | $        262,741     |   | $                 19,703                           |   | $                    40,771                                  |   | $            37,790       |   | $                    - |   | $        482,930       |   | $          (368,100       | ) | $             475,835       |  
|Segment capital
          expenditures                                                                                                                                                                                                                          | $          18,566    |   | $                      111                         |   | $                         954                                |   | $                      -  |   | $            3,085     |   | $          11,985      |   | $                       - |   | $               34,701      |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Predecessor Company
       For the Two Months Ended
          February 28,
      2002                                                                                                                                                                           |                      |   |                                                    |   |                                                              |   |                           |   |                        |   |                        |   |                           |  
|Total net revenues                                                                                                                                                                                                                                              | $        227,906     |   | $               28,501                             |   | $                  41,101                                    |   | $                     -   |   | $          29,815      |   | $                    - |   | $           (25,477       | ) | $              301,846      |  
|Operating expenses, 
          corporate general and
         administrative
          expense and provision
         for  losses on
         accounts receivable                                                                                               | 227,118              |   | 24,872                                             |   | 37,818                                                       |   | -                         |   | 28,505                 |   | 8,559                  |   | (25,477                   | ) | 301,395                     |  
|Depreciation and
         amortization                                                                                                                                                                                                                          | 1,847                |   | 253                                                |   | 566                                                          |   | -                         |   | 382                    |   | 1,417                  |   | -                         |   | 4,465                       |  
|Interest, net                                                                                                                                                                                                                                                   | 273                  |   | 1                                                  |   | (2                                                           | ) | -                         |   | 120                    |   | 2,280                  |   | -                         |   | 2,672                       |  
|Net segment
          income (loss)                                                                                                                                                                                                                             | $          (1,332    | ) | $                  3,375                           |   | $                    2,719                                   |   | $                     -   |   | $               808    |   | $         (12,256      | ) | $                      -  |   | $                (6,686     | )
|                                                                                                                                                                                                                                                                | =======              |   | =========                                          |   | =========                                                    |   | ============              |   | =======                |   | =======                |   | ======                    |   | =======                     |  
|Intersegment
          revenues                                                                                                                                                                                                                                 | $                (92 | ) | $                15,755                            |   | $                    8,325                                   |   | $                    -    |   | $            1,489     |   | $                    - |   | $           (25,477       | ) | $                         - |  
|Identifiable segment
          assets                                                                                                                                                                                                                           | $        430,847     |   | $                80,477                            |   | $                115,259                                     |   | $                    -    |   | $          51,733      |   | $        514,167       |   | $         (364,067        | ) | $              828,416      |  
|Segment capital
          expenditures                                                                                                                                                                                                                          | $            1,987   |   | $                       38                         |   | $                       249                                  |   | $                    -    |   | $               124    |   | $            1,573     |   | $                      -  |   | $                  3,971    |  
|                                                                                                                                                                                                                                                                |                      |   |                                                    |   |                                                              |   |                           |   |                        |   |                        |   |                           |   |                             |  
|Predecessor Company For the Year Ended 
         December 31, 2001                                                                                                                                                                                              |                      |   |                                                    |   |                                                              |   |                           |   |                        |   |                        |   |                           |  
|Total net revenues                                                                                                                                                                                                                                              | $     1,609,388      |   | $                175,159                           |   | $                   257,579                                  |   | $             23,887      |   | $        178,065       |   | $            1,393     |   | $          (170,237       | ) | $           2,075,234       |  
|Operating expenses, 
         corporate general and
         administrative
         expense and provision
         for losses on
         accounts receivable                                                                                                  | 1,561,766            |   | 150,340                                            |   | 233,944                                                      |   | 22,953                    |   | 176,468                |   | 50,715                 |   | (170,237                  | ) | 2,025,949                   |  
|Depreciation and
         amortization                                                                                                                                                                                                                          | 12,576               |   | 1,752                                              |   | 4,311                                                        |   | -                         |   | 3,193                  |   | 10,953                 |   | -                         |   | 32,785                      |  
|Interest, net                                                                                                                                                                                                                                                   | 2,758                |   | 32                                                 |   | 4                                                            |   | 1,183                     |   | 513                    |   | 8,145                  |   | -                         |   | 12,635                      |  
|Income (loss) before
         corporate allocations                                                                                                                                                                                                             | 32,288               |   | 23,035                                             |   | 19,320                                                       |   | (249                      | ) | (2,109                 | ) | (68,420                | ) | -                         |   | 3,865                       |  
|Corporate management fees                                                                                                                                                                                                                                       | 52,294               |   | 10,344                                             |   | 15,085                                                       |   | -                         |   | 7,360                  |   | (85,083                | ) | -                         |   | -                           |  
|Net segment
         income (loss)                                                                                                                                                                                                                              | $         (20,006    | ) | $                  12,691                          |   | $                       4,235                                |   | $                 (249    | ) | $           (9,469     | ) | $          16,663      |   | $                       - |   | $                  3,865    |  
|                                                                                                                                                                                                                                                                | =======              |   | =========                                          |   | ==========                                                   |   | ========                  |   | =======                |   | =======                |   | ========                  |   | =========                   |  
|Intersegment
          revenues                                                                                                                                                                                                                                 | $              (526  | ) | $                  99,549                          |   | $                     62,209                                 |   | $                       - |   | $            9,005     |   | $                    - |   | $          (170,237       | ) | $                         - |  
|Identifiable segment
         assets                                                                                                                                                                                                                            | $        382,581     |   | $                  30,515                          |   | $                     74,815                                 |   | $                       - |   | $          59,796      |   | $        519,711       |   | $          (417,614       | ) | $              649,804      |  
|Segment capital
         expenditures                                                                                                                                                                                                                           | $          17,595    |   | $                       472                        |   | $                          937                               |   | $                  537    |   | $            1,865     |   | $            8,924     |   | $                       - |   | $                30,330     |  
|                                                                                                                                                                                                                                                                |                      |   |                                                    |   |                                                              |   |                           |   |                        |   |                        |   |                           |  

F-43

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

||PredecessorCompany                                                                                                                                                      | InpatientServices   |   | Rehabilitationand
      RespiratoryTherapyServices |  | Pharmaceutical
      and
       Medical
      SupplyServices |   | InternationalOperations   |   | OtherOperations    |   | Corporate           |   | IntersegmentEliminations  |   | Consolidated                |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------- | - | -------------------------------------------------- |  | ------------------------------------------------------------ | - | ------------------------- | - | ------------------ | - | ------------------- | - | ------------------------- | - | --------------------------- | -
|For the Year Ended
         December 31,
      2000                                                                                                                      |                     |   |                                                    |  |                                                              |   |                           |   |                    |   |                     |   |                           |   |                            
|Total Net Revenues                                                                                                                                                       | $     1,718,178     |   | $                204,367                           |  | $                   311,276                                  |   | $           265,501       |   | $        171,430   |   | $            1,381  |   | $          (213,205       | ) | $           2,458,928       |  
|Operating expenses,
         corporate general
         and administrative
         expenses, and
         provision for
         losses on
        accounts  receivable | 1,649,920           |   | 170,722                                            |  | 291,140                                                      |   | 261,814                   |   | 172,359            |   | 84,171              |   | (213,074                  | ) | 2,417,052                   |  
|Depreciation and
         amortization                                                                                                                                   | 20,192              |   | 3,023                                              |  | 6,856                                                        |   | 2,502                     |   | 3,084              |   | 10,355              |   | (131                      | ) | 45,881                      |  
|Interest, net                                                                                                                                                            | 10,567              |   | 188                                                |  | 58                                                           |   | 12,989                    |   | 1,416              |   | 9,051               |   | -                         |   | 34,269                      |  
|Income (loss)
         before corporate 
        allocations                                                                                                             | 37,499              |   | 30,434                                             |  | 13,222                                                       |   | (11,804                   | ) | (5,429             | ) | (102,196            | ) | -                         |   | (38,274                     | )
|Corporate interest
        allocation                                                                                                                                    | 24,444              |   | 8,946                                              |  | 10,577                                                       |   | 7,902                     |   | 5,823              |   | (57,692             | ) | -                         |   | -                           |  
|Corporate
         management fees                                                                                                                                       | 42,394              |   | 5,097                                              |  | 7,434                                                        |   | 1,815                     |   | 4,089              |   | (60,829             | ) | -                         |   | -                           |  
|Net segment
         income (loss)                                                                                                                                       | $         (29,339   | ) | $                  16,391                          |  | $                      (4,789                                | ) | $            (21,521      | ) | $         (15,341  | ) | $          16,325   |   | $                       - |   | $              (38,274      | )
|                                                                                                                                                                         | =======             |   | =========                                          |  | ==========                                                   |   | ========                  |   | =======            |   | =======             |   | ========                  |   | =========                   |  
|Intersegment
         revenues                                                                                                                                           | $               601 |   | $                113,265                           |  | $                     88,295                                 |   | $                       - |   | $          10,716  |   | $               328 |   | $          (213,205       | ) | $                         - |  
|Identifiable
         segment assets                                                                                                                                     | $        234,735    |   | $                  48,018                          |  | $                     52,022                                 |   | $             83,826      |   | $          68,974  |   | $     1,011,775     |   | $          (649,362       | ) | $              849,988      |  
|Segment capital
          expenditurest                                                                                                                                  | $          24,781   |   | $                       289                        |  | $                          994                               |   | $               4,590     |   | $            3,172 |   | $          21,540   |   | $                       - |   | $                55,366     |  

Measurement of Segment Income or Loss and Segment Assets

The accounting policies of the
operating segments are the same as those described in the summary of significant
accounting policies (see Note 3). We evaluate financial performance and allocate
resources primarily based on income or loss from operations before income taxes,
excluding any usual items.

The following tables reconcile net segment income (loss) to
consolidated loss before income taxes:



|                                  | Reorganized Company                             |   |    | Predecessor
      Company                              |  
|--------------------------------- | ----------------------------------------------- | - | -- | ------------------------------------------------------ | -
|                                  | For the Ten Months
      EndedDecember 31, 2002 |   |    | For the Two Months
      Ended February 28,
      2002 |  
|                                  |                                                 |   | |  |                                                        |  
|Net segment income (loss)         | $                (38,530                        | ) | |  | $                       (6,686                         | )
|Loss on impairment                | 407,760                                         |   | |  | -                                                      |  
|Legal and regulatory matters, net | -                                               |   | |  | -                                                      |  
|Restructuring costs               | -                                               |   | |  | -                                                      |  
|Gain on sale of assets, net       | (8,714                                          | ) | |  | -                                                      |  
|Reorganization costs, net         | -                                               |   | |  | (1,483                                                 | )
|Loss before income taxes          | $               (437,576                        | ) | || | $                     (5,203                           | )
|                                  | ==========                                      |   | |  | ============                                           |  

F-44

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(17)  Emergence from Chapter 11 Bankruptcy Proceedings

(a)  Confirmation of Joint Plan of
Reorganization



|Type
      of
      Claim/Security | Treatment
      under Plan of
      Reorganization                                                              
|---------------------------------- | ----------------------------------------------------------------------------------------------------------------
|1.                                 | General unsecured creditors with claims of $50,000 or
      less                                                
|2.                                 | General unsecured creditors with claims of more than
      $50,000                                              
|3.                                 | Senior bank lenders                                                                                             
|4.                                 | Senior subordinated note holders                                                                                
|5.                                 | Common stock, options, warrants, convertible debt,
      and convertible
      trust issued preferred securities
|6.                                 | United States Health Care Program Claims                                                                        
|7.                                 | State Medicaid Program Claims                                                                                   

(b)  Financial Reporting
Matters

Under Chapter 11, certain claims against us
in existence prior to the Filing Date were stayed while we continued operations
as a debtor-in-possession. These claims are reflected in the accompanying
consolidated balance sheets for 2001 and 2000 as "liabilities subject to
compromise." Claims secured by our assets ("secured claims") also were stayed
although the holders of such claims had the right to petition the Bankruptcy
Court for relief from the automatic stay to permit such creditors to foreclose
on the property securing their claim.

F-45

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

We determined that, generally, the fair
market value of the collateral was less than the principal amount of our secured
prepetition debt obligations; accordingly, we discontinued accruing interest on
substantially all of these obligations as of the Filing Date. We received
approval from the Bankruptcy Court to pay or otherwise honor certain of our
prepetition obligations, including employee wages and benefits.

The principal categories and the balances of
Chapter 11 claims reclassified in the accompanying consolidated balance sheets
as of December 31, 2001 and included in "liabilities subject to compromise" are
identified below (in thousands):

|                                                               |                        
|-------------------------------------------------------------- | -----------------------
|Revolving Credit Facility                                      | $               437,066
|Credit Facility Term Loans                                     | 358,981                
|Senior Subordinated Notes due 2007                             | 250,000                
|Senior Subordinated Notes due 2008                             | 150,000                
|Interest payable                                               | 101,856                
|Prepetition trade and other miscellaneous
      claims         | 88,171                 
|Convertible Subordinated Debentures due
2004                   | 83,300                 
|Mortgage notes payable due at various dates through
      2005 | 46,023                 
|Other long-term debt                                           | 14,377                 
|Industrial Revenue Bonds                                       | 8,365                  
|Senior Subordinated Notes due 2002                             | 6,161                  
|Capital leases                                                 | 3,457                  
|Convertible Subordinated Debentures due
2003                   | 1,382                  
|Total liabilities subject to
      compromise                  | $            1,549,139 
|                                                               | =============          

(c)  Debtor-in-Possession
Financing

On October 14, 1999, we entered into a
Revolving Credit Agreement with CIT/Business Credit, Inc. and Heller Healthcare
Finance, Inc. (the "DIP Financing Agreement"). The DIP Financing Agreement
provided for maximum borrowings by us of $200 million, subject to certain
limitations. We used borrowings from new loan agreements to pay off our
borrowings outstanding under the DIP Financing Agreement on February 28, 2002.

(d)  Reorganization Costs

Reorganization costs under Chapter 11 are
items of expense or income that were incurred or realized by us because we were
in reorganization. These included, but were not limited to, professional fees
and similar types of expenditures incurred directly relating to the Chapter 11
proceeding, loss accruals or realized gains or losses resulting from activities
of the reorganization process and interest earned on cash accumulated by us
because we were not paying prepetition liabilities.

F-46

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

The components of reorganization costs (gain), net, were as
follows for the periods indicated (in thousands):

|                                                                    | Predecessor
      Company                      |  
|------------------------------------------------------------------- | ---------------------------------------------- | -
|                                                                    | For the TwoMonths EndedFebruary 28,
      2002 |  
|                                                                    |                                                |  
|Professional fees                                                   | $                     8,171                    |  
|Restructuring                                                       | 3,843                                          |  
|Adjust carrying value of assets no longer
            held for sale | (12,811                                        | )
|Adjust carrying value of assets held for
            sale           | (598                                           | )
|Loss on sale of assets                                              | -                                              |  
|Miscellaneous                                                       | -                                              |  
|Less:                                                               |                                                |  
|Interest earned on accumulated
      cash                           | (88                                            | )
|                                                                    |                                                |  
|Total reorganization costs
      (gain), net                        | $                   (1,483                     | )
|                                                                    | =============                                  |  

(18)  Fresh-Start Accounting



F-47

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

A reconciliation of fresh-start accounting recorded as of February 28, 2002
follows (in thousands):

|                            | PredecessorCompany     |  | || | Fresh-start         | ReorganizedCompany |                  
|--------------------------- | ---------------------- |  | -- | ------------------- | ------------------ | -----------------
|                            | February
      28,2002 |  | || | Debt Re-structuring |                    | Adjustments      
|Current assets:             |                        |  | |  |                     |                    |                  
|Cash and cash equivalents   | $        69,162        |  | |  | $              -    |                    | $             (18
|Accounts receivable, net    | 211,248                |  | |  | -                   |                    | (449             
|Inventory, net              | 21,367                 |  | |  | -                   |                    | -                
|Other receivables, net      | 5,089                  |  | |  | -                   |                    | (182             
|Prepaids and other assets   | 12,554                 |  | |  | -                   |                    | (16              
|                            |                        |  | |  |                     |                    |                  
|Total current assets        | 319,420                |  | |  | -                   |                    | (665             
|                            |                        |  | |  |                     |                    |                  
|Property and equipment, net | 132,482                |  | |  | -                   |                    | 55,407           
|Assets held for sale        | 18,288                 |  | |  | -                   |                    | -                
|Goodwill, net               | 180,269                |  | |  | -                   |                    | 34,548           
|Other assets, net           | 30,963                 |  | |  | -                   |                    | 57,704           
|                            |                        |  | |  |                     |                    |                  
|Total assets                | $       681,422        |  | |  | $                -  |                    | $       146,994  
|                            | ========               |  | |  | ========            |                    | =========        

|F-48SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2002 |                   
|------------------------------------------------------------------------------------------------------------------------ | ------------------
|                                                                                                                         | PredecessorCompany
|                                                                                                                         | February 28, 2002 
|Current liabilities:                                                                                                     |                   
|Current portion of long-term debt                                                                                        | $           4,879 
|Current portion of capital leases                                                                                        | -                 
|Accounts payable                                                                                                         | 16,142            
|Accrued compensation and benefits                                                                                        | 78,301            
|Accrued self-insurance obligations                                                                                       | 42,996            
|Income taxes payable                                                                                                     | 13,123            
|Other accrued liabilities                                                                                                | 82,219            
|                                                                                                                         |                   
|Total current liabilities                                                                                                | 237,660           
|                                                                                                                         |                   
|Liabilities subject to compromise                                                                                        | 1,546,292         
|Accrued self-insurance obligations,  net of current
      portion                                                        | 54,530            
|Long-term debt, net of current portion                                                                                   | 134,535           
|Capital leases, net of current portion                                                                                   | -                 
|Other long-term liabilities                                                                                              | 22,176            
|                                                                                                                         |                   
|Total liabilities                                                                                                        | 1,995,193         
|                                                                                                                         |                   
|Commitments and contingencies                                                                                            |                   
|                                                                                                                         |                   
|Minority interest                                                                                                        | 5,767             
|                                                                                                                         |                   
|Convertible Preferred Stock                                                                                              | 296,101           
|                                                                                                                         |                   
|Stockholders' equity (deficit):                                                                                          |                   
|Reorganized Company
      common    stock, par value                                                                     | -                 
|Predecessor Company common
          stock  par value                                                                    | 652               
|Additional paid-in capital                                                                                               | 824,739           
|                                                                                                                         |                   
|Retained earnings
      (accumulated    deficit)                                                                         | (2,413,644        
|                                                                                                                         |                   
|Less:                                                                                                                    |                   
|Predecessor Company
      common      stock held in
      treasury                                                       | (27,376           
|Predecessor Company grantor stock                                                                                        | (10               
|Total stockholders' equity (deficit)                                                                                     | (1,615,639        
|Total liabilities and
      stockholders'    equity (deficit)                                                            | $       681,422   
|                                                                                                                         | =========         

F-49

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

|(a)  To record the discharge of indebtedness in accordance with the Plan of
      Reorganization (in thousands):                                                                                                                                                                                                                                   
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                   
|Revolving Credit Facility                                                                                                                                                                                                                                                                                                                          
|Credit Facility Term Loans                                                                                                                                                                                                                                                                                                                         
|Senior Subordinated Notes due 2007                                                                                                                                                                                                                                                                                                                 
|Senior Subordinated Notes due 2008                                                                                                                                                                                                                                                                                                                 
|Interest payable                                                                                                                                                                                                                                                                                                                                   
|Prepetition trade and other miscellaneous
         claims                                                                                                                                                                                                                                                                                          
|Convertible Subordinated Debentures due
         2004                                                                                                                                                                                                                                                                                              
|Other long-term debt                                                                                                                                                                                                                                                                                                                               
|Senior Subordinated Notes due 2003                                                                                                                                                                                                                                                                                                                 
|Capital leases                                                                                                                                                                                                                                                                                                                                     
|Convertible Subordinated Debentures due
         2003                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                   
|(b)   To record the discharge of the Convertible Preferred Stock of the
      Predecessor.                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                   
|(c)   To eliminate the Common Stock of the Predecessor.                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                   
|(d)   To record the gain on extinguishment of indebtedness.                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                   
|(e)   To reflect the issuance of the Reorganized Company's
      common stock.                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                   
|(f)   To reflect the fair value of the Reorganized Company's
      common stock and warrants that are to be issued to various pre-petition
      debt holders after emergence.                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                   
|(g)   To adjust the carrying amount of assets and liabilities
      to fair value. Fair value was determined based upon third-party valuations
      of our long-lived assets and liabilities. The allocation of goodwill to
      our reporting units is not yet final, pending further analysis of our
      plans for certain leased facilities.
|                                                                                                                                                                                                                                                                                                                                                   
|(h)   To reclassify the pre-petition priority, secured and
      unsecured claims that were assumed by the Reorganized Company in
      accordance with the Plan of Reorganization.                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                   
|(i)   To record miscellaneous provisions of the Plan of
      Reorganization.                                                                                                                                                                                                                                                                      

(19)  Gain on Extinguishment of Debt

In connection with the restructuring of our
debt in accordance with the provisions of the Plan of Reorganization, we
realized an extraordinary gain of $1,498.4 million. This gain has been reflected
in the operating results of the Predecessor Company for the two months ended
February 28, 2002.

F-50

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

A summary of the extraordinary gain follows (in
thousands):

|Liabilities extinguished:                                                                                                                                                                                           |                        
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------
|                                                                                                                                                                                                                    |                        
|Revolving Credit Facility                                                                                                                                                                                           | $               437,066
|Credit Facility Term
Loans                                                                                                                                                                                          | 358,981                
|Senior Subordinated Notes due
      2007                                                                                                                                                                            | 250,000                
|Senior Subordinated Notes due
      2008                                                                                                                                                                            | 150,000                
|Interest payable                                                                                                                                                                                                    | 101,855                
|Prepetition trade and other
      miscellaneous claims                                                                                                                                                              | 86,776                 
|Convertible Subordinated Debentures due
      2004                                                                                                                                                                  | 83,300                 
|Other long-term debt                                                                                                                                                                                                | 8,087                  
|Senior Subordinated Notes due
      2003                                                                                                                                                                            | 6,161                  
|Capital leases                                                                                                                                                                                                      | 2,503                  
|Convertible Subordinated Debentures due
      2003                                                                                                                                                                  | 1,382                  
|Company-obligated mandatorily redeemable
      convertible      preferred securities of
      a subsidiary trust holding solely
            7% convertible junior subordinated
      debentures of the      Company | 296,101                
|                                                                                                                                                                                                                    | 1,782,212              
|Consideration exchanged:                                                                                                                                                                                            |                        
|Common Stock                                                                                                                                                                                                        | 270,000                
|Cash payments to senior
      lenders                                                                                                                                                                               | 6,652                  
|Cash payments to trade creditors -
      convenience class                                                                                                                                                          | 4,400                  
|Warrants                                                                                                                                                                                                            | 1,800                  
|Payment of other executory
      contracts                                                                                                                                                                          | 1,000                  
|                                                                                                                                                                                                                    | 283,852                
|                                                                                                                                                                                                                    |                        
|                                                                                                                                                                                                                    | $            1,498,360 
|                                                                                                                                                                                                                    | =============          

(20)  Convertible Trust Issued Preferred Securities

In May 1998, a statutory business
trust, all of whose common securities are owned by us, issued $345.0 million of
7.0% Convertible Trust Issued Preferred Securities ("CTIPS") with a liquidation
amount of $25.00 per CTIP. Each CTIP was convertible into 1.2419 shares of our
common stock (equivalent to a conversion price of $20.13 per share). The CTIPS
holders were entitled to receive cumulative cash distributions at an annual rate
of 7.0%, payable quarterly. During 2000, approximately $26.9 million of CTIPS
were converted into approximately 1.3 million shares of common stock. During
1999, $22.0 million of CTIPS were converted into approximately 1.1 million
shares of common stock. Our 2001 and 2000 statements of losses excluded the
dividends as the fair value of the dividends was immaterial. As a result of the
consummation of our Joint Plan of Reorganization on February 28, 2002, all of
the CTIPS were cancelled without any recovery to the CTIP holders.

F-51

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(21)  Filer/Non-Filer Financial Statements

In accordance with SOP 90-7, the debtor
entities are required to present condensed consolidated financial statements for
the years ended after the Filing Date:

CONSOLIDATING STATEMENT OF OPERATIONSPredecessor Company
For the Two Months Ended February 28, 2002 (in
thousands)

|                                                                                                                                   | Filers            |   | Non-filers           |   | Elimination          |   | Consolidated         |  
|---------------------------------------------------------------------------------------------------------------------------------- | ----------------- | - | -------------------- | - | -------------------- | - | -------------------- | -
|                                                                                                                                   |                   |   |                      |   |                      |   |                      |  
|Total net revenues                                                                                                                 | $         295,812 |   | $             6,884  |   | $               (850 | ) | $            301,846 |  
|                                                                                                                                   |                   |   |                      |   |                      |   |                      |  
|Costs and expenses:                                                                                                                |                   |   |                      |   |                      |   |                      |  
|Operating costs                                                                                                                    | 279,869           |   | 6,097                |   | (850                 | ) | 285,116              |  
|Corporate general and administrative                                                                                               | 15,862            |   | -                    |   | -                    |   | 15,862               |  
|Depreciation and amortization                                                                                                      | 4,285             |   | 180                  |   | -                    |   | 4,465                |  
|Provision for losses on accounts
    receivable                                                                                    | 362               |   | 55                   |   | -                    |   | 417                  |  
|Interest, net                                                                                                                      | 2,552             |   | 120                  |   | -                    |   | 2,672                |  
|Equity interest in losses of
    subsidiaries                                                                                      | (613              | ) | -                    |   | 613                  |   | -                    |  
|Total costs and expenses                                                                                                           | 302,317           |   | 6,452                |   | (237                 | ) | 308,532              |  
|Management fee (income) expense                                                                                                    | 181               |   | (181                 | ) | -                    |   | -                    |  
|(Loss) income before reorganization costs (gain), net, income
      taxes,    discontinued operations and
      extraordinary item | (6,686            | ) | 613                  |   | (613                 | ) | (6,686               | )
|Reorganization costs (gain), net                                                                                                   | (1,483            | ) | -                    |   | -                    |   | (1,483               | )
|Income taxes                                                                                                                       | 147               |   | -                    |   | -                    |   | 147                  |  
|Loss from discontinued operations                                                                                                  | (1,569            | ) | -                    |   | -                    |   | (1,569               | )
|Loss on write-down of assets held for sale                                                                                         | (6,070            | ) | -                    |   | -                    |   | (6,070               | )
|Extraordinary gain on extinguishment of debt                                                                                       | 1,498,360         |   | -                    |   | -                    |   | 1,498,360            |  
|Net income                                                                                                                         | $      1,485,371  |   | $                613 |   | $               (613 | ) | $         1,485,371  |  
|                                                                                                                                   | ========          |   | ========             |   | ========             |   | =========            |  

F-52

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(21)  Filer/Non-Filer Financial Statements (Continued)

CONSOLIDATING STATEMENT OF CASH FLOWSPredecessor Company
For the Two Months Ended February 28, 2002(in
thousands)



|                                                                                                | Filers               |   | Non-filers                |   | Elimination                |   | Consolidated       |  
|----------------------------------------------------------------------------------------------- | -------------------- | - | ------------------------- | - | -------------------------- | - | ------------------ | -
|Cash flows from operating activities:                                                           |                      |   |                           |   |                            |   |                    |  
|Net income                                                                                      | $          1,485,371 |   | $                     613 |   | $               (613       | ) | $        1,485,371 |  
|Adjustments to reconcile net income to net
      cash used for
           operating activities: |                      |   |                           |   |                            |   |                    |  
|Equity interest in losses of
      subsidiaries                                                 | (613                 | ) | -                         |   | 613                        |   | -                  |  
|Extraordinary gain on extinguishment of
      debt                                              | (1,498,360           | ) | -                         |   | -                          |   | (1,498,360         | )
|Reorganization costs (gain),
net                                                                | (1,483               | ) | -                         |   | -                          |   | (1,483             | )
|Depreciation and amortization                                                                   | 4,285                |   | 180                       |   | -                          |   | 4,465              |  
|Provision for losses on accounts and other
      receivables                                    | 362                  |   | 55                        |   | -                          |   | 417                |  
|Loss on write-down of assets held for
      sale                                                | 6,070                |   | -                         |   | -                          |   | 6,070              |  
|Other, net                                                                                      | 5,588                |   | (4,872                    | ) | -                          |   | 716                |  
|Changes in operating assets and
      liabilities:                                              |                      |   |                           |   |                            |   |                    |  
|Accounts receivable                                                                             | (7,875               | ) | 507                       |   | -                          |   | (7,368             | )
|Other current assets                                                                            | (9,196               | ) | 2,721                     |   | -                          |   | (6,475             | )
|Income taxes payable                                                                            | 693                  |   | -                         |   | -                          |   | 693                |  
|Other current liabilities                                                                       | (4,263               | ) | (745                      | ) | -                          |   | (5,008             | )
|Net cash used for operating activities before
      reorganization costs                        | (19,421              | ) | (1,541                    | ) | -                          |   | (20,962            | )
|Net cash paid for reorganization costs                                                          | (2,781               | ) | -                         |   | -                          |   | (2,781             | )
|Net cash used for operating activities                                                          | (22,202              | ) | (1,541                    | ) | -                          |   | (23,743            | )
|Cash flows from investing activities:                                                           |                      |   |                           |   |                            |   |                    |  
|Capital expenditures, net                                                                       | (3,971               | ) | -                         |   | -                          |   | (3,971             | )
|Decrease in long-term notes receivable                                                          | 168                  |   | -                         |   | -                          |   | 168                |  
|Other                                                                                           | (1,884               | ) | 2,026                     |   | -                          |   | 142                |  
|Net cash (used for) provided by investing
      activities                                      | (5,687               | ) | 2,026                     |   | -                          |   | (3,661             | )
|Cash flows from financing activities:                                                           |                      |   |                           |   |                            |   |                    |  
|Net payments under Revolving Credit Agreement                                                   | (55,382              | ) | -                         |   | -                          |   | (55,382            | )
|Long-term debt borrowings                                                                       | 112,988              |   | -                         |   | -                          |   | 112,988            |  
|Long-term debt repayments                                                                       | -                    |   | (13                       | ) | -                          |   | (13                | )
|Principal payments on prepetition debt authorized by
      Bankruptcy Court                     | (7,966               | ) | -                         |   | -                          |   | (7,966             | )
|Intercompany advances                                                                           | (94                  | ) | 94                        |   | -                          |   | -                  |  
|Other                                                                                           | (3,729               | ) | 1                         |   | -                          |   | (3,728             | )
|Net cash provided by financing
      activities                                                 | 45,817               |   | 82                        |   | -                          |   | 45,899             |  
|Net increase in cash and cash equivalents                                                       | 17,928               |   | 567                       |   | -                          |   | 18,495             |  
|Cash and cash equivalents at beginning of year                                                  | 49,917               |   | 732                       |   | -                          |   | 50,649             |  
|Cash and cash equivalents at end of period                                                      | $             67,845 |   | $                  1,299  |   | $                        - |   | $          69,144  |  
|                                                                                                | ========             |   | ========                  |   | ========                   |   | =======            |  

F-53

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(21)  Filer/Non-Filer Financial Statements (Continued)

CONSOLIDATING BALANCE SHEETPredecessor Company
As of December 31, 2001(in thousands except share
data)



|ASSETS                     
|---------------------------
|                           
|                           
|Current assets:            
|Cash and cash equivalents  
|Accounts receivable, net   
|Inventory, net             
|Other receivables, net     
|Prepaids and other assets  
|Total current assets       
|                           
|Property and equipment, net
|Assets held for sale       
|Notes receivable, net      
|Goodwill, net              
|Other assets, net          
|Investment in subsidiaries 
|Total assets               
|                           

F-54

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(21)  Filer/Non-Filer Financial Statements (Continued)

CONSOLIDATING BALANCE SHEETPredecessor Company
As of December 31, 2001(in thousands except share
data)



|LIABILITIES AND STOCKHOLDERS' EQUITY
      (DEFICIT)                                                                                                                                             
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                 
|                                                                                                                                                                                                 
|Current liabilities:                                                                                                                                                                             
|Current portion of long-term debt                                                                                                                                                                
|Accounts payable                                                                                                                                                                                 
|Accrued compensation and benefits                                                                                                                                                                
|Accrued self-insurance obligations                                                                                                                                                               
|Income taxes payable                                                                                                                                                                             
|Other accrued liabilities                                                                                                                                                                        
|Total current liabilities                                                                                                                                                                        
|                                                                                                                                                                                                 
|Liabilities subject to compromise (see Note 2)                                                                                                                                                   
|Accrued self-insurance obligations, net of current
portion                                                                                                                                       
|Long-term debt, net of current portion                                                                                                                                                           
|Other long-term liabilities                                                                                                                                                                      
|Total liabilities                                                                                                                                                                                
|Commitments and contingencies (see Note 10)                                                                                                                                                      
|Minority interest                                                                                                                                                                                
|Company-obligated mandatorily redeemable convertible
      preferred   Securities of a subsidiary trust holding
      solely 7% convertible junior   Subordinated debentures
      of the Company
|Intersegment                                                                                                                                                                                     
|Stockholders' deficit:                                                                                                                                                                           
|Common stock of $.01 par value, authorized
      155,000,000 shares,      65,209,188
      shares issued and outstanding as
      of      December 31,
    2001                                  
|Additional paid-in capital                                                                                                                                                                       
|Accumulated deficit                                                                                                                                                                              
|Less:                                                                                                                                                                                            
|Common stock held in treasury, at
      cost, 2,213,537 shares as
      of         December 31,
      2001                                                                                       
|Grantor stock trust, at market,
      1,915,935 shares as
      of         December 31,
      2001                                                                                               
|Total stockholders' deficit                                                                                                                                                                      
|Total liabilities and stockholders'
    deficit                                                                                                                                                  
|                                                                                                                                                                                                 

F-55

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(21)  Filer/Non-Filer Financial Statements (Continued)

CONSOLIDATING STATEMENT OF OPERATIONSPredecessor Company

|                                                                | Filers            |   | Non-filers          |   | Elimination          |   | Consolidated          |  
|--------------------------------------------------------------- | ----------------- | - | ------------------- | - | -------------------- | - | --------------------- | -
|                                                                |                   |   |                     |   |                      |   |                       |  
|Total net revenues                                              | $ 2,008,534       |   | $ 71,668            |   | $ (4,968             | ) | $ 2,075,234           |  
|Costs and expenses:                                             |                   |   |                     |   |                      |   |                       |  
|Operating costs                                                 | 1,832,761         |   | 67,869              |   | (4,968               | ) | 1,895,662             |  
|Corporate general and administrative                            | 102,599           |   | 1,716               |   | -                    |   | 104,315               |  
|Depreciation and amortization                                   | 31,371            |   | 1,414               |   | -                    |   | 32,785                |  
|Provision for losses on accounts
    receivable                 | 25,162            |   | 810                 |   | -                    |   | 25,972                |  
|Loss on impairment                                              | 14,482            |   | 4,343               |   | -                    |   | 18,825                |  
|Interest, net (contractual interest expense
      $142,800)     | 10,960            |   | 1,675               |   | -                    |   | 12,635                |  
|Legal and regulatory matters, net                               | 11,000            |   | -                   |   | -                    |   | 11,000                |  
|Restructuring costs                                             | -                 |   | 1,064               |   | -                    |   | 1,064                 |  
|Gain on sale of assets, net                                     | (782              | ) | (43                 | ) | -                    |   | (825                  | )
|Equity interest in losses of
    subsidiaries                   | 9,463             |   | -                   |   | (9,463               | ) | -                     |  
|Total costs and expenses                                        | 2,037,016         |   | 78,848              |   | (14,431              | ) | 2,101,433             |  
|Management fee (income) expense before reorganization
    items | (2,810            | ) | 2,810               |   | -                    |   | -                     |  
|Losses before reorganization costs, net, and income taxes       | (25,672           | ) | (9,990              | ) | 9,463                |   | (26,199               | )
|Reorganization costs, net                                       | 43,473            |   | (556                | ) | -                    |   | 42,917                |  
|Income taxes                                                    | 291               |   | 30                  |   | -                    |   | 321                   |  
|Net losses                                                      | $         (69,436 | ) | $            (9,464 | ) | $              9,463 |   | $             (69,437 | )
|                                                                | ==========        |   | ==========          |   | ===========          |   | ============          |  

F-56

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(21)  Filer/Non-Filer Financial Statements (Continued)

CONSOLIDATING STATEMENT OF CASH FLOWSPredecessor CompanyFor the Year Ended December 31, 2001(in
thousands)

|                                                                                                            | Filers                         |   | Non-filers              |   | Elimination              |   | Consolidated         |  
|----------------------------------------------------------------------------------------------------------- | ------------------------------ | - | ----------------------- | - | ------------------------ | - | -------------------- | -
|Cash flows from operating activities:                                                                       |                                |   |                         |   |                          |   |                      |  
|Net losses                                                                                                  | $ (69,437                      | ) | $ (9,464                | ) | $ 9,464                  |   | $ (69,437            | )
|Adjustments to reconcile net losses to net cash provided by
         (used for)
      operating activities: |                                |   |                         |   |                          |   |                      |  
|Equity interest in losses of
    subsidiaries                                                               | 9,464                          |   | -                       |   | (9,464                   | ) | -                    |  
|Loss on impairment                                                                                          | 14,482                         |   | 4,343                   |   | -                        |   | 18,825               |  
|Depreciation and amortization                                                                               | 31,371                         |   | 1,414                   |   | -                        |   | 32,785               |  
|Provision for losses on accounts
    receivable                                                             | 25,162                         |   | 810                     |   | -                        |   | 25,972               |  
|Legal and regulatory costs                                                                                  | 11,000                         |   | -                       |   | -                        |   | 11,000               |  
|(Gain) loss on sale of assets, net                                                                          | (782                           | ) | (43                     | ) | -                        |   | (825                 | )
|Reorganization costs, net                                                                                   | 43,473                         |   | (556                    | ) | -                        |   | 42,917               |  
|Other, net                                                                                                  | 9,844                          |   | (248                    | ) | -                        |   | 9,596                |  
|Changes in operating assets and liabilities:                                                                |                                |   |                         |   |                          |   |                      |  
|Accounts receivable                                                                                         | (39,226                        | ) | 2,312                   |   | -                        |   | (36,914              | )
|Other current assets                                                                                        | (2,749                         | ) | 3,694                   |   | -                        |   | 945                  |  
|Other current liabilities                                                                                   | 16,072                         |   | (8,051                  | ) | -                        |   | 8,021                |  
|Income taxes payable                                                                                        | 3,810                          |   | (2,743                  | ) | -                        |   | 1,067                |  
|Net cash provided by (used for) operating activities
      before
            reorganization costs          | 52,484                         |   | (8,532                  | ) | -                        |   | 43,952               |  
|Net cash paid for reorganization costs                                                                      | (19,583                        | ) | -                       |   | -                        |   | (19,583              | )
|Net cash (used for) provided by operating
      activities                                                  | 32,901                         |   | (8,532                  | ) | -                        |   | 24,369               |  
|Cash flows from investing activities:                                                                       |                                |   |                         |   |                          |   |                      |  
|Capital expenditures, net                                                                                   | (29,793                        | ) | (537                    | ) | -                        |   | (30,330              | )
|Acquisitions, net of cash acquired                                                                          | -                              |   | -                       |   | -                        |   | -                    |  
|Proceeds from sale of assets                                                                                | 14,676                         |   | 3,488                   |   | -                        |   | 18,164               |  
|Proceeds from redemption of strategic
      investment                                                      | 10,115                         |   | -                       |   | -                        |   | 10,115               |  
|(Increase) decrease in long-term notes
      receivable                                                     | 885                            |   | -                       |   | -                        |   | 885                  |  
|Decrease in other assets                                                                                    | 6,568                          |   | (3,942                  | ) | -                        |   | 2,626                |  
|Net cash (used for) provided by investing
      activities                                                  | 2,451                          |   | (991                    | ) | -                        |   | 1,460                |  
|Cash flows from financing activities:                                                                       |                                |   |                         |   |                          |   |                      |  
|Net (repayments) borrowings under Revolving Credit
           Agreement (postpetition)                      | (12,441                        | ) | -                       |   | -                        |   | (12,441              | )
|Long-term debt borrowings                                                                                   | 3,748                          |   | 94                      |   | -                        |   | 3,842                |  
|Long-term debt repayments (prepetition)                                                                     | -                              |   | (82                     | ) | -                        |   | (82                  | )
|Principal payments on prepetition debt authorized by
            Bankruptcy Court                           | (3,017                         | ) | -                       |   | -                        |   | (3,017               | )
|Other financing activities                                                                                  | 2                              |   | (3                      | ) | -                        |   | (1                   | )
|Intersegment advances                                                                                       | (5,257                         | ) | 5,257                   |   | -                        |   | -                    |  
|Net cash provided by (used for)
      financing activities                                                  | (16,965                        | ) | 5,266                   |   | -                        |   | (11,699              | )
|Effect of exchange rate on cash and cash equivalents                                                        | (1,070                         | ) | -                       |   | -                        |   | (1,070               | )
|Net increase (decrease) in cash and cash equivalents                                                        | 17,317                         |   | (4,257                  | ) | -                        |   | 13,060               |  
|Cash and cash equivalents at beginning of year                                                              | 32,600                         |   | 4,989                   |   | -                        |   | 37,589               |  
|Cash and cash equivalents at end of year                                                                    | $                       49,917 |   | $                   732 |   | $                      - |   | $             50,649 |  
|                                                                                                            | ===========                    |   | =======                 |   | ========                 |   | ========             |  

F-57

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(21)  Filer/Non-Filer Financial Statements
(Continued)

CONSOLIDATING STATEMENT OF OPERATIONSPredecessor CompanyFor the Year Ended December 31, 2000(in
thousands)



|                                                                | Filers           |   | Non-filers       |   | Elimination       |   | Consolidated         |  
|--------------------------------------------------------------- | ---------------- | - | ---------------- | - | ----------------- | - | -------------------- | -
|                                                                |                  |   |                  |   |                   |   |                      |  
|Total net revenues                                              | $ 2,145,659      |   | $ 318,485        |   | $ (5,216          | ) | $ 2,458,928          |  
|Costs and expenses:                                             |                  |   |                  |   |                   |   |                      |  
|Operating costs                                                 | 1,931,901        |   | 303,738          |   | (5,216            | ) | 2,230,423            |  
|Corporate general and administrative                            | 140,117          |   | 13,016           |   | -                 |   | 153,133              |  
|Depreciation and amortization                                   | 43,000           |   | 2,881            |   | -                 |   | 45,881               |  
|Provision for losses on accounts
    receivable                 | 32,973           |   | 523              |   | -                 |   | 33,496               |  
|Loss on impairment                                              | 191,199          |   | 117              |   | -                 |   | 191,316              |  
|Interest, net (contractual interest expense
      $146,406)     | 20,260           |   | 14,009           |   | -                 |   | 34,269               |  
|Legal and regulatory matters, net                               | 2,480            |   | -                |   | -                 |   | 2,480                |  
|Restructuring costs                                             | (1,090           | ) | -                |   | -                 |   | (1,090               | )
|(Gain) loss on sale of assets, net                              | (21,405          | ) | 5                |   | -                 |   | (21,400              | )
|Equity interest in losses of
    subsidiaries                   | 129,311          |   | -                |   | (129,311          | ) | -                    |  
|Intersegment interest expense (income)                          | (2,198           | ) | 2,198            |   | -                 |   | -                    |  
|Total costs and expenses                                        | 2,466,548        |   | 336,487          |   | (134,527          | ) | 2,668,508            |  
|Management fee (income) expense before reorganization
    items | (828             | ) | 828              |   | -                 |   | -                    |  
|Losses before reorganization costs, net, and income taxes       | (320,061         | ) | (18,830          | ) | 129,311           |   | (209,580             | )
|Reorganization costs, net                                       | 225,423          |   | 110,452          |   | -                 |   | 335,875              |  
|Income taxes                                                    | 227              |   | 29               |   | -                 |   | 256                  |  
|Net losses                                                      | $       (545,711 | ) | $       (129,311 | ) | $         129,311 |   | $           (545,711 | )
|                                                                | =======          |   | =======          |   | =======           |   | ========             |  

F-58

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002

(21)  Filer/Non-Filer Financial Statements (Continued)

CONSOLIDATING STATEMENT OF CASH FLOWSPredecessor CompanyFor the Year Ended December 31, 2000(in
thousands)

|                                                                                                               | Filers                       |   | Non-filers             |   | Elimination              |   | Consolidated          |  
|-------------------------------------------------------------------------------------------------------------- | ---------------------------- | - | ---------------------- | - | ------------------------ | - | --------------------- | -
|Cash flows from operating activities:                                                                          |                              |   |                        |   |                          |   |                       |  
|Net losses                                                                                                     | $ (545,711                   | ) | $ (129,311             | ) | $ 129,311                |   | $ (545,711            | )
|Adjustments to reconcile net losses to net cash provided by
            (used for)
      operating activities: |                              |   |                        |   |                          |   |                       |  
|Equity interest in losses of
    subsidiaries                                                                  | 129,311                      |   | -                      |   | (129,311                 | ) | -                     |  
|Loss on impairment                                                                                             | 191,199                      |   | 117                    |   | -                        |   | 191,316               |  
|Depreciation and amortization                                                                                  | 43,000                       |   | 2,881                  |   | -                        |   | 45,881                |  
|Provision for losses on accounts
    receivable                                                                | 32,973                       |   | 523                    |   | -                        |   | 33,496                |  
|Legal and regulatory costs                                                                                     | 1,245                        |   | -                      |   | -                        |   | 1,245                 |  
|(Gain) loss on sale of assets, net                                                                             | (21,405                      | ) | 5                      |   | -                        |   | (21,400               | )
|Reorganization costs, net                                                                                      | 225,423                      |   | 110,452                |   | -                        |   | 335,875               |  
|Other, net                                                                                                     | (18,388                      | ) | (1,798                 | ) | -                        |   | (20,186               | )
|Changes in operating assets and liabilities:                                                                   |                              |   |                        |   |                          |   |                       |  
|Accounts receivable                                                                                            | (19,886                      | ) | 1,166                  |   | -                        |   | (18,720               | )
|Other current assets                                                                                           | (6,737                       | ) | 17,766                 |   | -                        |   | 11,029                |  
|Other current liabilities                                                                                      | 1,582                        |   | (723                   | ) | -                        |   | 859                   |  
|Income taxes payable                                                                                           | 4,827                        |   | (2,712                 | ) |                          |   | 2,115                 |  
|Net cash provided by (used for) operating activities
      before
            reorganization costs             | 17,433                       |   | (1,634                 | ) | -                        |   | 15,799                |  
|Net cash paid for reorganization costs                                                                         | (17,520                      | ) | -                      |   |                          |   | (17,520               | )
|Net cash (used for) provided by operating
      activities                                                     | (87                          | ) | (1,634                 | ) |                          |   | (1,721                | )
|Cash flows from investing activities:                                                                          |                              |   |                        |   |                          |   |                       |  
|Capital expenditures, net                                                                                      | (48,236                      | ) | (7,130                 | ) | -                        |   | (55,366               | )
|Acquisitions, net of cash acquired                                                                             | (974                         | ) | -                      |   | -                        |   | (974                  | )
|Proceeds from sale of assets held for
    sale                                                                 | 2,987                        |   | 21,993                 |   | -                        |   | 24,980                |  
|(Increase) decrease in long-term notes
      receivable                                                        | (8,024                       | ) | 1,936                  |   | -                        |   | (6,088                | )
|Decrease in other assets                                                                                       | 5,536                        |   | -                      |   |                          |   | 5,536                 |  
|Net cash (used for) provided by investing
      activities                                                     | (48,711                      | ) | 16,799                 |   |                          |   | (31,912               | )
|Cash flows from financing activities:                                                                          |                              |   |                        |   |                          |   |                       |  
|Net borrowings under Revolving Credit Agreement
      (postpetition)                                           | 54,901                       |   | -                      |   | -                        |   | 54,901                |  
|Long-term debt borrowings                                                                                      | 6,108                        |   | 3,559                  |   | -                        |   | 9,667                 |  
|Long-term debt repayments (prepetition)                                                                        | -                            |   | (14,663                | ) | -                        |   | (14,663               | )
|Principal payments on prepetition debt authorized by
      Bankruptcy Court                                    | (3,358                       | ) | (48                    | ) | -                        |   | (3,406                | )
|Other financing activities                                                                                     | 28                           |   | (32                    | ) | -                        |   | (4                    | )
|Intersegment advances                                                                                          | 5,187                        |   | (5,187                 | ) |                          |   | -                     |  
|Net cash provided by (used for)
      financing activities                                                     | 62,866                       |   | (16,371                | ) |                          |   | 46,495                |  
|Effect of exchange rate on cash and cash equivalents                                                           | -                            |   | (320                   | ) |                          |   | (320                  | )
|Net increase (decrease) in cash and cash equivalents                                                           | 14,068                       |   | (1,526                 | ) | -                        |   | 12,542                |  
|Cash and cash equivalents at beginning of year                                                                 | 18,532                       |   | 6,515                  |   | -                        |   | 25,047                |  
|Cash and cash equivalents at end of year                                                                       | $                     32,600 |   | $                4,989 |   | $                      - |   | $              37,589 |  
|                                                                                                               | ==========                   |   | ========               |   | ========                 |   | ========              |  

F-59

---

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
SUPPLEMENTARY DATA (UNAUDITED)QUARTERLY FINANCIAL
DATA

The following tables reflects
unaudited quarterly financial data for fiscal years 2002 and 2001 (in thousands,
except per share data):



|                                                                                                                                                                             | PredecessorCompany                                           | Reorganized
      CompanyTen
      Months Ended December
      31,  2002
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------ | ------------------------------------------------------------------------
|                                                                                                                                                                             | Two Months
      Ended
      February 28,
       
      2002 |                                                                         
|                                                                                                                                                                             |                                                              |                                                                         
|Total net revenues                                                                                                                                                           | $           301,846                                          |                                                                         
|                                                                                                                                                                             | ==========                                                   |                                                                         
|(Loss) income before
         income taxes,
         discontinued
         operations and
         extraordinary item                                                        | $             (5,203                                         | )                                                                       
|                                                                                                                                                                             | ==========                                                   |                                                                         
|Loss on discontinued
          operations                                                                                                                                    | $              7,639                                         |                                                                         
|                                                                                                                                                                             | ==========                                                   |                                                                         
|Net (loss) income
          before extraordinary
          item                                                                                                              | $             (5,350                                         | )                                                                       
|                                                                                                                                                                             | ==========                                                   |                                                                         
|Extraordinary item                                                                                                                                                           | $       1,485,360                                            |                                                                         
|                                                                                                                                                                             | ==========                                                   |                                                                         
|Net (loss) income                                                                                                                                                            | $  
           1,485,371                                     |                                                                         
|                                                                                                                                                                             | ==========                                                   |                                                                         
|Net (loss) income per
          common and
          common equivalent
          share, before
          discontinued
          operations and
          extraordinary item: |                                                              |                                                                         
|                                                                                                                                                                             |                                                              |                                                                         
|Basic and diluted (1)                                                                                                                                                        | $               (0.09                                        | )                                                                       
|                                                                                                                                                                             | ============                                                 |                                                                         
|Net (loss) income per
         common and
         common equivalent
         share:                                                                                         |                                                              |                                                                         
|                                                                                                                                                                             |                                                              |                                                                         
|Basic and diluted (1)                                                                                                                                                        | $               24.32                                        |                                                                         
|                                                                                                                                                                             | =============                                                |                                                                         

|(1) | Earnings per share are computed independently for each of
      the periods presented and therefore, may not sum to the totals for the
      year (see Note 13).
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | We
      recorded a loss on asset impairment of $407.8 million.                                                                                                 
|(3) | We
      have reclassified certain amounts recorded in the March 31, 2002 10-Q to
      conform to the presentation for the ten months ended December 31, 2002. 

----------------------------------------------------------------------------------------------------------------------------

1

---

|                                                 | Predecessor Company                     
|------------------------------------------------ | ----------------------------------------
|                                                 | Year
      Ended December 31,
      2001
|                                                 | FirstQuarter                            
|                                                 |                                         
|Total net revenues                               | $           529,834                     
|                                                 | ========                                
|Loss before income taxes                         | $            (15,944                    
|                                                 | ========                                
|Net loss                                         | $            (15,967                    
|                                                 | ========                                
|Net loss per common and common equivalent share: |                                         
|                                                 |                                         
|Basic and diluted (1)                            | $                (0.26                  
|                                                 | ========                                

|(1) | Earnings per share are computed independently for each of
      the quarters presented and therefore, may not sum to the totals for the
      year (see Note 13).
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

2

---

NOTE: The following report is a copy of a report previously issued by Arthur
Andersen LLP and has not been reissued by Arthur Andersen LLP.



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To the Board of Directors and Stockholders of
Sun Healthcare Group, Inc.:

We have audited in accordance
with auditing standards generally accepted in the United States, the
consolidated financial statements of Sun Healthcare Group, Inc.
(Debtor-in-Possession) and subsidiaries in this Form 10-K and have issued
our report thereon dated March 18, 2002. Our audit was made for the purpose of
forming an opinion on the basic consolidated financial statements taken as a
whole. The schedule identified as SCHEDULE II is the responsibility of the
Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in our audit of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.

/s/  Arthur Andersen
LLP

Albuquerque, New MexicoMarch 18, 2002

3

---



SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)



|                                                | Column A                            |  | Column B                           |      | Column C                                 |      | Column D               |      | Column E                        |    
|----------------------------------------------- | ----------------------------------- |  | ---------------------------------- | ---- | ---------------------------------------- | ---- | ---------------------- | ---- | ------------------------------- | ---
|Description                                     | Balance at
      Beginningof Period |  | Charged to
      Costs andExpenses |      | Additions
      Charged toOther Accounts |      | DeductionsOther        |      | Balance at
      End ofPeriod   |    
|Reorganized Company                             |                                     |  |                                    |      |                                          |      |                        |      |                                 |    
|For the Ten Months Ended December 31, 2002:     |                                     |  |                                    |      |                                          |      |                        |      |                                
|Allowance for doubtful
            accounts     | $              68,723               |  | $             13,639               | (1)  | $                          -             |      | $           (36,547    | )    | $                   45,905      |    
|                                                | =========                           |  | =======                            |      | ==========                               |      | =======                |      | ==========                      |    
|Notes receivable reserve                        | $                5,321              |  | $                  1,148           | (1)  | $                           -            |      | $                (50)  |      | $                     6,419     | (2)
|                                                | =========                           |  | =======                            |      | ==========                               |      | =======                |      | ==========                      |    
|Reserve for assets held for
           sale     | $                4,820              |  | $              1,021               |      | $                          -             |      | $            (5,841    | )    | $                             - |    
|                                                | =========                           |  | =======                            |      | ==========                               |      | =======                |      | ==========                      |    
|Corporate restructure reserve                   | $                2,676              |  | $                       -          |      | $                          -             |      | $              (2,676  | )    | $                            -  |    
|                                                | =========                           |  | =======                            |      | ==========                               |      | =======                |      | ==========                      |    
|                                               
|Predecessor Company                             |                                     |  |                                    |      |                                          |      |                        |      |                                 |    
|For the Two Months Ended February 28,
    2002: |                                     |  |                                    |      |                                          |      |                        |      |                                
|Allowance for doubtful
           accounts      | $              73,819               |  | $               417                | (1)  | $                      175               | (3)  | $              (5,688  | )(4) | $                   68,723      |    
|                                                | =========                           |  | =======                            |      | ==========                               |      | =======                |      | ==========                      |    
|Notes receivable reserve                        | $                 6,216             |  | $                  -               |      | $                          -             |      | $                 (895 | )(4) | $                     5,321     | (2)
|                                                | =========                           |  | =======                            |      | ==========                               |      | =======                |      | ==========                      |    
|Reserve for assets held for sale                | $              12,904               |  | $           (7,339                 | )(5) | $                          -             |      | $                 (745 | )(6) | $                     4,820     |    
|                                                | =========                           |  | =======                            |      | ==========                               |      | =======                |      | ==========                      |    
|Corporate restructure reserve                   | $                    905            |  | $           3,843                  | (7)  | $                    (905                | )(8) | $              (1,167  | )(9) | $                    2,676      |    
|                                                | =========                           |  | =======                            |      | ==========                               |      | =======                |      | ==========                      |    
|                                                |                                     |  |                                    |      |                                          |      |                        |      |                                 |    
|Predecessor Company                             |                                     |  |                                    |      |                                          |      |                        |      |                                 |    
|Year ended December 31, 2001:                   |                                     |  |                                    |      |                                          |      |                        |      |                                
|Allowance for doubtful
            accounts     | $              128,106              |  | $             22,435               | (1)  | $-                                       |      | $        (76,722       | )    | $                   73,819      |    
|                                                | =========                           |  | ========                           |      | ==========                               |      | =======                |      | ==========                      |    
|Notes receivable reserve                        | $                  1,979            |  | $               3,537              | (1)  | $                       700              |      | $                    - |      | $                     6,216     | (2)
|                                                | =========                           |  | ========                           |      | ==========                               |      | =======                |      | ==========                      |    
|Reserve for assets held for sale                | $              233,746              |  | $             14,442               |      | $-                                       |      | $      (235,284        | )    | $                  12,904       |    
|                                                | =========                           |  | ========                           |      | ==========                               |      | =======                |      | ==========                      |    
|Corporate restructure reserve                   | $                     729           |  | $               1,064              |      | $-                                       |      | $             (888     | )    | $                       905     |    
|                                                | =========                           |  | ========                           |      | ==========                               |      | =======                |      | ==========                      |    
|Predecessor Company                             |                                     |  |                                    |      |                                          |      |                        |      |                                 |    
|Year ended December 31, 2000:                   |                                     |  |                                    |      |                                          |      |                        |      |                                
|Allowance for doubtful
            accounts     | $              151,841              |  | $             33,496               | (1)  | $-                                       |      | $        (57,231       | )    | $                 128,106       |    
|                                                | =========                           |  | ========                           |      | ==========                               |      | =======                |      | ==========                      |    
|Notes receivable reserve                        | $                  6,556            |  | $-                                 |      | $-                                       |      | $          (4,577      | )    | $                     1,979     | (2)
|                                                | =========                           |  | ========                           |      | ==========                               |      | =======                |      | ==========                      |    
|Reserve for assets held for sale                | $                84,522             |  | $           288,660                |      | $-                                       |      | $      (139,436        | )    | $                 233,746       |    
|                                                | =========                           |  | ========                           |      | ==========                               |      | =======                |      | ==========                      |    
|Corporate restructure reserve                   | $                  1,964            |  | $              (1,090              | )    | $-                                       |      | $             (145     | )    | $                        729    |    
|                                                | =========                           |  | ========                           |      | ==========                               |      | =======                |      | ==========                      |    
|4                                               |                                    

|(1) | Charges included in provision for losses on accounts
      receivable.
|--- | ----------------------------------------------------------------------
|    |                                                                       
|(2) | Included in the note receivable reserve are the
  following:          
|    |                                                                       
|    |                                                                       
|    |                                                                       

|(3) | Provision for facilities included in discontinued operations.                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                    
|(4) | Represents write-offs
      of applicable receivables.                                                                                             
|    |                                                                                                                                                    
|(5) | Represents
      reorganization costs (gain), net, and loss on discontinued operations for
      adjustments to assets held for sale.              
|    |                                                                                                                                                    
|(6) | Represents
      disposition of assets held for sale.                                                                                              
|    |                                                                                                                                                    
|(7) | Recorded
      as a component of reorganization costs (gain), net.                                                                                 
|    |                                                                                                                                                    
|(8) | Reserves
      were related to claims subject to compromise and were extinguished in
      connection with the Company's emergence from bankruptcy.
|    |                                                                                                                                                    
|(9) | Represents
      amounts paid for severance and other restructuring activities.                                                                    



5

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