UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                   ___________

                                    FORM 10-K


|X| Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
    Act of 1934
                  For the fiscal year ended December 31, 1999

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

                         Commission file number 1-12040

                           SUN HEALTHCARE GROUP, INC.

             (Exact name of registrant as specified in its charter)

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

                               101 Sun Avenue NE
                         Albuquerque, New Mexico 87109
                                 (505) 821-3355
                  (Address and telephone number of Registrant)

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

                              Title of each class

                    Common Stock, par value $.01 per share,
                      and Preferred Stock Purchase Rights

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

     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. |_|

     On May 5, 2000,  Sun  Healthcare  Group, Inc.  had  64,576,183  outstanding
shares of Common Stock. Of those, 64,103,305 shares of Common Stock were held by
nonaffiliates.  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 May 5, 2000 was approximately $5,769,297.

     Indicate  by check  mark  whether  the  registrant  has filed  all  reports
required 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 |_| No |_|  N/A  |X| No plan of  reorganization  has  been  filed  with  the
bankruptcy court as of this date.

                                       1


<PAGE>

                           SUN HEALTHCARE GROUP, INC.
                             (Debtor-in-Possession)

                                    FORM 10-K

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

                                      INDEX
<TABLE>
<CAPTION>
                                                                                                                Page
<S>             <C>                                                                                             <C>
PART I

Item 1.         Business.......................................................................................  3
Item 2.         Properties..................................................................................... 20
Item 3.         Legal Proceedings.............................................................................. 22
Item 4.         Submission of Matters to a Vote of Security Holders............................................ 22

PART II

Item 5.         Market for Registrant's Common Equity and Related Stockholder Matters.......................... 23
Item 6.         Selected Financial Data........................................................................ 23
Item 7.         Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 27
Item 7A.        Quantitative and Qualitative Disclosure About Market Risk...................................... 52
Item 8.         Financial Statements and Supplementary Data.................................................... 52
Item 9.         Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.......... 52

PART III

Item 10.        Directors and Executive Officers of the Registrant............................................. 53
Item 11.        Executive Compensation......................................................................... 58
Item 12.        Security Ownership of Certain Beneficial Owners and Management................................. 63
Item 13.        Certain Relationships and Related Transactions................................................. 64

PART IV

Item 14.        Exhibits, Financial Statement Schedules and Reports on Form 8-K................................ 66
                Signatures..................................................................................... 73
</TABLE>


     SunBridge, SunDance, SunScript,  SunSolution, SunCare, SunFactors, SunPlus,
SunChoice and  CareerStaff  Unlimited  and related  names herein are  registered
trademarks of Sun Healthcare Group, Inc. and its subsidiaries.
                                  ___________



                                       2
<PAGE>
                                     PART I
ITEM 1.   BUSINESS

GENERAL

     Sun Healthcare Group,  Inc.,  through its direct and indirect  subsidiaries
(collectively  referred  to  herein  as "Sun" or the  "Company"),  is one of the
largest  providers  of  long-term,  subacute  and related  specialty  healthcare
services  in the United  States and the United  Kingdom.  The  Company  also has
operations in Spain,  Germany and Australia.  The Company  operates through four
principal business segments:  (i) inpatient  services,  (ii)  rehabilitation and
respiratory therapy services,  (iii)  pharmaceutical and medical supply services
and (iv) international  operations. In October 1999, the Company commenced cases
under  Chapter 11 of the U.S.  Bankruptcy  Code and is currently  operating  its
business as a debtor-in-possession subject to the jurisdiction of the Bankruptcy
Court for the  District  of  Delaware  (the  "Bankruptcy  Court")  (see  "Recent
Developments  -  Bankruptcy").  The following  describes the Company's  business
segments and other operations.  Financial  information for the business segments
is set forth in "Note 21 - Segment  Information  in the  Company's  Consolidated
Financial Statements."

     INPATIENT SERVICES. At December 31,  1999, Sun owned, leased or managed 354
long-term  and  subacute  care  facilities  (consisting  of 346 skilled  nursing
facilities and eight hospitals, but not including 22 assisted living facilities)
in 27 states with 39,867  licensed beds in the United States  primarily  through
SunBridge  Healthcare  Corporation  ("SunBridge").  The Company's  long-term and
subacute  care  facilities  provide  inpatient  skilled  nursing  and  custodial
services  as  well  as  rehabilitative,  restorative  and  transitional  medical
services.  The Company  provides  24-hour  nursing care in these  facilities  by
registered  nurses,  licensed  practical nurses and certified nursing aides. The
Company is  reviewing  its  portfolio  of  facilities  and  intends to  continue
divesting  marginal and  unprofitable  facilities.  See "Recent  Developments  -
Divestitures",  "Item 7 -  Management's  Discussion  and  Analysis of  Financial
Condition  and  Results  of  Operations",  "Note  5 -  Acquisitions",  "Note 7 -
Impairment  of  Long-Lived  Assets  and  Assets  Held for  Sale"  and "Note 24 -
Subsequent Events in the Company's Consolidated Financial Statements".

     REHABILITATION   AND   RESPIRATORY    THERAPY   SERVICES.    Sun   provides
rehabilitation therapy through SunDance Rehabilitation  Corporation ("SunDance")
and oxygen and  respiratory  therapy  supplies  and  equipment  through  SunCare
Respiratory  Services,  Inc.  ("SunCare").  At December 31,  1999,  Sun provided
therapy services and supplies to 1,531  facilities in 37 states,  1,158 of which
were operated by nonaffiliated  parties.  The Company is currently  pursuing the
divestiture of its SunCare  respiratory  therapy supply operations.  See "Recent
Developments - Divestitures"  and "Note 24 - Subsequent  Events in the Company's
Consolidated Financial Statements.

     PHARMACEUTICALS   AND  MEDICAL  SUPPLY   SERVICES.   The  Company  provides
pharmaceutical services through SunScript Pharmacy Corporation ("SunScript") and
medical  supplies  through   SunChoice   Medical   Supply,Inc.   ("SunChoice").
Pharmaceutical services include dispensing  pharmaceuticals for such purposes as
infusion therapy, pain management,  antibiotic therapy and parenteral nutrition.
Additional services include providing  consultant  pharmacists and assistance in
preparation of billing documentation.  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
December 31,  1999, Sun operated 38 regional pharmacies,  six in-house long-term
care  pharmacies and one  pharmaceutical  billing and  consulting  center in the
United States, which together provided pharmaceutical products and services to a
total of 885 long-term and subacute care  facilities in 22 states,  550 of which
were operated by  nonaffiliated  parties.  As of December 31, 1999, Sun provided
medical supplies to approximately 1,622 affiliated and nonaffiliated facilities.

                                       3
<PAGE>
     INTERNATIONAL OPERATIONS. Sun operated 145 long-term care facilities in the
United  Kingdom with 8,320  licensed beds as of  December 31,  1999. The Company
holds a majority  interest  in  Eurosar,  S.A.  ("Eurosar"),  a  privately-owned
company that, as of December 31,  1999, operated 11 long-term care facilities in
Spain  with  1,640  licensed  beds.  Sun  holds  38.2%  of the  equity  of Alpha
Healthcare Limited  ("Alpha"),  a publicly held acute care provider in Australia
that as of  December 31,  1999 operated 10 facilities with 629 licensed beds. As
of  December 31,  1999,  Sun also operated five  hospitals in Australia with 335
beds. Sun holds a majority interest in Heim Plan-Uternehmensgruppe,  an operator
of 17  long-term  care  facilities  with  1,217  licensed  beds in  Germany.  In
addition, Sun provides  pharmaceutical  services in the United Kingdom,  Germany
and Spain and medical supplies in Australia.

     The Company is currently  soliciting  offers to purchase its  international
operations.  No assurance can be given that the international operations will be
sold or that, if they are sold,  the Company will not experience a material loss
on the sale. As of May 31, 2000, the Company had divested 18 pharmacies  that it
operated in the United Kingdom.  See "Recent  Developments -  Divestitures"  and
"Note  24  -  Subsequent   Events  in  the  Company's   Consolidated   Financial
Statements."

     OTHER  OPERATIONS.  The Company is also a nationwide  provider of temporary
medical staffing to hospitals,  nursing homes,  therapy  providers,  home health
care   providers   and   pharmacies    through    CareerStaff    Unlimited, Inc.
("CareerStaff").  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.  At December 31,  1999,  CareerStaff had 25 division
offices  providing  temporary  therapy  and nursing  staffing  services in major
metropolitan  areas  and one  division  office  specializing  in  placements  of
temporary traveling therapists in smaller cities and rural areas.

     The Company divested its hospice operations in the United States during the
fourth quarter of 1999. See "Recent  Developments - Divestitures," and "Note 7 -
Impairment  of  Long-Lived  Assets  and  Assets  held for Sale in the  Company's
Consolidated Financial Statements."

     Through  SunBridge,  Inc.,  the Company  also  operated 22 assisted  living
facilities  with 2,582 beds in the United States as of December 31, 1999.  These
facilities serve the elderly who do not need the full-time nursing care provided
by long-term or subacute care  facilities but who do need some  assistance  with
the  activities of daily living.  During the first quarter of 2000,  the Company
entered into an agreement to sell 16 of these assisted  living  facilities.  See
"Recent  Developments -  Divestitures"  and "Note 24 - Subsequent  Events to the
Company's  Consolidated  Financial Statements." Through SunAlliance and SunPlus,
the  Company  also  provides  mobile  radiology,  medical  laboratory  and  home
healthcare services in certain locations.

     Through Shared Healthcare Systems, Inc., which also does business under the
trade  name  SHS.com,  the  Company  develops  certain  software  for use in the
long-term  care  industry.   Shared   Healthcare   Systems,   Inc.  which  is  a
majority-owned  subsidiary of the Company, did not commence a case under Chapter
11 of the U.S. Bankruptcy Code.

     The Company's  principal  executive  offices are located at 101 Sun Avenue,
NE,  Albuquerque,  NM 87109,  and its telephone  number at such address is (505)
821-3355. The Company maintains a Web site at http://www.sunh.com.

                                       4
<PAGE>
RECENT DEVELOPMENTS

     BANKRUPTCY.   On  October  14,  1999,  Sun  Healthcare   Group,   Inc.  and
substantially all of its U.S. operating  subsidiaries filed voluntary  petitions
for  protection  under  Chapter  11 of the U.S.  Bankruptcy  Code  with the U.S.
Bankruptcy  Court for the District of Delaware  ("the  Bankruptcy  Court") (case
nos.   99-3657  through  99-3841,   inclusive).   On  February  3,  2000,  HoMed
Convalescent Equipment, Inc. ("HoMed"), an indirect subsidiary of Sun, commenced
its chapter 11 case in the Bankruptcy Court (case no. 00-00841). The Company has
obtained debtor-in-possession  financing and is currently operating its business
as a  debtor-in-possession  subject to the jurisdiction of the Bankruptcy Court.
On May 2, 2000, the Bankruptcy Court entered an order  establishing (i) June 20,
2000 at 5:00  p.m.  Eastern  Time as the last  date and time for each  person or
entity  to file a proof of claim  against  the  Company,  other  than  claims of
governmental  units against HoMed,  and (ii) August 1, 2000 at 5:00 p.m. Eastern
Time as the last date and time for  governmental  units  only to file  proofs of
claim  against  HoMed.  See  "Certain  Additional  Business  Risks",  "Item  7 -
Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations  --  Liquidity  and Capital  Resources"  and "Note 2,  Petitions  for
Reorganization under Chapter 11 in the Consolidated Financial Statements."

     APPOINTMENT OF ACTING CHAIRMAN AND ACTING CHIEF EXECUTIVE OFFICER.  On July
13, 2000, Andrew L. Turner took a leave of absence as the Company's  Chairman of
the Board of Directors and as Chief  Executive  Officer  pending the approval by
the Bankruptcy  Court of a Settlement  Agreement and an Expense  Indemnification
Agreement  between the Company and Mr.  Turner.  The Board of Directors  elected
James R.  Tolbert as the Acting  Chairman  of the Board and Mark G. Wimer as the
Acting Chief Executive  Officer.  Mr. Tolbert has been a director of the Company
since 1995 and lead  independent  director since 1999. Mr. Wimer has served with
the Company since 1993 and has been President and Chief Operating  Officer since
1997. Upon approval by the Bankruptcy Court of the Settlement  Agreement and the
Expense  Indemnification  Agreement,  Mr.  Turner will resign from all positions
that he holds with the Company and Mr.  Tolbert  will become the Chairman of the
Board and Mr.  Wimer will  become  the Chief  Executive  Officer.  See Item 10 -
"Directors and Executive  Officers of the  Registrant"  and Item 11 - "Executive
Compensation - Employment Agreements."

     DIVESTITURES.  During the year ended  December  31,  1999,  Sun divested 49
skilled nursing facilities, twelve assisted living facilities (four of which the
Company  managed  through the first  quarter of 2000),  a parcel of land and its
hospice  operations  in the United  States.  The  aggregate  cash  consideration
received was approximately  $4.1 million,  $4.6 million and $0.2 million for the
assisted  living  facilities,   parcel  of  land  and  the  hospice  operations,
respectively.  The  Company  did not  receive  any cash  consideration  from the
skilled nursing facility divestitures. In addition, the Company received parcels
of  land  valued  at  approximately  $9.2  million  and  a  note  receivable  of
approximately  $1.0 million for the assisted living facility  divestitures.  The
aggregate debt, capital lease  obligations,  notes payable and other liabilities
assumed by the purchasers and successors of the skilled  nursing  facilities and
the  assisted  living  facilities  were  approximately  $10.7  million and $21.0
million,  respectively.  The aggregate net loss on the skilled nursing  facility
divestitures was  approximately  $3.0 million dollars which was recorded to loss
on assets held for sale,  net in 1999.  The  aggregate  net loss on the assisted
living divestitures was approximately $68.4 million of which approximately $24.9
million and approximately  $43.5 million was recorded to loss on assets held for
sale,  net in 1999  and  1998,  respectively.  The  sale of the  parcel  of land
resulted in a net gain recorded in 1999 of approximately  $0.7 million.  The net
loss on the sale of the hospice  operations was  approximately  $7.2 million and
was  recorded to loss on assets held for sale,  net during  1999.  See "Note 7 -
Impairment  of  Long-Lived  Assets  and  Assets  Held for Sale in the  Company's
Consolidated Financial Statements."

                                       5
<PAGE>
     During the period of January 1, 2000 through  June 30,  2000,  Sun divested
one skilled nursing  facility,  closed one skilled nursing facility and arranged
for the sale of 16 assisted living facilities in the United States. See "Note 24
- Subsequent Events in the Company's Consolidated Financial Statements."

     During the period of January 1, 2000 through May 31,  2000,  Sun divested a
total of 18 pharmacies in the United Kingdom,  resulting in an aggregate gain of
approximately $1.0 million. The aggregate cash consideration  received for these
divestitures was approximately $9.7 million. See "Note 24 - Subsequent Events in
the Company's Consolidated Financial Statements."

     The Company is actively  reviewing its portfolio of properties  and intends
to divest those  properties  that it believes do not meet  acceptable  financial
performance standards or do not fit strategically into the Company's operations.
This process is expected to be ongoing  throughout  its  bankruptcy  cases.  The
Company is also pursuing the  disposition  of its  international  operations and
certain  non-core  businesses,  including  the sale of its  SunCare  respiratory
therapy supply business and the therapy  equipment  manufacturing  operations of
one of the  Company's  subsidiaries,  which is in the  process  of  closing  its
operations.  No  assurance  can be given that these  operations  will be sold or
that, if they are sold,  the Company will not  experience a material loss on the
sales.

     RESTRUCTURING.  The Company commenced a comprehensive restructuring in 1998
which  continued  in 1999.  The number of full and  part-time  employees  of the
Company worldwide has decreased from  approximately  80,700 on February 20, 1999
to  approximately   57,100  on  March  31,  2000.  The  decrease  was  primarily
attributable  to the elimination of  rehabilitation  therapy  employees  through
attrition,  layoffs and as a result of the  disposition of a number of inpatient
facilities.  The Company  restructured  its domestic  operations to more closely
align the inpatient,  rehabilitation and pharmaceutical services divisions.  The
Company also  decreased the number of layers in the  management  structure.  The
Company  also  restructured  all  of  its  international  operations  under  one
subsidiary,  SunHealthcare  Group  International  Corporation.  There  can be no
assurance  as to the  impact of the  restructuring  on the  Company's  financial
condition and results of operations.

REIMBURSEMENT FROM MEDICARE AND MEDICAID

     The following  table sets forth the total  revenues by payor source for the
Company's U.S. operations for the periods indicated:
<TABLE>
<CAPTION>

                                                                         YEAR ENDED DECEMBER 31,
                                                     -----------------------------------------------------------------
Sources of Revenues
                                                     1997                  1998                  1999
                                                                              (In thousands)
<S>                                                  <C>                   <C>                   <C>
Medicaid.......................................      $583,583             $  957,058             $1,041,662
Medicare......................................        479,201                834,200                446,820
Private pay and other (1) .....................       749,881              1,011,935                743,651
____________________
</TABLE>


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

                                       6
<PAGE>
     The  Medicare Part A program provides  reimbursement  for extended
care services  furnished to Medicare  beneficiaries  who are admitted to nursing
facilities  after  at least a  three-day  stay in an acute  care  hospital.  The
Medicare Part B program provides  reimbursement for patients receiving ancillary
services  who  have  not had the  required  stay at a  hospital.  Medicaid  is a
state-administrated program that provides assistance to the indigent and certain
other  eligible  persons.  Private  payment  patients  typically  have financial
resources  (including  insurance coverage) to pay for their monthly services and
do not rely on government programs for financial support.

     In the  Balanced  Budget  Act of 1997  ("BBA"),  Congress  passed  numerous
changes to the reimbursement  policies  applicable to certain hospital services,
skilled  nursing,  therapy and other  ancillary  services.  The BBA mandated the
implementation  of a  prospective  payment  system  ("PPS") for Medicare  Part A
skilled nursing facility services to be phased in over a four-year  period.  PPS
became effective on July 1,  1998 for the Company's  facilities that it acquired
from Retirement Care  Associates,  Inc.  ("RCA") and on January 1,  1999 for the
remainder of its facilities. Under PPS, Medicare pays skilled nursing facilities
a fixed fee per  patient  per day based on the  acuity  level of the  patient to
cover all Medicare Part A  patients,  including  nursing,  ancillary and capital
related costs for Medicare beneficiaries receiving skilled services.  Currently,
under  PPS,  each  patient  is  evaluated  and  assigned  to one of 44  Resource
Utilization   Group  ("RUG")   categories,   which   determines   the  per  diem
reimbursement rate for that patient. The higher the acuity level of the patient,
the more  services  that are  required by that  patient.  Accordingly,  a higher
acuity patient that requires more services is assigned to a higher RUG category,
resulting  in a higher per diem rate.  The  ability of the  Company to offer the
ancillary services required by higher acuity patients in a cost effective manner
will be critical to the Company's  success.  Prior to the implementation of PPS,
the costs of many of such services were generally reimbursed on a "pass through"
basis.  During the PPS phase-in,  payments will generally be based on a blend of
the facility's adjusted historical costs based on 1995 cost data and a federally
established per diem rate as follows:  (i) year one, 75% historical cost and 25%
federal rate;  (ii) year two, 50%  historical  cost and 50% federal rate;  (iii)
year three,  25%  historical  cost and 75% federal rate,  and (iv) year four and
thereafter, 100% federal rate.

     Effective  January 1,  1999,  for all Medicare  Part B  patients,  Medicare
reimbursement for many ancillary  services,  including  rehabilitation  therapy,
medical supplies,  and other ancillary services, are made to the skilled nursing
facility  pursuant to fee  schedules.  The  previous  reimbursement  methodology
reimbursed  skilled nursing facilities based upon the cost of ancillary services
provided.  The BBA also  imposed  an annual  per-beneficiary  cap of $1,500  per
provider for certain therapy services provided,  also effective January 1, 1999.
The BBA also  instituted  consolidated  billing  for  skilled  nursing  facility
services,  under  which all  payments  for  certain  non-physician  services  to
beneficiaries  are  made to the  facility,  regardless  of  whether  the item or
service was directly  furnished by the facility or by others under  arrangement.
While this  provision was to be effective for items or services  furnished on or
after July 1, 1998,  Congress has placed a  moratorium  on its  enforcement,  as
described  below.  Other  provisions  of the BBA  limited  Medicare  payments to
skilled nursing  facilities for certain drugs and  biologicals,  durable medical
equipment and parenteral and enteral nutrients and supplies.

     The   Company's   revenues  from  its   inpatient   facilities   have  been
significantly affected by the BBA's federally established PPS per diem rates and
Medicare Part B changes.  The following table sets forth the approximate amounts
of Medicare Part A revenues recorded by the Company's  long-term care facilities
for the years 1997, 1998 and 1999:

                                       7
<PAGE>
<TABLE>
<CAPTION>

                                               AVERAGE MEDICARE PART A
                                         REVENUE PER PATIENT, PER DAY(1)(2)
                                         ----------------------------------
                <S>                      <C>
                1997                                   $451.09
                1998                                    468.97
                1999                                    300.33
____________________
</TABLE>


(1) Includes estimated adjustments for routine cost limit ("RCL") exception
    revenue.
(2) The year-to-year comparisons are not on a same-store basis.

     In addition,  the  Company's  average  annual  Medicare  Part B revenue per
facility   decreased   approximately  83%  from  1997  to  1999.  Three  factors
contributed to the decline in Medicare Part B revenue:  volume  decreased due to
staffing cuts that occurred as part of the cost control measures  implemented by
the ancillary companies under the PPS system, the $1,500 annual  per-beneficiary
cap contributed to the decline in Medicare Part B revenue by limiting access for
Part B patients  requiring  therapy,  and  finally,  Part B therapy  pricing was
affected  negatively  when Part B  reimbursement  changed  to a  procedure  code
payment  system.  There can be no assurance  that the  provisions of the BBA, as
amended,  will not continue to have a material  adverse  effect on the Company's
financial condition and results of operations.

     On November 29, 1999, President Clinton signed into law the Balanced Budget
Refinement Act ("BBRA"),  which was designed to mitigate the adverse  effects of
the  BBA.  Prior  to the  implementation  of  PPS,  the  Health  Care  Financing
Administration ("HCFA") estimated that the BBA would reduce Medicare funding for
skilled  nursing  providers by  approximately  $12.9  billion for the  five-year
period of 1998 to 2002.  The BBRA was  intended  to restore  approximately  $2.7
billion in Medicare  funding for skilled nursing  providers over the years 2000,
2001 and  2002.  However,  in  April  2000 the  Congressional  Budgeting  Office
estimated  that the BBA, even with the BBRA  adjustments,  will reduce  Medicare
funding to skilled  nursing  providers by  approximately  $22.3  billion for the
five-year period of 1998 to 2002. The Company believes that the BBRA may restore
approximately 5% of the Company's reductions in revenues caused by the BBA.

     The key  provisions  of the BBRA  include:  (i) the  option  for a  skilled
nursing  provider to choose  between the higher of the current  blended  rate or
100%  of the  federally-determined  acuity-adjusted  rate,  effective  for  cost
reporting  periods  starting  on or after  January  1,  2000;  (ii) a  temporary
increase of 20% in the  federal  adjusted  per diem rates for 15 RUG  categories
covering  certain  medically  complex patients for the period from April 1, 2000
through  September 30, 2000; at which time, if HCFA has not adopted  refinements
for the medically complex patients in the RUG-III system,  the 20% increase will
be extended until such time as the refinements are adopted;  (iii) a 4% increase
in the federal adjusted per diem rates for all 44 RUG categories for each of the
periods  October 1,  2000 through September 30, 2001 and October 1, 2001 through
September 30, 2002; and (iv) a two-year  moratorium on  implementing  the Part B
$1,500  therapy  limitations  contained  in the BBA,  effective  January 1, 2000
through January 1, 2002.

     On April 10,  2000,  HCFA  released its  proposed  refinements  to PPS. The
proposed  changes include the following:  (i) the number of RUG categories would
increase  from 44 to 178;  (ii) the  BBRA's  temporary  20%  increase  in 15 RUG
categories  would terminate on September 30, 2000; and (iii) the  nursing,  wage
and other indices used to calculate the new reimbursement model would be updated
based on more recent  claims data and cost  reports.  The  proposed  changes are
expected to decrease the planned annual increase in Medicare funding for skilled
nursing  providers  by  approximately  $1.0 billion  during  2001.  The proposed
refinements are subject to change,  and the final refinements are intended to be
implemented  on October 1, 2000.  The Company  will be unable to  calculate  the
effect  of the  proposed  changes  on the  Company's  operations  until  further
regulations are proposed by HCFA that would allow the Company to determine which
patients will be designated  under each RUG category.  There can be no assurance
that  these  proposed  changes  will not have a material  adverse  affect on the
Company's financial condition and results of operation.

                                      8
<PAGE>
     In  addition  to  the  reduced  reimbursement  received  by  the  Company's
facilities as a result of PPS, the  implementation  of PPS resulted in a greater
than  expected  decline in demand for the Company's  therapy and  pharmaceutical
services.  For  instance,  the nursing home  industry has responded to the lower
reimbursement  levels under PPS by,  among other  things,  seeking  lower acuity
residents who need less  ancillary  services and by providing  therapy  services
in-house,  which has  resulted  in a  significant  decline in the demand for the
Company's therapy services.  Prior to the implementation of PPS, Sun's ancillary
services,   such  as  rehabilitation   and  respiratory   therapy  services  and
pharmaceutical  services,  had  significantly  higher operating margins than the
margins  associated  with Sun's  long-term  and  subacute  care  facilities  and
accordingly such services provided most of Sun's operating profits. Although the
Company has taken and continues to take actions to reduce its costs of providing
ancillary  services,  it is highly  unlikely  that the  Company  will be able to
achieve its pre-PPS profit margins on its ancillary services.

     Various cost  containment  measures adopted by governmental and private pay
sources  restrict the scope and amount of reimbursable  healthcare  expenses and
limit increases in reimbursement  rates for medical services.  Any reductions in
reimbursement levels under Medicaid,  Medicare or private payor programs and any
changes in applicable  government  regulations  or  interpretations  of existing
regulations could  significantly  adversely affect the Company's  profitability.
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
the Company's facilities and its therapy and pharmaceutical services businesses.
There can be no assurance  that  payments  under  governmental  or private payor
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 the Company's  financial
condition  and results of  operations,  including  the  possible  impairment  of
certain assets.

     Prior to the implementation of PPS,  reimbursement for therapy services was
evaluated under Medicare's reasonable cost principles. In 1995, and periodically
since  then,  HCFA  provided  information  to fiscal  intermediaries  for use in
determining  reasonable costs for therapy services.  This information,  although
not   intended  to  impose   limits  on  such  costs,   suggested   that  fiscal
intermediaries  should carefully  review costs,  which appear to be in excess of
what a "prudent  buyer" would pay for those  services.  Because PPS payments and
fee schedules have become the methods of reimbursement for these services,  HCFA
directives and reasonable  cost  guidelines  discussed in this paragraph have no
impact  on  the  Company  as to  services  rendered  after  January 1,  1999.  A
retroactive  adjustment of Medicare  reimbursement  could,  however, be made for
some prior periods. With respect to nonaffiliated  facilities,  an adjustment of
reimbursement  rates for  therapy  services  could  result in  indemnity  claims
against the Company,  based on the terms of  substantially  all of the Company's
existing  contracts with such facilities,  for payments  previously made by such
facilities to the Company that are reduced by Medicare in the audit process.

     For  periods  prior  to  the  effective  date  of  PPS,   certain  Medicare
regulations applied to transactions between related parties, such as between the
Company's  subsidiaries that operate skilled nursing facilities and subsidiaries
which provide ancillary  services.  These regulations are relevant to the amount
of Medicare  reimbursement  that the Company's  skilled  nursing  facilities are
entitled to receive  for  certain  rehabilitation  and  respiratory  therapy and
pharmaceutical   services   provided   by  the   Company's   ancillary   service
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 skilled nursing facility may receive  reimbursement
for services  provided by the Company's  ancillary  service  subsidiaries at the
rates  applicable to 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 this issue has been litigated
by others,  no consistent  standard has emerged as to the appropriate  threshold
necessary to satisfy the "substantial part" requirement.

                                       9
<PAGE>
     The implementation of PPS and the 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.  The Company's net revenues
from  rehabilitation  therapy  services,  including net revenues from  temporary
therapy staffing services, provided to nonaffiliated facilities represented 56%,
56% and 71% of total  rehabilitation  services  net revenues for the years ended
December 31,  1999, 1998 and 1997,  respectively.  Respiratory  therapy services
provided  to  nonaffiliated  facilities  represented  52%,  46% and 63% of total
respiratory therapy services net revenues for the years ended December 31, 1999,
1998 and 1997, respectively. Net revenues from pharmaceutical services billed to
nonaffiliated  facilities  represented 74%, 70% and 79% of total  pharmaceutical
services  revenues  for the  years  ended  December 31,  1999,  1998  and  1997,
respectively.  The Company considers RCA a nonaffiliated  entity for all periods
prior  to  its   acquisition.   The  Company  believes  that  it  satisfies  the
requirements  of  the  exception  to  the  regulations  regarding  nonaffiliated
business. Consequently, it has claimed and received reimbursement under Medicare
and Medicaid  for  rehabilitation  and  respiratory  therapy and  pharmaceutical
services provided to patients in its own facilities at fair market value, rather
than at Company  cost,  which  would  have  applied  if it did not  satisfy  the
exception.  If the Company were deemed not to have satisfied these  regulations,
the reimbursement  that the Company receives for  rehabilitation and respiratory
therapy and  pharmaceutical  services  provided to its own  facilities  could be
significantly reduced, which would materially and adversely affect the Company's
financial  condition  and  results of  operations.  If, upon audit by federal or
state reimbursement agencies, such agencies find that the exception has not been
satisfied,  and if, after appeal, such findings are sustained, the Company could
be  required  to  refund  some  or all of the  difference  between  its  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.  While the
Company  believes  that it has  satisfied  these  regulations,  there  can be no
assurance that its position would prevail if contested by relevant reimbursement
agencies.  The foregoing  statements  with respect to the  Company's  ability to
satisfy these  regulations are forward looking and could be affected by a number
of factors,  including the  interpretation  of  regulations  by federal or state
reimbursement  agencies  and  the  Company's  ability  to  provide  services  to
nonaffiliated facilities.

GOVERNMENT REGULATION

     REGULATORY REQUIREMENTS.  The Company's subsidiaries,  including those that
provide subacute and long-term care,  rehabilitation and respiratory therapy and
pharmaceutical   services,  are  engaged  in  industries  that  are  extensively
regulated.  As such, in the ordinary course of business, the operations of these
subsidiaries 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 the 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   individuals   from
participation in their program.  If a facility is decertified by HCFA or a state
as a  Medicare  or  Medicaid  provider,  the  facility  will not  thereafter  be
reimbursed by the federal  government  for caring for residents that are covered
by Medicare  and  Medicaid,  and the  facility  would be forced to care for such
residents without being reimbursed or to transfer such residents.

                                       10
<PAGE>
     Long-term  care  facilities  must  comply  with  certain   requirements  to
participate under 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 by HCFA
effective  July 1,  1995.  These  regulations  require  that  surveys  focus  on
residents'  outcomes of care and state that all  deviations  from  participation
requirements  will  be  considered   deficiencies,   but  a  facility  may  have
deficiencies  and  be  in  substantial  compliance  with  the  regulations.  The
regulations  identify  alternative  remedies against  facilities and specify the
categories  of  deficiencies  for which they will be  applied.  The  alternative
remedies include, but are not limited to: civil money 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 the Company  operates 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,  the
Company must obtain a Certificate of Need ("CON") which certifies that the state
has made a determination that a need exists for such new or additional beds, new
services or capital expenditures. The CON process is intended to promote quality
health care at the lowest possible cost and to avoid the unnecessary duplication
of services, equipment and facilities. These state determinations of need or CON
programs are designed to comply with certain  minimum  federal  standards and to
enable  states to  participate  in  certain  federal  and  state  health-related
programs.  Elimination or relaxation of CON requirements may result in increased
competition in such states and may also result in increased expansion.

     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.

     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;  offenses for violation 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 been made under the civil provisions
of the  statute in certain  qui tam  actions  that the  Company  has filed false
claims.  See  "Item  7 -  Management's  Discussion  and  Analysis  of  Financial
Condition and Results of Operations - Litigation."

                                       11
<PAGE>
     ENFORCEMENT  ACTIVITY.  Pursuant to the Health  Insurance  Portability  and
Accountability  Act of 1996,  Congress  has provided  additional  funding to the
Office of Inspector  General ("OIG") and the U.S.  Department of Justice ("DOJ")
to  investigate  potential  cases  of  reimbursement  abuse in the  health  care
services  industry.  This legislation also sets guidelines to encourage federal,
state,  and local law enforcement  agencies to share general  information and to
coordinate   specific   law   enforcement    activities   including   conducting
investigations, audits, evaluations, and inspections relating to the delivery of
and payment for health care.

     In 1995,  a major  anti-fraud  demonstration  project,  "Operation  Restore
Trust,"  was  announced  by the OIG. A primary  purpose  for the  project was to
scrutinize the activities of healthcare  providers who are reimbursed  under the
Medicare and Medicaid programs. Investigative efforts focused on skilled nursing
facilities,  home health and hospice  agencies,  and durable  medical  equipment
suppliers  as well as several  other  types of  healthcare  services.  Operation
Restore Trust investigative techniques will eventually be used in all 50 states,
and will be applied throughout the Medicare and Medicaid  programs.  The OIG has
issued,  and will continue to issue,  special fraud alert bulletins  identifying
"suspect"  characteristics  of potentially  illegal practices by providers,  and
illegal arrangements between providers. The bulletins contain "Hot Line" numbers
and   encourage   Medicare   beneficiaries,   health  care  company   employees,
competitors,  and  others to call to report  suspected  violations.  Enforcement
actions could include criminal  prosecutions,  suit for civil penalties,  and/or
Medicare and Medicaid program exclusion.

     President Clinton has announced initiatives designed to improve the quality
of care in nursing  homes and to reduce fraud in the Medicare  program.  On July
21, 1998, the President  directed HCFA to ensure that states  institute  tougher
enforcement  measures in surveying  skilled  nursing  facilities,  including the
onsite  imposition of fines without grace  periods,  the imposition of fines per
violation  rather  than  per  day of  noncompliance,  and  increased  review  of
facilities'  systems to prevent resident neglect and abuse. On December 7, 1998,
the President announced that the Administration  would continue its crackdown on
providers  who  commit   Medicare   program  fraud  by  empowering   specialized
contractors  to track down Medicare  fraud and program  waste,  and by requiring
providers  to report  evidence of fraud so  patterns of fraud can be  identified
early and stopped.

     In 1999,  the Clinton  Administration  launched a new National  Health Care
Fraud Task Force,  chaired by the Deputy Attorney  General,  in which Health and
Human Services ("HHS")/OIG,  HCFA, DOJ and state and local prosecutors will work
together in  formulating  strategies  to combat  health care fraud and abuse and
safeguard the well-being of Medicare and Medicaid beneficiaries.  A general data
sharing  process was  instituted  between the  Federal  Bureau of  Investigation
("FBI")  and  the  HHS/OIG  to  ensure  that  complete,   accurate  and  current
information  on federal  health  care fraud  investigations  is  maintained  and
readily  available.  While  this task force will focus on a wide range of health
care fraud and abuse  policy  issues,  particular  attention  will be devoted to
fighting nursing home fraud and abuse and excluding providers from participation
in Medicare,  Medicaid and other  government-funded  health care  programs.  The
Nursing  Home  Initiative,  coordinated  by the DOJ Civil  Division,  focuses on
enhanced  enforcement;  training;  outreach  to  industry,  resident  advocates,
medical professionals,  academics and others; new legislation to address gaps in
federal law; an analysis of the applicable state laws and improved  inter-agency
and governmental coordination, use of data, and services to victims.

                                       12
<PAGE>
     In March 2000, the OIG issued written  guidance to help nursing  facilities
design effective voluntary compliance programs to prevent fraud, waste and abuse
in  health  care  programs,   including  Medicare  and  Medicaid.   The  Company
voluntarily   implemented  a  compliance  program  in  1996,  and  believes  its
compliance  program  substantially  incorporates  the guidance  that the OIG has
proposed to be included in such programs. In addition, the Company believes that
if it reaches a global settlement of its outstanding government  investigations,
any such  settlement  would include a requirement  that the Company enter into a
corporate  integrity  agreement  with the OIG requiring the Company to implement
further internal  controls with respect to its quality of care standards and its
Medicare and Medicaid billing,  reporting and claims submission  processes.  See
Item 7 -  "Management's  Discussion  and  Analysis of  Financial  Condition  and
Results of Operations - Litigation."

     SURVEY,  CERTIFICATION AND ENFORCEMENT  ACTIVITIES AGAINST THE COMPANY. The
Company  believes that its facilities and service  providers  materially  comply
with applicable regulatory requirements. From time to time, however, the Company
receives notice of noncompliance with various requirements for Medicare/Medicaid
participation or state  licensure.  The Company reviews such notices for factual
correctness,  and based on such  review,  either  takes  appropriate  corrective
action and/or  challenges the stated basis for the allegation of  noncompliance.
In most cases, the Company and the reviewing agency will agree upon any measures
to be taken to bring the facility or service  provider  into  compliance.  Under
certain circumstances,  however, such as repeat violations or perceived severity
of the violations,  the federal and/or 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.
No such  enforcement  action  against a Company  operated  facility  or  service
provider has had a material adverse impact on the Company. However,  challenging
and appealing  notices of noncompliance  can require  significant legal expenses
and management attention.

     The Company  believes that  enforcement  activities at both the federal and
state levels and QUI TAM actions brought by private parties have increased.  See
"Item 7 -  Management's  Discussion  and  Analysis of  Financial  Condition  and
Results of Operations - Litigation."  In addition,  as a result of the Company's
pending bankruptcy  proceedings,  the Company has experienced a further increase
in  regulatory  oversight  from both federal and state  regulatory  bodies.  The
increased  oversight may result from such regulatory  bodies'  concerns that the
Company's current financial difficulties may result in a decrease in the quality
of care provided at the Company's  inpatient and other facilities.  There can be
no  assurance  that  substantial  amounts will not be expended by the Company to
cooperate with these  investigations  and  proceedings or to defend  allegations
arising therefrom.  If it were found that any of the Company's  practices failed
to comply with any of the anti-fraud  provisions,  including  those discussed in
the paragraphs above, the Company could be materially and adversely affected.

     If a facility is terminated  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  involuntarily  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,
proposed to terminate several of the Company's  facilities from the Medicare and
Medicaid  programs,  and has, on occasion,  imposed bans on admissions and civil
monetary  penalties  against  facilities,  on the  basis of  alleged  regulatory
deficiencies.  The Company typically vigorously contests such sanctions,  and in
some cases has sought and obtained  federal court  injunctions  against proposed
terminations.  While the Company has been  successful to date in preventing some
Medicare and Medicaid  terminations  that it has  contested,  such cases require
significant legal expenses and management  attention.  There can be no assurance
that the federal government will not attempt to terminate additional  facilities
of the Company from the Medicare and Medicaid programs, or that the Company will
continue to be successful contesting such terminations.

                                       13
<PAGE>
COMPETITION

     The long-term and subacute care industry is highly competitive.  The nature
of competition varies by location. The Company's 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 the Company and provide  services  not offered by the  Company,  and some are
operated by entities  having  greater  financial and other  resources and longer
operating histories than the Company. 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 the
Company.  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 the
Company.  The Company  competes with other  facilities  based on key competitive
factors such as its  reputation  for the quality and  comprehensiveness  of care
provided;  the commitment and expertise of its staff; the  innovativeness of its
treatment  programs;  local physician and hospital support;  marketing programs;
charges for services; and the physical appearance, location and condition of its
facilities.  The range of specialized services,  together with the price charged
for services,  are also  competitive  factors in attracting  patients from large
referral sources.

     The Company also competes 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  the  Company.  There  can be no  assurance  that  Sun  will not
encounter  increased  competition in the future that would adversely  affect its
financial condition and results of operations.

EMPLOYEES

     As of March 31, 2000, the Company had  approximately  57,100  full-time and
part-time employees. Of this total, there were approximately 36,900 employees at
the long-term and subacute care  facilities in the United States,  approximately
8,300  employees  at  the  long-term  care  facilities  in the  United  Kingdom,
approximately   800  employees  at  the  long-term  care  facilities  in  Spain,
approximately  800 employees  involved in providing  long-term  care services in
Germany,  approximately 500 employees  involved in providing acute care services
in Australia, approximately 4,400 employees involved in providing rehabilitation
therapy  services in the United  States,  approximately  2,400  employees in the
pharmaceutical  services  operations  in the  United  States,  approximately  70
employees in foreign pharmaceutical operations, approximately 1,400 employees in
the temporary  therapy  staffing  business,  approximately  200 employees of the
respiratory  therapy  services  business,  approximately  1,180 employees at the
corporate  and  regional  offices in the United  States  and  approximately  150
employees in the foreign corporate offices.

     Certain of the  Company's  employees in Alabama,  California,  Connecticut,
Georgia,  Massachusetts,  New  Mexico,  Ohio,  Tennessee,  Washington  and  West
Virginia are covered by collective bargaining contracts. The unions representing
certain of the Company's employees have from time to time gone on strike.  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 the Company's results of
operations or financial condition.

                                       14
<PAGE>
CERTAIN ADDITIONAL BUSINESS RISKS

     Information   provided   in  this  Form  10-K  by  the   Company   contains
"forward-looking" information, as that term is defined by the Private Securities
Litigation  Reform  Act of  1995  (the  "Act").  All  statements  regarding  the
Company's expected future financial position, results of operations,  results of
its bankruptcy  proceedings,  cash flows,  liquidity,  financing plans, 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. The Company cautions  investors that any  forward-looking
statements made by the Company 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 elsewhere herein and the following:

     EFFECT OF BANKRUPTCY REORGANIZATION ON COMMON STOCK AND DEBT SECURITIES. On
October 14, 1999, Sun Healthcare  Group,  Inc. and substantially all of its U.S.
operating subsidiaries filed voluntary petitions for protection under Chapter 11
of the U.S.  Bankruptcy Code with the U.S.  Bankruptcy Court for the District of
Delaware  ("the  Bankruptcy  Court").  The Company is  currently  operating  its
business as a debtor-in-possession subject to the jurisdiction of the Bankruptcy
Court.  On October  26,  1999,  the  Company  announced  that it had  reached an
agreement in principle with  representatives  of its bank lenders and holders of
approximately  two-thirds of its outstanding  senior  subordinated  bonds on the
terms of an overall restructuring of the Company's capital structure.

     If approved as part of the Company's chapter 11 plan of reorganization, the
agreement in principle  would provide the Company's  bank lenders with cash, new
senior  long-term debt, new preferred stock, and new common stock. The Company's
senior subordinated bondholders would receive new common stock. The agreement in
principle  would also provide new long-term  debt,  new preferred  stock and new
common stock to general unsecured creditors, and reinstate a significant portion
of Sun's secured debt. The agreement in principle provides for no recoveries for
the holders of Sun's  outstanding  convertible  subordinated  debt,  convertible
trust issued preferred  securities,  or common stock. The agreement in principle
expires on October 1, 2000.  The Company and the other  parties to the agreement
in principle have initiated discussions to amend the agreement in principle.  No
assurance can be given that a plan of  reorganization  will be confirmed or that
any plan of  reorganization  that is  confirmed  will  contain  the terms of the
agreement  in  principle.  During  the  pendency  of  the  Company's  bankruptcy
proceedings, the Company, absent an order of the Bankruptcy Court, is prohibited
from  making  payments  on its  debt  securities.  See  "Item  7 -  Management"s
Discussion  and Analysis of Financial  Condition  and Results of  Operations  --
Liquidity and Capital Resources."

     AVAILABLE  LIQUIDITY,  BORROWING  CAPACITY UNDER  FINANCING  AGREEMENT.  On
October 14, 1999, the Company entered into a Revolving Credit Agreement with CIT
Group/Business  Credit, Inc. and Heller Healthcare Finance,  Inc. to provide the
Company with up to $200.0  million in  debtor-in-possession  financing (the "DIP
Financing  Agreement").   The  DIP  Financing  Agreement  provides  for  maximum
borrowings  by  the  Company  equal  to the  sum  of  (i) up to 85% of the  then
outstanding  domestic eligible accounts  receivable and (ii) the lesser of $10.0
million or 50% of the aggregate value of eligible inventory. As of May 31, 2000,
up to  approximately  $132.0  million was available to the Company under the DIP
Financing  Agreement,  of which  amount the Company had  borrowed  approximately
$40.1 million and had issued  approximately  $19.1 million in letters of credit.
In  addition  to the  available  funds under the DIP  Financing  Agreement,  the
Company had cash book balances at May 31, 2000, of approximately $25.0 million.

                                       15
<PAGE>
     There can be no assurance  that the amount  available to the Company  under
the DIP Financing Agreement will be sufficient to fund the Company's  operations
until a plan of  reorganization is confirmed by the Bankruptcy Court or that the
Company will meet  required  financial  and  operating  covenants  under the DIP
Financing  Agreement.  In addition,  12 states have objected to the entry of the
order of the Bankruptcy Court approving the DIP Financing  Agreement because the
order prohibited the states from offsetting certain amounts the Company may have
owed to the states  against  amounts the states  owed to the  Company  under the
Medicaid  program.  The states contend that the order constituted a suit against
the  states  in  violation  of  the  Eleventh  Amendment  of the  United  States
Constitution.  The Bankruptcy Court overruled such objection and the states have
appealed,  which appeal is currently  pending before the United States  District
Court for the District of Delaware.  A decision of the District Court  reversing
the order of the Bankruptcy  Court could reduce the amount of funds available to
the  Company  under the DIP  Financing  Agreement.  See  "Item 7 -  Management's
Discussion  and Analysis of Financial  Condition  and Results of  Operations  --
Liquidity and Capital Resources".

     RISK OF POTENTIAL DEFAULTS UNDER THE DIP FINANCING AGREEMENT. In July 2000,
the  Company  obtained  conditional  waivers on several  defaults  under the DIP
Financing  Agreement.  If the  Company  is unable to comply  with the  covenants
contained in the DIP Financing Agreement and is unable to obtain a waiver of any
such  future  covenant  violation,  then the  Company  would lose its ability to
borrow under the DIP Financing Agreement for its working capital needs and could
lose access to a substantial  portion of its  operating  cash until such time as
the  outstanding  debt under the DIP  Financing  Agreement  was repaid.  In such
event,  the  Company's  liquidity  would  probably be  insufficient  to fund the
Company's ongoing operations.  See "Note 8 - Debtor-in-Possession  Financing, in
the Company's Consolidated Financial Statements."

     RISK OF FAILURE TO OBTAIN  FINANCING FOR  EMERGENCE  FROM  BANKRUPTCY.  The
Company  has  initiated  discussions  with  potential  lenders  to enter  into a
financing  agreement to fund the Company's  operations  upon  emergence from its
chapter 11 bankruptcy  cases.  The Company would probably not be able to conduct
its  operations  without  such  financing.  There can be no  assurance  that the
Company  will be able to obtain  such  financing  on terms  that will  allow the
Company to successfully operate its businesses.

     REDUCED  REVENUES   RESULTING  FROM  PROSPECTIVE   PAYMENT  SYSTEM.  For  a
description  of certain risks related to PPS, see  "Reimbursement  from Medicare
and Medicaid".

     RISKS  RELATED  TO  INVESTIGATIONS  AND LEGAL  PROCEEDINGS.  The  Company's
subsidiaries,  including  but not limited to those which  provide  subacute  and
long-term  care,  rehabilitation  and  respiratory  therapy  and  pharmaceutical
services,  are  engaged  in  industries  which are  extensively  regulated.  See
"-Potential Adverse Impact from Extensive  Regulation." As such, in the ordinary
course of  business,  the  operations  of these  subsidiaries  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. The Company's
subsidiaries have been subject to increased  regulatory oversight as a result of
the Company's  chapter 11 bankruptcy  filings.  The HHS and the DOJ periodically
investigate  matters that have come to their  attention  concerning the Company,
including  cost reporting  matters.  To expedite  resolution of any  outstanding
investigations,  the Company has requested that the HHS and the DOJ inform it of
any such  investigations  or  outstanding  concerns.  In  response,  the DOJ has
informed the Company of a number of  outstanding  inquiries,  some of which were
prompted by the filing of QUI TAM lawsuits  that remain under seal.  The Company
intends to expeditiously address whatever concerns the HHS and the DOJ may have.
There can be no assurance  that the outcome of any or all of these  matters will
not have a material  adverse  effect on the results of operations  and financial
condition of the Company.

                                       16
<PAGE>
     If any of the  Company's  subsidiaries  is ever  found to have  engaged  in
improper practices, it could be subjected to civil, administrative,  or criminal
fines,  penalties or restitutionary  relief and reimbursement  authorities could
also seek the  suspension  or exclusion of the  subsidiary or  individuals  from
participation  in their program.  From time to time, the existence of regulatory
investigations  has hindered or  prevented  the Company  from  pursuing  certain
business opportunities. There can be no assurance that the existence of any such
investigations  will not affect the Company's  ability to pursue future business
opportunities.  See "Item 7 - Management's  Discussion and Analysis of Financial
Condition and Results of Operations -- Litigation."

     RISKS  ASSOCIATED  WITH  REIMBURSEMENT   PROCESS.  The  Company  derives  a
substantial percentage of its total revenues from Medicare, Medicaid and private
insurance.  Net revenues  realizable  under  third-party  payor  agreements  are
subject to change due to examination and retroactive adjustment by payors during
the  settlement  process.  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.  The
Company  recognizes  revenues  from  third-party  payors and  accrues  estimated
settlement amounts in the period in which the related services are provided. The
Company estimates these settlement  balances by making  determinations  based on
its  prior  settlement  experience  and  its  understanding  of  the  applicable
reimbursement  rules and  regulations.  The  majority of Medicare  and  Medicaid
balances are settled two to  three years  following  the  provision of services,
although the Company has from time to time experienced delays in receiving final
settlement and reimbursement.

     The Company currently has a number of outstanding cost reports and requests
for exceptions to the routine cost limitations,  including cost reports filed by
former operators of facilities acquired by the Company for which the Company has
assumed responsibility for any overpayments to the prior operators.  Pursuant to
an agreement between the Company and the HHS, all Medicare payments directly due
to the Company for services rendered prior to October 14, 1999 (pre-bankruptcy),
and not previously paid to the Company,  will be withheld until the confirmation
of a plan of  reorganization.  In addition,  the Company will not be required to
pay any amounts alleged to be due to the federal government for periods prior to
October  14,  1999  until  confirmation  of a plan of  reorganization.  Upon the
confirmation of a plan of reorganization, the Company could file a motion in the
Bankruptcy Court seeking an adjudication of the funds withheld by the HHS if the
Company  believes that such funds exceed the claims that the HHS has against the
Company. As of February 29, 2000, the Company estimated that it had net Medicare
accounts  receivable of approximately  $74.5 million that were being withheld by
the HHS pursuant to this agreement. It is unlikely that the Company will recover
any of these receivables  because it is likely the HHS will claim more than such
amount.

     Payment of amounts due to the Company by the HHS for  services  provided on
or after  October 14,  1999  (post-bankruptcy)  are  largely  unaffected  by the
Company's  bankruptcy  cases;  the HHS has  agreed  not to offset  such  amounts
against amounts alleged to be due to the federal government from the Company for
periods prior to October 14, 1999.  However, if it is determined that there is a
pre-bankruptcy  overpayment  to the  Company  that is subject to offset  against
post-bankruptcy  payments due to the Company or previously  made to the Company,
the HHS may seek to have such  payments  treated  as an  administrative  expense
claim and withhold  such amounts if not already  paid.  If the amounts have been
previously  paid to the Company,  the Company would have to return such funds to
the HHS upon the occurrence of certain events,  including the  confirmation of a
plan of reorganization.  The Company's results of operations could be materially
and adversely  affected if the amounts actually received from third-party payors
in any reporting  period differs  materially  from the amounts  accrued in prior
periods.

                                       17
<PAGE>
     SELF-FUNDED  INSURANCE.  The Company's insurance carriers declined to renew
the Company's  high  deductible  general and  professional  liability  insurance
policies that expired on December 31, 1999.  Several major  insurance  companies
are no longer providing this type of coverage to long-term care providers due to
general  underwriting issues with the long-term care industry.  In January 2000,
the  Company  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.  There can be no assurance that this  self-funded  insurance
program  for 2000  will not have a  material  adverse  impact  on the  Company's
financial  condition  and results of  operations or that the Company will not be
required to continue  this  program in future  years.  In the recent  past,  the
Company's  insurance  companies  have paid  substantially  more to third parties
under  these   policies  than  the  Company  paid  in  insurance   premiums  and
deductibles. In addition, in certain states in which the Company has significant
operations,  including  California,  insurance coverage for the risk of punitive
damages arising from general and professional liability litigation is prohibited
by state law.  There can be no assurance that the Company 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 10 - Commitments and
Contingencies in the Company's Consolidated Financial Statements."

     COLLECTABILITY  OF CERTAIN  ACCOUNTS  RECEIVABLE.  Although  the  Company's
accounts receivable  decreased from approximately $617.3 million at December 31,
1998 to  approximately  $406.3  million at  December  31,  1999,  the  Company's
allowance for doubtful accounts  increased from  approximately  $79.0 million at
December 31,  1998 to  approximately  $151.8  million at December 31, 1999.  The
Company  believes  that  the  implementation  of PPS for  certain  nonaffiliated
ancillary  service  customers has negatively  affected their cash flows,  and in
many instances caused them to file for bankruptcy.  As a result, the Company has
increased its provision for doubtful accounts. The Company's financial condition
and results of operation could be materially adversely affected by the inability
to collect its accounts receivable.

     RISK OF ADVERSE EFFECT OF FUTURE  HEALTHCARE  REFORM.  In recent years,  an
increasing  number of legislative  proposals have been introduced or proposed in
Congress and in some state  legislatures  that would effect major changes in the
healthcare system,  either nationally or at the state level. Among the proposals
that have been  introduced are further changes in  reimbursement  by federal and
state payors such as Medicare and Medicaid  and health  insurance  reforms.  For
example,  federal and state government  officials are reviewing whether Medicare
and  Medicaid  pay too much for  prescription  drugs  as a result  of  providers
allegedly inflating the average wholesale prices of such drugs. Some states have
implemented  new policies  for how much their  Medicaid  programs  would pay for
these drugs,  and other state or federal  agencies are considering  implementing
similar policies. If fully implemented by the states and federal agencies, these
policies  could  adversely  affect the results of  operations  of the  Company's
pharmaceutical business.

     As another example of potential changes,  HCFA recently proposed changes in
billing  for  outpatient  rehabilitation  services  under  the  Medicare  Part B
program.  Such  services  are  documented  and billed using  Current  Procedural
Terminology  ("CPT")  code  units.  Many of the  codes are  billed in  15-minute
increments  such that a single  service unit  represents 15 minutes of a certain
treatment  procedure.  Under the proposed changes, if a patient is treated for 8
minutes of a 15-minute  CPT coded  procedure,  the  therapist may bill one unit.
However,  if several  procedures that are represented by 15-minute CPT codes are
performed,  the provider must consider the total  treatment time of the session.
Thus, where three separately  billable CPT code therapy treatments are completed
during a 30-minute treatment session, each procedure for 10 minutes, even though
the initial 8-minute threshold was met for each individual procedure,  the total
treatment  time of 30  minutes  only  allows  for  billing  2 units.  Therefore,
although  three  therapeutic  procedures  were  provided,  only two units can be
billed.  Under  such  circumstances,  this  two-tiered  billing  criteria  could
decrease  Medicare  Part B  reimbursement  and  adversely  affect the results of
operations of the Company's outpatient rehabilitation services business.

                                       18
<PAGE>
     It is not clear at this  time when or  whether  any new  proposals  will be
adopted, or, if adopted, what effect, if any, such proposals would have on Sun's
business.  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 Sun's financial condition or
results of operations. See "Reimbursement from Medicare and Medicaid."

     POTENTIAL  ADVERSE EFFECT OF CHANGE IN REVENUE SOURCES.  Changes in the mix
of patients among the Medicaid,  Medicare and private pay categories,  and among
different types of private pay sources,  could significantly affect the revenues
and the  profitability of Sun's  operations.  There can be no assurance that Sun
will continue to attract and retain private pay patients or maintain its current
payor or revenue mix. In addition, there can be no assurance that the facilities
operated by Sun, or the provision of services and products by Sun, 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 Sun's  reimbursement  under  Medicare or
Medicaid could have an adverse effect on its financial  condition and results of
operations.  See "-Risks Related to  Investigations  and Legal  Proceedings" and
"-Risk of Adverse Effect of Future Healthcare Reform."

     POTENTIAL ADVERSE IMPACT FROM EXTENSIVE  REGULATION.  All of the facilities
operated or managed by Sun are  required to be licensed in  accordance  with the
requirements  of  state  and  local  agencies  having  jurisdiction  over  their
operations.  Most of Sun's  facilities are also certified as providers under the
Medicaid  and  Medicare  programs.  The failure to obtain or renew any  required
regulatory approvals or licenses or to comply with applicable regulations in the
future  could  adversely  affect  Sun's  financial   condition  and  results  of
operations.  See "-Risks Related to  Investigations  and Legal  Proceedings" and
"Item 7 -  Management's  Discussion  and  Analysis of  Financial  Condition  and
Results of Operations --  Regulation."  To the extent that CONs or other similar
approvals  are  required  for  expansion  of Sun's  operations,  either  through
acquisitions  or additions  to or provision of new services at such  facilities,
such expansion could be adversely affected by the failure to obtain such CONs or
approvals.  There can be no assurance that Sun's business in the future will not
be materially adversely affected by licensing and certification  requirements of
state and federal authorities.

     Medicare  and  Medicaid  antifraud  and abuse  laws also  prohibit  certain
business practices and relationships that might affect the provision and cost of
healthcare  services   reimbursable  under  Medicare  and  Medicaid.   Expressly
prohibited  are  kickbacks,  bribes and rebates  related to Medicare or Medicaid
referrals.  Federal laws also provide civil and criminal penalties for any false
or  fraudulent  statements,  knowingly  made,  in any claim for payment  under a
federal or state health care  program as well as any material  omissions in such
claims.  In  addition,  certain  states have  adopted  fraud and abuse and false
claims laws that prohibit specified business practices.  Sanctions for violating
these laws include criminal  penalties and civil sanctions,  including fines and
possible  exclusion  from  the  Medicare  and  Medicaid  programs.  See  "Recent
Developments-Increase in Survey, Certification and Enforcement Activities."

     RISK OF  INTERNATIONAL  OPERATIONS;  FOREIGN  EXCHANGE  RISK. Sun currently
conducts business in the United Kingdom,  Spain, Germany and Australia.  Foreign
operations  accounted for approximately 12.0%, 9.0% and 10.0% of Sun's total net
revenues during the years ended December 31, 1999, 1998, and 1997, respectively,
and  approximately  19.0% and  17.0% of Sun's  consolidated  total  assets as of
December 31,   1999,  and  1998,   respectively.   Adverse  results  from  Sun's
international  operations have and continue to negatively affect Sun's financial
condition  and  results  of  operations.  The  success  of Sun's  operations  in
international  markets depends on numerous factors, many of which are beyond its
control.  Such factors include,  but are not limited to, economic conditions and
healthcare regulatory systems in the foreign countries in which Sun operates. In
addition,  international  operations  increase  Sun's  exposure to certain risks
inherent in doing business  outside the United States,  including slower payment
cycles,  unexpected changes in regulatory requirements,  potentially adverse tax
consequences, currency fluctuations, restrictions on the repatriation of profits
and assets,  compliance  with foreign laws and standards  and  political  risks.
Sun's financial  condition and results of operations are also subject to foreign
exchange risk. See "Recent Developments - Divestitures."

                                       19
<PAGE>
     INCREASED LABOR COSTS; AVAILABILITY OF PERSONNEL;  RETENTION OF MANAGEMENT.
In recent years Sun has  experienced  increases in its labor costs primarily due
to higher wages and greater  benefits  required to attract and retain  qualified
personnel  and  increased  staffing  levels in its  long-term  and subacute care
facilities.  The Company and other providers in the long-term care industry have
had and continue to have difficulties in attracting qualified personnel to staff
its long-term care facilities,  particularly nurses, and as a result the Company
often uses temporary  employment  agencies to provide additional  personnel.  In
addition, Sun's ability to hire and retain qualified employees has been affected
by, among other  things,  the  Company's  filing for  bankruptcy  protection  in
October, 1999 and the perceived  uncertainty about Sun's financial  performance.
The  Company  has  implemented  an  employee  retention  program  to retain  key
employees  during the pendency of the chapter 11 bankruptcy  proceedings,  which
will further increase the Company's labor costs.  There can be no assurance that
Sun will be able to retain  its  executive  officers  and key  employees  and to
continue  to hire and  retain a  sufficient  number of  qualified  personnel  to
operate the Company effectively. See "Business-Employees."

ITEM 2.   PROPERTIES

     The company operated an aggregate of 554 long-term care, subacute care, and
assisted living facilities world-wide as of december 31, 1999, 464 of which were
subject to long-term operating leases or subleases,  12 of which were subject to
long-term  management  agreements  and  78 of  which  were  owned.  The  company
considers its properties to be in good operating  condition and suitable for the
purposes for which they are being used. The company's facilities that are leased
are  subject to  long-term  operating  leases or  subleases  which  require  the
company, among other things, to fund all applicable capital expenditures, taxes,
insurance  and  maintenance  costs.  The annual rent  payable  under each 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.  The  company's  management  agreements  for  long-term  and subacute care
facilities  generally  provide  the  company  with  management  fees  based on a
percentage of the revenues of the managed  facility and may also include a fixed
fee component.

     Substantially  all of the Company's  facilities serve as collateral for its
obligations  under  the  DIP  Financing   Agreement  and  other  various  credit
facilities. The Company is actively reviewing its portfolio of properties and is
seeking,  and will continue to seek to divest those  properties that it believes
do  not  meet  acceptable  financial   performance   standards  or  do  not  fit
strategically  into  the  Company's  operations.   See  "Recent  Developments  -
Divestitures"  and "Note 7 - Impairment of Long-Lived Assets and Assets Held for
Sale in the Company's Consolidated Financial Statements.

     The Company calculated its aggregate  occupancy  percentages for all of its
long-term care, subacute care and assisted living facilities as 90%, 90% and 87%
in the United  States and 78%,  80% and 78% in the United  Kingdom for the years
ended December 31, 1997,  1998,  and 1999,  respectively.  However,  the Company
believes that occupancy  percentages,  either  individually or in the aggregate,
should not be relied upon alone to determine  the  profitability  of a facility.
Other  factors  include,  among other things,  the sources of payment,  terms of
reimbursement  and the acuity level for each of the patients in such facilities.
The Company also believes there is not a consistent  industry standard as to how
occupancy  is measured  and that the  information  may not be  comparable  among
long-term care providers.  The Company computes average occupancy percentages by
dividing the total number of beds  occupied by the total number of licensed beds
available for use during the periods indicated.

                                       20
<PAGE>
     FACILITIES IN THE UNITED  STATES.  The  following  table sets forth certain
information  concerning the long-term  care,  subacute care and assisted  living
facilities  leased,  owned or managed by the Company in the United  States as of
December 31, 1999. Included in the table are 354 facilities (346 skilled nursing
facilities  and eight  hospitals)  that are included in the  inpatient  services
segment  and 22  assisted  living  facilities  that are  included  in the  other
operations segment.

<TABLE>
<CAPTION>

                                NUMBER OF                                      NUMBER OF FACILITIES
STATE                        LICENSED BEDS(1)             LEASED            OWNED              MANAGED           TOTAL
-----                        ----------------             ------            -----              -------           -----
<S>                          <C>                          <C>               <C>                <C>               <C>
California                               9,266               89                  3                 1               93
Massachusetts                            4,733               32                  2                 2               36
Tennessee                                3,015               21                  6                 -               27
Texas                                    2,979               25                  -                 -               25
Washington                               2,294               19                  2                 4               25
Georgia                                  2,266               12                 12                 -               24
Florida                                  2,984               13                  9                 -               22
Arizona                                  1,943               12                  1                 -               13
Connecticut                              1,768               11                  1                 -               12
Illinois                                 1,302                9                  -                 3               12
North Carolina                           1,291               11                  -                 -               11
Alabama                                    947                9                  -                 -                9
Idaho                                      805                8                  1                 -                9
New Hampshire                              991                9                  -                 -                9
New Mexico                                 653                8                  -                 -                8
Ohio                                       982                5                  3                 -                8
Louisiana                                1,135                7                  -                 -                7
West Virginia                              739                7                  -                 -                7
New Jersey                                 580                4                  -                 -                4
Colorado                                   341                2                  1                 -                3
Virginia                                   494                2                  1                 -                3
Kentucky                                   137                2                  -                 -                2
Maryland                                   353                2                  -                 -                2
Oklahoma                                   135                2                  -                 -                2
Indiana                                     99                1                  -                 -                1
Missouri                                   103                1                  -                 -                1
Oregon                                     114                1                  -                 -                1
                                      --------             ----                ---               ---             ----
     Total                              42,449              324                 42                10              376
</TABLE>

(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.

                                       21
<PAGE>
     INTERNATIONAL  LONG-TERM CARE  FACILITIES.  The following  table sets forth
certain  information  concerning the long-term care facilities leased,  owned or
managed by the Company as of December 31, 1999.

<TABLE>
<CAPTION>

                           NUMBER OF LICENSED                                   NUMBER OF FACILITIES
                           ------------------            ------------------------------------------------------------
COUNTRY                         BEDS(1)                  LEASED              OWNED              MANAGED         TOTAL
-------                         -------                  ------              -----              -------         -----
<S>                        <C>                           <C>                 <C>                <C>             <C>
United Kingdom:
   England                                6,739             101                 18                 -              119
   Scotland                                 709               9                  -                 -                9
   Wales                                    460               5                  2                 -                7
   Northern Ireland                         412               9                  1                 -               10
Germany                                   1,217              15                  2                 -               17
Spain                                     1,640               1                  8                 2               11
Australia                                   335               -                  5                 -                5
                                       --------            ----                ---               ---             ----
     TOTAL                               11,512             140                 36                 2              178
</TABLE>


(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.

     PHARMACEUTICAL  SERVICES.  As of December 31, 1999, the Company operated 38
regional   pharmacies,   six  in-house   long-term  care  pharmacies,   and  one
pharmaceutical  billing and consulting center in the United States.  Also, as of
December  31,  1999,   the  Company   operated  18  pharmacies  and  two  supply
distribution centers in the United Kingdom. Subsequent to December 31, 1999, the
Company  divested  the 18  pharmacies  in the  United  Kingdom.  See  "Note 24 -
Subsequent Events to the Company's Consolidated Financial Statements."

ITEM 3.   LEGAL PROCEEDINGS

     See "Item 7 - Management's  Discussion and Analysis of Financial  Condition
and Results of Operations - Litigation."

ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were  submitted to a vote of security  holders during the fourth
quarter of fiscal 1999.

                                       22
<PAGE>
ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The Company's  common stock was traded on the New York Stock  Exchange (the
"NYSE")  under the symbol  "SHG"  until  June 29,  1999.  Since  that time,  the
Company's common stock has traded on the Over-the-Counter ("OTC") Bulletin Board
under the symbol "SHGE". The following table shows the high and low sales prices
for the common stock as reported by the NYSE and the OTC Bulletin  Board for the
periods indicated:

<TABLE>
<CAPTION>
                                                HIGH                   LOW
                                               ------                 -----

<S>                                          <C>                   <C>
       1998
  First Quarter . . . . . . . . . . .  .     $  20.13              $   18.13
  Second Quarter . . . . . . . . . . . .        19.25                  14.63
  Third Quarter  . . . . . . . . . . . .        17.69                   6.50
  Fourth Quarter . . . . . . . . . . . .         7.75                   4.88

        1999
  First Quarter . . . . . . . . . . . ..     $   6.75              $    0.81
  Second Quarter . . . . . . . . . . . .         1.63                   0.28
  Third Quarter  . . . . . . . . . . . .         0.50                   0.21
  Fourth Quarter . . . . . . . . . . . .         0.22                   0.07

</TABLE>
     There  were  6,925  holders  of record  as of May 5, 2000 of the  Company's
common stock.

     The Company has not paid nor  declared  any  dividends  on its common stock
since its inception.  During the pendency of the Company's chapter 11 bankruptcy
proceedings,  the Company is prohibited from paying dividends  without obtaining
Bankruptcy Court approval. See "Item 1. Recent Developments."

     Pursuant to an agreement in principle  entered into between the Company and
representatives  of its bank  lenders  and  holders of a majority  of its senior
subordinated  bonds,  the Company's  plan of  reorganization  would provide that
holders of outstanding equity securities,  including common stock and options to
acquire common stock, would not receive anything in recovery.  No assurances can
be given that the plan of reorganization that is confirmed, if any, will include
the  terms of the  agreement  in  principle.  See Item 1 -  "Certain  Additional
Business  Risks - Effect of Bankruptcy  Reorganization  on Common Stock and Debt
Securities."

ITEM 6. SELECTED FINANCIAL DATA

     The  following  Selected  Consolidated  Financial  Data for the years ended
December  31,  1999,  1998,  1997,  1996,  and 1995 have been  derived  from the
Company's 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 the  Company's
Consolidated Financial Statements and related notes thereto.

                                       23
<PAGE>
<TABLE>
<CAPTION>

                                                                 YEAR ENDED DECEMBER 31,
                                                                 -----------------------
                                            1999(1)            1998(2)             1997(3)            1996(4)          1995(5,6)
                                            -------            -------             -------            -------          ---------
                                                         (In thousands, except per share data)
<S>                                  <C>              <C>                 <C>                 <C>                <C>
Total net revenues...................   $  2,529,039       $   3,088,460       $   2,010,820       $  1,316,308     $  1,135,508
                                     ---------------  ------------------  ------------------  -----------------  ---------------
Earnings (losses) before income
   taxes, extraordinary loss and
   cumulative effect of change in
   accounting principle..............    (1,076,481)           (689,842)              95,882             52,466           12,794
                                     ---------------  ------------------  ------------------  -----------------  ---------------
Earnings (losses) before
   extraordinary loss and cumulative
   effect of change in accounting
   principle........................     (1,076,642)           (743,419)              54,729             21,536         (20,568)
Extraordinary loss..................              -            (10,274)            (19,928)                  -          (3,413)
                                     ---------------  ------------------  ------------------  -----------------  ---------------
Cumulative effect of change in
   accounting principle.............       (12,816)                   -                   -                  -                -
Net earnings (losses)...............  $ (1,089,458)       $   (753,693)        $     34,801        $    21,536      $  (23,981)
                                     ===============  ==================  ==================  =================  ===============
 Net earnings (losses) per common and
   common equivalent share:
 Net earnings (losses) before
   Extraordinary loss and
   cumulative effect of change
   in accounting principle:
  Basic..............................    $   (18.40)        $    (14.29)         $      1.18        $      0.46      $    (0.43)
                                     ===============  ==================  ==================  =================  ===============
  Diluted............................    $   (18.40)        $    (14.29)         $      1.12        $      0.46      $    (0.43)
                                     ===============  ==================  ==================  =================  ===============
Net earning (losses):
  Basic..............................    $   (18.62)        $    (14.49)         $      0.75        $      0.46      $    (0.51)
                                     ===============  ==================  ==================  =================  ===============
  Diluted............................    $   (18.62)        $    (14.49)         $      0.74        $      0.46      $    (0.51)
                                     ===============  ==================  ==================  =================  ===============
Weighted Average number of common
  and common equivalent shares:
  Basic..............................         58,504              52,008              46,329             46,360           47,419
                                     ===============  ==================  ==================  =================  ===============
  Diluted............................         58,504              52,008              51,851             46,868           47,419
                                     ===============  ==================  ==================  =================  ===============
Working Capital (Deficit)............    $  (17,282)       $   (539,636)         $   307,025        $   211,582      $   237,147
                                     ===============  ==================  ==================  =================  ===============
Total Assets.........................    $ 1,438,488       $   2,468,038         $ 2,579,236        $ 1,229,426      $ 1,042,503
                                     ===============  ==================  ==================  =================  ===============
Liabilities subject to compromise....    $ 1,558,518       $           -         $         -        $         -      $         -
                                     ===============  ==================  ==================  =================  ===============
Long term debt (7)...................    $   145,541       $   1,518,274         $ 1,545,678        $   512,435      $   358,877
                                     ===============  ==================  ==================  =================  ===============
Stockholder's equity (deficit).......   $(1,044,141)       $      33,759         $   617,053        $   572,137      $   569,042
                                     ===============  ==================  ==================  =================  ===============
</TABLE>

(1)  Results for the year ended  December 31, 1999 include a non-cash  charge of
     $457.4  million  related to the  Company's  estimate of goodwill  and other
     long-lived  asset  impairment (see Note 7, IMPAIRMENT OF LONG-LIVED  ASSETS
     AND  ASSETS  HELD  FOR  SALE,  in  the  Company's   Consolidated  Financial
     Statements),  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 the
     Company had  determined  are not integral to its core  business  operations
     (see Note 7,  IMPAIRMENT OF LONG-LIVED  ASSETS AND ASSETS HELD FOR SALE, in
     the Company's Consolidated  Financial  Statements),  a $27.4 million charge
     for corporate and financial restructuring (see Note 4, RESTRUCTURING COSTS,
     in the Company's Consolidated Financial Statements), a $2.5 million loss on
     the  termination of the interest rate swaps (see Note 9, LONG-TERM DEBT, in
     the Company's Consolidated Financial Statements) and a $48.1 million charge
     for reorganization items due to the Company's chapter 11 filings (see "Note
     2,  PETITIONS  FOR  REORGANIZATION  UNDER  CHAPTER  11,  in  the  Company's
     Consolidated Financial Statements").

                                       24
<PAGE>
(2)  Results for the year ended  December 31, 1998 include a non-cash  charge of
     $397.5  million  related to the  Company's  estimate of goodwill  and other
     asset  impairment (see Note 7,  IMPAIRMENT OF LONG-LIVED  ASSETS AND ASSETS
     HELD FOR SALE,  in the  Company's  Consolidated  Financial  Statements),  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  the  Company  had
     determined  are not integral to its core business  operations  (see Note 7,
     IMPAIRMENT OF LONG-LIVED  ASSETS AND ASSETS HELD FOR SALE, in the Company's
     Consolidated  Financial  Statements),  a $22.5 million charge for legal and
     regulatory  matters,  a $4.6 million charge for restructuring cost in order
     to  more  closely  align  the  Company's   inpatient,   rehabilitation  and
     respiratory  therapy, and pharmaceutical and medical supplies segments (see
     Note  4,  RESTRUCTURING  COSTS,  in the  Company's  Consolidated  Financial
     Statements),  and an extraordinary loss of $10.3 million, net of income tax
     benefit of $3.7 million,  to permanently  pay-down $300 million of the term
     loan portion of the  Company's  senior  credit  facility in addition to the
     $3.7  million  to  retire  $5.0  million  of  the  Contour  Medical,   Inc.
     ("Contour") convertible debentures purchased by the Company.

(3)  Results  for the year  ended  December  31,  1997  include a charge of $7.0
     million  recognized by the Company in order to reduce the carrying value of
     the Canadian operations to fair value based on revised estimates of selling
     value and of costs to sell. In addition,  in 1997, the Company  recorded an
     extraordinary  charge of $19.9 million,  net of the related tax benefit, in
     connection  with  the  Company's   purchase  of  Regency's   12.25%  Junior
     Subordinated  Notes  due  2003  and  of  Regency  Health  Services,  Inc.'s
     ("Regency") 9.875% Senior  Subordinated Notes due 2002 and an extraordinary
     charge of $2.1  million,  net of the  related tax  benefit,  related to the
     refinancing of the Company's senior credit facility.

(4)  Results  for the year ended  December  31,  1996,  include a $24.0  million
     charge  recognized by the Company to settle certain of the lawsuits brought
     by  shareholders  and,  as a  reduction  of this  settlement  charge,  $9.0
     million,  which  was  received  from the  Company's  director  and  officer
     liability insurance carrier in connection with the settlement. In addition,
     in 1996, the Company recorded  additional  expenses of $4.3 million related
     to  monitoring  and  responding  to the  investigation  by the  OIG  and to
     responding  to  the  remaining   shareholder   litigation  related  to  the
     announcement  of the OIG  investigation.  The  charges do not  contain  any
     estimated  amounts for  settlement  of the OIG  investigation  or remaining
     shareholder matters.

(5)  Results for the year ended  December 31, 1995 represent pro forma amount to
     include  pro forma  taxes of  CareerStaff  and  Golden  Care prior to their
     conversions to be taxed as C corporations,  which occurred in June 1994 and
     May 1995, respectively.

(6)  Results  for the year  ended  December  31,  1995  include a charge of $3.3
     million in connection  with the payment of an inducement  fee to affect the
     conversion  in  January  1995 of $39.4  million  of the  61/2%  Convertible
     Subordinated Debentures and an extraordinary charge of $3.4 million, net of
     the related income tax benefit,  in connection with the tender offer of the
     113/4 Senior Subordinated Notes. Also included in the results of operations
     for the year ended December 31, 1995 is $5.8 million of transaction-related
     merger  costs  incurred in  connection  with the merger of the Company with
     CareerStaff  (a temporary  therapy  staffing  provider)  and Golden Care (a
     respiratory therapy provider),  a $59.0 million impairment loss recorded by
     the Company which primarily relates to goodwill  associated with six of the
     forty facilities  acquired in conjunction with the Mediplex  acquisition in
     1994,  $4.0  million  related  to  averting a strike  and  negotiating  new
     contracts for certain unionized nursing home employees in Connecticut,  and
     a charge of $5.5  million  related  to  monitoring  and  responding  to the
     investigation  by the OIG and legal  fees  resulting  from the  shareholder
     litigation.

                                       25
<PAGE>
(7)  Long-term debt as of December 31, 1999 does not include $1,356.9 million of
     long-term debt subject to compromise  that would be classified as long-term
     debt except for the Company's bankruptcy filing and the related application
     of the guidance in SOP 90-7.

                                       26
<PAGE>
ITEM 7.  MANAGEMENT'S  DISCUSSION  AND ANALYSIS OF FINANCIAL  CONDITION AND
         RESULTS OF OPERATIONS

OVERVIEW

     Sun Healthcare Group,  Inc.,  through its direct and indirect  subsidiaries
(collectively  referred  to as "Sun" or the  "Company"),  is one of the  largest
providers of long-term,  subacute and related specialty  healthcare  services in
the United  States and the United  Kingdom.  The Company also has  operations in
Spain,  Germany and  Australia.  The Company  operates  through  four  principal
business segments. In October 1999, the Company commenced cases under Chapter 11
of the U.S.  Bankruptcy  Code  and is  currently  operating  its  business  as a
debtor-in-possession  subject to the  jurisdiction of the Bankruptcy  Court (see
"Recent Developments - Bankruptcy").

     INPATIENT SERVICES: This segment provides, among other services,  inpatient
skilled nursing and custodial  services as well as  rehabilitative,  restorative
and transitional medical services.  The Company provides 24-hour nursing care in
these facilities by registered  nurses,  licensed practical nurses and certified
nursing  aides.  At December  31,  1999,  the  Company  operated  354  inpatient
facilities  with 39,867  licensed  beds compared to 397  facilities  with 44,941
licensed  beds at  December  31,  1998.  Included  in the 354  facilities  as of
December 31, 1999, are 49 facilities  with 5,702 licensed beds which the Company
has  announced  its  intention  to  divest or not  renew  the  facility  leases.
Inpatient services facilities decreased by 43 on a net basis from 397 facilities
as of December  31, 1998 to 354  facilities  as of December  31,  1999.  The net
change  is  comprised  of i) the  divestiture  of 49  facilities  due  to  lease
termination  through mutual  agreements with the lessors,  lease  expirations or
sales,  ii)  the  termination  of  management  agreements  on  nine  facilities,
partially offset by iii) the transfer of four assisted living  facilities to the
inpatient services segment from the other operations segment,  iv) the execution
of management  agreements  for six facilities and v) the execution of five lease
agreements.  During the year ended December 31, 1998, the Company  acquired on a
net basis,  76  facilities  with 8,286  licensed  beds  including 75  facilities
acquired  in  connection  with the RCA  acquisition.  During  1997,  the Company
acquired  a net 50  facilities  with  5,988  licensed  beds in  addition  to 111
facilities  with 11,346  licensed beds  acquired in connection  with the Regency
acquisition.

     REHABILITATION  AND RESPIRATORY  THERAPY  SERVICES:  This segment provides,
among other  things,  physical,  occupational,  speech and  respiratory  therapy
services,  respiratory therapy supplies,  equipment and oxygen to affiliated and
nonaffiliated skilled nursing facilities. As of December 31, 1999, the Company's
rehabilitation  and respiratory  therapy services  segment provided  services to
1,531  facilities in 37 states,  of which 1,158 were  operated by  nonaffiliated
parties  compared to 1,715  facilities  as of December 31, 1998,  of which 1,294
were nonaffiliated.

     PHARMACEUTICAL AND MEDICAL SUPPLY SERVICES: This segment is comprised of an
institutional  pharmaceutical  subsidiary and a medical supply  subsidiary.  The
pharmaceutical   subsidiary  provides   pharmaceutical   products  primarily  to
long-term and subacute care  facilities  for such purposes as infusion  therapy,
pain  management,  antibiotic  therapy  and  parenteral  nutrition  as  well  as
providing  consultant   pharmacist  services.   The  medical  supply  subsidiary
primarily  provides  medical  supplies  to  long-term  care  and  subacute  care
facilities.  The Company's  pharmaceutical  subsidiary  provided  pharmaceutical
products and services to 885 long-term and subacute care  facilities,  including
550 nonaffiliated facilities, as of December 31, 1999, through its 44 pharmacies
and one  pharmaceutical  billing and  consulting  center.  At December 31, 1998,
pharmaceutical   products  and  services  were  provided  to  approximately  930
facilities including 584 nonaffiliated facilities.  The Company's medical supply
subsidiary   provided   products  to  over  1,622  and  2,100   affiliated   and
nonaffiliated facilities as of December 31, 1999 and 1998, respectively.

                                       27
<PAGE>
     INTERNATIONAL   OPERATIONS:   This  segment   consists  of  long-term  care
facilities  in the  United  Kingdom,  Spain and  Germany  as well as acute  care
hospitals in Australia.  This segment also provides  pharmaceutical  services in
the United  Kingdom,  Germany and Spain and medical  supplies in  Australia.  At
December 31, 1999,  the Company  operated 145  inpatient  facilities  with 8,320
licensed beds in the United Kingdom; 11 inpatient facilities with 1,640 licensed
beds in Spain;  17  facilities  with 1,217  licensed  beds in  Germany  and five
hospitals with 335 licensed beds in Australia  compared to 155  facilities  with
8,705 licensed beds in the United  Kingdom;  ten facilities  with 1,604 licensed
beds in Spain;  16  facilities  with 1,135  licensed  beds in Germany;  and five
hospitals  with 309 licensed  beds in Australia as of December 31, 1998.  During
1999 on a net basis,  the  Company's  international  operations  divested  eight
facilities which decreased licensed beds by 241 on a net basis. During 1998, the
Company  acquired or opened 18  facilities  with 868 licensed beds in the United
Kingdom.

     The Company's  international  operations also included  outpatient  therapy
services in Canada. The carrying amount of the Canadian assets held for sale was
$11.6  million as of December 31, 1998.  The Company  completed  the sale of the
Canadian  clinics during the first quarter of 1999. The Company  recorded losses
of approximately $7.0 million, $11.4 million and $2.0 million on the sale of the
Canadian  clinics  during the years  ended  December  31,  1997,  1998 and 1999,
respectively.  The results of  operations  of this business were not material to
the Company's consolidated results of operations.

     The Company is currently  soliciting  offers to purchase its  international
operations.  No assurance can be given that the international operations will be
sold or that, if they are sold,  the Company will not experience a material loss
on the sale.

     As of May 31, 2000,  the Company had divested 18  pharmacies  in the United
Kingdom.  See "Recent  Developments  -  Divestitures"  and "Note 24 - Subsequent
Events in the Company's Consolidated Financial Statements."

OTHER OPERATIONS

     The Company's other operations include temporary therapy services, assisted
living  services,  home  health  and  hospice,  software  development  and other
ancillary services.  The Company's temporary therapy service operations provided
approximately  1.1 million  temporary therapy staffing hours to nonaffiliates in
1999  compared to 2.4 million  hours in 1998.  The  assisted  living  subsidiary
operated 22 assisted  living  facilities with 2,582 beds in the United States as
of December 31, 1999 compared to 31  facilities  with 3,380 beds at December 31,
1998.  Subsequent to December 31, 1999, the Company  entered into  agreements to
sell 16 assisted living facilities See "Recent  Developments - Divestitures" and
"Note  24  -  Subsequent   Events  in  the  Company's   Consolidated   Financial
Statements."

     On June 30, 1998, a wholly owned subsidiary of the Company merged with RCA,
an operator of 98 skilled  nursing  facilities  and assisted  living  centers in
eight  states  primarily  in the  southeastern  United  States.  RCA also  owned
approximately 65% of the Contour Medical, Inc. ("Contour"),  a national provider
of  medical/surgical  supplies.  The Company also  acquired the remaining 35% of
Contour on June 30, 1998. Both the RCA merger and the Contour  acquisition  were
accounted for as purchases.

                                       28
<PAGE>
IMPACT OF MEDICARE PPS

     Effective  July  1,  1998,  Medicare  began  a  four  year  phase-in  of  a
prospective  payment  system ("PPS") for Medicare Part A patients which provides
for reimbursement of all costs including  ancillary services and capital-related
costs at a fixed fee. A small  percentage  of the  long-term  and subacute  care
industry transitioned to PPS on July 1, 1998, including the Company's facilities
that were  acquired in the RCA  acquisition.  The vast  majority of the industry
transitioned  to PPS on January 1, 1999.  The  Company's  average per diem rates
under PPS are less than the amounts received under cost-based reimbursement. The
implementation  of PPS at the  Company's  facilities  resulted in a  significant
decline in Medicare  revenues.  In  addition,  as a result of the  industry-wide
reductions  in Medicare  reimbursement,  the Company's  nonaffiliated  ancillary
service customers have  significantly  reduced their usage of such services.  In
the first  quarter of 1999,  the Company  experienced  a  significant  and rapid
decline  in the  demand  for  its  ancillary  services  from  its  nonaffiliated
customers  following the  implementation  of PPS. This reduced demand  continued
throughout 1999.

     The following table sets forth certain operating data for the Company as of
December 31.
<TABLE>
<CAPTION>

                                                                      1999         1998       1997
                                                                      ----         ----       ----
<S>                                                              <C>          <C>         <C>
Inpatient Services:
   Facilities                                                          354          397        321
   Licensed beds                                                    39,867       44,941     36,655

Rehabilitation and Respiratory Therapy Service Operations:
   Nonaffiliated facilities served                                   1,158        1,294      1,278
   Affiliated facilities served                                        373          421        287
                                                                 ----------   ----------  ---------
        Total                                                        1,531        1,715      1,565
                                                                 ==========   ==========  =========

Pharmaceutical and Medical Supply Services:
   Nonaffiliated facilities served                                   1,805        2,099        546
   Affiliated facilities served                                        702          936        255
                                                                 ----------   ----------  ---------
        Total                                                        2,507        3,035        801
                                                                 ==========   ==========  =========
International Operations:
   Facilities
      United Kingdom                                                   145          155        137
      Other foreign                                                     33           31         25
                                                                 ----------   ----------  ---------
        Total                                                          178          186        162
                                                                 ==========   ==========  =========

   Licensed beds
      United Kingdom                                                 8,320        8,705      7,837
      Other foreign                                                  3,192        3,048      2,611
                                                                 ----------   ----------  ---------
        Total                                                       11,512       11,753     10,448
                                                                 ==========   ==========  =========
</TABLE>

                                       29
<PAGE>
BANKRUPTCY FILING

     On October 14, 1999 (the "Filing  Date"),  Sun Healthcare  Group,  Inc. and
substantially all of its U.S. operating  subsidiaries filed voluntary  petitions
for reorganization  under Chapter 11 of the U.S. Bankruptcy Code ("Chapter 11").
The Company is presently operating its business as a debtor-in-possession  under
Chapter 11 and is subject to the  jurisdiction of the U.S.  Bankruptcy Court for
the District of Delaware (the "Bankruptcy  Court").  The consolidated  financial
statements of the Company have been  presented 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  have  been  prepared  in  accordance  with  generally  accepted  accounting
principles applicable to a going concern, which principles,  except as otherwise
disclosed,  assume  that  assets  will  be  realized  and  liabilities  will  be
discharged  in the  normal  course of  business.  The  chapter 11  filings,  the
uncertainty  regarding the eventual outcome of the reorganization cases, and the
effect of other unknown,  adverse factors could threaten the Company's existence
as a going concern.

     Under Chapter 11, certain claims against the Company in existence  prior to
the Filing  Date are stayed  while the Company  continues  its  operations  as a
debtor-in-possession.  These  claims are  reflected  in the  December  31,  1999
balance sheet as  "Liabilities  subject to  compromise."  Additional  chapter 11
claims  have  arisen and may  continue  to arise  subsequent  to the Filing Date
resulting from the rejection of executory contracts,  including leases, and from
the  determination by the Bankruptcy  Court of allowed claims for  contingencies
and other disputed  amounts.  Claims secured by the Company's  assets  ("secured
claims") also are stayed,  although the holders of such claims have 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.

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

     Since  October  14,  1999,  the  payment  of  certain   prepetition  claims
(principally  employee  wages and benefits and payments to critical  vendors and
utilities) that were approved by the Bankruptcy Court have reduced  "Liabilities
subject to compromise."

RESULTS OF OPERATIONS

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

                                                         1999          %         1998          %         1997          %
                                                         ----          -         ----          -         ----          -
<S>                                                  <C>          <C>        <C>          <C>         <C>          <C>
Inpatient Services.................................  $ 1,697,518      67.1   $ 2,045,270      66.2    $1,249,861      62.2
Rehabilitation and Respiratory Therapy Services....      234,008       9.3       678,803      22.0       466,358      23.2
Pharmaceutical and Medical Supply Services.........      300,959      11.9       254,455       8.2       157,336       7.8
International Operations...........................      296,906      11.7       285,267       9.2       198,155       9.9
Other Operations...................................      222,219       8.8       283,326       9.2       165,906       8.3
Corporate..........................................            -         -             -         -             -         -
Intersegment Eliminations..........................    (222,571)     (8.8)     (458,661)    (14.8)     (226,796)    (11.4)
                                                   -------------  --------  ------------  --------  ------------   -------

Total Net Revenues.................................  $ 2,529,039      100%    $3,088,460      100%    $2,010,820      100%
                                                   =============  ========  ============  ========  ============   =======
</TABLE>

     Inpatient  facilities  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  the  Company's
affiliated  operations.  Revenues for  rehabilitation  and  respiratory  therapy
services provided to domestic  affiliated  facilities were approximately  $126.9
million,  $344.1  million and $180.3  million for the years ended  December  31,
1999,  1998 and 1997,  respectively.  Revenues  for  pharmaceutical  and medical
supply services provided to domestic  affiliated  facilities were  approximately
$80.9 million,  $78.9 million and $32.6 million for the years ended December 31,
1999,  1998 and 1997,  respectively.  Revenues  for  services  provided by other
non-reportable  segments  to  affiliated  facilities  were  approximately  $14.1
million,  $35.6 million and $13.8 million for the years ended December 31, 1999,
1998 and 1997, respectively.

                                       30
<PAGE>
     The following table sets forth the amount of net segment earnings  (losses)
for the years ended December 31 (in thousands):
<TABLE>
<CAPTION>

                                                         1999            1998           1997
                                                         ----            ----           ----
<S>                                                <C>              <C>            <C>
Inpatient Services...............................    $ (245,254)    $ (109,722)         $ 1,619
Rehabilitation and Respiratory Therapy Services..       (43,820)        159,844         119,014
Pharmaceutical and Medical Supply Services.......       (29,633)        (9,729)           7,227
International Operations.........................       (41,878)       (43,906)        (26,646)
Other Operations.................................       (51,547)       (17,769)           3,518
                                                   ---------------  -------------  --------------
Earnings (losses) before income taxes, corporate
  allocation of interest and management fees.....      (412,132)       (21,282)         104,732
Corporate........................................       (50,216)       (37,849)         (1,850)
Intersegment eliminations........................              -              -               -
                                                   ---------------  -------------  --------------

Net segment earnings (losses)....................    $ (462,348)      $(59,131)        $102,882
                                                   ===============  =============  ==============
</TABLE>

     The  net  segment  earnings  amounts  detailed  above  do not  include  the
following items: legal and regulatory matters, net; loss on sale of assets, net;
loss on  termination  of interest  rate swaps;  impairment  loss;  restructuring
costs;  reorganization  costs,  net;  income  taxes,  extraordinary  items;  and
cumulative effect of a change in accounting principle.

     In accordance  with SOP 90-7,  items of expense or income that are incurred
or realized by the Company  because it is in  reorganization  are  classified as
reorganization  costs  in  the  Company's  Consolidated  Statement  of  Earnings
(Losses).  As a result,  net segment  earnings  (losses) do not include interest
earned subsequent to the Filing Date on cash accumulated  because the Company is
not paying its prepetition obligations. Interest earned prior to the Filing Date
is  included in net segment  earnings  (losses).  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 earnings (losses). The amortization
of debt  discounts  and  deferred  issuance  costs  prior to the Filing Date are
included  in net  segment  earnings  (losses).  Losses  on sales of  assets  and
professional  fees  related to the  reorganization  incurred  subsequent  to the
Filing Date are excluded  from net segment  earnings  which is  consistent  with
their treatment prior to the Filing Date.

     Corporate  expenses include amounts for interest and corporate  general and
overhead   expenses   including   those   related  to  managing  the   Company's
subsidiaries.  The Company  allocates these to its segments  through  management
fees and intercompany  interest  charges.  Management fees are assessed based on
segment net revenues.  Interest is charged based upon average net asset balances
at rates determined by management.

     The following  discussions of the "Year Ended December 31, 1999 compared to
the Year Ended December 31, 1998" and the "Year Ended December 31, 1998 compared
to the Year  Ended  December  31,  1997" is based on the  financial  information
presented  in "Note  21 - Segment  Information,  in the  Company's  Consolidated
Financial Statements."

                                       31
<PAGE>
      YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998

INPATIENT SERVICES

     Net  revenues,   which  include   revenues   generated   from  therapy  and
pharmaceutical services provided at the Inpatient Services facilities, decreased
approximately  $347.8 million from $2,045.3  million for the year ended December
31,  1998,  to $1,697.5  million for the year ended  December  31,  1999,  a 17%
decrease.  Net  revenues  were  negatively  impacted in 1999 and 1998 by certain
changes in accounting  estimates for third party  settlements (see "Effects from
Changes in Reimbursement"  and "Note 3 to the Company's  Consolidated  Financial
Statements" for information regarding the Company's revenue recognition policy).

     In  1999,  the  Company  recorded  negative  revenue  adjustments  totaling
approximately $105.0 million. The negative revenue adjustments included reserves
of  approximately  $83.9  million  for  certain  Medicare  cost  reimbursements,
primarily  requests  for  exceptions  to the Medicare  established  routine cost
limitations  which are not being paid pursuant to an agreement  with the federal
government pending  confirmation of a plan of reorganization.  In addition,  the
negative  revenue  adjustments  included  approximately  $11.3  million  for the
projected  settlement  of the 1998  facility cost reports based on the Company's
filing of the 1998 cost reports with its fiscal  intermediary and  approximately
$9.8 million of negative revenue  adjustments related to the actual or projected
results of certain Medicare and Medicaid cost report audits. Historically,  such
reimbursement was formula based and approval  ordinarily given upon confirmation
of the calculation by the Company's fiscal intermediary.  Revenue was recognized
when a reasonable estimate of the amount receivable was determined.  As a result
of the agreement, the Company believes it is unlikely that it will recover these
receivables and accordingly has substantially  reserved the amount  outstanding.
See  Item 1 -  "Certain  Additional  Business  Risks  -  Risks  Associated  with
Reimbursement Process."

     In  1998,  the  Company  recorded  negative  revenue  adjustments  totaling
approximately  $22.3  million.   The  negative  revenue   adjustments   included
approximately  $11.8  million  related  to the  actual or  projected  results of
certain Medicare and Medicaid cost report audits, reserves of approximately $8.1
million for certain Medicare cost  reimbursements and approximately $1.8 million
for the  projected  settlement  of the 1997 cost reports  based on the Company's
filing of the 1997 cost reports with its fiscal intermediaries.

     Excluding the effect of the negative  revenue  adjustments of approximately
$105.0  million  and $22.3  million in 1999 and 1998,  respectively,  and $196.7
million and $119.9 million of net revenues in 1999 and 1998, respectively,  from
the  facilities  acquired in the RCA  acquisition on June 30, 1998, net revenues
declined  $341.8 million or 17.6 %. This decrease is primarily the result of the
reduced  Medicare rates received under PPS in 1999.  Excluding the effect of the
RCA  acquisition  on  Medicare  revenues,  average  Medicare  rates  declined by
approximately 50.7%.

     Operating expenses, which include rent expense of $207.0 million and $217.8
million for the years ended December 31, 1999 and 1998, respectively,  decreased
10.8% from  $1,921.2  million for the year ended  December 31, 1998, to $1,713.2
million for the year ended December 31, 1999. After  considering  $194.3 million
and $126.3 million of operating expenses for 1999 and 1998, respectively related
to the facilities acquired in the RCA acquisition,  operating expenses decreased
$276.0 million or 15.4%. The decrease resulted  primarily from the restructuring
plan  in  response  to PPS,  including  reduced  ancillary  service  costs  from
affiliated  providers.  Operating  expenses  as a  percentage  of  net  revenues
excluding  the  effect  of  the  RCA  acquisition   and  the  negative   revenue
adjustments, increased from 92.2% for the year ended December 31, 1998, to 94.6%
for the year ended  December 31, 1999.  The increase in operating  expenses as a
percentage  of net revenue is primarily due to decreased  Medicare  revenue as a
result  of the  implementation  of PPS at the  Company's  facilities  without  a
corresponding  decline in the level of service provided to Medicare patients. It
is  expected  that   revenues  and   operating   margins  will  continue  to  be
significantly and adversely affected by the rates under PPS.

                                       32
<PAGE>
     Corporate general and administrative expenses, which include regional costs
for the  supervision of operations,  decreased  15.6% from $34.0 million for the
year ended  December 31, 1998, to $28.7 million for the year ended  December 31,
1999.  Excluding  the  impact of the  negative  revenue  adjustments,  corporate
general and administrative  expenses were 1.7% of the net revenues for the years
ended December 31, 1998 and 1999.

     Provision  for losses on accounts  receivable  increased  203.8% from $15.7
million for the year ended  December  31,  1998,  to $47.7  million for the year
ended  December  31,  1999.   Excluding  the  impact  of  the  negative  revenue
adjustments  and the  effect  of the RCA  acquisition,  as a  percentage  of net
revenues,  provision for losses on accounts  receivable  increased from 0.8% for
the year ended  December 31, 1998, to 2.7% for the year ended December 31, 1999.
The  Company  increased  its  provision  for losses on  accounts  receivable  in
response to deterioration in the aging of the accounts receivable.

     Excluding the impact of the negative  revenue  adjustment and the effect of
the RCA acquisition,  depreciation  and amortization  decreased 32.6% from $39.3
million for the year ended  December  31,  1998,  to $29.0  million for the year
ended   December  31,  1999.  The  decrease  is  primarily  the  result  of  the
determination  that certain of the Company's  long-lived  assets were  impaired,
which  resulted in  write-downs  of certain fixed and  intangible  assets in the
fourth quarter of 1998 and the second quarter of 1999.

     Net interest  expense  increased 53.1% from $6.4 million for the year ended
December  31, 1998 to $9.8 million for the year ended  December  31,  1999.  The
interest  expense  increase is primarily a result of certain  facility  specific
debt assumed in the RCA acquisition  offset by the interest that was not paid or
accrued  following  the  October  14,  1999  bankruptcy  filing.  See  "Note 2 -
Petitions for  Reorganization  under  Chapter 11 to the  Company's  Consolidated
Financial Statements."

REHABILITATION AND RESPIRATORY THERAPY SERVICES

     Net revenues from rehabilitation and respiratory therapy services decreased
65.5% from $678.8 million for the year ended December 31, 1998 to $234.0 million
for the year ended  December  31,  1999.  Revenues  from  services  provided  to
affiliated  facilities decreased from $344.1 million for the year ended December
31, 1998 to $126.9  million for the year ended  December 31, 1999, a decrease of
63.1%.  Revenues from services  provided to nonaffiliated  facilities  decreased
approximately  $227.6 million,  or 68.0%, from $334.7 million for the year ended
December  31,  1998 to $107.1  million  for the year ended  December  31,  1999.
Nonaffiliated  facilities served decreased 10.5% from 1,294 in 1998, to 1,158 in
1999.  These  decreases  are a result of the  industry's  transition to PPS. PPS
resulted in a reduction of therapy  provided  (volume) and downward  pressure on
market rates as contract therapy companies lowered prices in an effort to remain
competitive  with  other  methods  of  therapy  provision.   Specifically,  many
facilities  moved away from the use of contract  therapy  companies  in favor of
"in-house"  rehabilitation and respiratory models in an effort to better control
costs under a fixed  reimbursement  system.  This was especially existent within
respiratory  therapy  as  this  service  was not  covered  under  the  ancillary
component of the new PPS rate structure.  For rehabilitation  services,  therapy
hours worked decreased from  approximately 10.1 million in 1998 to approximately
3.4 million in 1999, or 66.3%,  indicating the volume decline;  and revenues per
facility  served  decreased  from  approximately  $33,300  per  month in 1998 to
approximately $17,200 per month in 1999, or 48.3%.

                                       33
<PAGE>
     Operating  expenses  decreased 50.1% from $428.9 million for the year ended
December  31,  1998,  to $213.9  million for the year ended  December  31, 1999.
Included in operating  costs are  write-downs to net  realizable  value of $19.0
million for inventory and software related to the Company's  continued shut-down
of its therapy equipment manufacturing operation, the operating results of which
are  immaterial.  The operating  expense  decrease  resulted  primarily from the
decline in demand for the Company's therapy services resulting in a reduction in
the  number of  therapists  employed  by the  Company.  See "Other  Special  and
Non-Recurring  Charges -  Restructuring  Costs."  In  addition,  demand  for the
Company's  respiratory  therapy  services  business has declined  significantly,
since  respiratory  therapy is no longer  reimbursed under PPS, while costs have
not declined  proportionately  as the  Company's  respiratory  therapy  services
develops  new   operating   strategies.   Operating   expenses,   excluding  the
write-downs,  as a percentage of total segment revenue  increased from 63.2% for
the year ended  December 31, 1998 to 83.3% for the year ended December 31, 1999.
This increase is  attributable to the decline in average revenue per therapy mod
while salaries and wage costs per mod decreased by a smaller percentage.

     Provision  for losses on  accounts  receivable  increased  15.2% from $29.6
million for the year ended  December  31,  1998,  to $34.1  million for the year
ended  December 31, 1999. As a percentage of net revenues,  provision for losses
on accounts receivable increased from 4.4% for the year ended December 31, 1998,
to 14.6% for the year ended  December  31,  1999.  The  increase  is a result of
additional  reserves  recorded  due to the  impact  of PPS,  which  for  certain
nonaffiliated  customers has  negatively  affected  their cash flows,  adversely
affecting the collectibility of amounts due to the Company.

     Depreciation  and  amortization  decreased  25.8% from $9.7 million for the
year ended  December  31, 1998 to $7.2  million for the year ended  December 31,
1999.  The decrease is primarily a result of the  determination  that certain of
the Company's long-lived assets were impaired,  which resulted in write-downs of
certain fixed and intangible assets in the fourth quarter of 1998 and the second
quarter of 1999.

PHARMACEUTICAL AND MEDICAL SUPPLY OPERATIONS

     Net revenues from  pharmaceutical  and medical  supply  services  increased
18.3% from $254.5  million for the year ended  December 31, 1998,  to $301.0 for
the year ended December 31, 1999.  Approximately  $64.9 million of this increase
is a result of the Company's  acquisition of Contour in connection  with the RCA
acquisition in June 1998.

     Operating  expenses  increased 22.6% from $222.1 million for the year ended
December 31, 1998, to $272.2  million for the year ended  December 31, 1999. The
increase  is  primarily  related  to  operating  expenses  attributable  to  the
increased revenue of the Company's medical supply operations. Operating expenses
as a percentage of revenue  increased from 87.3% for the year ended December 31,
1998 to 90.4% for the year ended December 31, 1999. This increase is primarily a
result of the acquisition of Contour,  whose business has higher operating costs
than the Company's pharmacy services operation.

     Provision  for losses on accounts  receivable  increased  163.7% from $10.2
million for the year ended  December  31,  1998,  to $26.9  million for the year
ended  December 31, 1999.  As a percentage  of net  revenues,  the provision for
losses on accounts  receivable  increased  from 4.0% for the year ended December
31, 1998 to 8.9% for the year ended December 31, 1999. This increase is a result
of the effect PPS has had on  nonaffiliated  customers'  cash flow (as discussed
above under Rehabilitation and Respiratory Therapy Services).  In addition,  the
Company recorded  additional  reserves for its Medicare Part B billing operation
related to increased aging of accounts receivable.

                                       34
<PAGE>
     Depreciation  and  amortization  decreased 35.2% from $10.8 million for the
year ended  December  31, 1998 to $7.0  million for the year ended  December 31,
1999. As a percentage of net revenues,  depreciation  and  amortization  expense
decreased  from 4.2% for the year ended  December  31, 1998 to 2.3% for the year
ended December 31, 1999,  respectively.  The decrease is primarily the result of
the determination that certain of the Company's long-lived assets were impaired,
which  resulted in  write-downs  of certain fixed and  intangible  assets in the
fourth quarter of 1998 and the second quarter of 1999.

INTERNATIONAL OPERATIONS

     Revenue  from  international   operations   excluding  the  effect  of  the
disposition of the Canadian  operation  increased  $26.8 million,  or 9.9%, from
approximately  $270.1  million  for the year ended  December  31, 1998 to $296.9
million for the year ended December 31, 1999. Approximately $12.0 million of the
increase is attributable to an increase in available beds and occupancy rates in
the United  Kingdom,  Spain and Germany  during  1999.  The Company  experienced
general growth in pharmacy and supply  distribution  sales of approximately $5.0
million and an  incremental  increase of  approximately  $9.0  million  from the
pharmacy operations it purchased in Australia during the fourth quarter of 1998.

     Operating expenses, excluding the effect of the disposition of the Canadian
operations,  which  include rent expenses of $41.1 million and $31.1 million for
the  years  ended   December   31,  1998  and  1999,   respectively,   increased
approximately  15.9% from $238.1 million for the year ended December 31, 1998 to
$275.9  million for the year ended  December  31, 1999.  As a percentage  of net
revenues,  operating expenses increased from 88.2% in 1998 to 92.9% in 1999. The
increase is primarily  attributable to increased temporary staffing costs in the
U.K.  due to a nursing  shortage and  increases  in rent expense  primarily as a
result of the sales-leaseback of 27 facilities  completed in October 1998 and 11
facilities in July 1999.

     Depreciation and amortization for international  operations,  excluding the
effect of the  disposition  of the Canadian  operations,  decreased $5.1 million
from $17.9  million for the year ended  December 31, 1998,  to $12.8 million for
the year ended  December 31, 1999.  The decrease is primarily  the result of the
determination  that certain of the Company's  long-lived  assets were  impaired,
which  resulted in  write-downs  of certain fixed and  intangible  assets in the
fourth quarter of 1998 and the second quarter of 1999.

     Net  interest  expense,  excluding  the  effect of the  disposition  of the
Canadian  operations,  decreased  31.3%  from $19.2  million  for the year ended
December 31, 1998 to $13.2  million for the year ended  December  31, 1999.  The
decrease is due to the  reduction of long-term  debt through the proceeds of the
sale-leaseback  of 32 facilities  completed in October 1998 and 11 facilities in
July 1999. Net interest  expense as a percentage of net revenues  decreased from
6.8% from the year ended  December 31, 1998 to 4.4% for the year ended  December
31, 1999.

     The Company is currently  soliciting  offers to purchase its  international
operations.  No assurance can be given that the international operations will be
sold or that if they are sold,  the Company will not  experience a material loss
on the sale.  See "Note 24 - Subsequent  Events,  in the Company's  Consolidated
Financial Statements."

                                       35
<PAGE>
OTHER NON-REPORTABLE SEGMENTS AND CORPORATE GENERAL ADMINISTRATIVE DEPARTMENTS

     Non-reportable  segments include temporary  therapy staffing,  home health,
software   development  and  other  ancillary  services.   Revenues  from  other
non-reportable  segments  decreased 21.6% from $283.3 million for the year ended
December  31,  1998,  to $222.2  million for the year ended  December  31, 1999.
Operating  expenses  decreased  16.0%  from  $261.3  million  for the year ended
December  31,  1998,  to $219.6  million for the year ended  December  31, 1999.
Operating  expenses as a  percentage  of  revenues  were 98.8% and 92.2% for the
years  ended  December  31,  1999 and 1998,  respectively.  Total  revenues  and
operating  expenses for  non-reportable  segments represent less than 10% of the
consolidated  Company's  results.  Growth in  revenues  and  operating  expenses
related to acquisitions in the Company's home health,  assisted living,  disease
state  management,   laboratory  and  radiology   subsidiaries  were  offset  by
significant  declines  in  revenues  and  operating  expenses  in the  Company's
temporary  therapy  staffing  majority  owned  subsidiary,  which was  adversely
affected by the long-term care industry's  transition to PPS.  Operating results
were also negatively impacted by expenses related to software  development costs
incurred by the Company's majority owned subsidiary,  Shared Healthcare Systems,
Inc.  These costs are being  expensed in accordance  with Statement of Financial
Accounting  Standards No. 86:  Accounting  for Costs of Computer  Software to be
Sold,  Leased or  Otherwise  Marketed.  Development  of the  Company's  software
products  are not  expected  to reach the stage under  which  capitalization  is
permitted until sometime in 2001.

     Corporate  general and  administrative  costs not  directly  attributed  to
segments  decreased  15.6% from $131.8  million for the year ended  December 31,
1998, to $116.3 million for the year ended December 31, 1999. As a percentage of
consolidated net revenues of $3,088.5 million and $2,529.0 million for the years
ended  December  31,  1998  and  1999,   respectively,   corporate  general  and
administrative  expenses not directly attributed to segments increased from 4.5%
in  1998 to 4.6%  in  1999.  Although  costs  declined,  corporate  general  and
administrative  costs as a percentage of consolidated net revenues  increased as
the  Company  was unable to reduce  overhead  costs as  quickly as net  revenues
decreased in 1999.

     Net interest  expense not directly  attributed to segments  decreased  6.2%
from $105.3  million for the year ended  December 31, 1998 to $98.8  million for
the year ended December 31, 1999. As a percentage of consolidated  net revenues,
interest  expense  increased  from 3.4% for the year ended  December 31, 1998 to
3.9% for the year ended  December 31,  1999.  The increase was related to (i) an
increase in the Company's  weighted  average  interest rate  resulting  from the
issuance of $150 million of 9 3/8% Notes in May 1998, (ii) higher interest rates
and borrowing  costs under the Company's  Senior Credit  Facility as a result of
non-compliance  under  certain  financial  covenants  under  the  Senior  Credit
Facility, and (iii) and increase in borrowings under the Company's Senior Credit
Facility  principally related to various acquisitions during 1998. The preceding
was offset by approximately  $30.5 million of interest expense that was not paid
or accrued in accordance with SOP 90-7 following the Filing Date.

DIVIDENDS ON CONVERTIBLE PREFERRED STOCK

     In May 1998, the Company issued $345 million of 7% Convertible Trust Issued
Preferred Securities ("CTIPS"). The Company paid interest of approximately $12.8
million  and $6.0  million in 1998 and 1999,  respectively.  Beginning  with the
interest  payment due on May 1, 1999,  Sun exercised its right to defer interest
payments.  As  interest  payments  are  deferred,  interest on the CTIPS and the
deferred interest payments continues to accrue. See "Note 14 - Convertible Trust
Issued Securities in the Company's Consolidated Financial Statements."

                                       36
<PAGE>
     The Company does not expect to make  principal or interest  payments on the
CTIPS in the future.  In 1999,  the amount of accrued and deferred  interest was
approximately $17.3 million.

OTHER SPECIAL AND NON-RECURRING CHARGES

IMPAIRMENT OF GOODWILL AND OTHER LONG-LIVED ASSETS

     The Company  periodically  evaluates the carrying value of goodwill and any
other related  long-lived  assets in relation to the future projected cash flows
of the underlying  business segment.  The long-lived assets are considered to be
impaired  when the expected  future cash flows of the  inpatient  facilities  or
other  business  segment  divisions do not exceed the  carrying  balances of the
goodwill or other long-lived assets. The Company recorded a non-cash  impairment
charge of $397.4  million in 1998 due primarily to the  anticipated  decrease in
net revenue  caused by the  implementation  of the  Medicare  PPS  reimbursement
method.  In the second quarter of 1999, the Company  determined  that its future
net revenues would be less than projected in connection with its 1998 impairment
analysis.  As a result of the reduction in projected  future net  revenues,  the
Company  determined that its investment in certain facilities and operations was
impaired; a $400.0 million charge was recorded in the second quarter of 1999 for
long-lived  asset  impairment.  In the third and fourth  quarters  of 1999,  the
Company  became  aware  that  the  projected  net  cash  flows  from  additional
facilities  and  operations  were not  sufficient for the Company to recover its
investments  in those  facilities  or  operations.  A loss of $57.4  million was
recorded in the second half of 1999 due to the  impairment  of these  long-lived
assets.  The 1998 charge  included  approximately  $293.1 million related to its
inpatient   services   facilities   segment,   $41.0  million   related  to  its
rehabilitation and respiratory  therapy services segment,  $36.7 million related
to certain inpatient  facilities in the United Kingdom,  $3.0 million related to
two pharmacies in its  pharmaceutical  and medical supply  services  segment and
approximately  $23.6  million  related  to other  operations.  The  1999  charge
included   approximately  $295.0  million  related  to  its  inpatient  services
facilities segment,  $60.5 million related to its rehabilitation and respiratory
therapy services segment, $61.3 million related to its international  operations
segment, $31.6 million related to its pharmaceutical and medical supply services
segment and approximately $9.0 million related to other operations.

     The significant write-down of goodwill and other long-lived assets resulted
from the decline in the level of Medicare  reimbursement  and the demand for the
Company's  rehabilitation and respiratory therapy and pharmaceutical and medical
supply  services  due to the  industry  changes  mandated by PPS.  Additionally,
certain of the United Kingdom facilities have not achieved profitability targets
established  upon their  acquisition.  See "Note 7 -  Impairment  of  Long-Lived
Assets  and  Assets  Held  for  Sale  in the  Company's  Consolidated  Financial
Statements."

LOSS ON SALE OF ASSETS, NET

     The Company recorded a non-cash charge of  approximately  $206.2 million in
1998  and  a net  non-cash  charge  of  $85.7  million  in  1999  due  to  lease
terminations  through mutual agreements with the lessors,  expiration of certain
facility  lease  agreements  in the ordinary  course of business and the sale of
certain other facilities and operations.  See "Note 7 - Impairment of Long-Lived
Assets Held for Sale in the Company's Consolidated Financial Statements."

                                       37
<PAGE>
LEGAL AND REGULATORY MATTERS, NET

     The Company  recorded  charges for  litigation and  investigation  costs of
approximately   $22.5  million  for  the  year  ended   December  31,  1998  for
professional  fees and settlement  costs related to certain legal and regulatory
matters.  The charge includes (i) approximately  $8.0 million for the settlement
of a shareholder  suit related to the Company's  acquisition of SunCare in 1995;
(ii) approximately $8.2 million for estimated costs to resolve the investigation
by the Connecticut  Department of Social Services;  and (iii) approximately $5.5
million provided for certain  monetary  penalties and general legal costs of its
inpatient services segment.

     In 1999, the Company reversed $3.1 million of the reserves recorded in 1998
that  were  determined  to not be  needed  in 1999.  Also in 1999,  the  Company
recorded a charge of $3.1 million  related  primarily to costs  associated  with
certain  regulatory  matters.  See  "Note  18 - Other  Events  in the  Company's
Consolidated Financial Statements."

RESTRUCTURING COSTS

     In the fourth quarter of 1998, the Company  initiated a restructuring  plan
focused  primarily  on reducing  the  operating  expenses  of its United  States
operations.  Related  to the 1998  corporate  restructuring  plan,  the  Company
recorded a 1998 fourth quarter charge of  approximately  $4.6 million.  The 1998
corporate  restructuring  plan included the elimination of  approximately  7,500
positions,  primarily in the Company's  rehabilitation  and respiratory  therapy
operations  and also included the closure of  approximately  70  divisional  and
regional  offices.   The  1998  corporate   restructuring   charge  consists  of
approximately  $3.7 million  related to employee  terminations and approximately
$0.9 million  related to lease termination  costs. As of December 31,  1998, the
Company had terminated 1,440 employees, and paid approximately  $1.4 million and
$0.1 million in termination benefits and lease termination costs,  respectively.
As of  December 31,  1998,  the Company's  1998  corporate  restructuring  costs
reserve balances  relating to employee  terminations and lease termination costs
were approximately $2.3 million and $0.8 million,  respectively. During 1999 the
Company paid approximately $1.1 million relating to employee terminations. As of
December  31,   1999,   approximately   $1.2  million  of  the  1998   corporate
restructuring  costs reserve balance of approximately  $2.0 million is comprised
of prepetition  severance accruals that are classified as liabilities subject to
compromise.  In  1999,  the  Company's  1998  corporate  restructuring  plan was
substantially complete.

     In the first  quarter of 1999,  the Company  initiated  a second  corporate
restructuring  plan focused on further  reducing the  operating  expenses of its
United States operations.  Related to the 1999 corporate restructuring plan, the
Company recorded a first quarter charge of approximately $11.4 million. The 1999
corporate  restructuring  plan included the termination of  approximately  3,000
employees,  primarily in its  rehabilitation  and respiratory  therapy  services
operations.   The  1999   restructuring   plan  also  includes  the  closure  of
approximately 23 divisional and regional offices. In addition, the plan included
the relocation of the management of the Company's  medical supply subsidiary and
temporary therapy services subsidiary to the Company's corporate headquarters in
Albuquerque,  New Mexico. As part of the relocation,  the Company  terminated 96
employees  of  these  subsidiaries.  The  1999  corporate  restructuring  charge
consisted  of  approximately  $9.1  million  related to  employee  terminations,
approximately  $1.4 million related to lease  termination costs and $0.9 million
related to asset disposals or write-offs.  The amounts paid out during 1999 were
consistent  with the charge  recorded in 1999.  As of  December  31,  1999,  the
Company's 1999 corporate restructuring plan was complete.

     During 1999, the Company recorded  financial  restructuring  costs of $16.0
million,  primarily  professional fees,  related to the Company's  activities in
response  to  the  defaults  under  the  Senior  Credit  Facility,  the  9  3/8%
Subordinated  Notes and the 9 1/2% Subordinated Notes and in preparation for its
filing for protection under Chapter 11 of the U.S. Bankruptcy Code.

                                       38
<PAGE>
REORGANIZATION COSTS, NET

     Reorganization  costs under  chapter 11 are items of expense or income that
are incurred or realized by the Company because it is in  reorganization.  These
include,  but are 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 the Company
because it is not paying its prepetition  liabilities.  The 1999  reorganization
costs included  charges of $37.6 million for the write-off of debt discounts and
deferred  issuance costs on  indebtedness  that is subject to  compromise,  $7.1
million to reserve  for losses on skilled  nursing  facilities  that the Company
decided to divest  subsequent to the Filing Date, $4.1 million for  professional
fees,  and a credit of $0.7  million  for  interest  earned on cash  accumulated
because the Company is not paying its prepetition liabilities.

EXTRAORDINARY LOSS

     In 1998, the Company recorded an extraordinary  loss of $10.3 million,  net
of income tax benefit of $3.7 million.  Approximately $10.2 million of the gross
loss of $14.0 million  relates to the permanent  pay-down of $300 million of the
term loan portion of the Company's credit  facility.  The remaining $3.7 million
of the  gross  loss  relates  to the  retirement  of  $5.0  million  of  Contour
convertible debentures which were purchased by the Company.

CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE

     In 1998,  the American  Institute of Certified  Public  Accountants  issued
Statement  of Position  98-5,  "Reporting  on the Costs of Start-up  Activities"
("SOP  98-5").   This  statement  requires  costs  of  start-up  activities  and
organization  costs to be expensed as incurred.  The  statement is effective for
financial  statements for fiscal years beginning after December 15, 1998. In the
first  quarter of 1999,  the Company  adopted the  provisions  of SOP 98-5 which
resulted in a cumulative  effect of a change in accounting  principle  charge of
$12.8 million.

CONSOLIDATED RESULTS OF OPERATIONS

     The net loss for the year ended  December  31,  1999 was  $1,089.5  million
compared to a net loss of $753.7  million for the year ended  December 31, 1998.
The net loss  before  extraordinary  loss and  cumulative  effect  of  change in
accounting  principle for the year ended December 31, 1999 was $1,076.6  million
compared to $743.4  million for the year ended  December 31,  1998.  The loss in
1998  and  1999  was due to the  negative  revenue  adjustments  for  change  in
estimates for third party  settlements;  the increased reserves for self-insured
workers  compensation  claims, the increased allowance for doubtful accounts and
the  implementation  of PPS and its resulting  adverse  impact on the demand for
ancillary services.

     Income tax expense for the year ended  December 31, 1999,  was $0.2 million
compared to $53.6  million for the year ended  December 31, 1998.  In 1999,  the
Company increased the valuation allowance by $311.7 million to fully reserve for
deferred tax assets  (including net operating loss  carryforwards and impairment
writedowns)  which may not be realized.  A compromise of debt  resulting from an
approved plan of reorganization  is likely to result in a significant  reduction
in tax loss and tax credit carryforwards.  In addition, a change in ownership in
an approved plan of reorganization could materially impact the Company's ability
to utilize any remaining  tax loss and tax credit  carryforwards.  In 1998,  the
Company  increased  the valuation  allowance by $115.5  million for deferred tax
assets which may not be realized.

                                       39
<PAGE>

     Income tax expense for the year ended  December 31, 1998 was $53.5  million
compared to $41.2  million for the year ended  December 31, 1997.  In 1998,  the
Company  increased  its valuation  allowance by $115.5  million for deferred tax
assets  which may not be realized  as a result of the adverse  effect of the new
operating  environment  under  PPS.  Also,  in 1998 the  Company  established  a
valuatin allowance of $12.5 million for U.K. deferred tax assets,  which may not
be  realizable.  In  addition,  the  Company's  effective  tax rate for 1998 was
unfavorably  impacted  by  the  significant  loss  incurred  and  the  resulting
disproportionate  effect of non-deductible items such as goodwill  amortization.
Excluding the above increases in valuation allowances, the resulting tax benefit
is 10.8% of the consolidated net loss before income taxes and extraordinary loss
compared to an effective tax rate of 47.1% in 1997.


      YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

INPATIENT SERVICES

     Net  revenues,   which  include   revenues   generated   from  therapy  and
pharmaceutical services provided at the Inpatient Services facilities, increased
approximately  $795.4 million from $1,249.9  million for the year ended December
31,  1997,  to $2,045.3  million for the year ended  December  31, 1998, a 63.6%
increase.  Net  revenues  were  negatively  impacted in 1998 and 1997 by certain
changes in accounting estimates for third party settlements (See - Note 3 to the
Consolidated  Financial  Statements  for  information  regarding  the  Company's
revenue recognition policy). In the fourth quarter of 1998, the Company recorded
negative revenue adjustments totaling  approximately $33.3 million primarily for
the  projected  settlement  of 1997  facility  cost reports which were not final
settled as of December 31, 1998,  and the projected  settlement of the 1998 cost
reports based on historical  information.  The $33.3  million  negative  revenue
adjustments  represent  approximately  3.8% of total Medicare  revenues.  In the
fourth  quarter of 1997,  the  Company  recorded  negative  revenue  adjustments
totaling   approximately  $15  million  resulting  from  changes  in  accounting
estimates of amounts realizable from third party payors.

     Approximately  $413.7 million  of the net revenue increase is attributed to
111  leased  or  owned   facilities   acquired  from  Regency  in  October 1997,
approximately $124.9 million of the increase resulted from the acquisition of 75
facilities  from  RCA  in  June 1998  and  approximately  $216.8 million  of the
increase resulted from an additional 61 facilities acquired or opened at various
times  since   December 31,   1996.  The  remaining  net  revenue   increase  of
$40.0 million,   after   giving   effect  to  a  decrease  in  net  revenues  of
approximately $15.9 million relating to six facilities sold during 1998 and four
facilities sold during 1997, is primarily attributable to an increase in revenue
per patient day and an increase in occupancy levels since December 31, 1997 on a
same facility basis for the 160, net leased or owned facilities in operation for
all of 1997 and 1998.  The  increase in revenue per patient day was  primarily a
result of payor rate  increases  and the  expansion  of the  Company's  subacute
services.

     Operating  expenses,  which  include  rent  expense of  $217.8 million  and
$122.9 million  for the year  ended  December 31,  1998 and 1997,  respectively,
increased 69.5% from $1,133.6 million for the year ended  December 31,  1997, to
$1,921.2  million for the year ended  December 31,  1998. The increase  resulted
primarily  from the net increase of 237 leased or owned  facilities  acquired at
various times since December 31, 1996. Operating expenses as a percentage of net
revenues increased from 90.7% for the year ended December 31,  1997 to 93.9% for
the year ended  December 31,  1998.  The  increase  in  operating  expenses as a
percentage of revenue is primarily due to decreased Medicare revenue as a result
of the  implementation of PPS at the Company's RCA facilities  effective July 1,
1998, and the effect of the negative  revenue  adjustments  discussed  above for
which  there  was  not a  corresponding  reduction  in  operating  expenses.  In
addition,  operating expenses were negatively impacted by state-mandated changes
in Regency workers' compensation  self-insurance reserves,  primarily related to
preacquisition  periods and  increases  in rent expense for therapy and computer
equipment rentals.

                                       40
<PAGE>
     Corporate  general and  administrative  expenses,  which  include  regional
costs,  related to the  supervision of operations,  increased  125.2% from $15.1
million for the year ended December 31, 1997 to $34.0 million for the year ended
December 31,  1998.  As a  percentage  of net  revenues,  corporate  general and
administrative  expenses  increased  from 1.2% for the year  ended  December 31,
1997, to 1.7% for the year ended  December 31,  1998. The increase was primarily
due to an increase in costs  relating to the expansion of the Inpatient  Service
segment's  corporate  and  regional  infrastructure  to support  newly  acquired
operations including the acquisition of Regency and RCA.

     Provision  for losses on  accounts  receivable  increased  214.0% from $5.0
million for the year ended  December 31,  1997,  to  $15.7 million  for the year
ended December 31,  1998. As a percentage of net revenues,  provision for losses
on accounts receivable increased from 0.4% for the year ended December 31, 1997,
to 0.8% for the year ended  December 31,  1998.  The change was primarily due to
increased aging of certain accounts receivable.

     Depreciation and amortization  increased 82.3% from  $22.6 million  for the
year ended  December 31,  1997, to $41.2 million for the year ended December 31,
1998. As a percentage of net revenues,  depreciation  and  amortization  expense
increased from 1.8% for the year  December 31,  1997, to 2.0% for the year ended
December 31,  1998.  The  increase  is  primarily  a result of  amortization  of
goodwill recorded in connection with the acquisitions of Regency in October 1997
and RCA in June 1998.

     Net interest expense  increased 56.1% from  $4.1 million for the year ended
December 31,  1997, to $6.4 million for the year ended  December 31,  1998. As a
percentage of net revenues, interest expense remained consistent at 0.3% for the
years ended December 31, 1997 and 1998, respectively.  The increase is primarily
a result of facility specific debt assumed in the RCA acquisition.

REHABILITATION AND RESPIRATORY THERAPY SERVICES

     Net revenues from rehabilitation and respiratory therapy services increased
45.6% from  $466.4 million for the year ended  December 31,  1997, to $678.8 for
the year ended December 31,  1998. Revenues from services provided to affiliated
facilities  increased from $180.3 million for the year ended December 31,  1997,
to $344.1 million  for the year ended  December 31,  1998, an increase of 90.8%.
This increase is a result of the net 237 inpatient facilities acquired or opened
at various times since  December 31,  1996.  Revenues from services  provided to
nonaffiliated facilities increased approximately  $48.5 million,  or 16.9%, from
$286.1 million for the year ended  December 31,  1997, to $334.6 million for the
year ended  December 31,  1998.  Nonaffiliated  facilities served increased 1.3%
from 1,278 in 1997,  to 1,294 in 1998. In the fourth  quarter of 1998,  revenues
from nonaffiliated facilities decreased significantly from $93.6 million in 1997
to  $63.9 million  in 1998,  a 31.7%  decrease.  The decrease is a result of the
industry's  transition  to PPS and  the  resulting  decline  in  demand  for the
Company's therapy services.

     In addition to the decline in demand for the  Company's  therapy  services,
market rates for these services declined  significantly in the fourth quarter of
1998 and the first  quarter of 1999.  This  decline is  attributed  to  downward
pricing  pressure as a result of an excess supply of therapy  service  providers
due to the industry's restructuring in response to decreased reimbursement under
PPS.

                                       41
<PAGE>
     Operating expenses  increased 40.0% from  $306.2 million for the year ended
December 31,  1997, to $428.8 million for the year ended December 31,  1998. The
increase resulted primarily from the increase in the number of facilities served
from  1,565  to  1,715  for  the  years  ended   December 31,   1998  and  1997,
respectively.  Operating  expenses  as a  percentage  of total  segment  revenue
decreased from 65.7% for the year ended December 31, 1997, to 63.2% for the year
ended December 31, 1998.

     Provision  for losses on  accounts  receivable  increased  215.0% from $9.4
million for the year ended December 31, 1997 to $29.6 million for the year ended
December 31,  1998.  As a percentage  of net  revenues,  provision for losses on
accounts receivable increased from 2.0% for the year ended December 31,  1997 to
4.4% for the year ended December 31,  1998. Approximately  $11.7 million of this
increase was  recognized in connection  with the  financial  deterioration  of a
major customer in the fourth quarter of 1997. The remaining increase is a result
of  additional  reserves  recorded  due to the impact of PPS,  which for certain
nonaffiliated  customers has  negatively  affected  their cash flows,  adversely
affecting the collectibility of amounts due to the Company.  Other nonaffiliated
customers,  in  preparation  for the  impending  transition  to PPS have slowed,
reduced or stopped  payment for service  because of the adverse  effect PPS will
have on their cash flow.

     Depreciation  and amortization  increased 131.0% from  $4.2 million for the
year ended  December 31,  1997 to $9.7 million  for the year ended  December 31,
1998. As a percentage of net revenues,  depreciation  and  amortization  expense
increased  from 0.9% for the year  December 31,  1997 to 1.4% for the year ended
December 31,  1998.  The increase is primarily a result of the  expansion of the
Company's respiratory therapy and therapy equipment manufacturing  businesses in
1998,  as well as  amortization  of  goodwill  recorded in  connection  with the
acquisition of Regency's therapy subsidiary in October 1997.

PHARMACEUTICAL AND MEDICAL SUPPLY OPERATIONS

     Net revenues from  pharmaceutical  and medical  supply  services  increased
61.7% from $157.3 million for the year ended December 31, 1997 to $254.5 for the
year ended December 31,  1998. Approximately $28.5 million of this increase is a
result of the company's  medical supply  operations  acquired in connection with
the RCA and  Contour  mergers in  June 1998.  Approximately  $51.9 million  is a
result  of the  addition  of 10  pharmacies  and  related  affiliated  contracts
acquired from Regency.  The  remaining  increase is a result of four  pharmacies
opened or acquired in 1998.

     Operating expenses  increased 65.5% from  $134.2 million for the year ended
December 31,  1997 to  $222.1 million  for the  year  ended  December 31,  1998.
Operating  expenses as a percentage of revenue increased from 85.3% for the year
ended  December 31,  1997 to 87.3% for the year ended  December 31,  1998.  This
increase is primarily a result of the  acquisition of Contour,  which has higher
operating  costs  than the  company's  pharmacy  services  operation.  Excluding
Contour,  operating  expenses as a percentage  of revenue  remained  constant at
approximately 85.2%.

     Provision  for losses on  accounts  receivable  increased  827.3% from $1.1
million for the year ended December 31, 1997 to $10.2 million for the year ended
December 31,  1998.  As a percentage  of net  revenues,  provision for losses on
accounts receivable increased from 0.7% for the year ended December 31,  1997 to
4.0% for the year ended  December 31,  1998.  This  increase  is a result of the
effect PPS has had on  nonaffiliated  customers'  cash flow (as discussed  above
under Rehabilitation and Respiratory Therapy Services). In addition, the Company
recorded  additional reserves for its Medicare Part B billing operations related
to increased aging of accounts receivable.

                                       42
<PAGE>
     Depreciation  and amortization  increased 227.3% from  $3.3 million for the
year ended  December 31,  1997 to $10.8 million for the year ended  December 31,
1998. As a percentage of net revenues,  depreciation  and  amortization  expense
increased  from 2.1% for the year  December 31,  1997 to 4.2% for the year ended
December 31,  1998.  The increase is primarily a result of the  amortization  of
goodwill  recorded in  connection  with the  acquisition  of Regency's  pharmacy
operation in October 1997 and the RCA and Contour acquisitions in June 1998.

INTERNATIONAL OPERATIONS

     Revenues from international operations increased  $87.1 million,  or 44.0%,
from approximately $198.2 million for the year ended December 31, 1997 to $285.3
million for the year ended  December 31,  1998.  Approximately  $43.4 million of
this increase is a result of  acquisitions  in late 1997 and 1998 in Germany and
Australia.  An additional  $44.5 million of this increase was provided by United
Kingdom inpatient services whose net revenues increased from  $168.3 million for
the  year  ended  December 31,   1997  to  $212.8 million  for  the  year  ended
December 31,  1998.  The  increase  in  United  Kingdom  revenues  is due to the
addition of 18 facilities  during 1998 as well as an increase in occupancy rates
from 77.6% in 1997 to 80.3% in 1998.

     Operating  expenses,  which include rent expense of $14.7 million and $31.2
million for the years ended December 31, 1997 and 1998, respectively,  increased
approximately 53.3% from $163.6 million for the year ended December 31,  1997 to
$250.8 million  for  the  year  ended  December 31,  1998.  As a  percentage  of
revenues,  operating  expenses increased from 82.6% in 1997 to 87.9% in 1998. In
addition to  increased  operating  costs  associated  with  acquisitions  in new
international  markets,  operating  costs in the United Kingdom were impacted by
increased temporary staffing costs due to a nursing shortage.  Increases in rent
expense are primarily a result of expansion into new  international  markets and
the sale-leaseback of 32 facilities completed in October 1998.

     Depreciation and amortization for international  operations  increased $3.8
million from $15.5 million for the year ended December 31, 1997 to $19.3 million
for  the  year  ended  December 31,  1998.  Approximately  $2.4 million  of this
increase is directly attributed to acquisitions in late 1997 and 1998 in Germany
and Australia.

OTHER   NON-REPORTABLE   SEGMENTS  AND  CORPORATE  GENERAL  AND   ADMINISTRATIVE
DEPARTMENTS

     Non-reportable  segments include temporary  therapy staffing,  home health,
software   development  and  other  ancillary  services.   Revenues  from  other
non-reportable  segments increased 70.6% from  $165.9 million for the year ended
December 31,  1997 to  $283.1 million  for the  year  ended  December 31,  1998.
Operating  expenses  increased  76.4%  from  $148.1 million  for the year  ended
December 31,  1997 to  $261.3  million  for the year  ended  December 31,  1998.
Operating  expenses as a  percentage  of  revenues  were 89.3% and 92.2% for the
years  ended  December 31,  1997 and  1998,  respectively.  Total  revenues  and
operating  expenses for  non-reportable  segments represent less than 10% of the
consolidated  Company's  results.  Growth in  revenues  and  operating  expenses
relates  primarily to acquisitions  in the Company's home health,  disease state
management,  laboratory  and  radiology  subsidiaries.  Operating  results  were
negatively  impacted by expenses related to software  development costs incurred
by the Company's  subsidiary,  Shared Healthcare  Systems,  Inc. These costs are
being expensed in accordance  with Statement of Financial  Accounting  Standards
No.  86:  Accounting  for  Costs of  Computer  Software  to be Sold,  Leased  or
Otherwise  Marketed.  Development of the Company's  products are not expected to
reach the stage under which capitalization is permitted until late 1999 or 2000.
In addition,  the Company's  temporary  therapy staffing  business' results were
adversely  affected  by  the  long-term  care  industry's   transition  to  PPS.
Nonaffiliated  revenues declined 73.8% in the fourth quarter of 1998 as compared
to the same period in 1997.

                                       43
<PAGE>
     Corporate  general and  administrative  costs not  directly  attributed  to
segments increased 93.8% from $71.1 million for the year ended December 31, 1997
to  $137.8 million  at December 31,  1998. As a percentage of  consolidated  net
revenues  of  $3,088.5   million  and  $2,010.8  million  for  the  years  ended
December 31,  1998 and 1997, respectively,  corporate general and administrative
expenses not directly  attributed to segments  increased from 3.5% to 4.5%. This
increase was primarily due to an increase in costs  relating to the expansion of
the  Company's  corporate  infrastructure  to support  newly  acquired  domestic
operations  including Regency and RCA, as well as implementation of new business
strategies.

     Net interest  expense not directly  attributed to segments  increased 95.7%
from  $53.8 million for the year ended  December 31,  1997 to $105.3 million for
the year ended December 31,  1998. As a percentage of consolidated net revenues,
interest  expense  increased from 2.7% for the year ended  December 31,  1997 to
3.4% for the year ended  December 31,  1998.  The increase was related to (i) an
increase in the Company's  weighted  average  interest rate  resulting  from the
issuance of $250 million of 9 1/2% Notes in July 1997 and the Company's issuance
of  $150 million  of 93/8% Notes in  May 1998,  (ii) higher  interest  rates and
borrowing  costs under the Company's  Senior Credit  Facility as compared to the
previous credit facility that was retired in October 1997,  (iii) an increase in
borrowings  under the Company's  Senior Credit Facility  principally  related to
various  acquisitions  during  1997 and 1998 and  (iv) offset  partially  by the
Company's hedging strategy (see "Liquidity and Capital Resources").

LIQUIDITY AND CAPITAL RESOURCES

     On  October  14,  1999,  the  Company  and  substantially  all of its  U.S.
operating subsidiaries filed voluntary petitions for protection under Chapter 11
of the U.S. Bankruptcy Code with the Bankruptcy Court (case nos. 99-3657 through
99-3841,  inclusive).  On February 3, 2000, an additional indirect subsidiary of
the Company  commenced its Chapter 11 case with the  Bankruptcy  Court (case no.
00-00841).   The   Company   is   currently   operating   its   business   as  a
debtor-in-possession subject to the jurisdiction of the Bankruptcy Court.

     On October 14, 1999, the Company entered into a Revolving  Credit Agreement
with CIT  Group/Business  Credit,  Inc. and Heller Healthcare  Finance,  Inc. to
provide the Company with up to $200.0 million in debtor-in-possession  financing
(the "DIP  Financing  Agreement").  The DIP  Financing  Agreement  provides  for
maximum  borrowings by the Company equal to the sum of (i) up to 85% of the then
outstanding  domestic eligible accounts  receivable and (ii) the lesser of $10.0
million or 50% of the aggregate value of eligible inventory.

     On November 12, 1999,  the  Bankruptcy  Court granted final approval of the
DIP Financing Agreement.  As of May 31, 2000, up to approximately $132.0 million
was available to the Company under the DIP Financing Agreement,  of which amount
the  Company  had   borrowed   approximately   $40.1   million  and  had  issued
approximately  $19.1 million in letters of credit.  In addition to the available
funds under the DIP financing  agreement,  the Company had cash book balances at
May 31, 2000 of approximately  $25.0 million. In July 2000, the Company obtained
waivers  on  several  defaults  under the DIP  Financing  Agreement,  subject to
certain  conditions.  If the  Company  is unable to  comply  with the  covenants
contained in the DIP Financing  Agreement or is unable to obtain a waiver of any
such  future  covenant  violation,  then the  Company  would lose its ability to
borrow under the DIP Financing Agreement for its working capital needs and could
lose access to a substantial  portion of its  operating  cash until such time as
the  outstanding  debt under the DIP  Financing  Agreement  was repaid.  In such
event,  the  Company's  liquidity  would be  insufficient  to fund the Company's
ongoing  operations.  See  "Note  8  -  Debtor-in-Possession  Financing  in  the
Company's Consolidated Financial Statements."

                                       44
<PAGE>
     Under the Bankruptcy Code, actions to collect prepetition  indebtedness are
enjoined.  In  addition,  the Company may reject real estate  leases,  unexpired
lease obligations and other prepetition executory contracts under the Bankruptcy
Code. The Company is analyzing and reviewing its lease  portfolio and expects to
terminate certain leases and/or seek rent relief for certain facilities. Parties
affected by these  rejections may file claims with the Bankruptcy  Court. If the
Company is able to successfully reorganize,  substantially all liabilities as of
the petition  date would be treated under a plan of  reorganization  to be voted
upon by all  impaired  classes of  creditors  and equity  security  holders  and
approved by the Bankruptcy Court.

     On October 26, 1999, the Company announced that it had reached an agreement
in  principle  with   representatives   of  its  bank  lenders  and  holders  of
approximately  two-thirds of its outstanding  senior  subordinated  bonds on the
terms of an  overall  restructuring  of the  Company's  capital  structure.  The
specific  terms of the agreement in principle  are reflected in a  restructuring
term sheet dated October 26, 1999, a copy of which was filed with the Securities
and Exchange  Commission as an exhibit to the  Company's  Form 8-K dated October
14,  1999 and  filed  October  26,  1999.  Implementation  of the  agreement  in
principle is subject to appropriate  documentation,  including a Chapter 11 plan
of reorganization,  and approval by the Bankruptcy Court, among other things. If
approved, the agreement in principle would provide Sun's bank lenders with cash,
new senior  long-term  debt,  new preferred  stock and new common  stock.  Sun's
senior subordinated bondholders would receive new common stock. The agreement in
principle  would also provide new long-term  debt,  new preferred  stock and new
common stock to general unsecured creditors, and reinstate a significant portion
of Sun's secured debt. The agreement in principle provides no recoveries for the
holders of Sun's outstanding  convertible  subordinated debt,  convertible trust
issued preferred  securities,  or common stock. The Company and other parties to
the agreement in principle have initiated  discussions to amend the agreement in
principle.  No  assurance  can be given  that a plan of  reorganization  will be
confirmed or that any plan of reorganization  that is confirmed will contain the
terms of the agreement in principle.

     The accompanying  Consolidated Financial Statements have been prepared on a
going concern basis, which contemplates continuity of operations, realization of
assets and  liquidation  of  liabilities  in the  ordinary  course of  business.
However, as a result of the chapter 11 filing and circumstances relating to this
event,  including the Company's  leveraged  financial  structure and losses from
operations, such realization of assets and liquidation of liabilities is subject
to  significant  uncertainty.  While  under the  protection  of Chapter  11, the
Company  may sell or  otherwise  dispose  of  assets,  and  liquidate  or settle
liabilities,  for  amounts  other  than  those  reflected  in  the  consolidated
financial statements.  Further, a plan of reorganization could materially change
the amounts reported in the Consolidated Financial Statements, which do not give
effect to all  adjustments of the carrying  value of assets or liabilities  that
might  be  necessary  as  a  consequence  of  a  plan  of  reorganization.   The
appropriateness  of using the going concern basis is dependent upon, among other
things, confirmation of a plan of reorganization,  future successful operations,
the  ability to comply  with the terms of the DIP  Financing  Agreement  and the
ability to generate  sufficient cash from operations and financing  arrangements
to meet obligations.

     Due to the  failure to make  payments  and comply  with  certain  financial
covenants  and to the  commencement  of the chapter 11 cases,  the Company is in
default on substantially all of its long-term obligations. These obligations are
classified  as current  liabilities  as of December 31, 1998 and as  liabilities
subject to  compromise  as of December  31, 1999 in the  Company's  Consolidated
Balance Sheets.

                                       45
<PAGE>
     For the year ended  December 31, 1999,  net cash provided by operations was
$7.3  million  compared  to net cash  used  for  operations  for the year  ended
December 31, 1998 of $45.6 million.  The net cash provided by operations for the
year ended  December 31, 1999 is  primarily  the result of the receipt of income
tax refunds of $49.4 million. Excluding the income tax refunds, net cash used by
operations  was  $42.1   million,   which  reflects  lower  cash  received  from
non-affiliated  ancillary  customers.  The  decrease was  partially  offset by a
slowdown in accounts payable and interest payments.

     The Company incurred $102.5 million in capital expenditures during the year
ended December 31, 1999. Expenditures related primarily to the construction of a
corporate office building,  the construction of two inpatient  facilities in the
United  States and two inpatient  facilities  in the United  Kingdom and routine
capital  expenditures.  The Company had construction  commitments as of December
31, 1999,  under various  contracts of $7.2 million in the United States.  These
include  contractual  commitments to improve existing facilities and to develop,
construct  and  complete  a  corporate  office  building  and a  long-term  care
facility.

     In the fourth quarter of 1998, the Company  initiated a restructuring  plan
focused  primarily  on reducing  the  operating  expenses  of its United  States
operations.  Related  to the 1998  corporate  restructuring  plan,  the  Company
recorded a 1998 fourth quarter charge of  approximately  $4.6 million.  The 1998
corporate  restructuring  plan included the elimination of  approximately  7,500
positions,  primarily in the Company's  rehabilitation  and respiratory  therapy
operations  and also included the closure of  approximately  70  divisional  and
regional  offices.   The  1998  corporate   restructuring   charge  consists  of
approximately  $3.7 million  related to employee  terminations and approximately
$0.9 million  related to lease termination  costs. As of December 31,  1998, the
Company had terminated 1,440 employees, and paid approximately  $1.4 million and
$0.1 million in termination benefits and lease termination costs,  respectively.
As of  December 31,  1998,  the Company's  1998  corporate  restructuring  costs
reserve balances  relating to employee  terminations and lease termination costs
were approximately $2.3 million and $0.8 million,  respectively. During 1999 the
Company paid approximately $1.1 million relating to employee terminations. As of
December  31,   1999,   approximately   $1.2  million  of  the  1998   corporate
restructuring  costs reserve balance of approximately  $2.0 million is comprised
of prepetition  severance accruals that are classified as liabilities subject to
compromise.  In  1999,  the  Company's  1998  corporate  restructuring  plan was
substantially complete.

     In the first  quarter of 1999,  the Company  initiated  a second  corporate
restructuring  plan focused on further  reducing the  operating  expenses of its
United States operations.  Related to the 1999 corporate restructuring plan, the
Company recorded a first quarter charge of approximately $11.4 million. The 1999
corporate  restructuring  plan included the termination of  approximately  3,000
employees,  primarily in its  rehabilitation  and respiratory  therapy  services
operations.   The  1999   restructuring   plan  also  includes  the  closure  of
approximately 23 divisional and regional offices. In addition, the plan included
the relocation of the management of the Company's  medical supply subsidiary and
temporary therapy services subsidiary to the Company's corporate headquarters in
Albuquerque,  New Mexico. As part of the relocation,  the Company  terminated 96
employees  of  these  subsidiaries.  The  1999  corporate  restructuring  charge
consisted  of  approximately  $9.1  million  related to  employee  terminations,
approximately  $1.4 million related to lease  termination costs and $0.9 million
related to asset disposals or write-offs.  The amounts paid out during 1999 were
consistent  with the charge  recorded in 1999.  As of  December  31,  1999,  the
Company's 1999 corporate restructuring plan was complete.

     During 1999, the Company recorded  financial  restructuring  costs of $16.0
million,  primarily  professional fees,  related to the Company's  activities in
response  to  the  defaults  under  the  Senior  Credit  Facility,  the  9  3/8%
Subordinated  Notes and the 9 1/2% Subordinated Notes and in preparation for its
filing for protection under Chapter 11 of the U.S. Bankruptcy Code.

                                       46
<PAGE>
     The  Company's  insurance  carriers  declined to renew the  Company's  high
deductible general and professional liability insurance policies that expired on
December 31, 1999.  Several major  insurance  companies are no longer  providing
this type of coverage to long-term  care  providers due to general  underwriting
issues  with  the  long-term  care  industry.   In  January  2000,  the  Company
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.  There can be no assurance that this self-funded  insurance  program for
2000  will  not  have a  material  adverse  impact  on the  Company's  financial
condition  and results of operations or that the Company will not be required to
continue  this  program in future  years.  In the  recent  past,  the  Company's
insurance  companies have paid  substantially  more to third parties under these
policies than the Company paid insurance in premiums and deductibles.

     The Company also conducts business in the United Kingdom,  Spain, Australia
and Germany. International operations accounted for 12.0%, 9.0% and 10.0% of the
Company's  total net revenues during the years ended December 31, 1999, 1998 and
1997,  respectively,  and 19.0% and 17.0% of the  Company's  consolidated  total
assets as of December 31, 1999 and 1998,  respectively.  The Company's financial
condition  and  results of  operations  are  subject to foreign  exchange  risk.
Exceptional   planned  foreign   currency  cash  flow   requirements,   such  as
acquisitions  overseas,  are hedged  selectively to prevent  fluctuations in the
anticipated  foreign  currency value.  Changes in the net worth of the Company's
foreign  subsidiaries  arising from currency  fluctuations  are reflected in the
accumulated other comprehensive income component of stockholders' equity.

     The  Company,   through  its  United  Kingdom   subsidiary,   entered  into
sales-leaseback  transactions in 1999, 1998 and 1997. During 1999, the Company's
United Kingdom  subsidiary sold 11 long-term care  facilities for  approximately
$38.6 million in cash and leased the 11 facilities back under  twelve-year lease
terms.  During 1998,  the  Company's  United  Kingdom  subsidiary  sold 7 of its
long-term  care  facilities and land for  approximately  $117.9 million in cash.
Five of the long-term care facilities were  leased-back  under operating  leases
with lease terms ranging from 11 to 20 years.  During 1997, the Company's United
Kingdom  subsdiary sold 27 long-term care  facilities  for  approximately  $49.3
million and leased them back under  twelve-year  terms.  Also during  1997,  the
Company sold five of its  long-term  care and subacute  care  facilities  in the
United States for  approximately  $31.2 million in cash and  approximately  $5.6
million in  assumption  of debt.  The five  facilities  were  leased-back  under
fourteen-year leases.

     Subsequent to December 31, 1998, the Company  decided to dispose of several
non-core  businesses   including  assisted  living  facilities,   rehabilitation
hospitals, certain other inpatient facilities and other non-core businesses. The
Company  recorded  a loss of $159.8  million  in the  fourth  quarter of 1998 to
reduce the carrying amount of these  businesses  identified for disposal to fair
value  based on  estimates  of selling  value and costs to sell.  The  aggregate
carrying  amount of assets held for sale is $192.4 million at December 31, 1998.
During 1999,  the Company  decided not to divest the  rehabilitation  hospitals,
certain other inpatient facilities and certain other non-core businesses because
the Company  believed that the offers it received for these  businesses were not
sufficient.  In 1999, the Company identified additional inpatient facilities for
disposal.  Certain of these  facilities were operated under long-term  operating
leases which the Company has or intends to terminate based on mutual  agreements
with the  lessors or will  transfer to other  parties.  The  aggregate  carrying
amount of the assets held for sale is $70.6  million at December 31,  1999.  The
Company  recorded a net loss on the sale of assets of $85.8 million for the year
ended  December 31, 1999,  which is recorded in loss on sale of assets,  net and
reorganization  costs  in the  Company's  Consolidated  Statements  of  Earnings
(Losses).

                                       47
<PAGE>
     During the year ended  December 31, 1999,  Sun divested 49 skilled  nursing
facilities, twelve assisted living facilities (four of which the Company managed
through the first quarter of 2000), a parcel of land and its hospice  operations
in  the  United   States.   The  aggregate  cash   consideration   received  was
approximately  $4.1  million,  $4.6  million and $0.2  million for the  assisted
living facilities, parcel of land and the hospice operations,  respectively. The
Company did not receive any cash consideration from the skilled nursing facility
divestitures.  In  addition,  the  Company  received  parcels of land  valued at
approximately  $9.2 million and a note receivable of approximately  $1.0 million
for the assisted living facility divestitures. The aggregate debt, capital lease
obligations,  notes payable and other liabilities  assumed by the purchasers and
successors of the skilled nursing  facilities and the assisted living facilities
were approximately $10.7 million and $21.0 million,  respectively. The aggregate
net loss on the skilled nursing  facility  divestitures was  approximately  $3.0
million dollars which was recorded to loss on assets held for sale, net in 1999.
The aggregate net loss on the assisted  living  divestitures  was  approximately
$68.4  million of which  approximately  $24.9  million and  approximately  $43.5
million  was  recorded  to loss on assets  held for sale,  net in 1999 and 1998,
respectively.  The sale of the parcel of land resulted in a net gain recorded in
1999 of  approximately  $0.7  million.  The net loss on the sale of the  hospice
operations  was  approximately  $7.2  million and was recorded to loss on assets
held for sale,  net during 1999.  See "Note 7 - Impairment of Long-Lived  Assets
and Assets Held for Sale in the Company's Consolidated Financial Statements."

     In the first quarter of 2000, the Company entered into an agreement to sell
16 assisted living facilities, one of which includes a skilled nursing facility.
The  transaction  closed during the second and third  quarters of 2000. The cash
consideration  received from this transaction was approximately $1.0 million. In
addition,  the Company received a note receivable of approximately $0.5 million.
The  aggregate  debt,  capital  leases  and  other  liabilities  assumed  by the
purchaser totaled approximately $66.7 million. The estimated aggregate net loss,
which has been reserved for this transaction,  was approximately  $71.2 million,
of which  approximately  $17.4 million and $53.8 million was recorded to loss on
assets  held  for  sale,  net in 1999 and  1998,  respectively.  See  "Note 24 -
Subsequent Events in the Company's Consolidated Financial Statements

     During the period of January 1, 2000 through May 31,  2000,  Sun divested a
total of 18 pharmacies in the United Kingdom,  resulting in an aggregate gain of
approximately $1.0 million. The aggregate cash consideration  received for these
divestitures was approximately $9.7 million. See "Note 24 - Subsequent Events in
the Company's Consolidated Financial Statements."

     During the period of January 1, 2000  through  June 30,  2000,  the Company
divested one skilled nursing facility and closed one skilled nursing facility.

     During 1998,  certain  leases were not renewed.  In  connection  with these
lease  terminations,  the  Company  recorded  a loss of  $25.6  million  related
primarily  to the  carrying  amount of  building  improvements,  equipment,  and
goodwill related to the facilities.

     In May 1998,  the  Company  issued  $345.0  million  of 7% CTIPS and $150.0
million  of 9  3/8%  Senior  Subordinated  Notes  due  2008  (yield  of  9.425%)
(collectively  the  "Offerings").   Each  convertible   preferred   security  is
convertible  into 1.2419 shares of Sun common stock,  par value $0.01 per share,
of Sun  (equivalent  to an initial  conversion  price of $20.13 per share of Sun
common stock).  Of the net proceeds,  $300.0 million from the Offerings was used
by the Company to permanently  repay certain  outstanding  borrowings  under the
term loan portion of the Senior  Credit  Facility  and the  remainder of the net
proceeds from the Offerings was used to reduce  certain  outstanding  borrowings
under the revolving credit portion of the Company's Senior Credit Facility.  See
"Note 14 -  Convertible  Trust  Issued  Preferred  Securities  in the  Company's
Consolidated Financial Statements."

                                       48
<PAGE>
     On  May  5,  1998,   the  Company   entered  into  certain   interest  rate
transactions,  with an aggregate  notional value of $850.0 million,  to minimize
the risks and/or costs associated with certain long-term debt of the Company. On
April 9, 1999,  the interest rate swap  transactions  were  terminated due to an
event of default relating to the Company's non-compliance with certain covenants
contained in the Senior Credit Facility.  The termination  resulted in a pre-tax
loss of $2.5  million  in the  first  quarter  of  1999.  The  Company  does not
otherwise  utilize  financial  instruments  for  trading  or  other  speculative
purposes.  The interest  rate swap  transactions  were  designated as hedges for
accounting purposes.

     On June 30, 1998, a wholly owned subsidiary of the Company merged with RCA,
an operator of skilled  nursing  facilities and assisted living centers in eight
states  principally in the  southeastern  United States (the "RCA  Merger").  In
connection  with the RCA  Merger,  the  Company  recorded  purchase  liabilities
including  $24.7  million for  severance  and related costs and $1.4 million for
costs associated with the shutdown of certain administrative  facilities.  As of
December  31, 1999,  the  Company's  purchase  liabilities  reserve  balance was
approximately $15.5 million.

     In May,  1997,  the Company  announced its intent to sell and divest of its
outpatient  rehabilitation  clinics in the United States as well as Canada.  The
carrying  amount of the assets held for sale was $11.6 million and $22.5 million
as of December 31, 1998 and 1997,  respectively.  The Company completed the sale
of  certain of the U.S.  rehabilitation  clinics  and a portion of the  Canadian
clinics during 1998. The remaining Canadian clinics were sold during March 1999.
The Company  recorded a loss of $2.0  million,  $11.4  million and $7.0  million
during 1999, 1998 and 1997, respectively,  in order to reduce the carrying value
of the Canadian  operations to fair value based on revised  estimates of selling
value less costs to sell.  The results of operations of these  businesses is not
material to the Company's consolidated results of operations.

     The common  stock of the  Company  was  suspended  and then  delisted  from
trading on the New York Stock  Exchange  (the  "Exchange")  on June 29, 1999 and
August 20,  1999,  respectively.  The  delisting  was the result of the  Company
falling below the Exchange's  minimum continued listing criteria relating to the
Company's  (i) net  tangible  assets  available  to common  stock (less than $12
million)  and (ii) average net income after taxes for the past three years (less
than  $600,000).  The  Company's  common  stock has  subsequently  traded on the
Over-the-Counter Bulletin Board under the symbol "SHGE".

LITIGATION

     The Company and substantially all of its U.S. operating  subsidiaries filed
voluntary  petitions for protection under Chapter 11 of the U.S. Bankruptcy Code
with the Bankruptcy  Court (case nos. 99-3657 through  99-3841,  inclusive).  On
February 3, 2000, an additional indirect subsidiary of the Company commenced its
Chapter 11 case in the  Bankruptcy  Court  (case no.  00-00841).  The Company is
currently  operating  its  business  as a  debtor-in-possession  subject  to the
jurisdiction of the Bankruptcy Court.

     In May 1999, a former  employee of SunBridge  filed a proposed class action
complaint   against  SunBridge  in  the  Western  District  of  Washington  (the
"SunBridge  Action").  The  plaintiff  sought to represent  certain  current and
former  employees of SunBridge  who were  allegedly not paid  appropriate  wages
under  federal  and state law since May 1996.  In August  1999,  several  former
employees of SunDance filed a proposed class action  complaint  against SunDance
in the Western  District of Washington (the "SunDance  Action").  The plaintiffs
sought to represent  certain  current and former  employees of SunDance who were
allegedly  not paid  appropriate  wages under federal and state law since August
1996. The plaintiffs in both of these actions are  represented by the same legal
counsel.  These  lawsuits  are  currently  stayed as a result  of the  Company's
pending Chapter 11 cases.  In June 2000, the plaintiffs in the SunBridge  Action
and the SunDance Action filed motions in the Bankruptcy Court seeking to certify
their  respective  classes they seek to represent and an  enlargement of the bar
date for their class members.  Plaintiffs filed claims in the pending Chapter 11
cases in the amount of $780 million in the  SunDance  Action and $242 million in
the SunBridge  Action,  plus  interest,  costs and attorney  fees.  Although the
Company and its  subsidiaries  intend to vigorously  defend  themselves in these
matters,  there can be no assurance  that the outcome of either of these matters
will not have a  material  adverse  effect  on the  results  of  operations  and
financial condition of the Company.

                                       49
<PAGE>
     In  March 1999  and through  April 19, 1999,  several  stockholders  of the
Company filed class action  lawsuits  against the Company and three  officers of
the Company in the United States  District Court for the District of New Mexico.
The  lawsuits  allege,  among other  things,  that the Company did not  disclose
material  facts  concerning  the  impact  that PPS would  have on the  Company's
results of operations.  The lawsuits seek compensatory  damages and other relief
for   stockholders   who  purchased  the  Company's   common  stock  during  the
class-action period. As a result of the Company's commencement of its Chapter 11
cases,  these  lawsuits are stayed with respect to the Company.  The Company has
filed a motion with the Bankruptcy  Court requesting an extension of the stay to
the individual  defendants.  Although the Company  intends to vigorously  defend
itself and its  officers  in this  matter,  there can be no  assurance  that the
outcome of this matter will not have a material adverse effect on the results of
operations and financial condition of the Company.

     In January 1999, the state of Florida filed criminal charges in the Circuit
Court of the Eighth Judicial  Circuit for Alachua County,  Florida against three
subsidiaries  which were acquired by the Company on June 30,  1998: RCA, Capitol
Care Management  Co., Inc.  and Gainesville Health Care Center, Inc.  All of the
allegations  of  wrongdoing  related  to  activities  prior  to  June 30,  1998.
Florida's allegations included violations of certain RICO laws, abuse or neglect
of elderly or disabled persons, grand theft and Medicaid fraud at a nursing home
facility in Florida.  Also named as defendants  were five  individuals  who were
involved in the  operation  of the  facility in their  capacities  as  officers,
directors or employees of the defendant entities. In December 1999, the state of
Florida  agreed to settle the action for an amount not considered by the Company
to be material to its  operations.  In January  2000,  the state  dismissed  all
charges  against the three  subsidiaries  and five  individuals.  The settlement
agreement was approved by the Bankruptcy Court on May 11, 2000.

     The Company and certain of its  subsidiaries  are defendants in two QUI TAM
lawsuits brought by private citizens in the United States District Court for the
Eastern District of California  alleging  violations of the Federal False Claims
Act. The  plaintiffs  allege that  skilled  nursing  facilities  operated by the
subsidiaries  and others  conspired over the last decade to (i) falsely  certify
compliance with regulatory  requirements in order to participate in the Medicare
and Medicaid  programs,  and (ii) falsify records to conceal failures to provide
services in accordance with such regulatory  requirements.  Although the Company
and its subsidiaries  intend to vigorously  defend  themselves in these matters,
there can be no assurance  that the outcome of any one of these matters will not
have a material  adverse  effect on the  results  of  operations  and  financial
condition of the Company. These lawsuits are currently stayed as a result of the
Company's filing for chapter 11 bankruptcy protection.

     The Company and certain of its  subsidiaries  are  defendants  in a QUI TAM
lawsuit  brought by a private citizen in the United States District Court of the
Central District of California  alleging  violations of the Federal False Claims
Act and a related wrongful termination. The plaintiff alleges that a home health
agency operated by one of the Company's subsidiaries submitted bills for several
years that were improper for various reasons, including bills for patients whose
treatment had not been authorized by their physicians. The government intervened
to the extent that the lawsuit  alleges  billing  without  obtaining  proper and
timely  physician  authorization,  but declined to intervene in the remainder of
the lawsuit.  Although  the Company and its  subsidiaries  intend to  vigorously
defend themselves in this matter,  there can be no assurance that the outcome of
this matter will not have a material adverse effect on the results of operations
and financial  condition of the Company.  This lawsuit is currently  stayed as a
result of the Company's filing for chapter 11 bankruptcy protection.

                                       50
<PAGE>
     In addition,  the Department of Health & Human Services (the "HHS") and the
Department  of Justice (the "DOJ")  periodically  investigate  matters that have
come to  their  attention  concerning  the  Company,  including  cost  reporting
matters. To expedite resolution of any outstanding  investigations,  the Company
has requested that the HHS and the DOJ inform it of any such  investigations  or
outstanding concerns. In response, the DOJ informed the Company of the existence
of a number of outstanding inquiries,  some of which were prompted by the filing
of qui tam lawsuits  that remain under seal and which are not  described  above.
The DOJ has  recently  advised  the  Company  of the  nature of  several  of the
allegations under investigation regarding the Company's subsidiaries,  including
allegations that the Company's subsidiaries were inappropriately  reimbursed for
(i)  certain  management  fees  related to the  provision  of therapy  services,
(ii) nursing services provided by skilled nursing facilities for which there was
inadequate documentation and (iii) respiratory therapy services.

     The DOJ and the Company are having ongoing discussions regarding a possible
global  settlement of these  investigations.  The Company believes that any such
settlement  would include a monetary payment to the government and a requirement
that the Company enter into a corporate integrity agreement with the HHS' Office
of  Inspector  General  requiring  the  Company to  implement  further  internal
controls  with  respect to its quality of care  standards  and its  Medicare and
Medicaid  billing,  reporting  and claims  submission  processes.  Although  the
Company and its  subsidiaries  intend to vigorously  defend  themselves in these
matters, the Company is unable to determine at this time when the investigations
will be concluded, how large a monetary payment, if any, the parties would agree
on,  the  nature of any  other  remedies  that may be sought by the  government,
whether or when a settlement  will in fact occur or whether any such  settlement
or any other outcome of the  investigations  will have a material adverse effect
on the Company's financial condition or results of operations.

     In 1997,  the  Company  was  notified  by a law firm  representing  several
national insurance  companies that these companies believed that the Company had
engaged in improper billing and other practices in connection with the Company's
delivery  of therapy and  related  services.  In  response,  the  Company  began
discussions  directly  with  these  insurers,  hoping to resolve  these  matters
without  litigation;  however,  the  Company  is unable at this time to  predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.

     The Company is a party to various  other legal  actions and  administrative
proceedings  and is subject to various claims arising in the ordinary  course of
its  business,  including  claims that its services  have  resulted in injury or
death to the  residents  of its  facilities.  The  Company  has  experienced  an
increasing  trend in the number  and  severity  of  litigation  claims  asserted
against  the  Company.  The Company  believes  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  awareness by  plaintiff's
lawyers of potentially large recoveries.  In certain states in which the Company
has significant  operations,  including  California,  insurance coverage for the
risk of  punitive  damages  arising  from  general  and  professional  liability
litigation is not available due to state law public policy  prohibitions.  There
can be no assurance  that the Company  will not be liable for  punitive  damages
awarded in  litigation  arising in states for which  punitive  damage  insurance
coverage is not  available.  The Company also believes 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 the Company.

                                       51
<PAGE>
YEAR 2000 UPDATE

     The Company did not experience any significant problems in its operating or
business  systems as a result of the year 2000 date change.  Based on operations
since January 1, 2000, the Company does not expect any significant impact to its
ongoing  operations as a result of the Year 2000 issues  related to its computer
systems. The Company estimates that its aggregate costs directly related to Year
2000 compliance  efforts were  approximately  $6.2 million.  Of these costs, the
Company estimates that  approximately  $3.1 million were spent to repair systems
and equipment and $3.1 million were spent to replace systems and equipment.

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.  The Company's
operations could be adversely  affected if it experiences  significant delays in
receiving  reimbursement  rate increases from Medicaid and Medicare  sources for
its labor and other costs.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     Not applicable.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Information   with  respect  to  Item  8  is  contained  in  the  Company's
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

     None.

                                       52
<PAGE>
PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The directors and executive officers of Sun as of July 13, 2000 were:
<TABLE>
<CAPTION>
Name                      Position with Sun
----                      -----------------
<S>                       <C>

Mark G. Wimer             Acting Chief Executive Officer, President, Chief
                            Operating Officer and Director
Andrew L. Turner          Chairman of the Board of Directors and Chief Executive
                            Officer
Robert D. Woltil          Chief Financial Officer and Director
Robert F. Murphy          General Counsel and Secretary
Warren C. Schelling       President and Chief Operating Officer-Sun Healthcare
                            Group International Corporation
Matthew G. Patrick        Vice President and Treasurer
Jack V. Tindal            Chief Administrative Officer
Andrew P. Masetti         Vice President-Finance
William R. Anixter        Director
John E. Bingaman          Director
Martin G. Mand            Director
Lois E. Silverman         Director
James R. Tolbert, III     Acting Chairman of the Board
R. James Woolsey          Director
</TABLE>

     Set forth below are the names of the  executive  officers and  directors of
Sun and their ages as of July 13,  2000.  The Board of Directors is divided into
three classes elected for staggered terms.  Each director holds office until the
next annual meeting of  stockholders at which the class of directors of which he
or she is a member is elected or until his or her  successor  has been  elected.
The terms of Mr. Wimer and Ms.  Silverman  expired in 1999,  however,  no annual
meeting of  stockholders  was held in 1999,  and therefore they will continue to
hold office until the next annual meeting of  stockholders  is held or until his
or her  successor  has been elected.  The terms of Messrs.  Turner,  Anixter and
Woltil  expire in 2000 and the terms of  Messrs.  Bingaman,  Mand,  Tolbert  and
Woolsey  expire in 2001.  The executive  officers of Sun are chosen  annually to
serve  until the first  meeting  of the Board of  Directors  following  the next
annual meeting of stockholders  and until their  successors are elected and have
qualified, or until death, resignation or removal, whichever is sooner.

     On October 14, 1999,  Sun filed in the United States  Bankruptcy  Court for
the District of Delaware a voluntary  petition  for relief  under  Chapter 11 of
Title 11, United States  Bankruptcy  Code. The executive  officers and directors
set forth  below,  with the  exception of Jack V.  Tindal,  all  occupied  their
positions with the Company on the date of such bankruptcy filing.

     Mark G. Wimer,  age 47, has been a director  of the Company  since 1993 and
the President and Chief  Operating  Officer of the Company since September 1997.
In July 2000,  Mr. Wimer was  appointed  Acting Chief  Executive  Officer of the
Company.  See Item 1 - "Business - Recent  Developments  - Appointment of Acting
Chairman  of the  Board and  Acting  Chief  Executive  Officer."  Mr.  Wimer had
previously  served as Senior Vice  President  for  Inpatient  Services from 1996
until  September  1997, and as the President of SunRise  Healthcare  Corporation
("SunRise"),   the  Company's  subsidiary  responsible  for  operations  of  the
Company's  long-term care  facilities,  from 1993 until 1995. From 1988 to 1993,
Mr. Wimer was President  and Chief  Operating  Officer of  Franciscan  Eldercare
Corporation,  a non-profit organization that develops and manages long-term care
facilities.  From 1984 through 1988,  Mr. Wimer was Regional  Vice  President of
Operations for Hillhaven and had responsibility for management of long-term care
facilities for Hillhaven in Washington, Oregon, Idaho and Montana.

                                       53
<PAGE>
     Andrew L.  Turner,  age 53, has been the Chairman of the Board of Directors
and Chief  Executive  Officer of the Company  since its  formation and served as
President of the Company from the Company's  formation until September 1997. Mr.
Turner is also the founder of the Company and has  overseen the  development  of
the Company's  business  since its  inception in 1989. In July 2000,  Mr. Turner
began a leave of  absence  as the  Company's  Chairman  of the  Board  and Chief
Executive Officer. See Item 1 - "Business - Recent Developments - Appointment of
Acting Chairman of the Board and Acting Chief Executive Officer." Mr. Turner was
also a founder  and  previously  served as Chief  Operating  Officer  of Horizon
Healthcare Corporation, a healthcare services provider, from 1986 to 1989. Prior
to 1986,  Mr.  Turner  served as a Senior Vice  President of  Operations  of The
Hillhaven Corporation ("Hillhaven").  Mr. Turner has over 25 years of experience
in the  long-term  care  industry.  Mr.  Turner is also a member of the Board of
Directors of Watson  Pharmaceuticals,  Inc., a pharmaceutical  products company,
and of The Sports Club Company, Inc., an operator of sports and fitness clubs.

     Robert D. Woltil, age 45, has been a director of the Company since 1996 and
the Chief  Financial  Officer  of the  Company  since  1996.  From 1982 to 1996,
Mr. Woltil   served  in  various   capacities   for  Beverly   Enterprises, Inc.
("Beverly"),  a healthcare services provider.  From 1995 until 1996,  Mr. Woltil
was President and Chief Executive Officer of Pharmacy  Corporation of America, a
subsidiary of Beverly.  From 1992 to 1995, he was the Chief Financial Officer of
Beverly,  and from  1990 to 1992,  Mr. Woltil  was the Vice  President-Financial
Planning  and  Control  for  Beverly.  Mr. Woltil  is  also a  certified  public
accountant.

     Robert F.  Murphy,  age 47, has been General  Counsel of the Company  since
1995 and  Secretary  of the  Company  since 1996.  From 1986 to 1995  Mr. Murphy
served  in  several   capacities   as  an  officer  and  legal  counsel  to  FHP
International Corporation, and his last position with them was as Vice President
and Associate General Counsel. Prior to 1986, Mr. Murphy was in private practice
for several years.

     Warren C. Schelling, age 47, has been President and Chief Operating Officer
of Sun Healthcare  Group  International  since February  1999.  Previously,  Mr.
Schelling was the Senior Vice President for  Pharmaceuticals of the Company from
1996 to February 1999, a director of the Company from 1996 to 1998 and President
of SunScript from 1994 to 1996. Prior to joining the Company,  Mr. Schelling was
the President and Chief Operating  Officer of HPI Health Care Services,  Inc., a
subsidiary of Diagnostek,  Inc., which provides pharmacy  management services to
hospitals, HMOs, long-term care facilities and health systems, from 1993 to July
1994. From January 1994 to July 1994, Mr. Schelling also served as the Executive
Vice President/Pharmacy  Services Officer at Diagnostek, Inc. From 1985 to 1993,
Mr. Schelling was a manager in HPI Health Care Services, Inc.

     Matthew G.  Patrick,  age 40, has been Vice  President and Treasurer of the
Company since 1998.  From 1993 to 1998,  Mr. Patrick  was Vice  President of the
Dallas Agency of The Sanwa Bank, Ltd.  From 1992 to 1993,  Mr. Patrick served as
financial  consultant  for  Merrill,  Lynch,  Pierce,  Fenner and  Smith, Inc.'s
Private  Client Group in Dallas and from 1985 to 1990 he held various  financial
positions in the International Division of National Westminster Bank, PLC.

     Jack V.  Tindal,  age 45,  has been  Chief  Administrative  Officer  of the
Company  since  January,  2000.  From 1997 to January  2000 he was  Senior  Vice
President of Human Resources for the Company's Inpatient Services.  From 1995 to
1997 he was  Vice  President  of Human  Resources  for  SunDance  Rehabilitation
Corporation,   the  subsidiary  responsible  for  the  Company's  rehabilitative
services.

                                       54
<PAGE>
     Andrew P. Masetti, age 42, has been  Vice-President-Finance  of the Company
since  October 1997.  From  June 1997  to  October 1997,  Mr. Masetti  was  Vice
President  and  Controller  of Rehab  Services  of Sun.  Prior to  joining  Sun,
Mr. Masetti was Divisional Chief Financial  Officer of Harte- Hanks from 1996 to
1997,  Chief  Financial  Officer of Vista  Healthcare  from 1995 to 1996,  Chief
Financial  Officer of Diagnostek from 1994 to 1995 and he held various financial
management positions with Martin Marietta/General Electric from 1979 to 1994.

     William R. Anixter, age 76, became a director of the Company in April 1998.
Mr. Anixter  has been the President of Chama  Resources, Inc.,  a privately held
real estate management company,  since 1990. He was co-founder and vice chairman
of Anixter  Bros., Inc.,  a publicly  owned  international  distributor of wire,
cable,  fiber  optics  and  related  networking  products,  which was sold to an
investor group in 1986. Mr. Anixter also serves on the boards of Anicom, Inc., a
publicly owned distributor of communications-related equipment, the United World
College and the Boys Club of Albuquerque.

     John E.  Bingaman,  age 54,  became  a  director  of the  Company  in 1993.
Mr. Bingaman also served as a consultant to the Company from 1994 to 1996. Since
1993, Mr. Bingaman has been Vice President of BKS Properties. From 1991 to 1993,
Mr. Bingaman  was the  President  of Four Seasons  Healthcare  Management, Inc.,
which  was  the  Company's   subsidiary  that  managed  certain  long-term  care
facilities   through   management   contracts.   Between  1984  and   July 1993,
Mr. Bingaman was Chief Executive Officer of Honorcare Corporation ("Honorcare"),
a provider of long-term care services,  responsible  for the overall  management
and  strategic  planning  of  Honorcare.   Mr. Bingaman  has  over  25 years  of
experience in the long-term care industry.

     Martin G. Mand,  age 63,  became a director of the  Company in 1996.  Since
1995, Mr. Mand has been Chairman,  President and Chief Executive Officer of Mand
Associates, Limited, a financial consulting, speaking and writing firm. Mr. Mand
was previously  Executive Vice President and Chief Financial Officer of Northern
Telecom, Ltd.,  a global manufacturer of telecommunications equipment, from 1990
to 1994. Mr. Mand also previously served as Vice President and Treasurer of E.I.
du Pont de  Nemours &  Co., a  chemical,  allied  products  and energy  company.
Mr. Mand  also  serves  on the  Board of  Directors  of the Fuji  Bank and Trust
Company and Imagyn Medical Technologies, Inc. and Townsends, Inc.

     Lois E.  Silverman,  age 59,  became a  director  of the  Company  in 1995.
Ms. Silverman  was a  co-founder,  served  as the  Chairman  of the Board of CRA
Managed  Care, Inc.  from  1994 to  September 1997  and as its  Chief  Executive
Officer from 1988 to 1995.  Ms. Silverman  is the President of the  Commonwealth
Institute,  a nonprofit organization she established in 1997 for the advancement
of women entrepreneurs. Ms. Silverman is also a Trustee at Beth Israel Deaconess
Medical Center,  an overseer of Tufts  University  Medical School,  a Trustee at
Simmous College and Brandeis University, and a Director of Immunetics.

     James R. Tolbert, III, age 65, became a director of the Company in 1995 and
was appointed  Lead  Independent  Director of the Board of Directors in 1998. In
July 2000, Mr. Tolbert was appointed  Acting  Chairman of the Board of Directors
of the Company.  See Item 1 - "Business - Recent  Developments  - Appointment of
Acting  Chairman of the Board and Acting Chief  Executive  Officer." Mr. Tolbert
has served as the Chairman,  President, Chief Executive Officer and Treasurer of
First Oklahoma Corporation,  a holding company, since 1986. Mr. Tolbert has over
15 years of experience in the nursing home industry. In addition, Mr. Tolbert is
a member of the Board of Directors of Bonray Drilling Corporation, a corporation
engaged in domestic onshore contract drilling of oil and gas wells.

                                       55
<PAGE>
     R.  James  Woolsey,  age 58,  became a  director  of the  Company  in 1995.
Mr. Woolsey  has been a partner in the law firm of Shea &  Gardner  since  1995,
where he previously  had been a partner from 1980 to 1989 and from 1991 to 1993.
From 1993 to 1995,  Mr. Woolsey  served as the Director of Central  Intelligence
for the U.S. government.  From 1989 to 1991,  Mr. Woolsey was the Ambassador and
U.S. Representative to the Negotiation on Conventional Armed Forces in Europe.

                                       56
<PAGE>
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

     Section 16(a)  of the  Exchange  Act and the rules  promulgated  thereunder
require the Company's  directors and executive officers and persons who own more
than ten percent of the  Company's  Common Stock to report their  ownership  and
changes  in their  ownership  of Common  Stock to the  Securities  and  Exchange
Commission (the  "Commission")  and the New York Stock  Exchange.  Copies of the
reports  must  also be  furnished  to the  Company.  Specific  due dates for the
reports have been  established  by the Commission and the Company is required to
report in this Proxy Statement any failure of its 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 it, or
written  representations  from certain reporting  persons,  the Company believes
that  during  1999  all  Section 16(a)  filing  requirements  applicable  to its
directors,  executive  officers and greater than ten percent  beneficial  owners
were met with the exception of Kenneth C. Noonan (a former executive  officer of
the Company) and Andrew L. Turner, each of whom reported transactions reportable
on Form 4 one month late due to oversights.


                                       57
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

     The  following  table  provides  information   concerning  the  annual  and
long-term  compensation  for  services  as  employees  of the  Company  and  its
subsidiaries  for the fiscal  years  shown of those  persons  ("Named  Executive
Officers")  who were,  during the year ended  December 31, 1999,  (i) the  chief
executive  officer and  (ii) the  other four most highly  compensated  executive
officers of the Company:

<TABLE>
<CAPTION>
                                                  LONG-TERM COMPENSATION AWARDS
                                                 -----------------------------
                                                                                               SECURITIES
     NAME AND                                 ANNUAL COMPENSATION           RESTRICTED STOCK   UNDERLYING           ALL OTHER
 PRINCIPAL POSITION           YEAR         SALARY($)         BONUS($)         AWARDS($)(1)     OPTIONS(#)         COMPENSATION($)
 ------------------           ----         ---------         --------         ------------     ----------         ---------------
<S>                           <C>         <C>               <C>             <C>                <C>                <C>
Andrew L. Turner              1999        $ 700,024         $      -           $        -       38,000(2)         $      6,998(3)
  Chief Executive             1998          659,634                -                    -       50,000                  26,873
  Officer                     1997          537,312          550,000            5,490,625            -                   5,771

Mark G. Wimer                 1999          450,008                -                    -       16,960(2)                3,313(4)
  President and Chief         1998          443,274                -                    -       25,000                   9,424
  Operating Officer           1997          367,387          255,000            2,712,500            -                   1,503

Robert D. Woltil              1999          425,022                -                    -       14,000(2)                1,810(5)
  Chief Financial             1998          418,288                -                    -       25,000                  10,069
  Officer                     1997          374,428          240,000            1,443,750            -                     870

Warren C. Schelling           1999          320,008                -                    -        13,600(2)                1,587(6)
  President of Sun            1998          277,892                -                    -        30,000                   4,848
  Healthcare Group            1997          247,385           90,000            1,268,750             -                   4,662
  International
  Corporation

Robert F. Murphy              1999          285,012                -                    -        11,200(2)                2,458(7)
  General Counsel and         1998          280,973                -                    -        30,000                   5,872
  Secretary                   1997          267,469          108,000            1,290,625             -                     685
</TABLE>
______________________

(1)  All unvested shares of restricted  stock awarded in 1997 were cancelled and
     rescinded  effective  January 2000. The 1997  restricted  stock awards were
     valued at the Company's  closing stock price ($21.875) on the date of grant
     (January 20, 1997).

(2)  Represents  options issued by the Company in exchange for the  cancellation
     of previously granted stock options in May 1999.

(3)  Consists of $1,200 of matching  contributions  under the  Company's  401(k)
     Plan and the value of $5,798 of life insurance  premiums paid on his behalf
     by the Company.

(4)  Consists of $1,040 of matching  contributions  under the  Company's  401(k)
     Plan and the value of $2,273 of life insurance  premiums paid on his behalf
     by the Company.

                                       58
<PAGE>
(5)  Consists of $1,200 of matching  contributions  under the  Company's  401(k)
     Plan and the value of $610 of life insurance premiums paid on his behalf by
     the Company.

(6)  Consists of the value of life insurance  premiums paid on his behalf by the
     Company.

(7)  Consists of $1,056 of matching  contributions  under the  Company's  401(k)
     Plan and the value of $1,402 of life insurance  premiums paid on his behalf
     by the Company.

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, 1999:
<TABLE>
<CAPTION>
                                                       INDIVIDUAL GRANTS
                                   -----------------------------------------------------------
                                                                                                      POTENTIAL
                                                   % OF TOTAL                                      REALIZABLE VALUE
                                                     OPTIONS                                      AT ASSUMED ANNUAL
                                     NUMBER OF     GRANTED TO                                    RATES OF STOCK PRICE
                                    SECURITIES    EMPLOYEES IN    EXERCISE OR                      APPRECIATION FOR
                                    UNDERLYING       FISCAL        BASE PRICE     EXPIRATION       OPTION TERM (3)
      NAME                          OPTIONS (1)      YEAR (%)      ($/SH) (2)        DATE            5%         10%
      ----                          -----------      --------      ----------        ----            --         ---
<S>                                 <C>           <C>             <C>             <C>             <C>         <C>
Andrew L. Turner                      38,000             5.0%        $1.0625       05/19/09       $22,260     $54,827
Mark G. Wimer                         16,960             2.2          1.0625       05/19/09         9,935      24,470
Robert D. Woltil                      14,000             1.8          1.0625       05/19/09         8,201      20,199
Warren C. Schelling                   13,600             1.8          1.0625       05/19/09         7,967      19,622
Robert F. Murphy                      11,200             1.4          1.0625       05/19/09         6,560      16,160
__________________________
</TABLE>

(1)  All options were granted under the Company's 1997 Incentive Stock Plan. The
     amounts shown represent  options issued on May 19, 1999 in exchange for the
     cancellation of previously granted stock options.

(2)  All  options  were  granted at an  exercise  price equal to the fair market
     value of Common  Stock on the option grant date.  The closing  price of the
     Company's  stock on May 19, 1999 was $1.0625  per share.  All options  will
     vest and become  exercisable  at a rate of one-third each year beginning on
     the  first  anniversary  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)  Pursuant to an agreement in principle  entered into between the Company and
     representatives of its bank lenders and holders of a majority of its senior
     subordinated bonds, the Company's plan of reorganization would provide that
     holders  of  outstanding  equity  securities,  including  common  stock and
     options to acquire common stock, would not receive anything in recovery. No
     assurances can be given that the plan of reorganization  that is confirmed,
     if any, will include the terms of the agreement in principle.  See Item 1 -
     "Certain Additional Business Risks - Effect of Bankruptcy Reorganization on
     Common Stock and Debt Securities."

                                       59
<PAGE>

FISCAL YEAR-END OPTION VALUES

     Set forth in the table below is  information  concerning the value of stock
options held as of December 31,  1999 by each of the Named  Executive  Officers.
None of the Named Executive Officers exercised any stock options during the year
ended December 31, 1999.
<TABLE>
<CAPTION>
                             NUMBER OF SECURITIES               VALUE OF UNEXERCISED
                            UNDERLYING UNEXERCISED              IN-THE-MONEY OPTIONS
                          OPTIONS-AT-YEAR-END (#)(1)             AT-YEAR-END ($)(2)
                          --------------------------             ------------------
NAME                    EXERCISABLE       UNEXERCISABLE     EXERCISABLE       UNEXERCISABLE
----                    -----------       -------------     -----------       -------------
<S>                     <C>               <C>               <C>               <C>
Andrew L. Turner           -0-               38,000           $ -0-            $  -0-
Mark G. Wimer              -0-               16,960             -0-               -0-
Robert D. Woltil           -0-               14,000             -0-               -0-
Warren C. Schelling        -0-               13,600             -0-               -0-
Robert F. Murphy           -0-               11,200             -0-               -0-
___________
</TABLE>

(1)  Pursuant to an agreement in principle  entered into between the Company and
     representatives of its bank lenders and holders of a majority of its senior
     subordinated bonds, the Company's plan of reorganization would provide that
     holders  of  outstanding  equity  securities,  including  common  stock and
     options to acquire common stock, would not receive anything in recovery. No
     assurances can be given that the plan of reorganization  that is confirmed,
     if any, will include the terms of the agreement in principle.  See Item 1 -
     "Certain Additional Business Risks - Effect of Bankruptcy Reorganization on
     Common Stock and Debt Securities."

(2)  Based on the last reported sales price of the Common Stock,  as reported on
     the Over-The-Counter Bulletin Board, at December 31,  1999, which was $.042
     per share.

COMPENSATION OF DIRECTORS

     Non-employee directors of the Company are entitled to receive an annual fee
of $24,000, which is payable in four equal quarterly installments.  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.  The  Lead  Independent  Director  of the  Board of  Directors  is
entitled to an additional annual fee of $42,000,  which is payable in four equal
quarterly  installments.  Prior to December  1999,  non-employee  directors  and
Committee  Chairpersons  had the election of  receiving  (i) the  entire  annual
retainer  and  Committee   Chairpersons   fees,  if  applicable,   in  cash,  or
(ii) one-half of the retainer and Committee Chairperson fees, if applicable,  in
cash and the remaining  one-half in the form of  restricted  common stock awards
pursuant to the 1997 Non-Employee Directors' Stock Plan. If restricted stock was
elected,  for  every  dollar of cash  given  up,  the  recipient  would  receive
restricted  stock  worth  $1.10.  In  December  1999,  the  Board  of  Directors
terminated the 1997 Non-Employee Directors Stock Plan.

     Non-employee directors are also entitled to receive fees of $1,750 for each
Board of  Directors  meeting  attended in person.  Directors  are entitled to an
additional $500 for each subsequent meeting attended that same day. The fees for
any meetings that are attended by telephone are $500. Non-employee directors are
also  reimbursed  for  out-of-pocket  expenses for  attendance at such meetings.
Prior to December 1999, pursuant to the 1997 Non-Employee Directors' Stock Plan,
(i) non-employee  directors  already serving on the Board were awarded  annually
2,000 shares of  restricted  common  stock and  non-qualified  stock  options to
purchase 4,000 shares of common stock and  (ii) non-employee  directors who were
elected to the Board for the first time or after a period of not  serving on the
Board were  entitled to one-time  awards of 5,000  shares of  restricted  common
stock and non-qualified stock options to purchase 10,000 shares of common stock.

                                       60
<PAGE>
EMPLOYMENT AGREEMENT

     Mr. Turner and the Company entered into a five-year Employment Agreement as
of June 2, 1998.  The  Employment  Agreement  provides  for an annual  salary of
$700,000 which was effective  April 1,  1998. The Agreement  provides for salary
increases of $150,000 on each of April 1,  1999 and 2000 and for an annual bonus
determined  pursuant to a formula.  Mr.  Turner has elected to forego his salary
increases  scheduled  for April 1,  1999 and  2000.  The  Agreement  contains  a
two-year  non-competition  covenant and a covenant  prohibiting  Mr. Turner from
disclosing any confidential information of the Company.

     The Company  intends to enter into a  Settlement  Agreement  and an Expense
Indemnification  Agreement  with Mr.  Turner,  both of which are  subject to the
approval of the Bankruptcy  Court.  The Settlement  Agreement would provide for,
among other things,  (i) Mr. Turner  resigning  from all positions that he holds
with the Company,  (ii) the termination of Mr. Turner's Employment Agreement and
all obligations  thereunder,  and (iii) Mr. Turner and the Company releasing the
other from all claims  against each other that are existing as of the  effective
date of the Settlement Agreement.  The Expense  Indemnification  Agreement would
provide for, among other things, (i) the Company indemnifying Mr. Turner against
certain  potential  expenses  incurred by him, (ii) the  advancement of expenses
prior to any determination of whether indemnification is appropriate,  and (iii)
the payment of Mr. Turner's  reasonable  legal fees and expenses in the event of
any litigation  concerning the Expense  Indemnification  Agreement.  The Expense
Indemnification  Agreement  uses  the same  standards  as are  contained  in the
Indemnification Agreement between the Company and Mr. Turner dated July 3, 1996.

RETENTION PLAN AND SEVERANCE AGREEMENT

     On December 15, 1999,  the U.S.  Bankruptcy  Court  approved the  Company's
Employee Retention Program (the "Program") that authorized retention payments to
approximately 930 employees and to certain  executives.  As part of the Program,
Messrs.  Turner, Wimer, Woltil and Murphy will receive incentive payments on the
effective date of a plan of reorganization in the amounts of $500,000, $350,000,
$350,000 and $200,000,  respectively, if they remain employees of the Company on
that date.  These  amounts  will be increased by 5% for each full month prior to
September 30, 2000 that a reorganization plan becomes effective, or decreased by
5% (up to a maximum  reduction of 15%) for each full month  following  September
30, 2000 that the reorganization plan becomes effective.

     Pursuant to the Program,  these  executives are also eligible for severance
payments in the event of termination  without cause. The severance payments will
be equal to 24 months of salary  (based on rates in effect at  termination).  In
addition  to the  severance  payments,  the  Program  provides  them,  and their
eligible  dependents,  with the right to  participate  in the  medical,  dental,
health, life and other fringe benefit plans and arrangements  applicable to them
immediately prior to termination. The right to this participation will expire at
either the earlier of two years from the date of  termination or until such time
that  they  become  eligible,   through  a  subsequent   employer,   to  receive
substantially equivalent or greater benefits. Severance payments will be made in
accordance with an election made by the Company. If so elected,  the Company can
make the  severance  payments  over time,  which would cause the executive to be
released  from  existing  non-compete  restrictions.  Under this option,  if the
executive finds employment  during the severance  period,  his severance payment
will be reduced by the  amount of the salary  earned by him,  up to a maximum of
50% of the aggregate severance payments.  Otherwise, the payments may be made in
a lump sum with the executive made subject to certain competitive prohibitions.

                                       61
<PAGE>
     Mr.  Woltil has an  agreement  with the  Company  whereby,  in return for a
commitment to remain  employed  until  December 31, 2000, he will be entitled to
receive a payment  equal to 12 months of his  current  salary if he  voluntarily
terminates  his  employment  with the  Company  at the end of such  period.  The
Company  is bound to this  payment  even if the  payment is to be paid on a date
that is a post-effective date of a confirmed plan of reorganization.

     The Company has a severance  agreement with Mr.  Schelling dated January 7,
1997 which provides,  among other things,  for a severance  payment equal to two
times his salary plus accrued but unpaid  salary and incentive  bonus  payments.
This  agreement  has not been  assumed or rejected  in the Chapter 11 case.  The
Company  intends  to  replace  this  agreement  with a new  severance  and bonus
agreement   between  Mr.  Schelling  and  one  of  the  Company's   non-domestic
subsidiaries.  The new agreement will provide Mr. Schelling with essentially the
same severance and fringe benefits as described above for Messrs. Turner, Wimer,
Woltil and Murphy.  Mr.  Schelling will also be entitled to a $75,000  retention
payment on September 30, 2000, a $75,000  retention  payment on January 1, 2001,
and an incentive  payment of $200,000 on completion of the sale of the Company's
international division.

                                       62
<PAGE>
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table and footnotes set forth certain  information  regarding
the  beneficial  ownership  of  Common  Stock as of March 15,  2000 by  (i) each
director,  (ii) the  Named  Executive  Officers  (as defined  below),  (iii) all
directors  and  executive  officers of the  Company as a group,  and each person
believed by the Company to be the beneficial  owner of more than five percent of
Common Stock of the Company.  Pursuant to an agreement in principle entered into
between  the Company and  representatives  of its bank  lenders and holders of a
majority of its senior  subordinated bonds, the Company's plan of reorganization
would provide that holders of outstanding  equity  securities,  including common
stock and  options  to acquire  common  stock,  would not  receive  anything  in
recovery.  No assurances  can be given that the plan of  reorganization  that is
confirmed,  if any, will include the terms of the  agreement in  principle.  See
Item  1  -  "Certain   Additional   Business   Risks  -  Effect  of   Bankruptcy
Reorganization on Common Stock and Debt Securities."
<TABLE>
<CAPTION>

                                                 SHARES                    PERCENT OF
NAME OF BENEFICIAL OWNER                   BENEFICIALLY OWNED(1)           CLASS(1)(%)
------------------------                   ---------------------           -----------
<S>                                        <C>                            <C>
Andrew L. Turner                                359,604  (2)                     *
William R. Anixter                               22,792  (3)(4)                  *
John E. Bingaman                                193,610  (3)(5)                  *
Martin G. Mand                                   10,979  (3)(6)                  *
Robert F. Murphy                                 22,507  (7)                     *
Warren C. Schelling                               4,533  (8)                     *
Lois E. Silverman                                12,960  (3)(9)                  *
James R. Tolbert, III                            18,897  (3)(9)(10)              *
Mark G. Wimer                                     5,653  (11)                    *
Robert D. Woltil                                 12,167  (12)                    *
R. James Woolsey                                 10,333  (3)(9)                  *
Peter C. Kern                                 3,502,777  (13)                  5.7%
  206 St. Johns Road
  Pilot Point, TX  76258
All directors and executive officers
As a group (14 persons, including
  those named above)                            579,416  (14)                    *
___________

*        Less than 1%
</TABLE>

(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 15, 2000 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)  Includes  84,372  shares of Common  Stock  owned by the  Turner  Children's
     Trust,  1,500  shares of Common  Stock  owned by the Andrew and Nora Turner
     Trust and  261,065  shares  of  Common  Stock  owned by the  Turner  Family
     Foundation  (Mr. Turner  disclaims  beneficial  ownership of these shares).
     Also includes  currently  exercisable  options to purchase 12,667 shares of
     Common Stock.

                                       63
<PAGE>
(3)  Includes  restricted  shares awarded under the Company's 1997  Non-Employee
     Directors'  Plan which may be subject to a substantial  risk of forfeiture.
     The number of  restricted  shares  included for each person listed above as
     having restricted shares is as follows: Mr. Anixter - 5,000; Mr. Bingaman -
     3,333;  Mr. Mand - 3,333;  Ms. Silverman - 3,333;  Mr. Tolbert - 3,333; and
     Mr. Woolsey - 3,333.

(4)  Includes  15,000  shares of Common  Stock  owned by the  William  and Nancy
     Anixter Trust.

(5)  Includes currently  exercisable options to purchase 44,583 shares of Common
     Stock.

(6)  Includes currently  exercisable  options to purchase 5,583 shares of Common
     Stock.

(7)  Includes currently  exercisable  options to purchase 3,733 shares of Common
     Stock.

(8)  Includes currently  exercisable  options to purchase 4,533 shares of Common
     Stock.

(9)  Includes currently  exercisable  options to purchase 6,333 shares of Common
     Stock.

(10) Includes  5,000  shares  held  by  First  Oklahoma  Corporation,  the  sole
     shareholder of which is Mr. Tolbert.

(11) Includes currently  exercisable  options to purchase 5,653 shares of Common
     Stock.

(12) Includes  5,000  shares owned by Mr.  Woltil and his wife,  as to which Mr.
     Woltil has shared voting and  investment  power.  Also  includes  currently
     exercisable options to purchase 4,667 shares of Common Stock.

(13) Based upon a Schedule 13G filed with the Commission in April, 1999.

(14) Includes an aggregate of 106,538  shares of Common Stock  issuable upon the
     exercise of options that are currently exercisable.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Mr.  Woolsey,  in his  capacity  as a  partner  in the  law  firm of Shea &
Gardner,  provided  certain  legal  services to the  Company in 1999.  The total
amount  paid to Shea & Gardner  in 1999 for  such  services  was  approximately
$131,536.

     As  of  December 31,   1999,  the  Company's  nursing  home   subsidiaries,
(collectively  "SunBridge"),  were lessees or sublessees  of 45 facilities  from
partnerships  or corporations  in which Mr. Zev  Karkomi,  who resigned from the
Company's  Board of  Directors  in July  1999,  was a  partner,  stockholder  or
director.  These  arrangements were entered into from 1989 to 1999, with varying
lease terms.  The aggregate  lease  payments,  including base rents,  contingent
rents and other  miscellaneous  payments in connection  with leases in which Mr.
Karkomi held an interest totaled  approximately  $18.1 million  in 1999.  During
1999,  the  Company  terminated  leases to 11  facilities  that were leased from
affiliates of Mr. Karkomi.

                                       64
<PAGE>
     In 1994, a subsidiary of the Company  entered into a lease  agreement for a
nursing   facility  in  Bellingham,   Washington  with   Bellingham   Associates
("Bellingham"),   an  affiliate  of  Mr.  Karkomi.   Subsequently,  the  Company
determined  to build a  replacement  facility  in  Bellingham,  Washington,  and
entered  into a  construction  agreement in June 1998 with a third party for the
construction  of a 122 bed  nursing  home.  The  lease  with  Bellingham  on the
existing facility was bought out, and the facility was purchased, by the Company
with a purchase mortgage from Bellingham in April 1999. The replacement facility
was  completed  in 1999 but the  opening  was  delayed  as a result of a dispute
between  the Company  and  Bellingham  over their  rights and  obligations  with
respect to the existing facility and the replacement facility. In February 2000,
the Company and  Bellingham  entered  into an  agreement to resolve the disputes
related to the two Bellingham facilities as well as a number of other facilities
leased by the  Company  from Mr.  Karkomi and his  affiliates,  as well as other
issues  between the parties,  which  includes the  following  features:  (i) the
return to  affiliates  of Mr.  Karkomi of 17 leased  nursing  homes and assisted
living  facilities;  (ii) the release of all damage claims by Mr. Karkomi or his
affiliates  related to  prepetition  claims and certain  postpetition  claims on
those 17 facilities,  including lease rejection damages; (iii) the forfeiture by
the Company of an aggregate of approximately $1.3 of security deposits on the 17
facilities;  and (iv) the assumption by the Company of leases  covering 28 other
nursing  homes,  including  certain  modifications  to the terms of some  leases
including  rent  concessions,  options to purchase or close certain  facilities,
shortening  of lease  maturities  and rights of first  refusal to  purchase  the
facilities.

     Additionally,   the  Company  entered  into  a  lease  agreement  with  the
construction  company that built the replacement  facility which  supercedes the
construction  agreement and allowed that facility to be opened concurrently with
the closure of the existing facility.  Both of the  above-referenced  settlement
agreements  were approved by the Bankruptcy  Court in May 2000 and are currently
being  implemented,  and as a result the  existing  facility  was closed and the
replacement facility opened in June 2000.

     As of  December 31,  1999,  SunBridge  was a lessee  or  assignee  of seven
facilities from  partnerships in which  Mr. Bingaman,  a current director of the
Company, had an equity interest of greater than ten percent. Each of these lease
arrangements  was  entered  into  prior to the  closing  of the  acquisition  of
Honorcare.  All of the leases commenced on July 13,  1993 and terminate in 2001.
The aggregate lease payments,  including base rents,  contingent rents and other
miscellaneous  payments in connection with these leases,  totaled  approximately
$2.2 million in 1999.

     The Company believes the terms of all of the foregoing  transactions are as
favorable  to  the  Company  as  those  that  could  have  been   obtained  from
non-affiliated  parties in  arm's-length  transactions.  However,  the Company's
contractual  relationship with entities  affiliated with members of the Board of
Directors creates the potential for conflicts of interest.

                                       65
<PAGE>

                                     PART IV

ITEM 14.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)  Financial Statements and Financial Statement Schedules

      (i) Financial Statements:

             Report of Independent Public Accountants

             Consolidated Balance Sheets for the years ended December 31, 1999
             and 1998

             Consolidated Statements of Earnings (Losses) for the years ended
             December 31, 1999, 1998 and 1997

             Consolidated  Statements of  Stockholders'  Equity (Deficit) for
             the years ended December 31, 1999, 1998 and 1997

             Consolidated Statements of Cash Flows for the years ended December
             31, 1999, 1998 and 1997

             Notes to Consolidated Financial Statements

     (ii) Financial Statement Schedules:

             Consent of Independent Public Accountants

             Schedule II Valuation and Qualifying Accounts for the years ended
             December 31, 1999, 1998 and 1997


(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

     Report dated October 14, 1999 and filed October 27, 1999 reporting that the
Company  and its U.S.  operating  subsidiaries  filed  voluntary  petitions  for
protection under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy
Court for the  District of  Delaware  (case  numbers  99-3657  through  99-3841,
inclusive).

     Report dated  November 24, 1999 and filed  November 24, 1999  reporting the
August,  1999 summary  financial  projections  that the Company  provided to the
representatives of its bank lenders and senior subordinated  bondholders as part
of the  negotiations  regarding  the terms of an  overall  restructuring  of the
Company's capital structure.

(c)     Exhibits

                                       66
<PAGE>

EXHIBIT NUMBER                          DESCRIPTION OF EXHIBITS
--------------                          -----------------------

2.1(9)                  Agreement and Plan of Merger and  Reorganization, dated
                        as of February 17, 1997 among the Company, Peach
                        Acquisition Corporation and Retirement Care Associates,
                        Inc.

2.2(9)                  Agreement and Plan of  Merger and Reorganization, dated
                        as of February 17, 1997 among the Company, Nectarine
                        Acquisition  Corporation and Contour Medical, Inc.

2.3(14)                 Amendment  No. 1 to the Agreement and Plan of Merger and
                        Reorganization dated as of February 17, 1997 among the
                        Company, Retirement Care Associates, Inc. and Peach
                        Acquisition Corporation dated May 27, 1997

2.4(15)                 Amendment No. 2 to the Agreement and Plan of Merger and
                        Reorganization dated as of February 17, 1997 among the
                        Company, Retirement Care Associates, Inc. and Peach
                        Acquisition Corporation dated August 21, 1997

2.5(15)                 Amendment No. 1 to the Agreement and Plan of Merger and
                        Reorganization  dated as of February 17, 1997 among
                        the Company, Contour Medical, Inc. and Nectarine
                        Acquisition Corporation dated August 21, 1997

2.6(16)                 Amendment No. 3 to the Agreement and Plan of Merger and
                        Reorganization  dated as of February 17, 1997 among
                        the Company, Retirement Care Associates, Inc. and Peach
                        Acquisition Corporation dated November 25, 1997

2.7(16)                 Amendment No. 2 to the Agreement and Plan of Merger and
                        Reorganization dated as of February 17, 1997 among
                        the Company, Contour Medical, Inc. and Nectarine
                        Acquisition Corporation dated November 25, 1997

2.8(13)                 Agreement and Plan of Merger,  dated as of July 26,
                        1997, among the Company,  Sunreg  Acquisition  Corp. and
                        Regency Health Services, Inc.

2.9(21)                 Amendment No. 4 to the Agreement and Plan of Merger and
                        Reorganization  dated as of February 17, 1997 among
                        the Company, Retirement Care Associates, Inc. and Peach
                        Acquisition Corporation, dated April 3, 1998

2.10(21)                Amendment  No. 3 to the  Agreement and Plan of Merger
                        and Reorganization  dated as of  February  17, 1997
                        among the Company, Contour Medical, Inc. and Nectarine
                        Acquisition Corporation dated April 3, 1998

3.1(19)                 Certificate of Incorporation of the Company, as amended

3.2(1)(4)               Bylaws of the Company, as amended

4.1(2)                  Fiscal Agency  Agreement dated as of March 1, 1994
                        between the Company and  NationsBank of Texas,  N.A., as
                        Fiscal Agent

                                       67
<PAGE>
4.2(6)                  Form of Rights Agreement, dated as of June 2, 1995,
                        between the Company and Boatmen's Trust Company, which
                        includes the form of Certificate of Designations for
                        the Series A Preferred Stock as Exhibit A, the form of
                        Right Certificate as Exhibit B and the form of Summary
                        of Preferred Stock Purchase Rights as Exhibit C

4.3(7)                  First Amendment to Rights Agreement, dated as of August
                        11, 1995,  amending the Rights Agreement, dated as
                        of June 2, 1995, between the Company and Boatmen's Trust
                        Company

4.4(22)                 Removal of Rights Agent, Appointment and Acceptance of
                        Successor Rights Agent and Amendment No. 2 to Rights
                        Agreement  among the Company, Chase Mellon Shareholder
                        Services,  LLC and American Stock Transfer & Trust
                        Company

4.5(19)                 Certificate of Designations of Series A Preferred Stock
                        of the Company

4.6(18)                 Amended and  Restated  Declaration of Trust of Sun
                        Financing I among the  Company, as sponsor, Robert F.
                        Murphy, Robert D. Woltil and William Warrick, as
                        trustees, the Bank of New York (Delaware), as trustee,
                        and the Bank of New York, dated as of May 4, 1998

4.7(18)                 Preferred Securities Guarantee among the Company and the
                        Bank of New York, as trustee, dated as of May 4, 1998

4.8(18)                 Registration Rights Agreement among the Company, certain
                        guarantors and Bear, Stearns & Co., Inc., Donaldson,
                        Lufkin & Jenrette Securities Corporation, J.P. Morgan
                        Securities, Inc., NationsBanc Montgomery Securities  LLC
                        and Schroder & Co., Inc., dated as of May 4, 1998 (7%
                        Convertible Trust Issued Preferred Securities)

4.9(18)                 Registration  Rights Agreement among Sun Financing I,
                        the Company and Bear, Stearns & Co., Inc.,  Donaldson,
                        Lufkin & Jenrette Securities  Corporation,  J.P. Morgan
                        Securities,  Inc., NationsBanc Montgomery Securities
                        LLC and Schroder & Co., Inc., dated as of May 4, 1998
                        (93/8% Senior Subordinated Debentures due 2008)

10.1(3)                 Amendment and Restatement of Loan Agreement [Brookline]
                        by and between Mediplex of Massachusetts, Inc. and
                        Meditrust Mortgage Investments, Inc., dated June 23,
                        1994

10.2(3)                 Amendment and Restatement of Loan Agreement [Columbus]
                        by and between Mediplex Rehabilitation of Massachusetts,
                        Inc. and Meditrust Mortgage Investments, Inc., dated
                        June 23, 1994

10.3(3)                 Loan Agreement [Denver] by and between Mediplex of
                        Colorado, Inc. and Valley View Psychiatric Services,
                        Inc. and Meditrust Mortgage Investments, Inc., dated
                        June 23, 1994

                                       68
<PAGE>
10.4(8)                 Omnibus Amendment to Loan Agreements, dated as of March
                        28, 1996, by and between certain subsidiaries of The
                        Mediplex Group, Inc. and certain subsidiaries of the
                        Company

10.5(12)                Credit Agreement among the Company, certain lenders,
                        certain co-agents, and NationsBank of Texas,  N.A., as
                        Administrative Lender, dated October 8, 1997

10.6(12)                Form of First Amendment to Credit Agreement dated
                        October 8, 1997 among the Company, certain lenders,
                        certain co-agents, and NationsBank of Texas, N.A., as
                        Administrative Lender, to be dated as of November 12,
                        1997

10.7(5)                 First Amendment to the Company's 1992 Director Stock
                        Option Plan

10.8(1)                 The Company's 1993 Combined Incentive and Nonqualifie
                        Stock Option Plan

10.9(1)                 The Company's 1993 Directors Stock Option Plan

10.10(5)                Amendments to the Company's 1993 Combined Incentive and
                        Nonqualified Stock Option Plan

10.11(8)                The Company's 1995 Non-Employee Directors' Stock Option
                        Plan

10.12(8)                The Company's Employee Stock Purchase Plan

10.13(8)                1996 Combined Incentive and Nonqualified Stock Option
                        Plan

10.14(1)                Form of Indemnity Agreement between the Company and each
                        of the Company's Directors before July 3, 1996

10.15(18)               Form of Indemnity  Agreement between the Company and
                        each of the Company's Directors from and after July 3,
                        1996

10.16(10)               Form of Severance Agreement entered into between the
                        Company and its President, Chief Financial Officer and
                        Senior Vice Presidents

10.17(11)               The Company's 1997 Non-Employee Directors' Stock Plan

10.18(11)               The Company's 1997 Stock Incentive Plan

10.19(18)               Second Amendment to Credit Agreement dated October 8,
                        1997 among the Company, certain lenders, certain
                        co-agents, and NationsBank of Texas, N.A., as
                        Administrative Lender, dated as of March 27, 1998

10.20(20)               Fourth Amendment to Credit  Agreement dated October 8,
                        1997 among the Company, certain lenders, certain
                        co-agents, and NationsBank of Texas, N.A., as
                        Administrative Lender, dated as of October 30, 1998

10.21(20)               Employment Agreement dated June 2, 1998 between Andrew
                        L. Turner and the Company.

                                       69
<PAGE>
10.22(17)               Indenture dated July 8, 1997 by and between the Company,
                        the Guarantors named therein, and First Trust
                        National Association (9 1/2% Senior Subordinated Notes
                        due 2007)

10.23(3)                Amended and Restated Indenture, dated October 1, 1994,
                        among the Company, The Mediplex Group, Inc. and Fleet
                        Bank of Massachusetts, N.A. as Trustee (6% Convertible
                        Subordinated Debentures due 2004)

10.24(3)                Amended and Restated First Supplemental Indenture to
                        Amended and Restated Indenture, dated October 1, 1994,
                        among the Company, The Mediplex Group, Inc. and Fleet
                        Bank of Massachusetts, N.A. as Trustee (6 1/2%
                        Convertible Subordinated Debentures due 2003)

10.25(18)               Indenture dated May 4, 1998 among the Company, the Bank
                        of New York, as trustee (7% Convertible Junior
                        Subordinated Debentures due 2028)

10.26(18)               Indenture dated May 4, 1998 among the Company,  U.S.
                        Bank Trust National Association, as trustee, and
                        certain guarantors (93/8% Senior Subordinated Notes due
                        2008)

10.27(23)               Limited Waiver and Agreement, dated as of April 27,
                        1999, to Credit Agreement among the Company, certain
                        lenders, certain co-agents, and NationsBank of Texas,
                        N.A. as Administrative Lender

10.28(24)               Revolving Credit Agreement dated October 14, 1999 among
                        the Company and each of its subsidiaries named
                        therein (as borrowers).  The CIT Group/Business Credit,
                        Inc. (as Lender's Agent) and Heller Financial,  Inc.
                        (as Collateral Agent)

10.29(25)               Term Sheet for Plan of Reorganization Prepared by Senior
                        Lenders' Working Group dated October 26, 1999.

21*                     Subsidiaries of the Registrant

23*                     Consent of Arthur Andersen LLP

27*                     Financial Data Schedule
______________________
*        Filed herewith.

(1)  Incorporated  by  reference  from  exhibits to the  Company's  Registration
     Statement (No. 33-62670) on Form S-1.

(2)  Incorporated  by reference  from exhibits to the  Company's  Form 8-K dated
     March 11, 1994.

(3)  Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended September 30, 1994.

(4)  Incorporated  by  reference  from  exhibits to the  Company's  Registration
     Statement (No. 33-77870) on Form S-1.

                                       70
<PAGE>
(5)  Incorporated  by reference from exhibits to the Company's  Annual Report on
     Form 10-K for the fiscal year ended December 31, 1994.

(6)  Incorporated  by reference  from exhibits to the  Company's  Form 8-A filed
     June 6, 1995.

(7)  Incorporated by reference from exhibits to the Company's Form 8-A/A-1 filed
     August 17, 1995.

(8)  Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended March 31, 1996.

(9)  Incorporated  by reference  from exhibits to the  Company's  Form 8-K dated
     February 17, 1997.

(10) Incorporated  by reference from exhibits to the Company's  Annual Report on
     Form 10-K for the fiscal year ended December 31, 1996.

(11) Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended March 31, 1997.

(12) Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended September 30, 1997.

(13) Incorporated  by reference  from exhibits to the  Company's  Form 8-K dated
     October 8, 1997.

(14) Incorporated by reference from exhibits to the Company's Form 8-K dated May
     27, 1997.

(15) Incorporated  by reference  from exhibits to the  Company's  Form 8-K dated
     August 21, 1997.

(16) Incorporated  by reference  from exhibits to the  Company's  Form 8-K dated
     November 25, 1997.

(17) Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended June 30, 1997.

(18) Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended March 31, 1998.

(19) Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended June 30, 1998.

(20) Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended September 30, 1998.

(21) Incorporated  by reference  from exhibits to the  Company's  Form 8-K dated
     April 3, 1998.

(22) Incorporated  by reference from exhibits to the Company's  Annual Report on
     Form 10-K for the fiscal year ended December 31, 1998.

(23) Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended March 31, 1999.

                                       71
<PAGE>
(24) Incorporated  by reference from exhibits to the Company's Form 10-Q for the
     quarter ended September 30, 1999.

(25) Incorporated  by reference  from exhibits to the  Company's  Form 8-K dated
     October 27, 1999.

                                       72
<PAGE>

                                   SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                                 SUN HEALTHCARE GROUP, INC.


                                                 By: /s/ Mark G. Wimer
                                                 ------------------------
                                                     Mark G. Wimer
                                                     Acting Chief Executive
                                                       Officer, President and
                                                       Chief Operating Officer

July 13, 2000




                                POWER OF ATTORNEY

     Each person whose signature appears below hereby appoints each of Robert D.
Woltil and Robert F. Murphy, as his  attorney-in-fact to sign this Report on his
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 on July 13, 2000 in the capacities indicated.

         SIGNATURES                              TITLE
         ----------                              -----

/s/ Mark G. Wimer              Acting Chief Executive Officer, President,
-----------------               Chief Operating Officer and Director
    Mark G. Wimer               (Principal Executive Officer)


                               Chairman of the Board of Directors and Chief
                               Executive Officer (1)
---------------------
     Andrew L. Turner


                               Chief Financial Officer and Director (Principal
/s/  Robert D. Woltil          Financial Officer)
---------------------
     Robert D. Woltil


                                       73
<PAGE>
                               Vice President-Finance (Principal Accounting
/s/ Andrew P. Masetti          (Officer)
---------------------
    Andrew P. Masetti



/s/ James R. Tolbert           Acting Chairman of the Board
--------------------
    James R. Tolbert



/s/ William R.  Anixter        Director
-----------------------
    William R. Anixter



/s/ John E. Bingaman           Director
--------------------
    John E. Bingaman



/s/ Martin G. Mand             Director
------------------
    Martin G. Mand



/s/ Lois Silverman             Director
------------------
    Lois Silverman



/s/ R. James Woolsey           Director
--------------------
    R. James Woolsey


(1)  On July 13,  2000,  Mr.  Turner  began a leave of  absence  from all of his
     positions with the Company.  See "Item 1 - Business - Recent Developments -
     Appointment  of Acting  Chairman  of the Board and Acting  Chief  Executive
     Officer.

                                       74
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999
<TABLE>
<CAPTION>
                                                                                                        PAGE
                                                                                                        ----

<S>                                                                                                     <C>
Report of Independent Public Accountants.........................................................        F-2

Consolidated Balance Sheets as of December 31, 1999 and 1998.....................................        F-3

Consolidated Statements of Earnings (Losses) for the years ended December 31, 1999,5
   1998 and 1997.................................................................................        F-5

Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31,
   1999, 1998 and 1997...........................................................................        F-6

Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998
   and 1997......................................................................................        F-7

Notes to Consolidated Financial Statements.......................................................        F-8
</TABLE>

                                      F-1
<PAGE>
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. (a Delaware  corporation) and subsidiaries as of December
31, 1999 and 1998, and the related consolidated statements of earnings (losses),
stockholders' equity (deficit) and cash flows for each of the three years in the
period  ended   December  31,  1999.   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.

     The Company is the subject of Federal investigations, including allegations
of inappropriate  reimbursement for certain services, and other litigation.  See
Note  18 to  the  Consolidated  Financial  Statements  for  further  information
regarding  these  matters.

     In our opinion,  the financial statements referred to above present fairly,
in all material  respects,  the financial position of Sun Healthcare Group, Inc.
and  subsidiaries  as of  December  31,  1999 and 1998,  and the  results of its
operations  and its cash flows for the three years in the period ended  December
31, 1999, in conformity with  accounting  principles  generally  accepted in the
United States.

     As explained in Note 3(p) to the financial statements, effective January 1,
1999 the  Company  changed  its  method  of  accounting  for  costs of  start-up
activities.

     The accompanying  financial statements have been prepared assuming that the
Company  will  continue  as a  going  concern.  As  discussed  in  Note 2 to the
Consolidated Financial Statements, the Company incurred net losses for the years
ended  December  31,  1999 and 1998 of  $1,089.5  million  and  $753.7  million,
respectively,  and as of  December  31,  1999  has a  stockholders'  deficit  of
$1,044.1 million and a working capital deficiency of $17.3 million.  As a result
of its  recurring  losses,  the  Company  was  not in  compliance  with  certain
financial covenants of its Debtor-in-Possession Financing Agreement. The Company
has  received  a waiver  for the  non-compliant  covenants  subject  to  certain
conditions.  This matter is  discussed in Note 8 to the  Consolidated  Financial
Statements.  Also, on October 14, 1999, the Company and substantially all of its
domestic  subsidiaries  filed  separate  voluntary  petitions  for relief  under
Chapter  XI of the U.S.  Bankruptcy  Code and  continue  to  operate  under  the
protection of Chapter XI. These matters,  among others,  raise substantial doubt
about the Company's ability to continue as a going concern.  Management's  plans
in  regard  to  these   matters,   including  its  intent  to  file  a  plan  of
reorganization that will be acceptable to the Bankruptcy Court and the Company's
creditors,  are also described in Note 2. In the event a plan of  reorganization
is  accepted,  continuation  of the  business  thereafter  is  dependent  on the
Company's  ability to achieve  successful  future  operations.  The accompanying
financial   statements   do  not  include  any   adjustments   relating  to  the
recoverability  and  classification of recorded asset amounts or the amounts and
classification  of  liabilities  that might be  necessary  should the Company be
unable to continue as a going concern.



/s/ Arthur Andersen LLP
-----------------------
    Arthur Andersen LLP

Albuquerque, New Mexico
July 13, 2000

                                      F-2
<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

                           CONSOLIDATED BALANCE SHEETS

                        AS OF DECEMBER 31, 1999 AND 1998
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                                                 1999              1998
                                                                                                 ----              ----
                                     ASSETS
<S>                                                                                     <C>              <C>
  Cash and cash equivalents.............................................................      $  25,047         $  27,504
  Accounts receivable, net of allowance for doubtful accounts of $151,841 and
    $79,015 at December 31, 1999 and 1998, respectively.................................        254,464           538,329
  Other receivables, net................................................................         15,916            48,073
  Inventory, net........................................................................         42,983            48,862
  Prepaids and other assets.............................................................         15,087            13,091
  Income tax receivables................................................................              -            15,874
                                                                                        ---------------  ----------------
  Total current assets..................................................................        353,497           691,733

Property and equipment, net.............................................................        446,176           601,270
Goodwill, net...........................................................................        475,567           795,945
Notes receivable, net of allowance of $6,556 and $1,712 at December 31, 1999 and 1998,
  respectively..........................................................................         22,698            32,334
Assets held for sale....................................................................         70,609           192,447
Other assets, net.......................................................................         69,941           148,309
Deferred tax assets.....................................................................              -             6,000
                                                                                        ---------------  ----------------
  Total assets..........................................................................    $ 1,438,488       $ 2,468,038
                                                                                        ===============  ================
</TABLE>

        The accompanying notes are an integral part of these consolidated
                                balance sheets.

                                      F-3
<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

                     CONSOLIDATED BALANCE SHEETS (CONTINUED)

                        AS OF DECEMBER 31, 1999 AND 1998
                      (IN THOUSANDS EXCEPT SHARE DATA)

                 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
                                                                                                1999              1998
                                                                                                ----              ----
<S>                                                                                    <C>               <C>
Current liabilities:
 Current portion of long-term debt.....................................................       $  44,776        $  812,621
 Current portion of obligations under capital leases...................................             433             3,703
 Accounts payable......................................................................          53,787            94,143
 Accrued compensation and benefits.....................................................          84,117           102,091
 Accrued interest......................................................................           2,972            26,095
 Accrued self-insurance obligations....................................................          59,075            54,865
 Other accrued liabilities.............................................................         116,489           137,851
 Income tax payables...................................................................           9,130                 -
                                                                                       ----------------  ----------------
 Total current liabilities.............................................................         370,779         1,231,369

Long-term debt, net of current portion.................................................         100,765           705,653
Obligations under capital leases, net of current portion...............................          65,675           103,679
Other long-term liabilities............................................................          36,794            41,061
Liabilities subject to compromise (see Note 2).........................................       1,558,518                 -
                                                                                       ----------------  ----------------
 Total liabilities.....................................................................       2,132,531         2,081,762

Commitments and contingencies..........................................................
Minority interest......................................................................           5,979             7,517
                                                                                       ----------------  ----------------
Company-obligated mandatorily redeemable convertible preferred securities of a
 subsidiary trust holding solely 7% convertible junior subordinated debentures of the           344,119           345,000
 Company...............................................................................
                                                                                       ----------------  ----------------
Stockholders' equity (deficit):
 Preferred stock of $.01 par value, authorized 5,000,000 shares, none issued...........               -                 -
 Common stock of $.01 par value, authorized 155,000,000 shares, 63,937,302
  and 61,930,159 shares issued and outstanding as of December 31, 1999
  and 1998, respectively...............................................................             639               619
 Additional paid-in capital............................................................         777,164           774,860
 Accumulated deficit...................................................................     (1,785,507)         (696,049)
 Accumulated other comprehensive income (loss) ........................................         (5,017)             2,902
                                                                                       ----------------  ----------------
                                                                                            (1,012,721)            82,332
 Less:
     Unearned compensation.............................................................         (3,966)           (8,552)
     Common stock held in treasury, at cost, 2,212,983 and 2,124,868 shares as
      of December 31, 1999 and 1998, respectively......................................        (27,376)          (26,967)
     Grantor stock trust, at market, 1,915,935 and 1,989,132 shares as of
      December 31, 1999 and  1998, respectively........................................            (78)          (13,054)
                                                                                       ----------------  ----------------
 Total stockholders' equity (deficit) .................................................     (1,044,141)            33,759
                                                                                       ----------------  ----------------
 Total liabilities and stockholders' equity (deficit)..................................     $ 1,438,488        $2,468,038
                                                                                       ================  ================
</TABLE>


        The accompanying notes are an integral part of these consolidated
                                balance sheets.

                                      F-4
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

                  CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES)

              FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
                      (IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>

                                                                                         1999           1998             1997
                                                                                         ----           ----             ----
<S>                                                                                  <C>            <C>             <C>
Total net revenues...............................................................      $ 2,529,039     $ 3,088,460      $ 2,010,820
                                                                                     -------------  --------------  ---------------
Costs and expenses:
  Operating costs................................................................        2,477,713       2,629,485        1,662,818
  Impairment loss................................................................          457,449         397,492                -
  Corporate general and administrative...........................................          159,671         180,934           98,169
  Interest, net (contractual interest expense $166,101)..........................          129,054         135,411           74,482
  Provision for losses on accounts receivable....................................          123,217          83,083           15,839
  Depreciation and amortization..................................................           81,325         102,515           56,630
  Loss on sale of assets, net....................................................           78,673         206,205            7,000
  Restructuring costs............................................................           27,353           4,558                -
  Loss on termination of interest rate swaps............................. .......            2,488               -                -
  Legal and regulatory matters, net..............................................               38          22,456                -
                                                                                     -------------  --------------  ----------------
  Total costs and expenses before reorganization items...........................        3,536,981       3,762,139        1,914,938
Dividends on convertible preferred securities of subsidiary......................           20,407          16,163                -
                                                                                     -------------  --------------  ---------------
Earnings (losses) before reorganization costs, income taxes, extraordinary loss and
  cumulative effect of change in accounting principle............................      (1,028,349)       (689,842)           95,882
Reorganization costs, net........................................................           48,132               -                -
                                                                                     -------------  --------------  ---------------
Earnings (losses) before income taxes, extraordinary loss and cumulative effect of
  change in accounting principle.................................................      (1,076,481)       (689,842)           95,882
Income taxes.....................................................................              161          53,577           41,153
                                                                                     -------------  --------------  ---------------
Earnings (losses) before extraordinary loss and cumulative effect of change in
  accounting principle...........................................................      (1,076,642)       (743,419)           54,729
Extraordinary loss from early extinguishment of debt, net of income tax benefit of
  $3,700 and $9,815 in 1998 and 1997, respectively...............................                -        (10,274)         (19,928)
Cumulative effect of change in accounting principle..............................         (12,816)               -                -
                                                                                     -------------  --------------  ---------------
Net earnings (losses)............................................................     $(1,089,458)     $ (753,693)        $  34,801
                                                                                     =============  ==============  ===============
Net earnings (losses) per common and common equivalent share:
Earnings (losses) before extraordinary loss and cumulative effect of change in
  accounting principle
  Basic..........................................................................       $  (18.40)      $  (14.29)        $    1.18
                                                                                     =============  ==============  ===============
  Diluted........................................................................       $  (18.40)      $  (14.29)        $    1.12
                                                                                     =============  ==============  ===============
Net earnings (losses):
  Basic..........................................................................       $  (18.62)      $  (14.49)        $    0.75
                                                                                     =============  ==============  ===============
  Diluted........................................................................       $  (18.62)      $  (14.49)        $    0.74
                                                                                     =============  ==============  ===============
Weighted average number of common and common equivalent shares outstanding:
  Basic..........................................................................           58,504          52,008           46,329
                                                                                     =============  ==============  ===============
  Diluted........................................................................           58,504          52,008           51,851
                                                                                     =============  ==============  ===============
</TABLE>


        The accompanying notes are an integral part of these Consolidated
                             Financial Statements.


                                      F-5


<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
              FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                       1999                    1998                   1997
                                                               --------------------------------------------------------------------
                                                               Shares       Amount       Shares     Amount      Shares      Amount
                                                               ------       ------       ------     ------      ------      ------
<S>                                                          <C>        <C>            <C>        <C>        <C>         <C>
COMMON STOCK
Issued and outstanding at beginning of year.................   61,930        $   619     51,698      $  517     51,143       $  511
Issuance of common stock for employee benefits..............        -              -         37           -        487            5
Conversion of 61/2% Convertible Subordinated Debentures due       774              8          2           -         68            1
  2003......................................................
Conversion of 7% Convertible Trust Issued Preferred
  Securities................................................    1,094             11          -           -          -            -
Cancellation of Restricted Stock Awards.....................     (18)              -          -           -          -            -
Employee Stock Purchase and other...........................      157              1          -           -          -            -
Common stock issued in connection with acquisitions.........        -              -      9,981         100          -            -
Common stock issued in connection with immaterial poolings..        -              -        212           2          -            -
                                                             --------  -------------  ---------  ----------  ---------  -----------
Issued and outstanding at end of year.......................   63,937            639     61,930         619     51,698          517
                                                             --------  -------------  ---------  ----------  ---------  -----------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year................................                 774,860                639,637                 611,434
Issuance of common stock for employee benefits..............                       -                    522                   5,518
Tax benefit of stock options exercised......................                       -                     57                   1,741
Conversion of 61/2% Convertible Subordinated Debentures due                   12,626                     33                   1,109
  2003......................................................
Conversion of 7% Convertible Trust Issued Preferred
  Securities................................................                     870                    121                     191
Adjustment to market value of common stock held by the
  Grantor Stock Trust.......................................                (12,512)               (26,895)                  19,644
Conversion of Mediplex convertible debt.....................                   1,579                      -                       -
Cancellation of Restricted Stock Awards.....................                   (259)                      -                       -
Common stock issued in connection with acquisitions.........                       -                161,376                       -
Common stock issued in connection with immaterial poolings..                       -                      9                       -
                                                             --------  -------------  ---------  ----------  ---------  -----------
Additional paid-in capital at end of year...................                 777,164                774,860                 639,637
                                                             --------  -------------  ---------  ----------  ---------  -----------
RETAINED EARNINGS
Balance at beginning of year................................               (696,049)                 57,114                  22,313
Net earnings (losses).......................................             (1,089,458)              (753,693)                  34,801
Common stock issued in connection with immaterial poolings..                       -                    530                       -
                                                             --------  -------------  ---------  ----------  ---------  -----------
Retained earnings (deficit) at end of year..................             (1,785,507)              (696,049)                  57,114
                                                             --------  -------------  ---------  ----------  ---------  -----------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of year................................                   2,902                  1,766                   3,718
Foreign currency translation adjustment, net of tax.........                 (7,919)                  1,136                 (1,952)
                                                             --------  -------------  ---------  ----------  ---------  -----------
Accumulated other comprehensive income at end of year.......                 (5,017)                  2,902                   1,766
                                                             --------  -------------  ---------  ----------  ---------  -----------
Total.......................................................   63,937    (1,012,721)     61,930      82,332     51,698      699,034
                                                             --------  -------------  ---------  ----------  ---------  -----------
UNEARNED COMPENSATION
Balance at beginning of year................................                 (8,552)               (14,203)                       -
Issuance of shares of restricted common stock...............                       -                  (564)                (17,458)
Cancellation of Restricted Stock Awards ....................                     260                      -                       -
Amortization of stock issued under restricted stock option
  plan......................................................                   4,326                  6,215                   3,255
                                                             --------  -------------  ---------  ----------  ---------  -----------
Unearned compensation at end of year........................                 (3,966)                (8,552)                (14,203)
                                                             --------  -------------  ---------  ----------  ---------  -----------
COMMON STOCK IN TREASURY
Balance at beginning of year................................                (26,967)               (25,574)                (25,069)
Acquired at cost............................................                   (409)                (1,393)                   (505)
                                                             --------  -------------  ---------  ----------  ---------  -----------
Common stock in treasury at end of year.....................                (27,376)               (26,967)                (25,574)
                                                             --------  -------------  ---------  ----------  ---------  -----------
GRANTOR STOCK TRUST
Balance at beginning of year................................                (13,054)               (42,204)                (40,770)
Issuance of common stock from the Grantor Stock Trust.......                     464                  1,692                     752
Issuance of shares of restricted common stock...............                       -                    563                  17,458
Adjustment to market value of common stock held by the
  Grantor Stock Trust.......................................                  12,512                 26,895                (19,644)
                                                             --------  -------------  ---------  ----------  ---------  -----------
Grantor stock trust at end of year..........................                    (78)               (13,054)                (42,204)
                                                             --------  -------------  ---------  ----------  ---------  -----------
Total stockholders' equity (deficit)........................   63,937   $(1,044,141)     61,930    $ 33,759     51,698   $  617,053
                                                             ========   ============  ==========  ==========  =========  ==========
</TABLE>
        The accompanying notes are an integral part of these consolidated
                             financial statements.

                                      F-6
<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                                        1999            1998           1997
                                                                                        ----            ----           ----
<S>                                                                               <C>             <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net earnings (losses).......................................................... $ (1,089,458)    $  (753,693)    $   34,801
                                                                                  --------------  --------------  ------------
 Adjustments to reconcile net earnings (losses) to net cash provided by (used for)
 operating activities:
     Extraordinary loss...........................................................             -          10,274        19,928
     Loss on sale of assets, net..................................................        78,673         206,205         7,000
     Impairment loss..............................................................       457,449         397,492             -
     Cumulative effect of change in accounting principle..........................        12,816               -             -
     Reorganization costs, net....................................................        48,132               -             -
     Depreciation and amortization................................................        81,325         102,515        56,630
     Provision for losses on accounts receivable..................................       123,217          83,083        15,839
     Other, net...................................................................        18,055           9,068         3,312
 Changes in operating assets and liabilities:
     Accounts receivable..........................................................       160,864        (61,679)     (164,966)
     Other current assets.........................................................         8,412        (19,557)       (6,323)
     Other current liabilities....................................................        72,607        (41,530)        24,228
     Income taxes payable.........................................................        35,430          22,242        31,284
                                                                                  --------------  --------------  ------------
 Net cash provided by (used for) operating activities before reorganization costs.         7,522        (45,580)        21,733
                                                                                  ---------------  --------------  ------------
 Net cash paid for reorganization costs ..........................................         (269)               -             -
 Net cash provided by (used for) operating activities.............................         7,253        (45,580)        21,733
                                                                                  --------------  --------------  ------------

 CASH FLOWS FROM INVESTING ACTIVITIES:
   Capital expenditures, net......................................................     (102,453)       (160,416)     (103,162)
   Acquisitions, net of cash acquired.............................................       (5,731)        (60,641)     (564,134)
   Proceeds from sale of assets held for sale.....................................         8,735               -             -
   Proceeds from sale and leaseback of property and equipment.....................        38,600         134,375        80,457
   Decrease (increase) in long-term notes receivable..............................        15,857         (5,977)      (57,431)
   Decrease (increase) in other assets............................................        45,179           6,794      (35,851)
                                                                                  ---------------  --------------  ------------
      Net cash provided by (used for) investing activities........................           187        (85,865)     (680,121)
                                                                                  ---------------  --------------  ------------

 CASH FLOWS FROM FINANCING ACTIVITIES:
    Net borrowings under Revolving Credit Agreement (postpetition) ...............        12,125               -             -
   Long-term debt borrowings......................................................       126,062         248,818     1,837,062
   Long-term debt repayments (prepetition)........................................      (92,502)       (438,607)     (966,024)
     Principal payments on prepetition debt authorized by Bankruptcy Court........      (36,118)               -             -
     Conversion of Mediplex 6.5% Convertible Subordinated Debentures due 2003.....       (6,649)               -             -
   Repurchase of 12.25% Junior Subordinated Notes and 9.875% Senior Subordinated Notes         -               -     (182,070)
   Net proceeds from issuance of convertible trust issued preferred securities of
   subsidiary.....................................................................             -         334,044             -
   Net proceeds from issuance of common stock.....................................         1,784           2,337         6,275
   Purchases of treasury stock....................................................         (409)         (1,393)         (505)
   Other financing activities.....................................................      (14,480)         (8,151)      (33,411)
                                                                                  --------------  --------------  ------------
      Net cash provided by (used for) financing activities........................      (10,187)         137,048       661,327
                                                                                  --------------  --------------  ------------
 Effect of exchange rate on cash and cash equivalents.............................         (290)             881         3,201
                                                                                  --------------  --------------  ------------
 Net increase (decrease) in cash and cash equivalents.............................       (2,457)           6,484         6,140
 Cash and cash equivalents at beginning of year...................................        27,504          21,020        14,880
                                                                                  --------------  --------------  ------------
 Cash and cash equivalents at end of year.........................................   $    25,047      $   27,504    $   21,020
                                                                                  ==============  ==============  ============
</TABLE>

        The accompanying notes are an integral part of these consolidated
                             financial statements.


                                      F-7


<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999

(1)  NATURE OF BUSINESS

     Sun Healthcare Group, Inc., a Delaware corporation,  through its direct and
indirect  subsidiaries  (hereinafter  collectively  referred  to as "Sun" or the
"Company"),  is  a  provider  of  long-term,   subacute  and  related  specialty
healthcare services,  including  rehabilitation and respiratory therapy services
and pharmaceutical and medical supply services.  Long-term and subacute care and
outpatient  therapy services are provided through  Company-operated  facilities.
Therapy  services and  pharmaceutical  and medical supply  services are provided
both in Company-operated  and in other  nonaffiliated  facilities located in the
United States.  The Company also provides  long-term care services in the United
Kingdom,  Spain and Germany, acute care services in Australia and pharmaceutical
services in the United Kingdom and Spain.

(2) PETITIONS FOR REORGANIZATION UNDER CHAPTER 11

     The Company has incurred net losses of $1,089.5  million and $753.7 million
in 1999 and 1998, respectively.  At December 31, 1999, the Company has a working
capital  deficiency  of $17.3  million and a  stockholders'  deficit of $1,044.1
million. As a result of the Company's net losses and the related  non-compliance
with most of its  long-term  debt  agreements,  on October 14, 1999 (the "Filing
Date"),  Sun Healthcare Group, Inc. and substantially all of its U.S.  operating
subsidiaries filed voluntary  petitions for  reorganization  under Chapter 11 of
the U.S.  Bankruptcy Code ("Chapter 11"). The Company is presently operating its
business  as a  debtor-in-possession  under  Chapter  11 and is  subject  to the
jurisdiction  of the U.S.  Bankruptcy  Court for the  District of Delaware  (the
"Bankruptcy Court").  The Consolidated  Financial Statements of the Company have
been  presented 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 have been prepared in
accordance with generally accepted accounting  principles  applicable to a going
concern,  which principles,  except as otherwise  disclosed,  assume that assets
will be realized and  liabilities  will be  discharged  in the normal  course of
business. The chapter 11 filings, the uncertainty regarding the eventual outcome
of the  reorganization  cases, and the effect of other unknown,  adverse factors
raise  substantial  doubt  about the  Company's  ability to  continue as a going
concern.

     On October 26, 1999, the Company announced that it had reached an agreement
in  principle  with   representatives   of  its  bank  lenders  and  holders  of
approximately  two-thirds of it  outstanding  senior  subordinated  bonds on the
terms  of an  overall  restructuring  of the  Company's  capital  structure.  If
approved  as part of the  Company's  chapter  11  plan  of  reorganization,  the
agreement in principle  would provide the Company's  bank lenders with cash, new
senior  long-term debt, new preferred stock, and new common stock. The Company's
senior subordinated bondholders would receive new common stock. The agreement in
principle  would also provide new long-term  debt,  new preferred  stock and new
common stock to general unsecured creditors, and reinstate a significant portion
of Sun's secured debt. The agreement in principle provides that holders of Sun's
outstanding  convertible  subordinated debt,  convertible trust issued preferred
securities  and common  stock  would not  receive  any  recovery  in the plan of
reorganization.  The Company and the other parties to the agreement in principle
have initiated discussions to amend the agreement in principle. No assurance can
be given that a plan of  reorganization  will be  confirmed  or that any plan of
reorganization  that is  confirmed  will  contain the terms of the  agreement in
principle. The agreement in principle expires on September 30, 2000.

                                      F-8
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     Under Chapter 11, certain claims against the Company in existence  prior to
the Filing  Date are stayed  while the Company  continues  its  operations  as a
debtor-in-possession.  These  claims are  reflected  in the  December  31,  1999
balance sheet as  "Liabilities  subject to  compromise."  Additional  chapter 11
claims  have  arisen and may  continue  to arise  subsequent  to the Filing Date
resulting from the rejection of executory contracts,  including leases, and from
the  determination by the Bankruptcy  Court of allowed claims for  contingencies
and other disputed  amounts.  Claims secured by the Company's  assets  ("secured
claims") also are stayed,  although the holders of such claims have 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.

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

     The principal categories and the balances of chapter 11 claims reclassified
in the  Consolidated  Balance  Sheet and  included  in  "Liabilities  subject to
compromise"  at December 31, 1999 are  identified  below.  These  amounts may be
subject to future adjustments  depending upon Bankruptcy Court actions,  further
developments  with  respect to disputed  claims,  whether or not such claims are
secured,  and the value of any security  interests securing such claims or other
events.
<TABLE>
<CAPTION>
                                                                        DECEMBER 31, 1999
                                                                      (dollars in thousands)
                                                                     -------------------------
<S>                                                                  <C>
Revolving Credit Facility                                                 $    411,137
Credit Facility Term Loans                                                     375,115
Senior Subordinated Notes due 2008                                             150,000
Senior Subordinated Notes dues 2007                                            250,000
Interest payable                                                               102,467
Convertible Subordinated Debentures due 2004                                    83,300
Prepetition trade and other miscellaneous claims                                79,948
Mortgage notes payable due at various dates through 2005                        47,703
Other long-term debt                                                            21,200
Capital leases                                                                  19,170
Industrial Revenue Bonds                                                        10,935
Senior Subordinated Notes due 2002                                               6,161
Convertible Subordinated Debentures due 2003                                     1,382
                                                                     -------------------------
     Total liabilities subject to compromise                               $ 1,558,518
                                                                     =========================
</TABLE>

                                      F-9
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     Since  October  14,  1999,  the  payment  of  certain   prepetition  claims
(principally  employee  wages and benefits and payments to critical  vendors and
utilities) that were approved by the Bankruptcy Court have reduced  "Liabilities
subject to compromise."

     It is not  possible  to  fully or  completely  estimate  the fair  value of
"Liabilities  subject to  compromise"  at December 31, 1999 due to the Company's
chapter  11 filing  and the  uncertainty  surrounding  the  ultimate  amount and
settlement terms for such liabilities.

     Under the  Bankruptcy  Code, the Company may elect to assume or reject real
estate  leases,   employment  contracts,   personal  property  leases,   service
contracts,  and other  unexpired  executory  prepetition  contracts,  subject to
Bankruptcy Court approval. The Company cannot presently determine with certainty
the  ultimate  aggregate  liability  which will result from the filing of claims
relating to such  contracts  which have been or may be rejected.  The Bankruptcy
Code generally  accords  priority to claims and expenses in the following order.
First,  distributions  are made to  secured  creditors  to the  extent  of their
interest  in  collateral.   Unencumbered  assets,  or  the  value  thereof,  are
distributed in the following order: to holders of super-priority claims, such as
the  lenders  under  the  debtor-in-possesion   financing  (the  "DIP  Financing
Agreement"),  holders of  administrative  expense  claims,  holder of claims for
wages and salaries,  holders of claims with respect to contributions to employee
benefit plans,  holders of certain tax claims,  holders of unsecured  claims and
holders of equity interests.

     The  Company  is in  default  with  respect  to  substantially  all  of its
prepetition borrowings. The Company's prepetition bank debt is collateralized by
(i) a pledge  of stock in the  Company's  U.S.  subsidiaries,  (ii) a pledge  of
approximately 66 percent of the stock in certain of the Company's direct foreign
subsidiaries,   (iii)  a  security   interest  in  intercompany   debt  owed  by
subsidiaries  to the  Company  and (iv) a pledge of  certain  notes  held by the
Company.

     Schedules were filed with the Bankruptcy Court setting forth the assets and
liabilities of the Company and its filing  subsidiaries as of the Filing Date as
shown by the Company's accounting records.  Differences between amounts shown by
the Company and claims filed by creditors are being  investigated  and resolved.
The ultimate amount and the settlement terms for such liabilities are subject to
a plan of  reorganization.  The plan,  when  filed,  is subject to a vote by the
Company's impaired creditors and stockholders and confirmation by the Bankruptcy
Court, and accordingly, is not presently determinable.

REORGANIZATION COSTS

     Reorganization  costs under  chapter 11 are items of expense or income that
are incurred or realized by the Company because it is in  reorganization.  These
include,  but are 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 the Company
because it is not paying its prepetition liabilities.

                                      F-10
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     For the period from the Filing Date to December  31,  1999,  reorganization
costs, net were $48.1 million and the components are as follows:
<TABLE>
<CAPTION>

                                                                 AMOUNT
REORGANIZATION COST                                          (in thousands)
<S>                                                          <C>
Write-off of debt discounts and deferred issuance costs         $37,614
Loss on sale of assets                                            7,085
Professional fees                                                 4,115
Less interest earned on accumulated cash                          (682)
                                                                -------
   Total                                                        $48,132
                                                                =======
</TABLE>


(3)  SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES

(A)      PRINCIPLES OF CONSOLIDATION

     The Consolidated  Financial  Statements include the accounts of the Company
and its greater than 50% owned subsidiaries. Investments in affiliates, in which
the Company owns 20% to 50%, are carried on the equity  method.  Investments  in
companies owned less than 20% are carried at cost. All significant  intercompany
accounts  and  transactions  have  been  eliminated  in   consolidation.   As  a
consequence of the bankruptcy filing in 1999, the non-filing subsidiaries of the
Company fully reserved for intercompany  receivables  from filing  subsidiaries.
These amounts were not material.

(B)      CASH EQUIVALENTS

     The Company  considers all highly  liquid,  unrestricted  investments  with
original  maturities  of  three  months  or less to be  cash  equivalents.  Cash
equivalents are stated at cost.

(C)      NET REVENUES

     Net revenues  consist of  long-term  and subacute  care  revenues,  therapy
services revenues, temporary therapy staffing services revenues,  pharmaceutical
and medical supply 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  frequently,  and  differences
between the net amounts  accrued and  subsequent  settlements  or  estimates  of
expected settlements are reflected in current results of operations.

     The  Company has  submitted  to the Health  Care  Financing  Administration
("HCFA")  various  requests for exceptions to the Medicare  established  routine
cost limits ("RCLs") for reimbursement.  The requests for exceptions to the RCLs
relate to services rendered in periods prior to the Company's  transition to the
Prospective Payment System ("PPS"). Prior to PPS, Medicare regulations permitted
providers to file  exception  requests in order to be reimbursed for the cost of
treating higher acuity patients. For the years ended December 31, 1998 and 1997,
included  in net  revenues  are  amounts  related to  exceptions  to the RCLs of
approximately  $30.9  million and $16.6  million,  respectively.  These  amounts
reflected  management's estimate based on its prior experience with the Medicare
Program's  regulations  and the Company's  records of service  provided,  of the
amounts  that  would  ultimately  be  approved  and paid by HCFA  related to the
requests for exceptions to the RCLs. Included in accounts receivable at December
31, 1998 were requests for exceptions to RCLs of approximately $41.0 million.

                                      F-11
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     During 1999,  HCFA denied  requests for exceptions to the RCLs filed by the
Company related to prior years. Additionally, HCFA retroactively denied requests
for exceptions  that had previously  been  approved.  The Company  established a
reserve of  approximately  $67.7  million at December  31, 1999 related to these
denials. The reserve, which is included in accounts receivable,  was recorded as
an  adjustment  to net  patient  revenues.  Differences  between the net amounts
accrued and  subsequent  settlements  or estimates of expected  settlements  are
recorded in operations in the period they occur.

(D)      ACCOUNTS RECEIVABLE

     The  Company's  accounts  receivable  relate to  services  provided  by its
various  operating  divisions to a variety of payors and customers.  The primary
payors for services  provided in long-term and subacute care facilities that the
Company  operates in the United States are the Medicare  program and the various
state Medicaid  programs.  The  rehabilitation  and respiratory  therapy service
operations in the United States  provides  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.  Because of the  significant
reduction in average payments per patient day as a result of the  implementation
of PPS,  the  Company's  estimate  of  uncollectible  accounts  receivable  from
unaffiliated  long-term care  facilities has  substantially  increased over time
(see Note 18).

(E)      INVENTORIES

     The majority of the Company's  inventories consist of merchandise purchased
for resale which are stated at the lower of FIFO  (first-in,  first-out) cost or
market.

(F)      PROPERTY AND EQUIPMENT

     Property and equipment are stated at cost.  Major renewals or  improvements
are  capitalized,  whereas  ordinary  maintenance  and repairs  are  expensed as
incurred.  Depreciation  and  amortization  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 including  renewal
options; equipment - 3 to 20 years.

     The Company  capitalizes  certain  costs  associated  with  developing  and
acquiring  healthcare  facilities and related outpatient  programs.  Capitalized
costs include site  investigation,  negotiation,  development,  acquisition  and
preconstruction  costs; indirect and general expenses related to such activities
are  expensed as  incurred.  Preconstruction  costs  include the direct costs of
securing control of the development site, obtaining the requisite certificate of
need and other  approvals,  as well as the direct costs of preparing  for actual
development  and   construction.   The  capitalized  costs  are  transferred  to
construction in progress as  construction  begins and transferred to depreciable
asset  categories  when completed.  The Company  capitalizes  interest  directly
related to the development  and  construction of new facilities as a cost of the
related asset.

                                      F-12
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(G)      GOODWILL

     The excess of the  purchase  price over the fair value of the net assets of
the  businesses  acquired by the Company is  amortized  using the  straight-line
method over periods  ranging from 20 to 40 years.  Accumulated  amortization  of
such costs was approximately  $91.7 million and $82.4 million as of December 31,
1999 and 1998, respectively.

(H)      IMPAIRMENT OF LONG-LIVED ASSETS

     The Company  periodically  evaluates the carrying  value of goodwill  along
with other related long-lived assets in relation to the future undiscounted cash
flows of the underlying  businesses to assess  recoverability in accordance with
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 121"). Under SFAS 121, an impairment loss is recognized if the sum of the
expected  cash flows is less than the carrying  amount of the goodwill and other
long-lived assets being evaluated. The difference between the carrying amount of
the goodwill and other long-lived  assets being evaluated and the estimated fair
market  value  of  the  assets  represents  the  impairment  loss.  The  Company
determines  estimated fair value for the long-lived  assets based on anticipated
future cash flows discounted at rates commensurate with the risks involved.

(I)      OTHER ASSETS

     The  accumulated  amortization  of  capitalized  debt  financing  costs was
approximately  $4.4 million as of December 31, 1998.  Substantially all deferred
debt discounts and issuance costs were expensed as Reorganization  costs in 1999
in accordance with SOP 90-7.

(J)      ACCRUED SELF-INSURANCE OBLIGATIONS

     It is the policy of the Company to self-insure for certain insurable risks,
including  general  and  professional  liability,  workers'  compensation,   and
employee health benefits, through the use of self-insurance or retrospective and
high deductible insurance policies and other hybrid policies,  which vary by the
states in which the Company  operates.  Provisions  for  estimated  settlements,
including  incurred but not reported  losses,  are provided in the period of the
related  coverage.  These  provisions  are based on internal  evaluations of the
merits  of  individual  claims  and  the  reserves  assigned  by  the  Company's
independent  insurance  carriers.  The  methods  of making  such  estimates  and
establishing the resulting accrued liabilities are reviewed frequently,  and any
adjustments resulting there from are reflected in current earnings. During 1998,
the Company  increased the accrued  self-insurance  obligations by approximately
$10.0 million primarily  related to unfavorable loss development  experience for
incurred  workers'  compensation  claims  prior to 1998.  Claims  are paid  over
varying  periods,  which  generally  range  from  one  to  five  years.  Accrued
liabilities for future claims are not discounted.

                                      F-13
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(K)      SOFTWARE DEVELOPMENT COSTS

     The Company, through an indirect,  majority owned subsidiary, is internally
developing  software  that it plans to use in its  operations  and to  market to
unaffiliated  long-term  care  providers.  All  costs  incurred  related  to the
development of the software have been expensed.  Once the Company concludes that
technological feasibility is established,  all subsequent development costs will
be capitalized  and reported at the lower of unamortized  cost or net realizable
value.  Software  development  costs are included in  operating  expenses in the
accompanying consolidated statements of earnings (losses).

(L)      INCOME TAXES

     Income tax  expense is based on  reported  earnings  before  income  taxes.
Deferred  income taxes reflect the impact of temporary  differences  between the
amount of assets and liabilities recognized for financial reporting purposes and
such amounts recognized for tax purposes. A valuation allowance is recognized if
it is anticipated that some or all of a deferred tax asset may not be realized.

(M)      FOREIGN CURRENCY TRANSLATION ADJUSTMENT

     The financial  position and results of operations of the Company's  foreign
subsidiaries  are  measured  using local  currency as the  functional  currency.
Assets and liabilities of these subsidiaries are translated at the exchange rate
in  effect at each  year  end.  Statement  of  earnings  (losses)  accounts  are
translated  at  the  average  rate  of  exchange  prevailing  during  the  year.
Translation  adjustments  arising from differences in exchange rates from period
to  period  are  included  in  accumulated  other  comprehensive  income  in the
consolidated statements of stockholders' equity (deficit).

(N)      STOCK-BASED COMPENSATION

     The Company accounts 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 the  Company's  stock at the date of the grant over the
amount an  employee  must pay to  acquire  the  stock.  Statement  of  Financial
Accounting   Standards   No. 123   "Accounting  for  Stock-Based   Compensation"
("SFAS 123")  was issued in 1995 and the  Company  has  adopted  the  disclosure
requirements of SFAS 123. The Company terminated its Directors' restricted stock
plan during October 1999 and terminated its unvested  employee  restricted stock
awards during January 2000 (see Note 15 - Capital Stock).

(O)      NET EARNINGS (LOSSES) PER SHARE

     Basic net earnings  (losses)  per share is based upon the weighted  average
number of common shares outstanding during the period.

                                      F-14
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     Diluted  net  earnings  per share in periods of  earnings 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,  including the assumption  that the Company's
convertible  securities  were  converted as of the beginning of the period.  Net
earnings,  if  conversion  of the  securities  is assumed,  is adjusted  for the
interest  on the  debentures,  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 earnings  (losses) per share is based upon the  weighted  average  number of
common  shares  outstanding   during  the  period.  The  Company's   convertible
securities  are  described  in  Note 14 -  Convertible  Trust  Issued  Preferred
Securities.  These securities were not dilutive for the years ended December 31,
1999 and 1998. See Note 16 - Earnings Per Share for  calculation of earnings per
share data for the years ended December 31, 1999, 1998 and 1997.

     The Company adopted Statement of Financial  Accounting  Standards  No. 128,
"Earnings per Share" in 1997.

(P)      ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS

     In 1998,  the American  Institute of Certified  Public  Accountants  issued
Statement  of Position  98-5,  "Reporting  on the Costs of Start-up  Activities"
("SOP  98-5").   This  statement  requires  costs  of  start-up  activities  and
organization  costs to be expensed as incurred.  The statement was effective for
financial statements for fiscal years beginning after December 15,  1998. During
the first quarter of 1999, the Company adopted the provisions of SOP 98-5, which
resulted in a cumulative  effect of a change in accounting  principle  charge of
approximately $12.8 million.

     In the first quarter of 1998,  the Company  adopted  Statement of Financial
Accounting Standards No. 130,  "Reporting  Comprehensive  Income"  ("SFAS 130").
Comprehensive  income is defined as the change in equity of a business  during a
period of  transactions  and  other  events  and  circumstances  from  non-owner
sources. Under SFAS 130, the term "comprehensive income" is used to describe the
total of net earnings plus other comprehensive  income,  which, for the Company,
includes foreign  currency  translation  adjustments.  The Company has presented
comprehensive  income in the  consolidated  statements of  stockholders'  equity
(deficit).

     In 1998, the Company adopted  Statement of Financial  Accounting  Standards
No. 131  "Disclosures  about Segments of an Enterprise and Related  Information"
("SFAS 131"). SFAS 131 establishes standards for the method that public business
enterprises  report  information  about operating  segments in annual  financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports.  It also establishes  standards
for related disclosures about products and services, geographic areas, and major
customers (see Note 21 - Segment Information).

(Q)      NEWLY ISSUED ACCOUNTING PRONOUNCEMENTS

     In June 1998,  the Financial Accounting Standards Board issued Statement of
Financial Accounting  Standards No. 133, "Accounting for Derivative  Instruments
and Hedging  Activities"  ("SFAS 133").  Under  SFAS 133,  all  derivatives  are
required to be recognized  in the balance  sheet at fair value.  Gains or losses
from  changes in fair value  would be  recognized  in  earnings in the period of
change unless the  derivative is  designated  as a hedging  instrument.  In June
1999, the Financial  Accounting  Standards  Board issued  Statement of Financial
Accounting  Standards No. 137,  which  amended SFAS 133,  delaying its effective
date to fiscal  years  beginning  after  June 15,  2000.  The  Company  does not
currently  hold  any  derivative  instruments  nor  does it  engage  in  hedging
activities.  The Company does not believe that the new standard  will impact its
Consolidated Financial Statements.

                                      F-15
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(R)      FINANCIAL STATEMENT PREPARATION AND PRESENTATION

     The  preparation  of financial  statements  in conformity  with  accounting
principles which are 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  financial  statements  and the  reported  amounts of revenues  and expenses
during the reporting period. Actual results could differ from those estimates.

     Certain amounts in the 1998 and 1997 Consolidated  Financial Statements and
notes thereto have been  reclassified to conform to the 1999  presentation.  The
reclassifications  had no effect on net losses, on net earnings or stockholders'
equity balances as previously reported.

(4)      RESTRUCTURING COSTS

     In the fourth quarter of 1998, the Company  initiated a restructuring  plan
focused  primarily  on reducing  the  operating  expenses  of its United  States
operations.  Related  to the 1998  corporate  restructuring  plan,  the  Company
recorded a 1998 fourth quarter charge of  approximately  $4.6 million.  The 1998
corporate  restructuring  plan included the elimination of  approximately  7,500
positions,  primarily in the Company's  rehabilitation  and respiratory  therapy
operations  and also included the closure of  approximately  70  divisional  and
regional  offices.   The  1998  corporate   restructuring   charge  consists  of
approximately  $3.7 million related to employee  terminations and  approximately
$0.9 million  related to lease  termination  costs. As of December 31, 1998, the
Company had terminated 1,440 employees,  and paid approximately $1.4 million and
$0.1 million in termination benefits and lease termination costs,  respectively.
As of December  31, 1998,  the  Company's  1998  corporate  restructuring  costs
reserve balances  relating to employee  terminations and lease termination costs
were approximately $2.3 million and $0.8 million, respectively.  During 1999 the
Company paid approximately $1.1 million relating to employee terminations. As of
December  31,   1999,   approximately   $1.2  million  of  the  1998   corporate
restructuring  costs reserve balance of approximately  $2.0 million is comprised
of prepetition  severance accruals that are classified as liabilities subject to
compromise in the Company's  consolidated balance sheets. In 1999, the Company's
1998 corporate restructuring plan was substantially complete.

     In the first  quarter of 1999,  the Company  initiated  a second  corporate
restructuring  plan focused on further  reducing the  operating  expenses of its
United States operations.  Related to the 1999 corporate restructuring plan, the
Company recorded a first quarter charge of approximately $11.4 million. The 1999
corporate  restructuring  plan included the termination of  approximately  3,000
employees,  primarily in its  rehabilitation  and respiratory  therapy  services
operations.   The  1999   restructuring   plan  also  includes  the  closure  of
approximately 23 divisional and regional offices. In addition, the plan included
the relocation of the management of the Company's  medical supply subsidiary and
temporary therapy services subsidiary to the Company's corporate headquarters in
Albuquerque,  New Mexico. As part of the relocation,  the Company  terminated 96
employees  of  these  subsidiaries.  The  1999  corporate  restructuring  charge
consisted  of  approximately  $9.1  million  related to  employee  terminations,
approximately  $1.4 million related to lease  termination costs and $0.9 million
related to asset disposals or write-offs.  The amounts paid out during 1999 were
consistent  with the charges  recorded in 1999.  As of December  31,  1999,  the
Company's 1999 corporate restructuring plan was complete.

                                      F-16
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     During  1999,  the  Company  recorded  financial   restructuring  costs  of
approximately  $16.0  million,  primarily  professional  fees,  related  to  the
Company's  activities  in  response  to the  defaults  under the  Senior  Credit
Facility, the 9 3/8% Subordinated Notes and the 9 1/2% Subordinated Notes and in
preparation  for  its  filing  for  protection  under  Chapter  11 of  the  U.S.
Bankruptcy Code.

(5)      ACQUISITIONS

     In January 1999, the Company acquired a mobile radiology  services business
based in Louisiana and an orthotic products manufacturing and marketing business
based in  California.  The purchase  prices and results of  operations  of these
businesses  are  immaterial.   During  1999,  the  Company  executed  management
agreements for six facilities and executed lease  agreements for five facilities
in the United States.

     On June 30,  1998, the Company  acquired  Retirement Care  Associates, Inc.
("RCA")  and  approximately  35% of the common  stock of  Contour  Medical, Inc.
("Contour"),  collectively  referred  to as  the  RCA  Acquisition.  RCA  was an
operator of skilled  nursing  facilities  and assisted  living  centers in eight
states,  primarily in the  southeastern  United  States.  Contour was a national
provider  of medical  and  surgical  supplies.  RCA owned  approximately  65% of
Contour  prior  to  the  RCA  Acquisition.   The  Company  issued  approximately
7.6 million shares of its common stock valued at $122.0 million  (based upon the
average closing price of the Company's  common stock for 20 business  days prior
to the acquisition  closing date) for all  outstanding  common stock and certain
redeemable   preferred   shares  of  RCA.  In  addition,   the  Company   issued
approximately 1.9 million shares of its common stock valued at $27.6 million for
the minority interest in Contour's common stock. The Company also issued 298,334
shares of its Series B  Convertible  preferred  stock,  which were  subsequently
converted  into  287,892  shares  of Sun  common  stock,  in  exchange  for  the
outstanding  shares of RCA's  Series F  preferred  stock.  The  Company  assumed
approximately $170.4 million of RCA indebtedness.

     The RCA Acquisition was accounted for as a purchase with  $229.9 million of
goodwill  recorded  in  connection  with the  transaction.  Property,  plant and
equipment  was  recorded  at fair  value and  favorable  and  unfavorable  lease
intangibles were  identified.  The results of operations of RCA and Contour have
been  included in the  consolidated  statements  of earnings  (losses)  from the
acquisition date. In connection with the purchase, the Company recorded purchase
liabilities including approximately $2.4 million for severance and related costs
and   $1.4 million   for  costs   associated  with  the  shut  down  of  certain
administrative  facilities.  During 1998,  the Company paid  approximately  $1.7
million  and $0.3  million  for  severance  related  items  and the shut down of
certain facilities in connection with the purchase, respectively. As of December
31, 1998, the Company had purchase liabilities of approximately $0.7 million and
$1.1 million  related to severance  related costs and costs  associated with the
shut down of certain  facilities.  During 1999,  the Company paid  approximately
$0.7 million and $1.1 million for  severance  related items and the shut down of
certain facilities in connection with the purchase, respectively. As of December
31,  1999,  the  Company  had  no  purchase   liabilities  related  to  the  RCA
acquisition.

                                      F-17
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     In October 1997,  the Company  acquired the capital stock of Regency Health
Services,  Inc.  ("Regency"),  an operator of skilled  nursing  facilities and a
provider of related  specialty  healthcare  services,  including  rehabilitation
therapy,  pharmacy and home health  services in the United  States (the "Regency
Acquisition").  The Regency  Acquisition was accounted for as a purchase and the
operating  results of Regency have been included in the consolidated  statements
of earnings (losses) from the date of acquisition.  Total  consideration for the
shares  acquired  was  approximately  $367.2 million.  The total  fair  value of
Regency's assets acquired,  including goodwill of approximately  $412.2 million,
was approximately $736.6 million, and liabilities assumed totaled  approximately
$354.7 million.  In connection with the purchase,  the Company recorded purchase
liabilities  including  approximately  $11.2 million  for  severance and related
costs and  $2.0 million  for  costs  associated  with the shut  down of  certain
acquired pharmacies and home health service agencies that have been consolidated
with the Company's existing facilities. As of December 31, 1999, the Company had
no purchase liabilities related to the Regency acquisition.

     On  October 9,  1997,  the Company  completed a tender  offer for 100%,  or
$50.0 million,  of  Regency's  12.25%  Junior  Subordinated  Notes  due 2003 for
approximately  $60.1 million  plus accrued interest,  and  $109.6 million of the
$110.0 million  of  Regency's  9.875%  Senior  Subordinated  Notes  due 2002 for
approximately   $122.0 million  plus  accrued  interest.  As  a  result  of  the
repurchase  of  this  debt,  the  Company  recorded  an  extraordinary  loss  of
$17.9 million,  net of the related tax benefit,  in the fourth  quarter of 1997.
The  Company  repaid  Regency's   revolving  credit  facility  of  approximately
$39.0 million.  The  extinguishment  of certain  Regency  debt during the fourth
quarter of 1997  resulted  in an  increase  in certain  reimbursable  costs from
Medicare.

     The tender  offer for  Regency's  debt,  described  above,  was financed by
borrowings  under  the  Company's  Senior  Credit  Facility  and   approximately
$83.6 million  of net  proceeds  received  from  the sale  and  leaseback  of 30
facilities owned by Regency prior to its acquisition by the Company.

     The following  unaudited  proforma results assumes that the RCA Acquisition
and the Regency  Acquisition  occurred as of  January 1,  1997 and include their
results  of  operations  for the  years  ended  December 31,  1998  and 1997 (in
thousands, except per share data):
<TABLE>
<CAPTION>
                                                                                  1998             1997
                                                                                  ----             ----
                                                                                Unaudited       Unaudited
<S>                                                                             <C>             <C>
Net revenues..............................................................        $3,226,853       $2,761,531
Net losses before extraordinary items.....................................         (777,332)         (27,232)
Net losses................................................................         (787,605)         (47,325)
Per Share Data:
Net losses per share before extraordinary items...........................         $ (14.95)        $  (0.51)
Net losses per share......................................................         $ (15.14)        $  (0.88)
</TABLE>

     In addition,  during 1998, the Company  acquired from various third parties
the net ownership of, leasehold  rights to, or the management  contracts of, two
long-term care  facilities in the United States and 15 long-term care facilities
in the  United  Kingdom.  Also,  during the year ended  December 31,  1998,  the
Company acquired nine pharmacies in the United States.

                                      F-18
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     On  January 30,  1997,  the Company  acquired all of the capital  stock not
previously owned by the Company of Ashbourne PLC  ("Ashbourne")  which as of the
date of acquisition  provided healthcare services to patients through 49 nursing
facilities in the United Kingdom. Pursuant to the acquisition,  the Company paid
approximately  L67.3 million  ($110.1 million  as of  the  respective  dates  of
payment) for the portion of Ashbourne totaling 70.8% not previously owned by the
Company.  The  Company  had  previously  acquired  a 9%  minority  interest  for
$10.2 million in 1996 and a 20% minority interest for $25.9 million in 1995. The
acquisition  was  accounted  for  as  a  purchase  and  Ashbourne's  results  of
operations  have been included in the Company's  financial  statements  from the
date of  acquisition.  The  total  fair  value  of 100%  of  Ashbourne's  assets
acquired, including goodwill of approximately  $61.3 million,  was approximately
$300.0 million and liabilities assumed totaled approximately $147.7 million.

     In July 1997,  the Company  acquired a majority  interest in Eurosar,  S.A.
("Eurosar"),  a privately  owned  operator of eight nursing  homes in Spain.  In
August 1997, the Company acquired 38% of the equity of Alpha Healthcare Limited,
a publicly held acute care provider in Australia. In addition, in November 1997,
Sun acquired from Moran Healthcare Group Pty Ltd.  ("Moran") a majority interest
in six hospitals in Australia. In December 1997, the Company acquired a majority
interest  in  Heim-Plan  Unternehmensgruppe  ("Heim-Plan"),  an  operator  of 11
nursing homes in Germany.

     The  effects of the  Company's  acquisitions  during  1999,  1998 and 1997,
excluding the RCA Acquisition and the Regency  Acquisition,  individually and in
the  aggregate,  are  immaterial  to the  operating  results of the Company and,
therefore, pro forma information is not provided.

(6) PROPERTY AND EQUIPMENT

     Property and  equipment  consists of the  following as of  December 31  (in
thousands):
<TABLE>
<CAPTION>
                                                                                              1999               1998
                                                                                              ----               ----
       <S>                                                                              <C>                  <C>
       Land............................................................................        $  40,486         $  44,524
       Buildings and improvements......................................................          177,951           263,145
       Leasehold improvements..........................................................           50,498            68,037
       Equipment.......................................................................          140,013           126,358
       Construction in progress........................................................           46,549            30,449
       Assets held under capital leases................................................           49,587           109,207
                                                                                         ----------------    --------------
         Total.........................................................................          505,084           641,720
       Less accumulated depreciation...................................................         (49,961)          (29,130)
       Less accumulated amortization on assets held under capital leases...............          (8,947)          (11,320)
                                                                                         ----------------    --------------
         Property and equipment, net...................................................        $ 446,176         $ 601,270
                                                                                         ================    ==============
</TABLE>

     Amortization of assets held under capital lease agreements of $3.5 million,
$6.1 million and $4.4 million in 1999, 1998 and 1997, respectively, was recorded
in depreciation and amortization expense.

     During 1999,  the Company sold 11 long-term  care  facilities in the United
Kingdom for  approximately  $38.6  million in cash and leased the 11  facilities
back under twelve-year lease terms.

                                      F-19
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     During 1998,  the Company sold seven of its long-term  care  facilities and
land in the United Kingdom for approximately $117.9 million in cash. Five of the
long-term care facilities were leased back to the Company under operating leases
with lease terms ranging from 11 to 20 years.

     During 1997,  the Company sold 27 of its long-term  care  facilities in the
United  Kingdom  for  approximately  $49.3 million  and  leased  them back under
twelve-year leases. Also during 1997, the Company sold five of its long-term and
subacute care facilities in the United States for approximately $31.2 million in
cash and  approximately  $5.6 million in assumption of debt and leased them back
under fourteen-year leases.

(7)      IMPAIRMENT OF LONG-LIVED ASSETS AND ASSETS HELD FOR SALE

(A)      IMPAIRMENT OF LONG-LIVED ASSETS

     SFAS 121 requires  impairment losses to be recognized for long-lived assets
used in operations  when  indications of impairment are present and the estimate
of undiscounted  future cash flows is not sufficient to recover long-lived asset
carrying  amounts.  SFAS 121  also  requires  that  long-lived  assets  held for
disposal be carried at the lower of  carrying  value or fair value less costs of
disposal, once management has committed to a plan of disposal.

     The Balanced  Budget Act of 1997  established,  among other  things,  a new
Medicare  PPS for  skilled  nursing  facilities.  PPS became  effective  for the
Company's  facilities  acquired from RCA on July 1,  1998, and for the Company's
remaining  facilities  on  January 1,  1999.  The  Company's  revenues  from its
Inpatient  Services Division,  Rehabilitation  and Respiratory  Therapy Services
Division  and   Pharmaceutical   and  Medical  Supply  Services   Division  were
significantly and adversely impacted by the amount of the federally  established
reimbursement rates. In the first quarter of 1999, the Company became aware that
these reductions were expected to have a material adverse impact on net revenues
in 1999 and the decline was other than  temporary.  This served as an indication
to the  Company  that  the  carrying  values  of the  long-lived  assets  of its
Inpatient  Services Division,  Rehabilitation  and Respiratory  Therapy Services
Division  and its  Pharmaceutical  and Medical  Supply  Services  Division  were
impaired.

     During the second quarter of 1999, the Company  revised its  projections of
future cash flows for its various  business units as current  operating  results
were worse than  planned.  The  significant  write-down  of  goodwill  and other
long-lived assets resulted from the continued adverse impact of PPS on the level
of  Medicare  reimbursement  and  occupancy  and the  demand  for the  Company's
rehabilitation  and respiratory  therapy and  pharmaceutical  and medical supply
services.  Additionally,  certain  of the  United  Kingdom  facilities  have not
achieved profitability targets established upon their acquisition.

                                      F-20
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The following is a summary of the  impairment  loss by segment for the year
ended December 31, 1999 and 1998 (in thousands):

<TABLE>
<CAPTION>
                                                                             PROPERTY
                                                                                AND            OTHER
                                                              GOODWILL       EQUIPMENT         ASSETS           TOTAL
                                                              --------       ---------         ------           -----
<S>                                                      <C>            <C>              <C>             <C>
1999:
Inpatient Services...................................         $192,459        $  88,852        $ 13,701       $ 295,012
Rehabilitation and Respiratory Therapy...............           49,529           11,005              11          60,545
Pharmaceuticals and Medical Supply Services..........           29,133            2,417               -          31,550
International Operations.............................           29,322           31,959               -          61,281
Other Operations.....................................            5,327            1,794           1,940           9,061
                                                         -------------  ---------------  --------------  --------------
                                                             $ 305,770        $ 136,027        $ 15,652       $ 457,449
                                                         =============  ===============  ==============  ==============


                                                                              PROPERTY
                                                                                AND            OTHER
                                                              GOODWILL       EQUIPMENT         ASSETS           TOTAL
                                                              --------       ---------         ------           -----
1998:
Inpatient Services...................................         $223,241        $  55,736        $ 14,168        $293,145
Rehabilitation and Respiratory Therapy...............           36,734               60           4,216          41,010
Pharmaceuticals and Medical Supply Services..........            2,784              233              31           3,048
International Operations.............................           26,520           10,151               -          36,671
Other Operations.....................................           23,590               28               -          23,618
                                                         -------------  ---------------  --------------  --------------
                                                              $312,869        $  66,208        $ 18,415       $ 397,492
                                                         =============  ===============  ==============  ==============
</TABLE>

 (B)     ASSETS HELD FOR SALE

     The  Company  recorded  a loss of  $206.2  million  in 1998 to  reduce  the
carrying amount of the non-core  businesses  identified for disposal,  including
assisted  living  facilities,   rehabilitation  hospitals  and  other  inpatient
facilities and other non-core businesses.  The fair value of the assets held for
sale was based on  estimates of selling  value less costs to sell.  During 1999,
the Company decided not to divest the  rehabilitation  hospitals,  certain other
inpatient  facilities and certain other non-core  businesses because the Company
believed that the offers it received for these  businesses  were not sufficient.
The  losses  recorded  during  1998 of  $54.5  million  for  the  rehabilitation
hospitals and other  inpatient  facilities  were reversed and netted against the
loss on sale of assets for the year ended  December 31, 1999. The following is a
summary  (in  thousands)  of the  carrying  amounts  of assets  held for sale at
December  31,  1999 and 1998 and the loss on sales of assets and assets held for
sale,  net for the years ended  December 31, 1999 and 1998. The loss on sales of
assets for the year ended December 31, 1999 includes  approximately $7.1 million
recorded as a reorganization  cost in the Company's  Consolidated  Statements of
Earnings (Losses).

<TABLE>
<CAPTION>
                                                                      CARRYING
                                                                       AMOUNT                         LOSS, NET
                                                                       ------                         ---------
                                                                 1999           1998           1999          1998
                                                                 ----           ----           ----          ----
<S>                                                      <C>            <C>            <C>            <C>
Assisted living facilities...............................    $  67,116      $ 110,000       $ 41,667      $ 97,298
Rehabilitation hospitals and other inpatient facilities..            -         57,814         15,132        95,367
Other non-core businesses................................        3,493         24,633         28,959        13,540
                                                         -------------  -------------  -------------  ------------
  Total..................................................    $  70,609      $ 192,447       $ 85,758     $ 206,205
                                                         =============  =============  =============  ============
</TABLE>

                                      F-21
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     During the  fourth  quarter  of 1999,  the  Company  divested  its  hospice
operations in the United  States.  The Company  received cash  consideration  of
approximately $0.2 million from this transaction.  The aggregate net revenues of
the hospice  operations were approximately $7.5 million and $9.6 million in 1999
and 1998,  respectively.  The aggregate net losses before management  charges of
the  hospice  operation  were  approximately  $1.8 and  $2.2 in 1999  and  1998,
respectively. The loss on this transaction was approximately $7.2 million.

     In October 1999, the Company entered into an agreement to divest certain of
its assisted  living  facilities in the United  States.  In December  1999,  the
company  divested  eight  assisted  living  facilities,  which  it  had  held  a
ten-percent equity interest in. The Company managed these eight facilities until
divesting  them in December  1999.  The cash  consideration  received  from this
transaction was approximately  $3.7 million.  In addition,  the Company received
parcels of land valued at approximately  $9.2 million in this  transaction.  The
aggregate net loss on this transaction was approximately  $31.2 million of which
approximately  $15.8  million and $15.4  million was  recorded to loss on assets
held for sale, net in 1999 and 1998, respectively.

     In addition during  December 1999, the Company sold a majority  interest in
four assisted living facilities housed on three campuses one of which included a
skilled nursing facility.  The Company managed these facilities on behalf of the
purchaser during the first quarter of 2000. The cash consideration received from
this  transaction was  approximately  $0.4 million.  The Company also obtained a
note receivable of approximately $1.0 million from the purchaser.  The aggregate
debt,  capital  leases,  notes  payable  and other  liabilities  assumed  by the
purchaser totaled  approximately  $21.0 million.  The aggregate net loss on this
transaction was approximately  $37.2 million of which approximately $9.1 million
and $28.1 million was recorded to loss on assets held for sale,  net in 1999 and
1998, respectively.

     During  December  1999,  the Company  also sold a parcel of land.  The cash
consideration  received from this  transaction was  approximately  $4.6 million.
This transaction resulted in a gain of approximately $0.7 million.

     During 1999, the Company sold three skilled nursing facilities. The Company
did not receive any cash  consideration from these sales. The purchasers assumed
secured debt of $10.7 million related to these sales. The aggregate net revenues
of these facilities were approximately $9.5 million and $6.3 million in 1999 and
1998, respectively. The aggregate net operating losses before management charges
were approximately $2.6 million and $2.5 million in 1999 and 1998, respectively.
The Company  recorded an  aggregate  net gain of  approximately  $6.5 million on
these sales.

     During  1999,  11 skilled  nursing  facility  leases  expired  and were not
renewed. The aggregate net revenues of these facilities were approximately $13.4
million and $25.9  million in 1999 and 1998,  respectively.  The  aggregate  net
operating   losses  before   management   charges  of  these   facilities   were
approximately $0.1 million and $0.2 million in 1999 and 1998, respectively.  The
Company recorded an aggregate net loss of approximately  $3.8 million  primarily
related to the  write-off  of the  carrying  amount of  building  and  leasehold
improvements, equipment and goodwill.

                                      F-22
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     During  1999,  through  mutual  agreements  with the  lessors,  the Company
terminated 35 skilled nursing facility leases. The Company recorded an aggregate
net loss of approximately $5.8 million primarily related to the write-off of the
carrying amount of building and leasehold improvements,  equipment and goodwill.
The aggregate net revenues of these facilities were approximately  $71.6 million
and $105.3 million in 1999 and 1998,  respectively.  The aggregate net operating
losses before management  charges of these facilities were  approximately  $12.2
million and $3.7 million in 1999 and 1998, respectively.

     During the period of January 1, 2000 through May 31,  2000,  Sun divested a
total of 18 pharmacies in the United Kingdom,  resulting in an aggregate gain of
approximately $1.0 million. The aggregate cash consideration  received for these
divestitures was approximately $9.7 million.

     The  Company  is  actively   reviewing  its  portfolio  of  long-term  care
facilities and its ancillary  operations and intends to divest those  facilities
and operations  that it believes do not meet  acceptable  financial  performance
standards  or do not fit  strategically  into  the  Company's  operations.  This
process is expected to be ongoing at least throughout 2000.

     During the first quarter of 2000, the Company  entered into an agreement to
sell sixteen assisted living facilities, one of which includes a skilled nursing
facility. See "Note 24 - Subsequent Events."

     As of June 30,  2000,  the  Company  intends to divest 49  skilled  nursing
facilities.  The aggregate net revenues of these  facilities were  approximately
$186.2 million and $199.2 million in 1999 and 1998, respectively.  The aggregate
net operating losses and net gains before management  charges were approximately
$6.7  million and $1.5 million in 1999 and 1998,  respectively.  There can be no
assurance that the Company will be able to divest these  facilities,  or that if
divested,  the  Company  will  not  incur  significant  losses.  These  intended
divestitures are subject to Bankruptcy Court approval.

     During 1998,  certain  leases were not renewed.  In  connection  with these
lease terminations, the Company recorded a loss of $25.6 million in 1998 related
primarily  to the  carrying  amount  of  building  improvements,  equipment  and
goodwill  related  to  the  facilities.  The  results  of  operations  of  these
facilities is not material.

     In May 1997,  the  Company  announced  its intent to sell and divest of its
outpatient  rehabilitation clinics in the United States and Canada. The carrying
amount of the assets  held for sale was $11.6  million  and $22.5  million as of
December 31, 1998 and 1997, respectively. The Company completed the sales of the
United  States  rehabilitation  clinics  and a portion of the  Canadian  clinics
during 1998. The remaining Canadian clinics were sold in March 1999. The Company
recorded losses of  approximately  $2.0 million,  $11.4 million and $7.0 million
during 1999, 1998 and 1997, respectively,  in order to reduce the carrying value
of the Canadian  operations to fair value based on revised  estimates of selling
value less costs to sell.  The results of operations of these  businesses is not
material.

     In the second quarter of 1998,  the Company  recognized a $5.4 million loss
in connection with the anticipated  sale of five nursing homes,  and for certain
adjustments paid to the purchaser of three nursing homes sold in 1996.

                                      F-23
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(8)  DEBTOR-IN-POSSESSION FINANCING

     On October 14, 1999, the Company entered into a Revolving  Credit Agreement
with   CIT/Business   Credit,   Inc.  and  Heller   Healthcare   Finance,   Inc.
(collectively, the "DIP Lenders") to provide the Company with up to $200 million
in debtor-in-possession  financing.  The Bankruptcy Court granted final approval
of the DIP Financing Agreement on November 12, 1999. The DIP Financing Agreement
provides for maximum  borrowing by the Company equal to the sum of (i) up to 85%
of the then  outstanding  domestic  eligible  accounts  receivable  and (ii) the
lesser of $10 million or 50% of the aggregate value of eligible  inventory.  The
DIP Financing  Agreement matures on October 14, 2001. Fees and expenses of $4.25
million  were paid  under  this  agreement  in 1999 and are being  amortized  to
operations over one year.

     Interest  accrues  on  the  principal  amount  outstanding  under  the  DIP
Financing  Agreement at a per annum rate of interest equal to the Alternate Base
Rate ("ABR") (Chase Manhattan) plus 0.25% or the London International  Borrowing
Offer Rate  ("LIBOR")  plus  2.75% and is  payable  in arrears on each  Interest
Payment Date. The one-month  LIBOR was  approximately  5.8% at December 31, 1999
and 6.5% at May 31, 2000. In the event of an Event of Default,  interest accrues
on the principal  amount of the loans  outstanding  at a rate per annum equal to
the ABR plus  2.00% and is  payable  daily.  The ABR was  approximately  8.6% at
December 31, 1999 and 9.3% at May 31, 2000.

     The  obligations  of the  Company  under the DIP  Financing  Agreement  are
jointly and severally  guaranteed by each of the other Company debtors  pursuant
to the agreement.  Under the terms of the agreement,  the obligations of the DIP
Lenders  under  the  agreement  (the  "DIP   Obligations")   constitute  allowed
super-priority  administrative  expense claims pursuant to Section 364(c) of the
Bankruptcy  Code  (subject to a  carve-out  for  certain  professional  fees and
expenses  incurred by the Company  Debtors).  The DIP Obligations are secured by
perfected liens on all or substantially all of the assets of the Company Debtors
(excluding  bankruptcy causes of action),  the priority of which liens (relative
to prepetition creditors having valid,  non-avoidable,  perfected liens in those
assets and to any "adequate  protection"  liens granted by the Bankruptcy Court)
is established in the Initial  Company DIP Order and the related cash collateral
ordered  entered by the Bankruptcy  Court (the "Initial  Company Cash Collateral
Order"). The Bankruptcy Court has also granted certain prepetition  creditors of
the Company Debtors replacement liens and other rights as "adequate  protection"
against any diminution of the value of their  existing  collateral in which such
creditors had valid  non-avoidable  and perfected liens as of the Petition Date.
The  discussion  contained  in this  paragraph  is  qualified in its entirety by
reference  to the  Interim  Company  DIP  Order  and the  Initial  Company  Cash
Collateral  Order,  and  reference  should  be made to such  orders,  which  are
available  from the  Bankruptcy  Court,  for a more complete  description of the
terms.

     The Company's DIP Financing  Agreement contains customary  representations,
warranties,  and covenants of the Company Lenders,  as well as certain financial
covenants  relating to minimum  earnings before income taxes,  depreciation  and
amortization (EBITDA), maximum capital expenditures, and minimum patient census.
The breach of any such representations,  warranties, or covenants, to the extent
not waived or cured within any applicable grace or cure periods, could result in
the Company  being unable to obtain  further  advances  under the DIP  Financing
Agreement  or the  exercise  of  remedies  by the DIP  lenders,  either of which
occurrence  could  materially  impair the ability of the Company to successfully
reorganize in chapter 11.

                                      F-24
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     At May 31, 2000,  approximately  $132.0 million was available under the DIP
Financing  Agreement.  Letters of credit of  approximately  $19.1  million  were
outstanding  under the facility as of May 31, 2000.  Peak  borrowings  under the
agreement  during  1999  were  approximately  $56.7  million  with an  effective
interest rate during the year of approximately 8.8%.

     The DIP  Financing  Agreement  provides  that the Company  must comply with
certain financial  covenants which include a limitation on capital  expenditures
and a minimum amount on the last day of each month of EBITDA. The following is a
brief  summary  of the  limitations  on  capital  expenditures  and the  minimum
specified month end requirement for EBITDA.
<TABLE>
<CAPTION>

Capital Expenditures Aggregate Limitations on Corporate Headquarters:
<S>                        <C>
$3,000,000                 For the period October 14, 1999 to December 31, 1999
$6,000,000                 During fiscal 2000 and for each fiscal year until
                           maturity

Capital Expenditures on Domestic Healthcare Facilities:

$12,900,000                For the period October 14, 1999 to December 31, 1999
$49,300,000                During fiscal 2000 and for each fiscal year until
                           maturity
</TABLE>

<TABLE>
<CAPTION>

Minimum cumulative EBITDA at Month End:
<S>                                        <C>
October 1999                               $ 2,500,000
November 1999                              $ 3,600,000
December 1999                              $ 5,700,000
January 2000                               $11,900,000
February 2000                              $14,300,000
March 2000                                 $21,000,000
April 2000                                 $24,700,000
May 2000                                   $30,900,000
June 2000                                  $36,100,000
July 2000                                  $43,700,000
August 2000                                $52,900,000
September 2000                             $58,200,000
October 2000                               $64,100,000
November 2000                              $68,700,000
December 2000                              $73,000,000
</TABLE>

     It would be an event of default  if  cumulative  EBITDA for any  continuous
twelve-month   period  beginning  with  or  after  January  2001  is  less  than
$73,000,000.

                                      F-25
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The Company was not in  compliance  with the EBITDA  financial  covenant at
December  31, 1999 and in each of the months for the period  ended May 31, 2000.
The Company was also not in compliance with the DIP Financing  Agreement because
the Company did not timely provide the DIP Lenders with financial statements for
the year ended  December  31, 1999 and the quarter  ended  March 31,  2000.  The
Company  obtained a conditional  waiver of these  defaults in July 2000. The DIP
Lenders have agreed to waive the defaults  subject to, among other  things,  the
Company and the DIP Lenders  entering  into an  amendment  of the DIP  Financing
Agreement to modify the  cumulative  EBITDA  covenant and the payment to the DIP
Lenders  of a  $250,000  fee to enter  into the  amendment,  both of which  will
require the approval of the Bankruptcy Court.

(9) LONG-TERM DEBT

     As a result of the chapter 11 filing, substantially all short and long-term
debt at the Filing Date of October 14, 1999,  were  classified  as  "Liabilities
subject  to  compromise"  in  the  Company's   consolidated  balance  sheets  in
accordance  with SOP 90-7.  No  principal  has been paid or interest  accrued on
prepetition  obligations  since the Filing Date,  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.

     Under  the  Bankruptcy  Code,   actions  against  the  Company  to  collect
prepetition   indebtedness   are  subject  to  an  automatic   stay   provision.
Additionally,  the Company  may elect to assume or reject  real  estate  leases,
employment  contracts,  personal  property leases,  service  contracts and other
unexpired executory prepetition contracts subject to Bankruptcy Court approval.

                                      F-26
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

Long-term debt at December 31 consisted of the following (in thousands):
<TABLE>
<CAPTION>
                                                                                              1999              1998
                                                                                              ----              ----
<S>                                                                                     <C>               <C>
DIP Financing Agreement.................................................................    $ 12,126             $      -
Senior Credit Facility:
Revolving Credit Facility (see below)...................................................     411,137 (1)          360,100
Credit Facility Term Loans (see below)..................................................     375,115 (1)          385,473
RCA Line of Credit (see below)..........................................................           -               15,000
9 3/8% Senior Subordinated Notes due 2008...............................................     150,000 (1)          150,000
9 1/2% Senior Subordinated Notes due 2007...............................................     250,000 (1)          250,000
Convertible Subordinated Debentures due 2004, interest at 6.0% per annum................      83,300 (1)           83,300
Convertible Subordinated Debentures due 2003, interest at 6 1/2% per annum, includes
  unamortized premium of $1,899 as of December 31, 1998.................................       1,382 (1)           22,564
Senior Subordinated Notes due 2002, interest at 11 3/4% per annum, includes unamortized
  premium of $96 as of December 31, 1998................................................       6,161 (1)            6,257
Mortgage notes payable due at various dates through 2014, interest at rates from 8.0%
  to 11.42%, collateralized by various facilities.......................................      63,578 (2)           40,041
Mortgage notes payable in Spanish pesetas due at various dates through 2017,
  interest at rates from 4.97% to 14.0%, collateralized by various facilities in Spain..      13,977               16,268
Mortgage notes payable in pound sterling due at various dates in 2015 and 2016,
  interest at 9.50% per annum, collateralized by various facilities in the United              4,795                5,227
  Kingdom...............................................................................
Mortgage notes payable in German marks due at various dates through 2003, interest
  at rates from 6.25% to 6.75%, collateralized by various facilities in Germany.........       6,899                8,148
Mortgage notes payable in Australian dollars due at various dates through 2001,
  interest from 7.6 % to 8.04% collateralized by various facilities in Australia........      13,841                6,394
Revolving lines of credit with a bank due at various dates through 2000, payable in.
  pounds sterling, interest rates of 6.4% and variable rates from 1.0% to 3.0% over the
Finance House Base Rate, collateralized by the assets of various facilities.............       4,901                4,899
Industrial Revenue Bonds................................................................      63,660 (3)           83,919
Other long-term debt....................................................................      41,604 (4)           80,684
                                                                                        ----------------  ---------------
Total long-term debt....................................................................   1,502,476            1,518,274
Less long-term debt subject to compromise...............................................  (1,356,935)                   -
Less amounts due within one year........................................................     (44,776)             (50,378)
Less amounts in non-compliance classified as current....................................           -             (762,243)
                                                                                        ----------------  ---------------
Long-term debt, net of current portion................................................. $    100,765         $    705,653
                                                                                        ================  ===============
</TABLE>

     Long-term  debt at December 31, 1999,  includes one fully secured  mortgage
note  payable,  certain  Industrial  Revenue  Bonds  and  other  debt  of  which
approximately  $52.7 million was assumed by the purchaser in a Bankruptcy  Court
approved sales transaction subsequent to year end and the Company's foreign debt
obligations.

(1)  Classified   as   liabilities   subject  to  compromise  in  the  Company's
     consolidated balance sheets.

(2)  Approximately  $47,703  classified as liabilities  subject to compromise in
     the Company's consolidated balance sheets.

                                      F-27
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(3)  Approximately  $10,935  classified as liabilities  subject to compromise in
     the Company's consolidated balance sheets.

(4)  Approximatley  $21,200  classified as liabilities  subject to compromise in
     the Company's consolidated balance sheets.

     The scheduled  maturities of long-term  debt (not  including  that which is
subject to compromise) as of December 31, 1999 is as follows (in thousands):
<TABLE>
<CAPTION>

<S>                                                <C>
2000...............................................          $     44,776
2001...............................................                19,572
2002...............................................                 3,422
2003...............................................                 3,647
2004...............................................                 3,828
Thereafter.........................................                70,296
                                                   ----------------------
                                                              $   145,541
                                                   ======================
</TABLE>
     Included  in the  information  above,  is  approximately  $52.7  million of
Industrial Revenue Bonds and other debt which was assumed subsequent to year end
by the purchaser in a Bankruptcy Court approved sales transaction.

     In October 1997, the Company  entered into a credit  agreement with certain
lenders,  certain  co-agents,  and NationsBank of Texas,  N.A. as administrative
lender to replace the Company's prior revolving credit facility.  On October 30,
1998, the Company entered into a fourth  amendment to the credit  agreement (the
"Senior Credit  Facility").  The Senior Credit Facility  initially  provided for
borrowings by the Company of up to $1,200.0 million consisting of $500.0 million
in a revolving  credit facility which borrowings bear interest at the prevailing
prime rate plus 0.0% to 1.0% or the LIBOR  rate plus 0.75% to 2.50%,  and $700.0
million in term loans which bear interest at the  prevailing  prime rate plus 0%
to 1.5%. In May 1998, the Company permanently reduced the Senior Credit Facility
Term  Loans by  $300.0  million  with a  portion  of the net  proceeds  from the
offerings of the 7% Convertible Trust Issued Preferred Securities (see Note 14 -
Convertible Trust Issued Preferred Securities) and the 9 3/8% Notes. As a result
of the paydown,  the Company  recorded an  extraordinary  loss of  approximately
$10.3 million, net of income tax benefit of approximately $3.7 million.

     At December 31,  1998,  the Company was not in  compliance  with its Senior
Credit  Facility,  which would have allowed the Lenders to require  repayment of
all amounts  outstanding  under the Senior  Credit  Facility.  As a result,  the
Company  classified all borrowings  under the Senior Credit  Facility as current
liabilities in the  Company's consolidated  balance sheet as of December 31,
1998.

     Prior to the RCA  Acquisition,  RCA entered into a Revolving Line of Credit
Agreement ("RCA Line of Credit") with  Healthcare  Financial  Partners  ("HCFP")
that provided for borrowings by RCA of up to $15.0 million, with interest at the
prevailing prime rate plus 1% to 2% (9.75% at December 31, 1998) and maturity in
2001. The RCA Line of Credit was paid off during October 1999.

                                      F-28
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The Company had  approximately  $31.9 million of mortgages  with  Meditrust
(certain  Mortgage Notes) as of December 31, 1998, that contain less restrictive
covenants  and include  cross-default  provisions  with all other  mortgages and
leases  also  financed  by   Meditrust.   The   Meditrust   mortgages   were  in
non-compliance  as of December  31,  1998,  because the Company did not meet the
fixed  charge  ratio  of at  least  1.25  to  1.  Because  the  Company  was  in
non-compliance  with the terms of the  mortgages,  the  amounts  owed  under the
mortgages were classified as a current  liability as of  December 31,  1998. The
Company also has 36 facility  leases with Meditrust  which are in default due to
cross-default provisions with the Meditrust mortgages and leases.

     In  May  1998,  the  Company  entered  into  certain   interest  rate  swap
transactions with an aggregate  notional value of $850.0 million to minimize the
risks and/or costs  associated with certain  long-term debt of the Company.  The
Company does not otherwise  utilize  financial  instruments for trading or other
speculative  purposes.  The interest rate swap  transactions  were designated as
hedges for accounting purposes.  The amounts to be paid or received were accrued
and  recognized  as an  adjustment to interest  expense.  On April 9, 1999,  the
interest  rate swap  transactions  were  terminated  due to an event of  default
relating to the Company's non-compliance with certain covenants contained in the
Senior  Credit  Facility.  The  termination  resulted  in a  pre-tax  charge  of
approximately $2.5 million in 1999.

     The  Company  has  outstanding   letters  of  credit  primarily  under  its
prepetition credit facilities of approximately  $46.2 million as of December 31,
1999. As of May 31, 2000, the Company had issued  approximately $19.1 million in
letters of credit under the DIP Financing Agreement.

(10) COMMITMENTS AND CONTINGENCIES

(A)      PREPETITION ACCOUNTS RECEIVABLE

     In  certain  instances,  the  collection  of  amounts  from  non-affiliated
facilities for therapy  ancillary  services  provided to them by the Company has
slowed because payment is primarily  dependent upon such facilities'  receipt of
payment  from fiscal  intermediaries.  In  addition,  fiscal  intermediaries  of
long-term care  facilities  acquired by the Company are changed to the Company's
fiscal  intermediary,  resulting  in temporary  delays in timing of  third-party
payments.  Pursuant to an agreement  between the Company and the  Department  of
Health and Human Services (the "HHS"),  all Medicare payments due to the Company
for  services  rendered  prior to October  14,  1999  (pre-bankruptcy),  and not
previously  paid to the Company,  will be withheld until the  confirmation  of a
plan of  reorganization.  At such time,  the Company  could file a motion in the
Bankruptcy  Court seeking an adjudication of such funds if the Company  believes
that such funds  exceed the claims that the HHS has against the  Company.  As of
February  29, 2000,  the Company  estimated  that it had net  Medicare  accounts
receivable of  approximately  $74.5 million that were being  withheld by the HHS
pursuant to this agreement.  It is unlikely that the Company will recover any of
these receivables because it is likely the HHS will claim more than such amount.
Payment of amounts  due to the  Company by the HHS for  services  provided on or
after October 14, 1999 (post-bankruptcy) are largely unaffected by the Company's
bankruptcy  cases.  However,  if it is determined that there is a pre-bankruptcy
overpayment  to the Company  that is subject to offset  against  post-bankruptcy
payments due to the Company or previously made to the Company,  the HHS may seek
to have such payments  treated as an  administrative  expense claim and withhold
such amounts if not already  paid. If the amounts have been  previously  paid to
the  Company,  the  Company  would have to return such funds to the HHS upon the
occurrence  of  certain  events,   including  the  confirmation  of  a  plan  of
reorganization.

                                      F-29
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(B)      LEASE COMMITMENTS

     The  Company  leases  real  estate  and  equipment  under   cancelable  and
noncancelable  agreements.  Under the Bankruptcy  Code, the Company may elect to
assume or reject  executory  contracts,  including lease  agreements  subject to
Bankruptcy Court approval. As of December 31, 1999, the Company had not rejected
any material  lease  agreements  since the Filing  Date.  Future  minimum  lease
payments under  noncancelable  leases as of December 31, 1999 are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                                                        CAPITAL            OPERATING
                                                                                        LEASES             LEASES
                                                                                        ------             ------
<S>                                                                            <C>                 <C>
2000......................................................................            $   11,649          $  219,420
2001......................................................................                10,698             211,369
2002......................................................................                 9,028             208,497
2003......................................................................                 8,517             203,173
2004......................................................................                 9,111             193,738
Thereafter................................................................               242,223             918,298
                                                                               -----------------   -----------------
Total minimum lease payments..............................................               291,226         $ 1,954,495
                                                                                                   =================
Less amount representing interest.........................................              (205,948)
                                                                               -----------------
Present value of net minimum lease payments under capital leases..........            $   85,278
                                                                               =================
</TABLE>

     Included in the information above, is approximately $8.3 million of capital
leases that were assumed subsequent to year end by the purchaser in a Bankruptcy
Court approved sales transaction.

     Rent expense under operating leases totaled  approximately  $267.5 million,
$251.3 million, and $143.9 million in 1999, 1998 and 1997,  respectively.  As of
December 31, 1999, the Company leases or subleases 52 facilities from affiliates
of two  directors of the Company,  one of whom resigned  during 1999,  which are
included in the  information  above.  The  aggregate  lease expense for these 52
facilities  and an  additional  11 facility  leases with  affiliates  which were
terminated during 1999 was approximately $20.3 million,  $21.0 million and $20.2
million in 1999, 1998 and 1997,  respectively.  Future minimum lease commitments
related to the  facilities  the Company  leases from  affiliates of the existing
director  total  approximately  $5.9 million at December 31, 1999. The Company's
management believes the terms of all of the foregoing leases are as favorable to
the Company as those that could have been obtained from non-related  parties. As
of December 31,  1999 and 1998, the Company was in non-compliance with financial
covenants  contained  in master  lease  agreements  for certain  long-term  care
facilities in the United States and the United Kingdom.  The Company was also in
cross-default on some of its long-term care facilities in the United States.  As
a result,  the lessors under the master lease  agreements  have certain  rights,
including  the  right  to  require  that  the  Company   relinquish  the  leased
facilities.  The  ability  to  exercise  these  rights  under the  master  lease
agreement in the United States is subject to the  jurisdiction of the Bankruptcy
Court.

                                      F-30
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(C)      INSURANCE

     In the past, the Company has insured certain risks,  including  general and
professional  liability,  workers'  compensation,  and employee health benefits,
through  the  use  of  self-insurance,   retrospectively   rated  premium,  high
deductible  and other  hybrid  policies  which  vary by the  states in which the
Company  operated.  The  Company's  insurance  carriers  declined  to renew  the
Company's high deductible general and professional  liability insurance policies
that expired on December 31, 1999. In the recent past,  these carriers have paid
substantially  more to third parties under the policies than the Company paid in
premiums,  which the Company believes was prevalent  throughout the nursing home
industry.  Consequently,   several  major  insurance  companies  are  no  longer
providing this type of coverage to long-term care providers.

     In January 2000, the Company  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.  There can be no assurance that this
self-funded  insurance  program for 2000 will not have a material adverse impact
on the  Company's  financial  condition  and results of  operations  or that the
Company will not be required to continue this program in future years.

     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.  The aggregate annual loss exposure with respect to the
general and professional  liability policies was limited to $8.0 million in 1998
and $1.0 million in 1997. In 1999 there was an unlimited aggregate loss exposure
under the per claim  retention on these types of claims.  An actuarial  analysis
determined the expected  losses under this retention  level to be  approximately
$13.6 million in 1999.  Annual reviews of the actuarial  determinations  will be
performed to determine  variations from this expected number and any adjustments
made to  provisions  at that time.  Provisions  for  estimated  settlements  for
general  and  professional  liability  under  the  per  claim  retention  level,
including  incurred but not  reported  losses,  are provided on an  undiscounted
basis  in the  period  of  related  coverage.  The  reserve  for  such  risks is
approximately  $22.8  million and $8.4 million as of December 31, 1999 and 1998,
respectively.  Provisions for such risks were approximately $23.9 million, $14.6
million,  and $4.2 million for the years ended December 31, 1999, 1998 and 1997,
respectively,  and are included in operating  expenses and corporate general and
administrative expenses.

     For the years ended December 31, 1998 and 1999,  the workers'  compensation
insurance  was  guaranteed  cost and thus after  payment of the premium in those
years, risk was fully transferred to the third party insurance carrier.  For the
year 2000, the Company purchased workers' compensation  insurance for all states
except  Washington,  Ohio, and West  Virginia,  where the Company is required to
subscribe to those state and/or self-insured  programs. The 2000 policy provides
coverage  above  $250,000  per claim.  An  actuarial  analysis of losses at this
retention  amount was  completed  and the expected  losses are being funded on a
quarterly basis in full during 2000.  Total expected losses and costs under this
retention level were  determined to be  approximately  $30.0 million.  For years
prior  to  1998  in  which  the  Company   carried  various  forms  of  workers'
compensation  insurance as described  above,  aggregate losses are provided on a
fully  developed  basis,  including  any incurred but not reported  claims.  The
reserve for such risks is  approximately  $25.9  million and $26.2 million as of
December  31, 1999 and 1998,  respectively.  Provisions  for such risks  totaled
approximately $30.9 million, $27.8 million and $14.3 million for the years ended
December 31, 1999,  1998 and 1997,  respectively,  and are included in operating
expenses and corporate general and administrative expenses.

                                      F-31
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(D)     CONSTRUCTION COMMITMENTS

     As of December 31, 1999,  the Company had  construction  commitments  under
various  contracts of  approximately  $7.2 million in the United  States.  These
include  contractual  commitments to improve existing facilities and to develop,
construct  and  complete  a  corporate  office  building  and a  long-term  care
facility.  The  Company's  foreign  operations  did not  have  any  construction
commitments as of December 31, 1999.

(E)      LITIGATION

     The  Company  is a  party  to  various  legal  actions  and  administrative
proceedings  and subject to various  claims  arising in the  ordinary  course of
business (see Note 18(a), Other Events - Litigation).

(11) INCOME TAXES

     Income tax expense (benefit) on earnings (losses) before extraordinary loss
consists of the following for the year ended December 31 (in thousands):
<TABLE>
<CAPTION>
                                                                             1999             1998            1997
                                                                             ----             ----            ----
<S>                                                                 <C>               <C>              <C>
Current:
  Federal...........................................................      $  (4,913)        $ 10,009        $ 18,441
  State.............................................................             120           6,470           5,918
  Foreign...........................................................              41           (323)               -
                                                                    ----------------  --------------   -------------
                                                                             (4,752)          16,156          24,359
                                                                    ----------------  --------------   -------------
Deferred:
  Federal...........................................................           4,076          19,653          15,464
  State.............................................................             837          19,926           3,190
  Foreign...........................................................               -         (2,158)         (1,860)
                                                                    ----------------  --------------   -------------
                                                                               4,913          37,421          16,794
                                                                    ----------------  --------------   -------------
  Total.............................................................      $      161        $ 53,577        $ 41,153
                                                                    ================  ==============   =============
</TABLE>

                                      F-32
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     Actual tax  expense  differs  from the  "expected"  tax expense on earnings
(losses)  before  extraordinary  loss,  computed  by applying  the U.S.  Federal
corporate  income tax rate of 35% to earnings  (losses)  before income taxes and
extraordinary  loss of the Company as follows for the year ended December 31 (in
thousands):

<TABLE>
<CAPTION>
                                                                            1999             1998             1997
                                                                            ----             ----             ----
<S>                                                                 <C>               <C>               <C>
Computed "expected" tax (benefit) expense.........................        $ (381,254)       $ (241,445)       $ 33,559
Adjustments in income taxes resulting from:
 Amortization of goodwill........................................              5,036             9,439           3,765
 Impairment loss.................................................             94,978            89,333               -
 Increase in valuation allowance.................................            311,708           115,478           2,450
 Loss on sale of subsidiary stock................................                  -             4,340               -
 Legal and regulatory matters....................................                  -             5,847               -
 Loss (loss reversal) on planned asset dispositions..............           (21,236)            59,714               -
 State income tax expense, net of Federal income tax benefit.....           (12,863)             4,044           3,041
 Other...........................................................              3,792             6,827         (1,662)
                                                                    ----------------  ----------------  --------------
                                                                          $      161        $   53,577        $ 41,153
                                                                    ================  ================  ==============
</TABLE>

                                      F-33
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999
     Deferred tax assets  (liabilities)  were  comprised of the  following as of
December 31 (in thousands):
<TABLE>
<CAPTION>
                                                                                      1999                1998
                                                                                      ----                ----
<S>                                                                              <C>               <C>
Deferred tax assets:
 Accounts and notes receivable...............................................          $  78,117          $  18,644
 Accrued liabilities.........................................................             54,002             42,015
 Property and equipment......................................................            100,928             26,445
 Intangible assets...........................................................             76,938             39,945
 Carryforward of deductions limited by Internal Revenue Code Section 382.....              6,250              6,250
 Write-down of assets held for sale..........................................             13,591             13,862
 Deferred income.............................................................              1,118              1,565
 Shareholder settlement......................................................                  -              1,980
 Partnership investments.....................................................              5,505                  -
 Alternative minimum tax credit..............................................              5,712              4,411
 Jobs and other credit carryforwards.........................................              6,075              5,454
 Capital loss carryforwards..................................................              4,127              4,023
 Federal net operating loss carryforwards....................................            126,844              2,202
 State net operating loss carryforwards......................................             25,609             10,256
 United Kingdom trading loss carryforwards...................................             12,911             13,371
 United Kingdom capital loss carryforwards...................................              1,238              5,013
 Property and equipment attributable to United Kingdom operations............              4,175                  -
 Other.......................................................................              4,157              1,844
                                                                                 ---------------   ----------------
                                                                                         527,297            197,280
                                                                                 ---------------   ----------------
Less valuation allowance:
 Federal.....................................................................          (420,215)          (140,680)
 State.......................................................................           (85,064)           (27,616)
 United Kingdom..............................................................           (20,072)           (12,865)
                                                                                 ---------------   ----------------
                                                                                       (525,351)          (181,161)
                                                                                 ---------------   ----------------
Total deferred tax assets.....................................................            1,946             16,119
                                                                                 ---------------   ----------------
Deferred tax liabilities:
 Property and equipment attributable to United Kingdom operations............                 -            (3,529)
 Partnership investments.....................................................                 -            (2,701)
 Changes in certain subsidiaries' methods of accounting for income taxes                (1,936)            (1,899)
 Other.......................................................................              (10)            (1,990)
                                                                                 ---------------   ----------------
                                                                                        (1,946)           (10,119)
                                                                                 ---------------   ----------------
Deferred tax asset, net.......................................................         $     -           $  6,000
                                                                                 ===============   ================
</TABLE>

                                      F-34
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The Company  and  subsidiaries  have  Federal net  operating  loss  ("NOL")
carryforwards  of  $362.4 million  with expiration dates from 2004 through 2019.
Various subsidiaries have state NOL carryforwards  totaling  $609.3 million with
expiration  dates  through the year 2019.  In addition,  the Company has capital
loss  carryforwards of approximately  $11.8 million,  of which $4.5 million will
expire in 2001 and $7.3 million will expire in 2004. United Kingdom trading loss
carryforwards   of  $43.0 million   and  the  alternative   minimum  tax  credit
carryforwards  of $5.7 million  have no expiration  dates.  The  $6.1 million of
other tax  credit  carryforwards  will  expire in years  2000  through  2019.  A
compromise of debt resulting from an approved plan of  reorganization  is likely
to  result  in a  significant  reduction  in  these  tax  loss  and  tax  credit
carryforwards.  In  addition,  a change  in  ownership  in an  approved  plan of
reorganization  could  materially  impact the  Company's  ability to utilize any
remaining tax loss and tax credit carryforwards.

     In 1999 and 1998, the Company  increased the valuation  allowance by $311.7
million and $115.5  million,  respectively,  to fully  reserve for  deferred tax
assets which may not be realized. The Company recorded a $5.7 and a $5.2 million
valuation allowance in 1998 and 1997, respectively,  related to the deferred tax
assets  acquired in the  acquisition  of Regency.  The Company  recorded a $32.5
million and a $11.2 million valuation allowance in 1999 and 1998,  respectively,
related to the deferred tax assets acquired in the RCA acquisition. Tax benefits
recognized  in future  periods  attributable  to the  portions of the  valuation
allowance  established in connection with purchase  accounting for  acquisitions
(totaling  $82.8 million)  will be  allocated  to reduce  goodwill  recorded  in
connection with these acquisitions.

(12) SUPPLEMENTARY INFORMATION RELATING TO STATEMENTS OF CASH FLOWS

     Supplementary  information for the consolidated statements of cash flows is
set forth below for the year ended December 31 (in thousands):
<TABLE>
<CAPTION>
                                                                              1999          1998         1997
                                                                              ----          ----         ----
<S>                                                                         <C>            <C>          <C>
Cash paid during the year ended December 31 for:
  Interest, net of $1,124, $1,792 and $2,023 capitalized during
    1999, 1998 and 1997, respectively................................       $ 49,710     $ 143,850     $ 68,614
  Income taxes.......................................................        (47,974)       23,869        8,553
</TABLE>

     The  Company's  acquisitions  during  1999,  1998  and  1997  involved  the
following for the year ended December 31 (in thousands):
<TABLE>
<CAPTION>
                                                                    1999              1998              1997
                                                                    ----              ----              ----
<S>                                                          <C>                <C>               <C>
Fair value of assets acquired................................       $   6,781         $ 578,333        $1,159,012
Liabilities assumed..........................................          (1,050)         (356,268)         (613,988)
Cash payments or payables to former APTA shareholders........
                                                                            -                 -            19,300
Fair value of stock and warrants issued......................               -          (161,424)             (190)
                                                             ----------------   ----------------  ----------------
Cash payments made, net of cash received from others.........       $   5,731         $  60,641        $  564,134
                                                             ================   ================  ================
</TABLE>

                                      F-35
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(13) FAIR VALUE OF FINANCIAL INSTRUMENTS

     The estimated  fair values of the  Company's  financial  instruments  as of
December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
                                                                     1999                            1998
                                                                     ----                            ----
                                                           CARRYING                         CARRYING
                                                            AMOUNT         FAIR VALUE        AMOUNT        FAIR VALUE
                                                            ------         ----------        ------        ----------
<S>                                                       <C>              <C>             <C>             <C>
Cash and cash equivalents..........................       $  25,047        $  25,047       $  27,504       $  27,504
Long-term debt including current portion and amounts
  subject to compromise:
  Practicable to estimate fair value...............       1,502,476          539,536       1,251,437       1,088,178
  Not practicable to estimate fair value...........               -                -         266,837               -
Convertible Trust Issued Preferred Securities......         344,119                -         345,000         144,900
</TABLE>

     The cash and cash  equivalents  carrying  amount  approximates  fair  value
because  of the  short  maturity  of these  instruments.  The fair  value of the
Company's  long-term debt,  including current  maturities and amounts subject to
compromise,  and the Convertible Trust Issued Preferred Securities was estimated
based on quoted market  prices and  information  received from an  international
investment banking firm that is experienced with such securities.

(14) CONVERTIBLE TRUST ISSUED PREFERRED SECURITIES

     In May 1998, a statutory business trust, all of whose common securities are
owned by the Company,  issued  $345.0 million  of 7.0% convertible  trust issued
preferred securities due 2028 (the "CTIPS") with a liquidation amount of $25 per
CTIP. Each CTIP is convertible into  1.2419 shares of the Company's 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.   Payment  of  the  cash  distributions  and  principal  are
irrevocably guaranteed by the Company. Sun may defer cash distribution for up to
20 consecutive quarters. Beginning with the interest payment due on May 1, 1999,
Sun exercised its right to defer cash  distributions.  As cash distributions are
deferred,  dividends on the CTIPS will continue to accrue. In 1999,  accrued and
deferred  interest was approximately  $17.3 million.  The agreement in principle
discussed  in Note 2  provides  that  holders  of CTIPS  would not  receive  any
recovery under the plan of  reorganization.  During 1999,  $.88 million of CTIPS
were converted into  approximately 1.1 million shares of common stock with a par
value of approximately  $.01 million,  resulting in an increase of approximately
$0.9 million in additional paid-in capital.

(15) CAPITAL STOCK

(A)      COMMON STOCK REPURCHASE

     In 1999, 1998 and 1997, the Company repurchased  88,115,  71,661 and 23,091
shares of its outstanding  common stock at a cost of approximately $0.4 million,
$1.4 million and $0.5 million,  respectively.  Certain executive officers of the
Company  delivered  the shares to the  Company,  at the fair market value of the
stock, in order to pay withholding taxes incurred upon the vesting of previously
granted restricted stock.

                                      F-36
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(B)      STOCK OPTION PLANS

STOCK INCENTIVE PLANS

     The Company has stock incentive plans for certain employees,  officers, and
consultants  of the  Company.  Awards  made under the plan may be in the form of
stock options, stock appreciation rights, stock awards, performance share awards
or other  stock-based  awards.  A committee  appointed by the Board of Directors
determines the vesting schedule and the option price,  which is generally not to
be less than the fair market  value per share of the  Company's  common stock at
the date of grant.  Options granted prior to March 1996 generally  vested at the
end of three years and expire ten years from the date of grant.  Options granted
during and after March 1996  generally  vest ratably over three years and expire
ten years from the date of grant.

     In May 1999, the Company offered holders of certain  employee stock options
the right to exchange  outstanding stock options for new stock options.  The new
stock options cause the holders to receive fewer shares of the Company's  common
stock,  but the  exercise  price for these new stock  options  is lower than the
exercise price for the old stock options. These new stock options are subject to
a three-year vesting schedule and will be accounted for as variable options.

     As of December 31, 1999,  options for  1,279,450  shares were  outstanding,
options for 532,983  shares were vested and no shares were  available for future
grant  under  the  stock  incentive  plans.  Exercise  prices  of the  Company's
outstanding stock options range from $1.06 to $24.00.

     In connection  with the RCA  Acquisition,  the Company  issued  948,772 Sun
common stock options in exchange for  outstanding RCA and Contour stock options.
As of  December  31,  1999 and  1998,  options  for 6,562  and  349,852  shares,
respectively,  were outstanding and vested. Exercise prices of these outstanding
stock options range from $7.85 to $19.34 per share.

     In 1997,  the Company  awarded  783,000  shares of restricted  stock to ten
executives and in 1998 the Company awarded 14,000 shares of restricted  stock to
one  executive.  No  restricted  stock  awards  were made in 1999.  The  related
compensation  expense  associated with these awards was recognized  ratably over
the vesting  period of four to five years.  During  January  2000,  all unvested
restricted shares held by employees were cancelled and rescinded.

DIRECTOR STOCK PLANS

     The Company had stock plans for nonemployee  directors,  which provided for
grants of nonqualified options and stock awards.  Beginning in 1997, nonemployee
directors  generally  received an annual  grant of options for 4,000 shares at a
price not less than fair market value of the Company's  common stock at the date
of grant and an annual grant of 2,000 restricted  stock awards.  All awards vest
ratably over the three  succeeding  annual  meetings of  stockholders  and stock
option  awards  expire ten years  after the date of grant.  No vesting  occurred
during 1999, as an annual meeting was not held during 1999.  Exercise  prices of
outstanding  options  to  purchase  shares of common  stock  range from $9.50 to
$21.88.  During  the year ended  1998,  the  Company  awarded  21,222  shares of
restricted stock to nonemployee directors,  which were expensed over the vesting
period.  No awards of  restricted  stock were made in 1999.  As of December  31,
1999,  options for 93,000 shares were  outstanding and options for 38,415 shares
have vested. This plan was terminated in 2000.

                                      F-37
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The following is a summary of the status of the Company's  Stock  Incentive
Plans, the Director Stock Plans and assumed option plans from acquisitions as of
December 31,  1999, 1998, and 1997, and changes during the years ending on those
dates (shares in thousands):
<TABLE>
<CAPTION>
                                                1999                           1998                          1997
                                     ----------------------------  -----------------------------  ----------------------------
                                                    WEIGHTED                       WEIGHTED                      WEIGHTED
                                                    AVERAGE                        AVERAGE                        AVERAGE
                                      SHARES     EXERCISE PRICE     SHARES      EXERCISE PRICE     SHARES     EXERCISE PRICE
                                      ------     --------------     ------      --------------     ------     --------------
<S>                                  <C>         <C>               <C>          <C>               <C>         <C>
Outstanding at beginning of year        4,748             $16.75       3,339             $16.90       3,348            $15.91
Granted:
  Price equals fair value..........       910               1.91       2,781              15.54         814             18.06
Exercised..........................         -                  -        (37)              13.96       (487)             11.25
Cancelled..........................   (4,290)              15.92     (1,335)              14.44       (336)             17.28
                                     ---------                     ----------                     ----------
Outstanding at year-end............     1,368               9.00       4,748              16.75       3,339             16.90
                                     =========                     ==========                     ==========
Options exercisable at year-end           591              15.01       2,334              17.17       1,210             17.25
                                     =========                     ==========                     ==========
Options available for future grant     10,393                          7,013                          3,950
                                     =========                     ==========                     ==========
Weighted average fair value of
  options granted during the year       $1.00                          $8.02                          $5.89
                                     =========                     ==========                     ==========
</TABLE>

     The fair value of each option  granted in 1999,  1998 and 1997 is estimated
at the date of grant  using the  Black-Scholes  option  pricing  model  with the
following weighted-average assumptions:
<TABLE>
<CAPTION>
                                                     1999     1998     1997
                                                     ----     ----     ----
<S>                                                  <C>      <C>      <C>
Expected Life (in years)..........................      4        4        4
Risk-free Interest Rate...........................   5.41%    5.50%    6.26%
Expected Volatility...............................     76%      66%      42%
Dividend Yield....................................      -        -        -
</TABLE>


     Had  compensation  cost for the Company's 1999, 1998 and 1997 option grants
been  determined  consistent  with SFAS 123 (see Note 3 which  establishes  fair
value as the  measurement  basis  for  stock-based  awards,  the  Company's  net
earnings  (losses) and net earnings  (losses) per share for 1999,  1998 and 1997
would  approximate  the pro forma amounts below (in thousands,  except per share
data):

                                      F-38
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999
<TABLE>
<CAPTION>
                                       1999                           1998                            1997
                                       ----                           ----                            ----
                            AS REPORTED     PRO FORMA       AS REPORTED      PRO FORMA       AS REPORTED     PRO FORMA
                            -----------     ---------       -----------      ---------       -----------     ---------
<S>                         <C>             <C>              <C>              <C>             <C>             <C>
Net earnings (losses).....  $ (1,089,458)   $ (1,091,129)    $ (753,693)      $(759,169)      $  34,801       $  32,804
Net earnings (losses) per
  share:
  Basic...................  $     (18.62)   $     (18.65)    $   (14.49)      $  (14.60)      $    0.75       $    0.71
  Diluted.................  $     (18.62)   $     (18.65)    $   (14.49)      $  (14.60)      $    0.74       $    0.70
</TABLE>

     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, 1999 (shares in thousands):
<TABLE>
<CAPTION>
                                   OPTIONS OUTSTANDING                               OPTIONS EXERCISEABLE
                                   -------------------                               --------------------

                                              WEIGHTED AVERAGE          WEIGHTED                              WEIGHTED
                              NUMBER             REMAINING               AVERAGE            NUMBER            AVERAGE
RANGE OF EXERCISE PRICE    OUTSTANDING        CONTRACTUAL LIFE       EXERCISE PRICE        OUTSTANDING     EXERCISE PRICE
-----------------------    -----------        ----------------       --------------        -----------     --------------
<S>                       <C>                 <C>                    <C>                 <C>               <C>
$ 1.06 - $ 9.50..........         747                    8.82           $     2.57              116           $     8.73
 11.00 -  15.84..........         223                    5.16                13.21              211                13.13
 16.44 -  19.44..........         290                    7.05                17.57              174                17.88
 20.13 -  24.00..........         108                    6.44                21.81               90                22.01
                          ------------                                                   ----------
                                1,368                    7.66                 9.00              591                15.01
                          ============                                                   ==========
</TABLE>

(C)      WARRANTS

     In connection with the RCA Acquisition in 1998, the Company issued warrants
to purchase  527,123 shares of the Company's common stock at prices ranging from
$1.72 to $18.32  per  share in  exchange  for  outstanding  warrants  of RCA and
Contour.  All of these  warrants were  exercised or have expired  except for one
warrant to  purchase  25,250  shares at $13.80 per share,  which will  expire in
2001.

(D)      GRANTOR STOCK TRUST

     In the first  quarter of 1996,  the Company  sold  3,050,000  newly  issued
shares of the Company's common stock to a newly established  Grantor Stock Trust
("Trust") for approximately $37.7 million.  The Trust was created to fund future
obligations  under certain of the Company's  benefit plans,  including,  but not
limited to, stock option plans, a stock purchase plan,  health  insurance  plans
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 is 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 is reduced and stockholders'  equity increases
correspondingly.  The Trust held  1,915,935  shares and 1,989,132  shares of the
Company's common stock as of December 31, 1999 and 1998, respectively.

                                      F-39
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The Trust  delivered  to the Company a  promissory  note for  approximately
$37.7 million.  The cash portion of the purchase price of approximately  $31,000
represents the par value of the shares of the Company's common stock sold to the
Trust.  Amounts owed by the Trust will be repaid periodically with cash received
from the Company or will be forgiven by the Company thereby enabling the release
of shares  from the Trust to  satisfy  the  Company's  obligations  for  certain
employee compensation and benefit plans.

     The   agreement  in  principle   discussed  in  Note  2  provides  for  the
cancellation of the Company's  existing common stock,  including the shares held
by the  Trust.  Unless  the  plan of  reorganization  that is  confirmed  by the
Bankruptcy  Court provides that the Trust would hold the new equity to be issued
pursuant  to the  plan  of  reorganization,  the  Trust  would  most  likely  be
terminated.  Upon the termination of the Trust,  the debt it owes to the Company
would be forgiven.

(16)  EARNINGS PER SHARE

     Basic net earnings  (losses)  per share is based upon the weighted  average
number of common shares outstanding during the period.

     Diluted  net  earnings  per share in periods of  earnings 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,  including the assumption  that the Company's
convertible  securities  were  converted as of the beginning of the period.  Net
earnings,  if  conversion  of the  securities  is assumed,  is 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 the Company had a net loss
for the years ended December 31, 1999 and 1998, the Company's  stock options and
convertible debentures were anti-dilutive.

                                      F-40
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     Earnings  (losses)  per share is  calculated  as follows for the year ended
December 31 (in thousands, except per share data):
<TABLE>
<CAPTION>
                                                                                      1999               1998              1997
                                                                                      ----               ----              ----
<S>                                                                            <C>              <C>                <C>
BASIC:
Net earnings (losses) before extraordinary loss and cumulative effect of
  change in accounting principle...............................................  $ (1,076,642)       $ (743,419)        $  54,729
Net earnings (losses)..........................................................    (1,089,458)         (753,693)           34,801
Weighted average shares outstanding............................................        58,504            52,008            46,329
Earnings (losses) per share:
Net earnings (losses) before extraordinary loss and cumulative effects of
   change in accounting principle..............................................  $     (18.40)       $   (14.29)        $    1.18
Net earnings (losses)..........................................................  $     (18.62)       $   (14.49)        $    0.75
DILUTED:
Net earnings (losses) before extraordinary loss and cumulative effect of
   change in accounting principle used in basic calculation....................  $ (1,076,642)       $ (743,419)        $  54,729
Income impact of assumed conversions...........................................              -                 -            3,410
                                                                               ---------------  ----------------  ---------------
Adjusted net earnings (losses) before extraordinary loss and cumulative effect
   of change in accounting principle...........................................    (1,076,642)         (743,419)           58,139
Extraordinary loss.............................................................              -          (10,274)          (19,928)
Cumulative effect of change in accounting principle............................       (12,816)                 -                -
                                                                                ---------------  ----------------  ---------------
Net earnings (losses)..........................................................   $(1,089,458)       $ (753,693)        $  38,211
                                                                                ===============  ================  ===============

Weighted average shares used in basic calculation..............................         58,504            52,008           46,329
Effect of dilutive securities:
Stock options and warrants.....................................................              -                 -              832
Assumed conversion of convertible debt.........................................              -                 -            4,690
                                                                                ---------------  ----------------  ---------------
Weighted average common and common equivalent shares outstanding...............         58,504            52,008           51,851
                                                                                ===============  ================  ===============

Earnings (losses) per share:
Net earnings (losses) before extraordinary loss and cumulative effect of
   change in accounting principle..............................................     $  (18.40)        $  (14.29)         $   1.12
Net earnings (losses)..........................................................     $  (18.62)        $  (14.49)         $   0.74
</TABLE>

(17) 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 common
stock of the Company  for  stockholders  of record on June 15,  1995 and for all
future  issuances of common stock.  The Rights are currently not  exercisable or
transferable  apart from the common stock and have no voting rights.  Each Right
entitles the registered holder to purchase from the Company one one-hundredth of
a share of  Series A  Preferred  Stock,  par value  $0.01 per share.  The Rights
become  exercisable  ten business  days  following the date a person or group of
affiliated  persons  acquires  15.0% or more of the Company's  common stock,  or
announces  a tender or  exchange  offer  which  would  result in the  beneficial
ownership  by a  person  or group of  affiliated  persons  of 15% or more of the
outstanding  Company's common stock.  The Rights also become  exercisable if any
person,  who is the  beneficial  owner of 15.0% or more of the Company's  common
stock as of the  date of  record,  acquires  an  additional  1.0% or more of the
outstanding Company's common stock. The Rights may be redeemed by the Company at
a price of $.001 per Right before their expiration on June 2, 2005.

                                      F-41
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     In the event that the  Company is  acquired  in a merger or other  business
combination or certain other events occur,  provision shall be made so that each
holder of a Right,  excluding  the Rights  beneficially  owned by the  acquiring
persons,  shall have the right to  receive,  upon  exercise  thereof at the then
current  exercise price,  that number of shares of common stock of the surviving
company  which at the time of such  transaction  will have a market value of two
times the exercise price of the Right.

     The   agreement  in  principle   discussed  in  Note  2  provides  for  the
cancellation  of the  Company's  existing  common  stock.  Unless  the  plan  of
reorganization  that is  confirmed  by the  Bankruptcy  Court  provides  for the
continuation  of the Rights with the equity to be issued pursuant to the plan of
reorganization,  the Rights  would be cancelled  along with the existing  common
stock.

(18) OTHER EVENTS

(A)      LITIGATION

     The Company and substantially all of its U.S. operating  subsidiaries filed
voluntary  petitions for protection under Chapter 11 of the U.S. Bankruptcy Code
with the Bankruptcy  Court (case nos. 99-3657 through  99-3841,  inclusive).  On
February 3, 2000, an additional indirect subsidiary of the Company commenced its
Chapter 11 case in the  Bankruptcy  Court  (case no.  00-00841).  The Company is
currently  operating  its  business  as a  debtor-in-possession  subject  to the
jurisdiction of the Bankruptcy Court.

     In May 1999, a former  employee of SunBridge  filed a proposed class action
complaint   against  SunBridge  in  the  Western  District  of  Washington  (the
"SunBridge  Action").  The  plaintiff  sought to represent  certain  current and
former  employees of SunBridge  who were  allegedly not paid  appropriate  wages
under  federal  and state law since May 1996.  In August  1999,  several  former
employees of SunDance filed a proposed class action  complaint  against SunDance
in the Western  District of Washington (the "SunDance  Action").  The plaintiffs
sought to represent  certain  current and former  employees of SunDance who were
allegedly  not paid  appropriate  wages under federal and state law since August
1996. The plaintiffs in both of these actions are  represented by the same legal
counsel.  These  lawsuits  are  currently  stayed as a result  of the  Company's
pending Chapter 11 cases.  In June 2000, the plaintiffs in the SunBridge  Action
and the SunDance Action filed motions in the Bankruptcy Court seeking to certify
their  respective  classes they seek to represent and an  enlargement of the bar
date for their class members.  Plaintiffs filed claims in the pending Chapter 11
cases in the amount of $780 million in the  SunDance  Action and $242 million in
the SunBridge  Action,  plus  interest,  costs and attorney  fees.  Although the
Company and its  subsidiaries  intend to vigorously  defend  themselves in these
matters,  there can be no assurance  that the outcome of either of these matters
will not have a  material  adverse  effect  on the  results  of  operations  and
financial condition of the Company.

                                      F-42
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     In  March 1999  and through  April 19, 1999,  several  stockholders  of the
Company filed class action  lawsuits  against the Company and three  officers of
the Company in the United States  District Court for the District of New Mexico.
The  lawsuits  allege,  among other  things,  that the Company did not  disclose
material  facts  concerning  the  impact  that PPS would  have on the  Company's
results of operations.  The lawsuits seek compensatory  damages and other relief
for   stockholders   who  purchased  the  Company's   common  stock  during  the
class-action period. As a result of the Company's commencement of its Chapter 11
cases,  these  lawsuits are stayed with respect to the Company.  The Company has
filed a motion with the Bankruptcy  Court requesting an extension of the stay to
the individual  defendants.  Although the Company  intends to vigorously  defend
itself and its  officers  in this  matter,  there can be no  assurance  that the
outcome of this matter will not have a material adverse effect on the results of
operations and financial condition of the Company.

     In January 1999, the state of Florida filed criminal charges in the Circuit
Court of the Eighth Judicial  Circuit for Alachua County,  Florida against three
subsidiaries  which were acquired by the Company on June 30,  1998: RCA, Capitol
Care Management  Co., Inc.  and Gainesville Health Care Center, Inc.  All of the
allegations  of  wrongdoing  related  to  activities  prior  to  June 30,  1998.
Florida's allegations included violations of certain RICO laws, abuse or neglect
of elderly or disabled persons, grand theft and Medicaid fraud at a nursing home
facility in Florida.  Also named as defendants  were five  individuals  who were
involved in the  operation  of the  facility in their  capacities  as  officers,
directors or employees of the defendant entities. In December 1999, the state of
Florida  agreed to settle the action for an amount not considered by the Company
to be material to its  operations.  In January  2000,  the state  dismissed  all
charges  against the three  subsidiaries  and five  individuals.  The settlement
agreement was approved by the Bankruptcy Court on May 11, 2000.

     The Company and certain of its  subsidiaries  are defendants in two qui tam
lawsuits brought by private citizens in the United States District Court for the
Eastern District of California  alleging  violations of the Federal False Claims
Act. The  plaintiffs  allege that  skilled  nursing  facilities  operated by the
subsidiaries  and others  conspired over the last decade to (i) falsely  certify
compliance with regulatory  requirements in order to participate in the Medicare
and Medicaid  programs,  and (ii) falsify records to conceal failures to provide
services in accordance with such regulatory  requirements.  Although the Company
and its subsidiaries  intend to vigorously  defend  themselves in these matters,
there can be no assurance  that the outcome of any one of these matters will not
have a material  adverse  effect on the  results  of  operations  and  financial
condition of the Company. These lawsuits are currently stayed as a result of the
Company's filing for chapter 11 bankruptcy protection.

     The Company and certain of its  subsidiaries  are  defendants  in a QUI TAM
lawsuit  brought by a private citizen in the United States District Court of the
Central District of California  alleging  violations of the Federal False Claims
Act and a related wrongful termination. The plaintiff alleges that a home health
agency operated by one of the Company's subsidiaries submitted bills for several
years that were improper for various reasons, including bills for patients whose
treatment had not been authorized by their physicians. The government intervened
to the extent that the lawsuit  alleges  billing  without  obtaining  proper and
timely  physician  authorization,  but declined to intervene in the remainder of
the lawsuit.  Although  the Company and its  subsidiaries  intend to  vigorously
defend themselves in this matter,  there can be no assurance that the outcome of
this matter will not have a material adverse effect on the results of operations
and financial  condition of the Company.  This lawsuit is currently  stayed as a
result of the Company's filing for chapter 11 bankruptcy protection.

                                      F-43
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     In addition,  the Department of Health & Human Services (the "HHS") and the
Department  of Justice (the "DOJ")  periodically  investigate  matters that have
come to  their  attention  concerning  the  Company,  including  cost  reporting
matters. To expedite resolution of any outstanding  investigations,  the Company
has requested that the HHS and the DOJ inform it of any such  investigations  or
outstanding concerns. In response, the DOJ informed the Company of the existence
of a number of outstanding inquiries,  some of which were prompted by the filing
of qui tam lawsuits  that remain under seal and which are not  described  above.
The DOJ has  recently  advised  the  Company  of the  nature of  several  of the
allegations under investigation regarding the Company's subsidiaries,  including
allegations that the Company's subsidiaries were inappropriately  reimbursed for
(i)  certain  management  fees  related to the  provision  of therapy  services,
(ii) nursing services provided by skilled nursing facilities for which there was
inadequate documentation and (iii) respiratory therapy services.

     The DOJ and the Company are having ongoing discussions regarding a possible
global  settlement of these  investigations.  The Company believes that any such
settlement  would include a monetary payment to the government and a requirement
that the Company enter into a corporate integrity agreement with the HHS' Office
of  Inspector  General  requiring  the  Company to  implement  further  internal
controls  with  respect to its quality of care  standards  and its  Medicare and
Medicaid  billing,  reporting  and claims  submission  processes.  Although  the
Company and its  subsidiaries  intend to vigorously  defend  themselves in these
matters, the Company is unable to determine at this time when the investigations
will be concluded, how large a monetary payment, if any, the parties would agree
on,  the  nature of any  other  remedies  that may be sought by the  government,
whether or when a settlement  will in fact occur or whether any such  settlement
or any other outcome of the  investigations  will have a material adverse effect
on the Company's  financial  condition or results of  operations.  In 1999,  the
Company recorded a charge of  approximately  $3.0 million to cover the estimated
costs of professional  advisory services related to this matter. This amount was
recorded in legal and regulatory matters,  net in the accompanying  consolidated
statement of earnings (losses).

     In 1997,  the  Company  was  notified  by a law firm  representing  several
national insurance  companies that these companies believed that the Company had
engaged in improper billing and other practices in connection with the Company's
delivery  of therapy and  related  services.  In  response,  the  Company  began
discussions  directly  with  these  insurers,  hoping to resolve  these  matters
without  litigation;  however,  the  Company  is unable at this time to  predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.

     The Company is a party to various  other legal  actions and  administrative
proceedings  and is subject to various claims arising in the ordinary  course of
its  business,  including  claims that its services  have  resulted in injury or
death to the  residents  of its  facilities.  The  Company  has  experienced  an
increasing  trend in the number  and  severity  of  litigation  claims  asserted
against  the  Company.  The Company  believes  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  awareness by  plaintiff's
lawyers of potentially large recoveries.  In certain states in which the Company
has significant  operations,  including  California,  insurance coverage for the
risk of  punitive  damages  arising  from  general  and  professional  liability
litigation is not available due to state law public policy  prohibitions.  There
can be no assurance  that the Company  will not be liable for  punitive  damages
awarded in  litigation  arising in states for which  punitive  damage  insurance
coverage is not  available.  The Company also believes 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 the Company.

                                      F-44
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(B)      OTHER INQUIRIES

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

(C)      LEGISLATION, REGULATIONS AND MARKET CONDITIONS

     The Company is 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,  the  Company's  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.
The Company  believes that it is in substantial  compliance  with the applicable
laws and regulations.  However,  if the Company is ever found to have engaged in
improper practices,  it could be subjected to civil,  administrative or criminal
fines,  penalties or  restitutionary  relief  which may have a material  adverse
impact on the Company's financial results and operations.

(19)  SUMMARIZED FINANCIAL INFORMATION

     The Company acquired Mediplex on June 23, 1994 and became a co-obligor with
Mediplex  with  respect  to the 6 1/2%  Debentures  and the 11  3/4%  Debentures
subsequent to the acquisition.  Summarized financial  information of Mediplex is
provided below (in thousands):
<TABLE>
<CAPTION>
                                                AS OF DECEMBER 31,
                                                ------------------
                                               1999           1998
                                               ----           ----
<S>                                         <C>            <C>
Current assets.......................       $  78,726      $113,585
Noncurrent assets....................         145,922       225,586
Current liabilities..................           8,765        13,165
Noncurrent liabilities...............          53,130        69,454
Due to parent........................         291,150       206,161

</TABLE>

                                      F-45
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999
<TABLE>
<CAPTION>
                                                                                  YEAR ENDED DECEMBER 31,
                                                                                  -----------------------
                                                                         1999             1998            1997
                                                                         ----             ----            ----
<S>                                                               <C>               <C>             <C>
Net revenues...................................................       $  442,914       $  581,288      $ 507,750
Costs and expenses.............................................         (426,418)        (546,833)      (486,541)
Impairment loss................................................          (46,779)        (147,990)              -
Loss on sale of assets, net....................................          (41,019)                -              -
Cumulative effect of change in accounting principle............           (2,520)                -              -
                                                                  ---------------   --------------  -------------
Earnings (losses) before intercompany charges and income taxes.          (73,822)        (113,535)         21,209
Intercompany charges (1).......................................          (94,759)         (75,376)       (78,957)
                                                                  ---------------   --------------  -------------
Losses before income taxes.....................................         (168,581)        (188,911)       (57,748)
Income tax benefit (expense)...................................              (32)            3,619         18,326
                                                                  ---------------   --------------  -------------
Net losses.....................................................        $(168,613)      $ (185,292)      $(39,422)
                                                                  ===============   ==============  =============
</TABLE>


(1)  Through various  intercompany  agreements entered into by Sun and Mediplex,
     Sun provides  management  services,  licenses the use of its trademarks and
     acts on behalf of Mediplex to make financing  available for its operations.
     Sun  charged  Mediplex  for  management  services  totaling   approximately
     $14.9 million,   $23.0 million   and  $32.3 million  for  the  years  ended
     December 31,  1999,  1998 and 1997,  respectively.  Royalty fees charged to
     Mediplex for the years ended December 31,  1999, 1998 and 1997, for the use
     of  Sun  trademarks  were  approximately  $7.0 million,  $10.8 million  and
     $7.4 million,  respectively.  Intercompany interest charged to Mediplex for
     the years ended December 31, 1999, 1998 and 1997, for advances from Sun was
     approximately $72.9 million, $41.6 million and $39.3 million, respectively.

                                      F-46
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(20) QUARTERLY FINANCIAL DATA (UNAUDITED)

     The following tables reflects unaudited quarterly financial data for fiscal
years 1999 and 1998:
<TABLE>
<CAPTION>
                                                                           YEAR ENDED DECEMBER 31, 1999
                                                          -------------------------------------------------------------
                                                                 FIRST           SECOND           THIRD        FOURTH
                                                                QUARTER          QUARTER         QUARTER       QUARTER
                                                                -------          -------         -------       -------

<S>                                                       <C>              <C>             <C>             <C>
Total net revenues........................................    $  673,032      $  600,914      $  629,579    $  625,514
                                                          ===============  ==============  ==============  ============
Losses before income taxes and cumulative effect
   of change in accounting principle......................    $  (98,529)     $ (588,597)     $ (236,763)   $ (152,592)
                                                          ===============  ==============  ==============  ============
Net losses before cumulative effect of change
   in accounting principle................................    $  (99,421)     $ (588,597)     $ (236,856)   $ (151,768)
                                                          ===============  ==============  ==============  ============

Cumulative effect of change in accounting principle.......    $  (13,726)     $        -      $        -    $      910
                                                          ===============  ==============  ==============  ============
Net  losses...............................................    $ (113,147)     $ (588,597)     $ (236,856)   $ (150,858)
                                                          ===============  ==============  ==============  ============

Net losses per common and common equivalent share:
Net losses before cumulative effect of change
   in accounting principle (1):
  Basic...................................................     $   (1.73)     $   (10.10)      $   (4.03)     $  (2.56)
                                                          ===============  ==============  ==============  ============

  Diluted.................................................     $   (1.73)      $  (10.10)      $   (4.03)     $  (2.56)
                                                          ===============  ==============  ==============  ============

Net losses (1):
  Basic...................................................     $   (1.96)      $  (10.10)       $  (4.03)     $  (2.54)
                                                          ===============  ==============  ==============  ============

  Diluted.................................................     $   (1.96)      $  (10.10)       $  (4.03)     $  (2.54)
                                                          ===============  ==============  ==============  ============
</TABLE>

                                      F-47
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999
<TABLE>
<CAPTION>

                                                                         YEAR ENDED DECEMBER 31, 1998
                                                       ----------------------------------------------------------------
                                                              FIRST           SECOND           THIRD          FOURTH
                                                             QUARTER          QUARTER         QUARTER        QUARTER
                                                             -------          -------         -------        -------

<S>                                                    <C>               <C>             <C>             <C>
Total net revenues.....................................     $   741,490      $  752,392      $  814,408     $   780,170
                                                       ================  ==============  ==============  ==============
Earnings (losses) before income taxes and
  extraordinary losses.................................     $    31,977      $    1,568      $  (2,411)     $ (720,976)
                                                       ================  ==============  ==============  ==============
Net earnings (losses) before extraordinary loss........     $    18,387      $      753      $  (1,030)     $ (761,529)
                                                       ================  ==============  ==============  ==============
Extraordinary loss.....................................     $         -      $10,120(2)      $        -     $       154
                                                       ================  ==============  ==============  ==============
Net earnings (losses)..................................     $    18,387      $  (9,367)      $  (1,030)     $ (761,683)
                                                       ================  ==============  ==============  ==============
Net earnings (losses) before extraordinary loss(1):
  Basic................................................     $      0.39      $     0.02      $   (0.02)     $   (13.34)
                                                       ================  ==============  ==============  ==============
  Diluted..............................................     $      0.37      $     0.02      $   (0.02)     $   (13.34)
                                                       ================  ==============  ==============  ==============

Net earnings (losses)(1):
  Basic................................................      $     0.39      $   (0.20)      $   (0.02)     $   (13.34)
                                                       ================  ==============  ==============  ==============
  Diluted..............................................      $     0.37      $   (0.20)      $   (0.02)     $   (13.34)
                                                       ================  ==============  ==============  ==============
</TABLE>

__________

(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 16
     - Earnings Per Share).

(2)  In the second quarter of 1998, the Company recorded an  extraordinary  loss
     of $10.1 million, net of income tax benefit of $3.7 million, in relation to
     the  permanent  paydown of  $300.0 million  of the term loan portion of the
     credit facility and $3.7 million  related to the retirement of $5.0 million
     of Contour convertible debentures purchased by the Company.

(21) SEGMENT INFORMATION

     The Company  adopted  SFAS 131 in 1998,  which  changed the way the Company
reports information from its operating  segments.  Segment information from 1997
has been reclassified from the prior year's  presentation to conform to the 1998
presentation.  Previously,  the Company identified  segments based on geographic
location.

     The Company  operates  predominantly  in the long-term  care segment of the
healthcare  industry.  The Company is 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,  the Company  provides  services in the
United Kingdom, Spain, Germany and Australia.

                                      F-48
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The following  summarizes the services provided by the Company's 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.  The Company provides 24-hour nursing care in
these facilities by registered  nurses,  licensed practical nurses and certified
nursing aids.

     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.

     PHARMACEUTICAL AND MEDICAL SUPPLY SERVICES: This segment is comprised of an
institutional   pharmaceutical   company  and  a  medical  supply  company.  The
pharmaceutical company 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.  The medical supply company
provides  medical  supplies  primarily  to  long-term  care and  sub-acute  care
facilities.

     INTERNATIONAL   OPERATIONS:   This  segment   consists  of  long-term  care
facilities in the United Kingdom,  Spain, Australia and Germany as well as acute
care hospitals in Australia.  This segment also provides pharmaceutical services
in the United Kingdom,  Germany and Spain and medical supplies in Australia. The
Company sold certain of the Canadian operations in 1998 and the remainder in the
first  quarter of 1999.  Subsequent  to December 31,  1999,  the Company sold 18
pharmacies in the United Kingdom.  The Company is currently soliciting offers to
purchase the remainder of its international operations.

     OTHER  OPERATIONS:   This  segment  includes  temporary  therapy  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  and  Financial  Reporting
Policies".  The Company primarily  evaluates segment performance based on profit
or loss from  operations  after  allocated  expenses  and before  reorganization
items,  income taxes,  extraordinary  items and  cumulative  effect of change in
accounting  principle.  Gains or  losses on sales of assets  and  certain  items
including  impairment of assets recorded in connection with SFAS 121,  legal and
regulatory  matters,  restructuring  costs,  etc.  are  not  considered  in  the
evaluation  of segment  performance.  Allocated  expenses  include  intercompany
charges  assessed to segments  for  management  services  and asset use based on
segment operating results and average asset balances,  respectively. The Company
accounts for intersegment sales and provision of services at market prices.

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

                                      F-49
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The Company's 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.

                                      F-50
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The following tables summarize, for the years indicated,  operating results
and other financial information, by business segment (in thousands):
<TABLE>
<CAPTION>
                                        REHABILITATION
                                             AND        PHARMACEUTICAL
                                         RESPIRATORY     AND MEDICAL
                            INPATIENT      THERAPY         SUPPLY    INTERNATIONAL   OTHER                INTERSEGMENT
                            SERVICES       SERVICES       SERVICES    OPERATIONS   OPERATIONS  CORPORATE  ELIMINATIONS  CONSOLIDATED
                            --------       --------       --------    ----------   ----------  ---------  ------------  ------------
<S>                         <C>         <C>             <C>          <C>          <C>         <C>         <C>           <C>
FOR THE YEAR ENDED DECEMBER 31, 1999
Total Net Revenues.........$1,697,518   $   234,008     $  300,959   $  296,906   $ 222,219   $       -   $(222,571)    $2,529,039
Operating expenses,
  corporate general and
  administrative expenses,
  and provision for losses  1,789,570       248,027        299,068      290,272     237,054     116,315    (219,705)     2,760,601
  on accounts receivable...
Depreciation and               29,025         7,173          7,043       12,805      12,911      12,584        (216)        81,325
  amortization.............
Interest, net..............     9,773           305             76       13,191       6,902      98,807            -       129,054
Dividends on Preferred
  Securities...............         -             -              -            -           -      20,407            -        20,407
                            ---------   -----------    -----------  -----------  ----------  ----------  -----------  ------------
Losses before corporate     (130,850)      (21,497)        (5,228)     (19,362)    (34,648)   (248,113)      (2,650)     (462,348)
  allocations..............
Corporate interest             42,793        12,868         12,613       19,550      10,166    (97,990)            -             -
  allocation...............
Corporate management fees..    71,611         9,455         11,792        2,966       6,733    (99,907)      (2,650)             -
                            ---------   -----------    -----------  -----------  ----------  ----------  -----------  ------------
Net segment losses......... $(245,254)   $  (43,820)    $  (29,633)   $  (41,878)  $ (51,547)  $(50,216)   $        -    $(462,348)
                            =========   ===========    ===========  ===========  ==========  ==========  ===========  ============
Intersegment revenues...... $     598   $   126,880    $    80,944   $        -   $  14,149   $       -   $(222,571)    $       -
Identifiable segment assets $ 345,810   $    74,530    $   110,302   $  267,604   $ 159,259   $1,142,314  $(661,331)    $1,438,488
Segment capital
  expenditures, net........ $  23,114   $     6,696    $    3,184    $   25,632   $  11,616   $  32,211   $        -    $  102,453

FOR THE YEAR ENDED DECEMBER 31, 1998
Total Net Revenues......... $2,045,270  $   678,803    $   254,455   $  285,267   $ 283,326   $       -   $(458,661)    $3,088,460
Operating expenses,
  corporate general and
  administrative expenses,
  and provision for losses
  on accounts receivable...  1,970,887      458,464        232,219      264,927     280,000     137,809    (450,804)     2,893,502
Depreciation and
  amortization.............     41,223        9,727         10,755       19,296       8,968      12,546            -       102,515
Interest, net..............      6,422          (18)           409       19,412       3,853     105,333            -       135,411
Dividends on Preferred
  Securities                         -             -             -            -           -      16,163            -        16,163
                            ----------  ------------   -----------  -----------  ----------  ----------  -----------  ------------
Earnings (losses) before
  corporate allocations....    26,738       210,630         11,072     (18,368)     (9,495)   (271,851)      (7,857)      (59,131)
Corporate interest
  allocation..............     49,683        16,300         10,653       22,844       8,992   (108,472)            -             -
Corporate management fees..    86,777        34,486         10,148        2,694       (718)   (125,530)      (7,857)             -
                            ---------   -----------    -----------  -----------  ----------  ----------  -----------  ------------
Net segment earnings
  (losses)................. $(109,722)  $   159,844    $   (9,729)   $ (43,906)   $(17,769) $ (37,849)   $        -   $  (59,131)
                            ==========  ===========    ===========  ===========  ========== ==========  ===========   ===========
Intersegment revenues...... $       -   $   344,118    $    78,954   $        -   $  35,589  $        -   $(458,661)   $       -
Identifiable segment assets $ 661,349   $   203,365    $   141,664   $  419,660   $ 230,969  $1,427,243   $(616,212)   $ 2,468,038
Segment capital
  expenditures, net.........$  68,145   $     5,393    $    19,307   $    4,755   $  27,580  $   40,257   $  (5,021)   $   160,416

FOR THE YEAR ENDED DECEMBER 31, 1997
Total Net Revenues......... $1,249,861  $   466,358    $   157,336   $  198,155   $ 165,906  $        -   $(226,796)   $ 2,010,820
Operating expenses,
  corporate general and
  administrative expenses,
  and provision for losses
  on accounts receivable... 1,153,712       315,528        135,375      173,546     154,411      71,050    (226,796)     1,776,826
Depreciation and
  amortization.............    22,655         4,196          3,311       15,509       2,243       8,716            -        56,630
Interest, net..............     4,144          (53)             92       16,608        (91)      53,782            -        74,482
                            ---------   -----------    -----------  -----------  ----------  ----------  -----------  ------------
Earnings (losses) before
  corporate allocations....    69,350       146,687         18,558      (7,508)       9,343   (133,548)            -       102,882
Corporate interest
  allocation...............    18,779         8,869          5,169       17,175       3,900    (53,892)            -             -
Corporate management fees
  allocation...............    48,952        18,804          6,162        1,963       1,925    (77,806)            -             -
                            ----------  -------------  -----------  -----------  ----------  ----------  -----------  ------------
Net segment earnings
  (losses)................. $   1,619   $   119,014    $     7,227   $ (26,646)   $   3,518   $ (1,850)   $        -   $   102,882
                            =========   ===========    ===========  ===========  ==========  ==========  ===========  ============
Intersegment revenues...... $      -    $   180,303    $    32,648   $        -   $  13,845   $     -     $ (226,796)  $         -

Identifiable segment assets $ 611,752   $   211,526    $   110,811   $  566,136   $  51,739   $1,771,041  $ (743,769)  $ 2,579,236
Segment capital
  expenditures, net........ $  25,104   $     8,575    $     4,580   $   51,231   $     712   $  12,960   $        -   $   103,162
</TABLE>
                                      F-51
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     The  following   tables   reconcile  net  segment   earnings   (losses)  to
consolidated  earnings  (losses)  before  reorganization  items,  income  taxes,
extraordinary items and cumulative effect of change in accounting principle:
<TABLE>
<CAPTION>
                                                              FOR THE YEAR ENDED      FOR THE YEAR ENDED     FOR THE YEAR ENDED
                                                              DECEMBER 31, 1999       DECEMBER 31, 1998      DECEMBER 31, 1997
                                                              -----------------       -----------------      -----------------
<S>                                                         <C>                     <C>                     <C>
Net segment earnings (losses)....................             $  (462,348)              $ (59,131)            $ 102,882
Legal and regulatory matters, net................                     (38)                (22,456)                    -
Loss on sale of assets, net......................                 (78,673)               (206,205)              (7,000)
Loss on termination of interest rate swaps.......                  (2,488)                       -                    -
Impairment loss..................................                (457,449)               (397,492)                    -
Restructuring costs..............................                 (27,353)                 (4,558)                    -
Reorganization costs, net........................                 (48,132)                       -                    -
                                                           ----------------------   ---------------------   --------------------
Earnings (losses) before income taxes, extraordinary
  loss and cumulative effect of change in accounting
  principle......................................             $(1,076,481)              $(689,842)            $  95,882
                                                           ======================   =====================   ====================
</TABLE>

(22) SUMMARIZED CONSOLIDATING INFORMATION

     In connection with the Company's offering of the 9 1/2% Notes in July 1997,
and the 9 3/8% Notes in May 1998,  all direct and indirect  subsidiaries  of the
Company  other than the  Company's  direct and  indirect  foreign  subsidiaries,
CareerStaff  and  its  direct  and  indirect  subsidiaries,  and  certain  other
immaterial  subsidiaries  of the Company (the  "Guarantors")  have,  jointly and
severally,  unconditionally  guaranteed the 9 1/2% Notes and 9 3/8% Notes. These
guarantees  are  subordinated  to  all  existing  and  future  senior  debt  and
guarantees of the Guarantors and are unsecured.

     The Company conducts all of its business through and derives  virtually all
of its income from its  subsidiaries.  Therefore,  the Company's ability to make
required  payments with respect to its indebtedness  (including the 9 1/2% Notes
and the 9 3/8% Notes) and other obligations depends on the financial results and
condition  of its  subsidiaries  and its  ability  to  receive  funds  from  its
subsidiaries.

     Pursuant  to  Rule 3-10  of   Regulation S-X,   the  following   summarized
consolidating  information is for the Company, the wholly-owned Guarantors,  and
the Company's  non-Guarantor  subsidiaries  with respect to the 9 1/2% Notes and
the 9 3/8% Notes. This summarized  financial  information has been prepared from
the  books  and  records  maintained  by the  Company,  the  Guarantors  and the
non-Guarantor  subsidiaries.   The  summarized  financial  information  may  not
necessarily be indicative of results of operations or financial position had the
Guarantors or non-Guarantor  subsidiaries operated as independent entities.  The
separate  financial  statements  of the  Guarantors  are not  presented  because
management has determined they would not be material to investors.

                                      F-52
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

     Through various  intercompany  agreements entered into by the Company,  the
Guarantors  and  certain  of  the  non-Guarantor   subsidiaries,   Sun  provides
management  services,  and acts on behalf of the  Guarantors  and certain of the
non-Guarantor subsidiaries to make financing available for their operations. The
Company charged the Guarantors for management  services  totaling  approximately
$99.2 million, $124.9 million and $75.7 million for the years ended December 31,
1999,  1998 and  1997,  respectively.  The  Company  charged  the  non-Guarantor
subsidiaries  for  management  services  totaling  approximately   $1.1 million,
$4.4 million and $1.5 million  for the years ended  December 31,  1999, 1998 and
1997,  respectively.  Intercompany  interest  charged to the  Guarantors for the
years ended December 31,  1999, 1998 and 1997 for advances from the Company were
approximately  $78.0 million,  $190.5 million and $141.8 million,  respectively.
Intercompany  interest charged to the  non-Guarantor  subsidiaries for the years
ended  December 31,  1999,  1998 and  1997 for  advances  from the  Company  was
approximately $0.4 million, $3.8 million and $2.7 million, respectively.

                                      F-53
<PAGE>

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                           CONSOLIDATING BALANCE SHEET

                             AS OF DECEMBER 31, 1999
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                      COMBINED         COMBINED
                                                      PARENT         GUARANTOR       NON-GUARANTOR
                                                     COMPANY        SUBSIDIARIES     SUBSIDIARIES      ELIMINATION    CONSOLIDATED
                                                     -------        ------------     ------------      -----------    ------------
<S>                                               <C>              <C>              <C>               <C>             <C>
Current assets:
   Cash and cash equivalents...................    $      13,049    $       6,693     $       5,305     $         -    $     25,047
   Accounts receivable, net....................                -          235,745            20,659         (1,940)         254,464
   Other receivables, net......................          296,034        (191,118)          (89,000)               -          15,916
   Inventory, net..............................                -           35,333             7,650               -          42,983
   Prepaids and other assets...................            1,796            8,825             4,466               -          15,087
                                                  ---------------  ---------------  ----------------   -------------  --------------
  Total current assets.........................          310,879           95,478          (50,920)         (1,940)         353,497
Property and equipment, net....................           94,264          144,643           207,269               -         446,176
Goodwill, net..................................                -          407,093            68,474               -         475,567
Notes receivable, net..........................           14,750            1,436             6,512               -          22,698
Assets held for sale...........................                -           67,116             3,493               -          70,609
Other assets, net..............................           37,229           25,280             7,432               -          69,941
Investment in subsidiaries.....................      (1,242,314)                -                 -       1,242,314               -
                                                  ---------------  ---------------  ----------------   -------------  --------------
  Total assets.................................    $   (785,192)     $    741,046      $    242,260     $ 1,240,374    $  1,438,488
                                                  ===============  ===============  ================   =============  ==============

Current liabilities:
   Current portion of long-term debt...........           12,126            1,225            31,425               -          44,776
   Current portion of obligations under capital
     leases....................................                -              107               326               -             433
   Accounts payable............................           28,177           14,545            13,214         (2,149)          53,787
   Accrued compensation and benefits...........           13,011           61,642             9,464               -          84,117
   Accrued interest............................                -            2,034               938               -           2,972
   Accrued self-insurance obligations..........         (12,703)           70,512             1,266               -          59,075
   Other accrued liabilities...................           36,685           60,483            19,321               -         116,489
   Income tax payables.........................           17,498          (9,271)               903               -           9,130
                                                  ---------------  ---------------  ----------------   -------------  --------------
  Total current liabilities....................           94,794          201,277            76,857         (2,149)         370,779
Long-term debt, net of current portion.........                -           53,387            47,378               -         100,765
Obligations under capital leases, net of current
  portion......................................                -            8,188            57,487               -          65,675
Other long-term liabilities....................                -           34,768             2,026               -          36,794
Liabilities subject to compromise (see Note 2).        1,427,020          131,498                 -               -       1,558,518
                                                  ---------------  ---------------  ----------------   -------------  --------------
  Total liabilities............................        1,521,814          429,118           183,748         (2,149)       2,132,531
Intercompany payables/(receivables)............      (1,606,984)        1,622,789          (16,015)             210               -
Minority interest..............................                -            5,821               158               -           5,979
Company-obligated manditorily redeemable
  convertible preferred securities of a
  subsidiary trust holding solely 7% convertible
  junior subordinated debentures of the Company          344,119                -                 -               -         344,119
Total stockholders' equity (deficit)...........      (1,044,141)      (1,316,682)            74,369       1,242,313     (1,044,141)
                                                  ---------------  ---------------  ----------------   -------------  --------------
Total liabilities and stockholders' equity
  (deficit)....................................    $   (785,192)     $    741,046      $    242,260     $ 1,240,374    $  1,438,488
                                                  ===============  ===============  ================   =============  ==============
</TABLE>

                                      F-54
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                           CONSOLIDATING BALANCE SHEET

                             AS OF DECEMBER 31, 1998
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                              COMBINED          COMBINED
                                                PARENT        GUARANTOR       NON-GUARANTOR
                                                COMPANY      SUBSIDIARIES     SUBSIDIARIES        ELIMINATION    CONSOLIDATED
                                                -------      ------------     ------------       -----------    ------------
<S>                                           <C>            <C>              <C>                <C>             <C>
Current assets:
   Cash and cash equivalents...............      $ (9,964)      $   26,406         $    11,062         $     -      $   27,504
   Accounts receivable, net................            311         485,293              60,313         (7,588)         538,329
   Other receivables, net..................         14,304          17,600              16,169               -          48,073
   Inventory, net..........................             13          39,640               9,209               -          48,862
   Prepaids and other assets...............          2,651           9,151               1,289               -          13,091
   Income tax receivables..................         15,874               -                   -               -          15,874
                                              -------------  --------------  ------------------  --------------  --------------
  Total current assets.....................         23,189         578,090              98,042         (7,588)         691,733

Property and equipment, net................         66,341         228,732             306,197               -         601,270
Goodwill, net..............................              -         669,785             126,160               -         795,945
Notes receivable, net......................         21,999             693               9,642               -          32,334
Assets held for sale.......................              -         192,447                   -               -         192,447
Other assets, net..........................         75,710          50,287              22,312               -         148,309
Investment in subsidiaries.................          (904)               -                   -             904               -
Deferred tax assets........................          6,000               -                   -               -           6,000
                                              -------------  --------------  ------------------  --------------  --------------
  Total assets.............................      $ 192,335     $ 1,720,034        $    562,353      $  (6,684)     $ 2,468,038
                                              =============  ==============  ==================  ==============  ==============

Current liabilities:
   Current portion of long-term debt.......      $ 728,032      $   57,212         $    27,377         $     -      $  812,621
   Current portion of obligations under
     capitalleases.........................          1,134           2,333                 236               -           3,703
   Accounts payable........................         63,170          17,192              21,369         (7,588)          94,143
   Accrued compensation and benefits.......         19,160          69,510              13,421               -         102,091
   Accrued interest........................         19,616           5,957                 522               -          26,095
   Accrued self-insurance obligations......        (2,713)          56,241               1,337               -          54,865
   Other accrued liabilities...............         23,699          77,128              37,024               -         137,851
                                              -------------  --------------  ------------------  --------------  --------------
  Total current liabilities................        852,098         285,573             101,286         (7,588)       1,231,369

Long-term debt, net of current portion.....        502,822         162,061              40,770               -         705,653
Obligations under capital leases, net of
  current portion..........................              -          27,731              75,948               -         103,679
Other long-term liabilities................              -          39,123               1,938               -          41,061
                                              -------------  --------------  ------------------  --------------  --------------
  Total liabilities........................      1,354,920         514,488             219,942         (7,588)       2,081,762

Intercompany payables/(receivables)........    (1,541,344)       1,398,795             142,549               -               -
Minority interest..........................              -           6,118               1,399               -           7,517
Company-obligated manditorily redeemable
  convertible preferred securities of a
  subsidiary trust holding solely 7%
  convertible junior subordinated debentures
  of the Company...........................        345,000               -                   -               -         345,000
Total stockholders' equity (deficit).......         33,759       (199,367)             198,463             904          33,759
                                              -------------  --------------  ------------------  --------------  --------------
Total liabilities and stockholders' equity
  (deficit)................................     $  192,335     $ 1,720,034        $    562,353      $  (6,684)     $ 2,468,038
                                              =============  ==============  ==================  ==============  ==============
</TABLE>

                                      F-55
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                  CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)

                      FOR THE YEAR ENDED DECEMBER 31, 1999
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                COMBINED         COMBINED
                                                PARENT          GUARANTOR       NON-GUARANTOR
                                                COMPANY        SUBSIDIARIES     SUBSIDIARIES      ELIMINATION      CONSOLIDATED
                                                -------        ------------     ------------      -----------      ------------
<S>                                          <C>              <C>              <C>               <C>              <C>
Total net revenues..........................     $  (2,058)     $  2,201,463       $   335,188       $  (5,554)      $ 2,529,039
                                             ---------------  ---------------  ----------------  ---------------  ---------------
Costs and expenses:
   Operating costs..........................              -        2,159,004           324,263          (5,554)        2,477,713
   Impairment loss..........................          3,717          386,905            66,827                -          457,449
   Corporate general and administrative.....        115,544           30,124            14,003                -          159,671
   Interest, net (contractual interest
     $166,101)..............................         95,716           18,782            14,556                -          129,054
   Provision for losses on accounts
     receivable.............................          1,911          120,820               486                -          123,217
   Depreciation and amortization............          9,825           58,231            13,269                -           81,325
   Loss on sale of assets, net..............          9,760           52,131            16,782                -           78,673
   Restructuring costs......................         19,731            6,086             1,536                -           27,353
   Loss on termination of interest rate swap          2,488                -                 -                -            2,488
   Legal and regulatory matters, net........          2,907          (2,869)                 -                -               38
   Equity interest in losses of
     subsidiaries...........................      1,236,260                -                 -      (1,236,260)                -
   Intercompany interest expense (income)...       (20,125)           20,125                 -                -                -
                                             ---------------  ---------------  ----------------  ---------------  ---------------
   Total costs and expenses.................      1,477,734        2,849,339           451,722      (1,241,814)        3,536,981
                                             ---------------  ---------------  ----------------  ---------------  ---------------

Dividends on convertible preferred
  securities of subsidiary..................         20,407                -                 -                -           20,407
Intercompany charges........................      (454,977)          452,940             2,037                -                -
                                             ---------------  ---------------  ----------------  ---------------  ---------------
Losses before reorganization costs, income
  taxes and cumulative effect of change
  in accounting principle...................    (1,045,222)      (1,100,816)         (118,571)        1,236,260      (1,028,349)
Reorganization costs, net...................         41,047            7,085                 -                -           48,132
Income taxes................................            120                -                41                -              161
                                             ---------------  ---------------  ----------------  ---------------  ---------------
Net losses before cumulative effect of
  change in accounting principle............    (1,086,389)      (1,107,901)         (118,612)        1,236,260      (1,076,642)
Cumulative effect of change in accounting
  principle.................................        (3,069)          (9,351)             (396)                -         (12,816)
                                             ---------------  ---------------  ----------------  ---------------  ---------------
Net losses..................................   $(1,089,458)    $ (1,117,252)      $  (119,008)      $ 1,236,260     $(1,089,458)
                                             ===============  ===============  ================  ===============  ===============
</TABLE>


                                      F-56
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                  CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)

                      FOR THE YEAR ENDED DECEMBER 31, 1998
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                       COMBINED         COMBINED
                                         PARENT       GUARANTOR      NON-GUARANTOR
                                         COMPANY     SUBSIDIARIES     SUBSIDIARIES      ELIMINATION    CONSOLIDATED
                                         -------     ------------     ------------      -----------    ------------
<S>                                    <C>           <C>             <C>               <C>             <C>
Total net revenues..................      $  3,106     $ 2,657,853       $   447,617     $  (20,116)     $ 3,088,460
                                       ------------  --------------  ----------------  --------------  --------------
Costs and expenses:
   Operating........................         4,281       2,235,535           409,785        (20,116)       2,629,485
   Impairment loss..................         6,750         330,453            60,289               -         397,492
   Loss on sale of assets, net......        37,392         157,460            11,353               -         206,205
   Corporate general and                   122,081          41,144            17,709               -         180,934
     administrative.................
   Interest, net....................       102,745          12,124            20,542               -         135,411
   Depreciation and amortization....        10,364          69,928            22,223               -         102,515
   Provision for losses on
     accounts receivable............         5,433          73,937             3,713               -          83,083
   Legal and regulatory matters, net        22,050             406                 -               -          22,456
   Restructuring costs..............         1,003           3,429               126               -           4,558
   Equity interest in losses of
     subsidiaries...................       779,076               -                 -       (779,076)               -
                                       ------------  --------------  ----------------  --------------  --------------
   Total costs and expenses.........     1,091,175       2,924,416           545,740       (799,192)       3,762,139
                                       ------------  --------------  ----------------  --------------  --------------

Dividends on convertible preferred
  securities of subsidiary..........        16,163               -                 -               -          16,163
Intercompany charges................     (323,662)         315,450             8,212               -               -
                                       ------------  --------------  ----------------  --------------  --------------
Losses before income taxes and
  extraordinary loss................     (780,570)       (582,013)         (106,335)         779,076       (689,842)
Income taxes........................      (37,151)          96,222           (5,494)               -          53,577
                                       ------------  --------------  ----------------  --------------  --------------
Losses before extraordinary loss....     (743,419)       (678,235)         (100,841)         779,076       (743,419)
Extraordinary loss..................      (10,274)               -                 -               -        (10,274)
                                       ------------  --------------  ----------------  --------------  --------------
Net losses..........................    $(753,693)     $ (678,235)      $  (100,841)      $  779,076     $ (753,693)
                                       ============  ==============  ================  ==============  ==============
</TABLE>

                                      F-57
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                       CONSOLIDATING STATEMENT OF EARNINGS

                      FOR THE YEAR ENDED DECEMBER 31, 1997
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                             COMBINED          COMBINED
                                               PARENT        GUARANTOR       NON-GUARANTOR
                                               COMPANY     SUBSIDIARIES      SUBSIDIARIES      ELIMINATION    CONSOLIDATED
                                               -------     ------------      ------------      -----------    ------------
<S>                                          <C>           <C>             <C>                 <C>            <C>
Total net revenues.......................       $  2,337     $ 1,671,369        $    337,114        $     -     $ 2,010,820
                                             ------------  --------------  ------------------  -------------  --------------
Costs and expenses:
   Operating.............................              -       1,376,767             286,051              -       1,662,818
   Corporate general and administrative..         61,687          22,643              13,839              -          98,169
   Interest, net.........................         52,244           5,646              16,592              -          74,482
   Depreciation and amortization.........          4,574          35,301              16,755              -          56,630
   Provision for losses on accounts
     receivable..........................          (750)          15,733                 856              -          15,839
   Loss on sale of assets, net...........          7,000               -                   -              -           7,000
   Equity interest in losses of subsidiaries      22,925               -                   -       (22,925)               -
                                             ------------  --------------  ------------------  -------------  --------------
   Total costs and expenses..............        147,680       1,456,090             334,093       (22,925)       1,914,938
                                             ------------  --------------  ------------------  -------------  --------------

Earnings (losses) before income taxes,
  intercompany charges and extraordinary
  loss...................................      (145,343)         215,279               3,021         22,925          95,882
Intercompany charges.....................        221,738       (217,578)             (4,160)              -               -
                                             ------------  --------------  ------------------  -------------  --------------
Earnings (losses) before income taxes....         76,395         (2,299)             (1,139)         22,925          95,882
Income taxes.............................         39,544             935                 674              -          41,153
                                             ------------  --------------  ------------------  -------------  --------------


Earnings (losses) before extraordinary loss       36,851         (3,234)             (1,813)         22,925          54,729
Extraordinary loss.......................        (2,050)        (17,878)                   -              -        (19,928)
                                             ------------  --------------  ------------------  -------------  --------------
Net earnings (losses)....................       $ 34,801      $ (21,112)        $    (1,813)      $  22,925      $   34,801
                                             ============  ==============  ==================  =============  ==============
</TABLE>


                                      F-58
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                     CONSOLIDATING STATEMENTS OF CASH FLOWS

                      FOR THE YEAR ENDED DECEMBER 31, 1999
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                   COMBINED          COMBINED
                                                   PARENT         GUARANTOR       NON-GUARANTOR
                                                   COMPANY       SUBSIDIARIES      SUBSIDIARIES       ELIMINATION     CONSOLIDATED
                                                   -------       ------------      ------------       -----------     ------------
<S>                                              <C>             <C>               <C>                <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net losses....................................   $(1,089,458)     $(1,117,252)      $   (119,008)      $  1,236,260   $ (1,089,458)
Adjustments to reconcile net losses to net
  cash provided by (used for) operating
  activities:
      Equity interest in losses of subsidiaries     1,236,260                -                  -       (1,236,260)               0
      Loss on sale of assets, net.............          9,760           52,131             16,782                 -          78,673
      Cumulative effect of change in
         accounting  principle................          3,069            9,351                396                 -          12,816
      Impairment loss.........................          3,717          386,905             66,827                 -         457,449
      Depreciation and amortization...........          9,825           58,231             13,269                 -          81,325
      Provision for losses on accounts
         receivable...........................          1,911          120,820                486                 -         123,217
      Reorganization costs, net...............         41,047            7,085                  -                 -          48,132
      Other, net..............................          9,043            9,978              (966)                 -          18,055
Changes in operating assets and liabilities:
   Accounts receivable........................        (4,586)          150,077             15,373                 -         160,864
   Other current assets.......................         53,883         (20,544)           (24,927)                 -           8,412
   Other current liabilities..................         41,641           28,941              2,025                 -          72,607
   Income tax payables .......................         38,795          (6,802)              3,437                 -          35,430
                                                --------------  ---------------  -----------------  ----------------  --------------
Net cash provided by (used for) operating
  activities before reorganization costs......        354,907        (321,079)           (26,306)                 -           7,522
Net cash paid for reorganization costs........          (269)                -                  -                 -           (269)
                                                --------------  ---------------  -----------------  ----------------  --------------
Net cash provided by (used for) operating
  activities..................................        354,638        (321,079)           (26,306)                 -           7,253
                                                --------------  ---------------  -----------------  ----------------  --------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net.....................       (32,205)         (33,243)           (37,005)                 -       (102,453)
Proceeds from sale of assets held for sale....              -            8,735                  -                 -           8,735
Acquisitions, net of cash acquired............              -          (5,731)                  -                 -         (5,731)
Proceeds from the sale and leaseback of
  property and equipment......................              -                -             38,600                 -          38,600
Decrease (increase) in long-term notes
  receivable..................................         44,641         (30,414)              1,630                 -          15,857
Decrease (increase) in other assets...........          8,065           43,358            (6,244)                 -          45,179
                                                --------------  ---------------  -----------------  ----------------  --------------
Net cash provided by (used for) investing
  activities..................................         20,501         (17,295)            (3,019)                 -             187
                                                --------------  ---------------  -----------------  ----------------  --------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under Revolving Credit
  Agreement (postpetition) ...................         12,125                -                  -                 -          12,125
Long-term debt borrowings.....................         95,693            2,732             27,637                 -         126,062
Long-term debt repayments (prepetition).......       (13,800)         (42,977)           (35,725)                 -        (92,502)
Principal payments on prepetition debt
  authorized by Bankruptcy Court..............       (34,708)          (1,347)               (63)                 -        (36,118)
Conversion of Mediplex 6 1/2% subordinated
  debentures due 2003.........................        (6,649)                -                  -                 -         (6,649)
Net proceeds from issuance of common stock....          1,784                -                  -                 -           1,784
Purchases of treasury stock...................          (409)                -                  -                 -           (409)
Other financing activities....................       (27,242)           12,485                277                 -        (14,480)
Intercompany advances.........................      (378,987)          347,768             31,219                 -               -
                                                --------------  ---------------  -----------------  ----------------  --------------
Net cash provided by (used for) financing
  activities..................................      (352,193)          318,661             23,345                 -        (10,187)
                                                --------------  ---------------  -----------------  ----------------  --------------
Effect of exchange rate on cash and cash
  equivalents.................................             67                -                223                 -             290
                                                --------------  ---------------  -----------------  ----------------  --------------
Net increase (decrease) in cash and cash
  equivalents.................................         23,013         (19,713)            (5,757)                 -         (2,457)
Cash and cash equivalents at beginning of             (9,964)           26,406             11,062                 -          27,504
  period......................................
                                                --------------  ---------------  -----------------  ----------------  --------------
Cash and cash equivalents at end of period....      $  13,049       $    6,693        $     5,305          $      -      $   25,047
                                                ==============  ===============  =================  ================  ==============
</TABLE>

                                      F-59
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                      CONSOLIDATING STATEMENT OF CASH FLOWS

                      FOR THE YEAR ENDED DECEMBER 31, 1998
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                   COMBINED          COMBINED
                                                    PARENT        GUARANTOR        NON-GUARANTOR
                                                    COMPANY      SUBSIDIARIES      SUBSIDIARIES      ELIMINATION     CONSOLIDATED
                                                    -------      ------------      ------------      -----------     ------------
<S>                                                <C>           <C>               <C>               <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net losses....................................     $(753,693)     $  (678,235)       $   (100,841)     $  779,076      $ (753,693)
Adjustments to reconcile net losses to net cash
  provided by (used for) operating activities:
   Equity interest in losses of subsidiaries..        779,076                -                   -      (779,076)                -
   Extraordinary loss.........................         10,274                -                   -              -           10,274
   Loss on sale of assets, net................         37,392          157,460              11,353              -          206,205
   Impairment loss............................          6,750          330,453              60,289              -          397,492
   Depreciation and amortization..............         10,364           69,928              22,223              -          102,515
   Provision for losses on accounts receivable          5,433           73,937               3,713              -           83,083
   Other, net.................................          9,572                -               (504)              -            9,068
Changes in operating assets and liabilities:
   Accounts receivable........................        (1,525)         (56,853)             (3,301)              -         (61,679)
   Other current assets.......................        (5,083)          (3,262)            (11,212)              -         (19,557)
   Other current liabilities..................         88,371        (125,270)             (4,631)              -         (41,530)
   Income tax payables .......................       (30,387)           53,855             (1,226)              -           22,242
                                                  ------------  ---------------  ------------------  -------------  ---------------
Net cash provided by (used for) operating
  activities..................................        156,544        (177,987)            (24,137)              -         (45,580)
                                                  ------------  ---------------  ------------------  -------------  ---------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net.....................       (32,688)        (116,920)            (10,808)              -        (160,416)
Acquisitions, net of cash acquired............              -         (46,249)            (14,392)              -         (60,641)
Proceeds from the sale and leaseback of property
  and equipment...............................              -           16,833             117,542              -          134,375
Decrease (increase) in long-term notes
  receivable..................................       (24,686)           14,903               3,806              -          (5,977)
Decrease (increase) in other assets...........          5,593         (11,282)              12,483              -            6,794
                                                  ------------  ---------------  ------------------  -------------  ---------------
Net cash provided by (used for) investing
  activities..................................       (51,781)        (142,715)             108,631              -         (85,865)
                                                  ------------  ---------------  ------------------  -------------  ---------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings.....................        225,781                -              23,037              -          248,818
Long-term debt repayments.....................      (314,823)         (24,725)            (99,059)              -        (438,607)
Net proceeds from issuance of convertible trust
  issued preferred securities of subsidiary...        334,044                -                   -              -          334,044
Net proceeds from issuance of common stock....          2,337                -                   -              -            2,337
Purchases of treasury stock...................        (1,393)                -                   -              -          (1,393)
Other financing activities....................       (18,290)            8,875               1,264              -          (8,151)
Intercompany advances.........................      (340,802)          342,948             (2,146)              -                -
                                                  ------------  ---------------  ------------------  -------------  ---------------
Net cash provided by (used for) financing
  activities..................................      (113,146)          327,098            (76,904)              -          137,048
                                                  ------------  ---------------  ------------------  -------------  ---------------
Effect of exchange rate on cash and cash
  equivalents.................................              -                -                 881              -              881
                                                  ------------  ---------------  ------------------  -------------  ---------------
Net increase (decrease) in cash and cash
  equivalents.................................        (8,383)            6,396               8,471              -            6,484
Cash and cash equivalents at beginning of period      (1,581)           20,010               2,591              -           21,020
                                                  ------------  ---------------  ------------------  -------------  ---------------
Cash and cash equivalents at end of period          $ (9,964)       $   26,406         $    11,062        $     -       $   27,504
                                                  ============  ===============  ==================  =============  ===============
</TABLE>

                                      F-60
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                      CONSOLIDATING STATEMENT OF CASH FLOWS

                      FOR THE YEAR ENDED DECEMBER 31, 1997
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                 COMBINED         COMBINED
                                                   PARENT        GUARANTOR      NON-GUARANTOR
                                                  COMPANY      SUBSIDIARIES     SUBSIDIARIES      ELIMINATION      CONSOLIDATED
                                                  -------      ------------     ------------      -----------      ------------
<S>                                             <C>            <C>              <C>               <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (losses)........................       $ 34,801      $ (21,112)      $    (1,813)       $   22,925       $   34,801
Adjustments to reconcile net earnings (losses)
  to net cash provided by (used for) operating
  activities:
   Equity interest in losses of subsidiaries.         22,925               -                 -         (22,925)                -
   Extraordinary loss........................          2,050          17,878                 -                -           19,928
   Loss of sale of assets, net...............          7,000               -                 -                -            7,000
   Depreciation and amortization.............          4,574          35,301            16,755                -           56,630
   Provision for losses on accounts receivable             -          14,983               856                -           15,839
   Other, net................................          5,353         (1,697)             (344)                -            3,312
Changes in operating assets and liabilities:
   Accounts receivable.......................              -       (143,875)          (21,091)                -        (164,966)
   Other current assets......................         10,960         (8,939)           (8,344)                -          (6,323)
   Other current liabilities.................         38,152        (22,303)             8,379                -           24,228
   Income tax payables.......................         31,663             945           (1,324)                -           31,284
                                                -------------  --------------  ----------------  ---------------  ---------------
Net cash provided by (used for) operating
  activities.................................        157,478       (128,819)           (6,926)                -           21,733
                                                -------------  --------------  ----------------  ---------------  ---------------


CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net....................        (2,900)        (47,893)          (52,369)                -        (103,162)
Acquisitions, net of cash acquired...........              -       (346,054)         (218,080)                -        (564,134)
Proceeds from the sale and leaseback of
  property and equipment.....................              -          31,179            49,278                -           80,457
Increase in long-term notes receivable.......       (38,392)         (5,590)          (13,449)                -         (57,431)
Other asset expenditures.....................       (24,489)        (16,285)             4,923                -         (35,851)
                                                -------------  --------------  ----------------  ---------------  ---------------
Net cash used for investing activities.......       (65,781)       (384,643)         (229,697)                -        (680,121)
                                                -------------  --------------  ----------------  ---------------  ---------------


Cash flows from financing activities:
Long-term debt borrowings....................      1,793,711           4,508            38,843                -        1,837,062
Long-term debt repayments....................      (847,114)        (53,035)          (65,875)                -        (966,024)
Repurchase of certain Regency debt...........              -       (182,070)                 -                -        (182,070)
Net proceeds from issuance of common stock...          6,275               -                 -                -            6,275
Purchases of treasury stock..................          (505)               -                 -                -            (505)
Other financing activities...................       (33,369)               -              (42)                -         (33,411)
Intercompany advances........................    (1,014,502)         753,199           261,303                -                -
                                                -------------  --------------  ----------------  ---------------  ---------------
Net cash provided by (used for) financing
  activities................................        (95,504)         522,602           234,229                -          661,327
                                                -------------  --------------  ----------------  ---------------  ---------------
Effect of exchange rate on cash and cash
  equivalents................................              -               -             3,201                -            3,201
                                                -------------  --------------  ----------------  ---------------  ---------------
Net increase (decrease) in cash and cash
  equivalents................................        (3,807)           9,140               807                -            6,140
Cash and cash equivalents at beginning of
  period.....................................          2,226          10,870             1,784                -           14,880
                                                -------------  --------------  ----------------  ---------------  ---------------
Cash and cash equivalents at end of period...      $ (1,581)       $  20,010       $     2,591          $     -       $   21,020
                                                =============  ==============  ================  ===============  ===============
</TABLE>


                                      F-61
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                           CONSOLIDATING BALANCE SHEET

                             AS OF DECEMBER 31, 1999
                                 (IN THOUSANDS)

(23)      FILER/NON-FILER FINANCIAL STATEMENTS

     In accordance  with SOP 90-7,  the debtor  entities are required to present
condensed Consolidated Financial Statements for 1999.
<TABLE>
<CAPTION>

                                                          ASSETS

                                                                    FILERS       NON-FILERS      ELIMINATION     CONSOLIDATED
                                                                    ------       ----------      -----------     ------------
<S>                                                           <C>              <C>            <C>             <C>
Current assets:
  Cash and cash equivalents...................................  $    18,532    $     6,515     $          -    $      25,047
  Accounts receivable, net....................................      221,800         33,692          (1,028)          254,464
  Other receivables, net......................................      104,689       (88,773)                -           15,916
  Inventory, net..............................................       34,485          8,498                -           42,983
  Prepaids and other assets...................................       10,592          4,495                -           15,087
                                                              -------------   ------------    -------------   --------------

Total current assets..........................................      390,098       (35,573)          (1,028)          353,497

Property and equipment, net...................................      226,357        219,819                -          446,176
Goodwill, net.................................................      407,093         68,474                -          475,567
Notes receivable, net.........................................       16,185          6,513                -           22,698
Assets held for sale..........................................       67,116          3,493                -           70,609
Other assets, net.............................................       51,664         18,277                -           69,941
Investment in subsidiaries....................................       69,230              -         (69,230)                -
                                                              -------------   ------------    -------------   --------------
Total assets.................................................. $  1,227,743      $ 281,003       $ (70,258)      $ 1,438,488
                                                              =============   ============    =============   ==============
</TABLE>

                                      F-62
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                           CONSOLIDATING BALANCE SHEET

                             AS OF DECEMBER 31, 1999
                        (IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>

                                                                       LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

                                                                    FILERS        NON-FILERS     ELIMINATION    CONSOLIDATED
                                                                    ------        ----------     -----------    ------------
<S>                                                             <C>             <C>             <C>             <C>
Current liabilities:
  Current portion of long-term debt.............................    $  13,290       $   31,486              -        $  44,776
  Current portion of obligations under capital leases...........           70              363              -              433
  Accounts payable..............................................       43,796           11,566        (1,575)           53,787
  Accrued compensation and benefits.............................       74,737            9,380              -           84,117
  Accrued interest..............................................        1,572            1,400              -            2,972
  Accrued self-insurance obligations............................       58,463              612              -           59,075
  Other accrued liabilities.....................................       97,153           19,336              -          116,489
  Income tax payables...........................................        8,227              903              -            9,130
                                                                -------------   --------------  -------------  ---------------
Total current liabilities.....................................        297,308           75,046        (1,575)          370,779

Long-term debt, net of current portion..........................       47,872           52,893              -          100,765
Obligations under capital leases, net of current portion........        8,187           57,488              -           65,675
Other long-term liabilities.....................................       34,768            2,026              -           36,794
Liabilities subject to compromise (see Note 2)..................    1,558,518                -              -        1,558,518
                                                                -------------   --------------  -------------  ---------------
  Total liabilities.............................................    1,946,653          187,453        (1,575)        2,132,531

Commitments and contingencies...................................
Minority interest...............................................        3,394            2,585              -            5,979
Company-obligated mandatorily redeemable convertible preferred
  securities of a subsidiary trust holding solely 7%
  convertible junior subordinated debentures of the Company.....      344,119                -              -          344,119
Intercompany....................................................     (22,282)           21,735            547                -
Stockholders' equity (deficit):
  Preferred stock of $.01 par value, authorized
    5,000,000 shares, none issued...............................            -                -              -                -
  Common stock of $.01 par value, authorized 155,000,000 shares,
    63,937,302 shares issued and outstanding as of December 31,
    1999........................................................          639            2,579        (2,579)              639
  Additional paid-in capital....................................      777,164          263,250      (263,250)          777,164
  Accumulated deficit...........................................  (1,785,507)        (191,582)        191,582      (1,785,507)
  Accumulated other comprehensive loss..........................      (5,017)          (5,017)          5,017          (5,017)
                                                                -------------   --------------  -------------  ---------------
    Less:
      Unearned compensation.....................................      (3,966)                -              -          (3,966)
      Common stock held in treasury, at cost, 2,212,983
       shares as of December 31, 1999...........................     (27,376)                -              -         (27,376)
      Grantor stock trust, at market, 1,915,935 shares as of
       December 31, 1999........................................         (78)                -              -             (78)
                                                                -------------   --------------   ------------  ---------------
Total stockholders' equity (deficit) ...........................  (1,044,141)           69,230       (69,230)      (1,044,141)
                                                                -------------   --------------  -------------  ---------------
Total liabilities and stockholders' equity (deficit)............   $1,227,743       $  281,003     $ (70,258)      $ 1,438,488
                                                                =============   ==============  =============  ===============

</TABLE>


                                      F-63
<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                        CONSOLIDATING STATEMENT OF LOSSES

                      FOR THE YEAR ENDED DECEMBER 31, 1999
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                       FILERS        NON-FILERS     ELIMINATION     CONSOLIDATED
                                                                       ------        ----------     -----------     ------------
<S>                                                               <C>             <C>             <C>             <C>
Total net revenues................................................    $2,169,562      $ 363,510       $  (4,033)      $ 2,529,039
                                                                  --------------  -------------   --------------  ---------------
Costs and expenses:
  Operating costs.................................................     2,139,058        342,689          (4,034)        2,477,713
  Impairment loss.................................................       388,177         69,272                -          457,449
  Corporate general and administrative............................       145,307         14,364                -          159,671
  Interest, net (contractual interest expense $166,101)...........       112,222         16,832                -          129,054
  Provision for losses on accounts receivable.....................       120,880          2,337                -          123,217
  Depreciation and amortization...................................        62,214 `       19,111                -           81,325
  Loss on sale of assets, net.....................................        65,066         13,607                -           78,673
  Restructuring costs.............................................        25,589          1,764                -           27,353
  Loss on termination of interest rate swaps................ .....         2,488              -                -            2,488
  Legal and regulatory matters, net......................... .....            38              -                -               38
  Equity interest in losses of subsidiaries................. .....       119,928              -        (119,928)                -
  Intercompany interest expense (income) .........................            10           (10)                -                -
                                                                  --------------  -------------   --------------  ---------------
  Total costs and expenses........................................     3,180,977        479,966        (123,962)        3,536,981

Dividends on convertible preferred securities of subsidiary.......        20,407              -                -           20,407
Management fee (income) expense...................................       (2,786)          2,786                -                -
                                                                  --------------  -------------   --------------  ---------------
Losses before reorganization costs, net, income taxes and cumulative
  effect of change in accounting principle........................   (1,029,036)      (119,242)          119,929      (1,028,349)
Reorganization costs..............................................        48,132              -                -           48,132
Income taxes......................................................           120             41                -              161
                                                                  --------------  -------------   --------------  ---------------
Losses before cumulative effect of change in accounting principle.   (1,077,288)      (119,283)          119,929      (1,076,642)
Cumulative effect of change in accounting principle...............      (12,170)          (646)                -         (12,816)
                                                                  --------------  -------------   --------------  ---------------
  Net Losses......................................................  $(1,089,458)    $ (119,929)       $  119,929     $(1,089,458)
                                                                  ==============  =============   ==============  ===============
</TABLE>



                                      F-64

<PAGE>
                  SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                      CONSOLIDATING STATEMENT OF CASH FLOWS

                      FOR THE YEAR ENDED DECEMBER 31, 1999
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                          FILERS          NON-FILERS    ELIMINATION    CONSOLIDATED
                                                                          ------          ----------    -----------    ------------
<S>                                                                       <C>                 <C>             <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net losses..............................................................$(1,089,458)    $ (119,929)   $  119,929    $(1,089,458)
                                                                          ------------    -----------   -----------   ------------
Adjustments to reconcile net losses to net cash provided by (used for)
 operating activities:
  Extraordinary loss......................................................
  Loss on sale of assets, net.............................................     65,066         13,607              -        78,673
  Impairment loss.........................................................    388,177         69,272              -       457,449
  Cumulative effect of change in accounting principle.....................     12,170            646              -        12,816
  Reorganization costs, net...............................................     48,132              -              -        48,132
  Depreciation and amortization...........................................     62,214         19,111              -        81,325
  Provision for losses on accounts receivable.............................    120,880          2,337              -       123,217
  Equity interest in earnings (losses) of subsidiaries....................    123,963        (4,034)      (119,929)             -
  Other, net..............................................................     18,951          (896)              -        18,055
 Changes in operating assets and liabilities:
      Accounts receivable.................................................    142,083         18,781              -       160,864
      Other current assets................................................     28,452       (20,040)              -         8,412
      Other current liabilities...........................................     88,304       (15,697)              -        72,607
      Income taxes payable................................................     37,807        (2,377)              -        35,430
                                                                          -----------  -------------  -------------  ------------
 Net cash provided by (used for) operating activities before reorganization
  costs...................................................................     46,741       (39,219)              -         7,522
                                                                          -----------  -------------  -------------  ------------
 Net cash paid for reorganization activities (cash paid)..................      (269)              -              -         (269)
 Net cash provided by (used for) operating activities.....................     46,472       (39,219)              -         7,253
                                                                          -----------  -------------  -------------  ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Capital expenditures, net...............................................   (65,396)       (37,057)              -     (102,453)
  Acquisitions, net of cash acquired......................................    (5,731)              -              -       (5,731)
  Proceeds from sale of assets held for sale..............................      8,735              -              -         8,735
  Proceeds from sale and leaseback of property and equipment..............          -         38,600              -        38,600
  Increase in long-term notes receivable..................................     12,727          3,130              -        15,857
  Decrease (increase) in other assets.....................................     56,265       (11,086)              -        45,179
                                                                          -----------  -------------  -------------  ------------
    Net cash provided by (used for) investing activities..................      6,600        (6,413)              -           187
                                                                          -----------  -------------  -------------  ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Net borrowings under Revolving Credit Agreement (postpetition) ........     12,125              -              -        12,125
   Long-term debt borrowings..............................................    108,535         17,527              -       126,062
   Long-term debt repayments (prepetition)................................   (56,331)       (36,171)              -      (92,502)
   Principal payments on prepetition debt authorized by Bankruptcy Court..   (36,118)              -              -      (36,118)
   Conversion of Mediplex 6.5% Convertible Subordinated Debentures due
     2003.................................................................    (6,649)              -              -       (6,649)
   Net proceeds from issuance of common stock.............................      1,784              -              -         1,784
   Purchases of treasury stock............................................      (409)              -              -         (409)
   Intercompany advances..................................................   (51,500)         51,500              -             -
   Other financing activities.............................................   (22,170)          7,690              -      (14,480)
                                                                          -----------  -------------  -------------  ------------
     Net cash provided by (used for) financing activities.................   (50,733)         40,546              -      (10,187)
                                                                          -----------  -------------  -------------  ------------

Effect of exchange rate on cash and cash equivalents......................         67            223              -           290
                                                                          -----------  -------------  -------------  ------------
Net increase (decrease) in cash and cash equivalents......................      2,406        (4,863)              -       (2,457)
Cash and cash equivalents at beginning of year............................     16,126         11,378              -        27,504
                                                                          -----------  -------------  -------------  ------------
Cash and cash equivalents at end of year..................................$    18,532     $    6,515       $      -    $   25,047
                                                                          ===========  =============  =============  ============
</TABLE>


                                      F-65
<PAGE>
                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 1999

(24)  SUBSEQUENT EVENTS

     In the first  quarter  of 2000,  the  Company  began  soliciting  offers to
purchase  its  international  operations.  The company  anticipates  that it may
recognize  a  significant  loss  from  the  disposition  of  its   international
operations.  No purchase  agreements have been entered into for these operations
and the Company cannot predict when, or if, these operations will be sold.

     The  Company  is  also  pursuing  the   disposition  of  certain   non-core
businesses,  including the sale of its SunCare  respiratory therapy business and
the therapy equipment manufacturing operations. No purchase agreements have been
entered into for these  operations  and the Company  cannot predict when, or if,
these operations will be sold.

     During the period of January 1, 2000 through May 31,  2000,  Sun divested a
total of 18 pharmacies in the United Kingdom,  resulting in an aggregate gain of
approximately $1.0 million. The aggregate cash consideration  received for these
divestitures was approximately $9.7 million.

     In the first quarter of 2000, the Company entered into an agreement to sell
16 assisted living facilities, one of which includes a skilled nursing facility.
The  transaction  closed during the second and third  quarters of 2000. The cash
consideration  received from this transaction was approximately $1.0 million. In
addition,  the Company obtained a note receivable of approximately $0.5 million.
The  aggregate  debt,  capital  leases  and  other  liabilities  assumed  by the
purchaser totaled approximately $66.7 million. The estimated aggregate net loss,
which has been reserved for this transaction was approximately  $71.2 million of
which  approximately  $17.4  million and $53.8  million was  recorded to loss on
assets held for sale, net in 1999 and 1998, respectively.

     During 2000, the Company  transferred two assisted  living  facilities from
other operations to inpatient services.

     During the period of January 1, 2000  through  June 30,  2000,  the Company
divested one skilled nursing  facility and closed one skilled nursing  facility.
The  aggregate  net losses  recorded  were  approximately  $0.1 million and $0.3
million  for  the  divestiture  and the  closure,  respectively.  See  "Note 7 -
Impairment of Long-Lived Assets and Assets Held for Sale."

     During the period of January 1, 2000  through  June 30,  2000,  the Company
identified  29  additional   skilled   nursing   facilities  as  condidates  for
divestiture. These intended divestitures as well as the 20 facilities identified
as candidates for divestiture as of December 31, 1999 require  Bankruptcy  Court
approval.


                                      F-66
<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



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

     We have audited in accordance with generally  accepted auditing  standards,
the  Consolidated  Financial  Statements  of  Sun  Healthcare  Group,  Inc.  and
subsidiaries in this Form 10-K and have issued our report thereon dated July 13,
2000. Our report on the financial  statements includes an explanatory  paragraph
with the respect to the uncertainty  regarding the Company's ability to continue
as a going  concern,  as discussed in Note 2 to the  financial  statements.  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
-----------------------
    Arthur Andersen LLP


Albuquerque, New Mexico
July 13, 2000


<PAGE>

                                                                     SCHEDULE II

                   SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)

                        VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>

                                        COLUMN A         COLUMN B            COLUMN C         COLUMN D        COLUMN E
                                        --------         --------            --------         --------        --------
                                        BALANCE AT       CHARGED TO          ADDITIONS                        BALANCE AT
                                        BEGINNING        COSTS AND           CHARGED TO       DEDUCTIONS        END OF
DESCRIPTION                             OF PERIOD        EXPENSES          OTHER ACCOUNTS       OTHER           PERIOD
-----------                             ---------        --------          --------------       -----           ------
<S>                                   <C>               <C>               <C>                <C>            <C>
Year ended December 31, 1999:
  Allowance for doubtful accounts....      $   79,015    $118,373 (3)          $         -     $ (45,547)      $   151,841
                                      ================  ==============    =================  =============  ===============
  Exit costs for acquired businesses.      $    4,240    $         -           $         -     $  (4,240)      $         -
                                      ================  ==============    =================  =============  ===============
  Notes receivable reserve...........      $    1,712    $  4,844 (3)          $         -     $        -      $     6,556
                                      ================  ==============    =================  =============  ===============
  Reserve for assets held for sale...      $  159,828    $ 85,758              $         -     $(174,355)      $    71,231
                                      ================  ==============    =================  =============  ===============
  1998 corporate restructure reserve.      $    3,138    $      -              $         -     $  (1,174)      $     1,964
                                      ================  ==============    =================  =============  ===============
  1999 restructure reserve...........      $        -    $ 27,353              $         -     $ (27,353)      $         -
                                      ================  ==============    =================  =============  ===============


Year ended December 31, 1998:
  Allowance for doubtful accounts....      $   34,433    $ 81,371 (3)        $  10,726 (1)     $ (47,515)      $    79,015
                                      ================  ==============    =================  =============  ===============
  Exit costs for acquired businesses.      $    4,800    $      -            $   3,828 (2)     $  (4,388)      $     4,240
                                      ================  ==============    =================  =============  ===============
  Notes receivable reserve...........      $        -    $  1,712 (3)        $           -     $        -      $     1,712
                                      ================  ==============    =================  =============  ===============
  Reserve for assets held for sale...      $        -    $206,205            $           -     $ (46,377)      $   159,828
                                      ================  ==============    =================  =============  ===============
  1998 corporate restructure reserve.      $        -    $  4,558            $           -     $  (1,420)      $     3,138
                                      ================  ==============    =================  =============  ===============


Year ended December 31, 1997:
  Allowance for doubtful accounts....      $   16,877    $      15,839       $   10,241 (1)    $ (8,524)       $    34,433
                                      ================  ==============    =================  =============  ===============
  Exit costs for acquired business...      $        -    $           -       $   13,209 (2)    $ (8,409)       $     4,800
                                      ================  ==============    =================  =============  ===============
</TABLE>


(1)  Represents the allowance for doubtful  accounts of acquired entities at the
     date of acquisition

(2)  Exit costs for  acquired  businesses  are  included in the  purchase  price
     allocation.

(3)  Charges included in provision for losses on accounts receivable.