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

FORM 10-K/A

(AMENDMENT NO. 1)

(Mark One)



|[X]    Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934                                        
|-----------------------------------------------------------------------------------------------------------------------------------
|For the fiscal year ended December 31, 2003                                                                                        
|OR                                                                                                                                 
|[  ]    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from  to



Commission file number 0-49663



SUN HEALTHCARE GROUP, INC.



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

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



Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to Section 12(g) of the Act:  Title of each classCommon Stock, par value $.01 per share
Warrants to purchase Common Stock, $.01 par value per share

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

Indicate by check mark 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.  [   ]

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



The aggregate market value of the Registrant's Common Stock held by nonaffiliates, based on the last sales price of such shares on the Over-the-Counter Bulletin Board on June 30, 2003, was approximately $12.8 million.



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



On March 1, 2004, Sun Healthcare Group, Inc. had 14,559,818 outstanding shares of Common Stock.



Documents Incorporated by Reference:  None

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EXPLANATORY NOTE

The Registrant is filing this Amendment No. 1 on Form 10-K/A to its Annual Report on Form 10-K solely to amend its Management's Discussion and Analysis of Financial Condition and Results of Operations. These changes relate primarily to information for the year ended December 31, 2002. No changes have been made to the financial information reported in the Company's financial statements.  Except for changes reflected in this Amendment No. 1, no other changes have been made to the Report. This Amendment No. 1 does not update any other disclosure to reflect developments since the original date of filing.

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

Overview



We are one of the largest providers of long-term, subacute and related speciality healthcare services in the United States.  We currently operate through various direct and indirect subsidiaries that engage in the following five principal business segments: (i) inpatient services, primarily skilled nursing facilities, (ii) rehabilitation therapy services, (iii) medical staffing services, (iv) home health services and (v) laboratory and radiology services.  For continuing operations, during the year ended December 31, 2003, we received approximately 25.6% of our revenues from Medicare, 35.9% from Medicaid, and 38.5% from private insurance, self-pay residents, other third party payors and long-term care facilities that utilized our specialty medical services.  As with other providers in the long-term care industry, we face challenges associated with reduced levels of reimbursement from Medicare and Medicaid, increasing costs associated with litigation and insurance, compliance with federal and state regulations, and the retention of qualified personnel to staff our long-term care facilities.



We receive revenues from Medicare, Medicaid, private insurance, self-pay residents, other third party payors and long-term care facilities that utilize our specialty medical services. The sources and amounts of our inpatient services revenues are determined by a number of factors, including the number of licensed beds and occupancy rates of our facilities, the acuity level of patients and the rates of reimbursement among payors.



Federal and state governments continue to focus on methods to curb spending on health care programs such as Medicare and Medicaid. This focus has not been limited to skilled nursing facilities, but includes other services provided by us, such as therapy services. We cannot at this time predict the extent to which these proposals will be adopted or, if adopted and implemented, what effect, if any, such proposals will have on us. Efforts to impose reduced coverage, greater discounts and more stringent cost controls by government and other payors are expected to continue.



In an effort to improve our financial position and address our liquidity concerns, in January 2003, we initiated efforts to (i) reshape our portfolio of leases for our long-term care facilities to divest our under-performing facilities, decrease our exposure in any single state, exit high-cost general and professional liability states and better leverage our infrastructure; (ii) sell our pharmacy and software development operations to finance the restructuring efforts, and (iii) reduce our overhead and other expenses commensurate with the reduction in the size of our long-term care facility portfolio.  Between January 1, 2003 and December 31, 2003, we divested 127 long-term care facilities, our SunScript
pharmacy operations and our software development operations and reduced
corporate general and administrative expenses by $32.3 million. As of March 1,
2004, we operated 108 long-term care facilities and we intend to divest seven of
those facilities in 2004. With the exception of the anticipated transfer of the
remaining

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seven facilities, we believe that the restructuring we
commenced in January 2003 is substantially complete.



In February 2004, we completed a private placement of our common stock and warrants to purchase our common stock to accredited and institutional investors for net proceeds of approximately $52.3 million.  As of March 1, 2004, we had cash and cash equivalents of approximately $40.1 million and approximately $31.0 million available to us for additional borrowings under our loan agreement. We believe that our existing cash reserves and availability under our loan agreement will provide sufficient funds for our operations, capital expenditures and regularly scheduled debt service payments through the next 12 months.



Critical Accounting Policies

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

(a)  Net Revenues



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



(b)  Accounts Receivable and Related Allowance



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



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

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accounts receivable in subsequent periods may require changes
in the estimated provision for loss. Changes in these estimates are charged or
credited to the results of operations in the period of the change.



The allowance for uncollectible accounts related to facilities that we have divested was based on a percentage of outstanding accounts receivable at the time of divestiture and was recorded in gain or loss on disposal of discontinued operations, net.  As collections are recognized, the allowance will be adjusted as appropriate.  This percentage was 40% in 2002 and was adjusted to 30% in the fourth quarter of 2003.  The percentages were developed from historical collection trends of our divestitures.



The allowance for uncollectible accounts related to facilities that we currently operate is computed by applying a bad debt percentage to the individual accounts receivable aging categories based on historical collections.  An adjustment is then recorded each month to adjust the allowance based on the analysis.

(c)



We self-insure for certain insurable risks, including general and professional liability, workers' compensation liability and employee health insurance liability through the use of self-insurance or retrospective and self-funded insurance policies and other hybrid policies, which vary by the states in which we operate.  There exists a risk that any of the insurance companies we use may become insolvent and unable to fulfill their obligation to defend, pay or reimburse us when that obligation becomes due.  Provisions for estimated reserves, including incurred but not reported losses, are provided in the period of the related coverage. An independent actuarial analysis is prepared twice a year to determine the expected losses and reserves for estimated settlements for general and professional liability and workers' compensation insurance under the per claims retention level, including incurred but not reported losses.  The methods of making such estimates and establishing the resulting reserves are reviewed periodically, and any adjustments resulting there from are reflected in current earnings. Claims are paid over varying periods, and future payments may be different than the estimated reserves.



Based on the results of the actuarial analysis prepared as of September 30, 2002, which analysis considered nationwide nursing home liability results that showed significant increases in patient care liability costs, we recorded a pre-tax charge of $20.0 million for the ten months ended December 31, 2002 related to an increase in patient care liability costs for prior policy years.  Based on the results of the actuarial analysis prepared as of October 31, 2003, we recorded a net pre-tax charge of $0.4 million for the year ended December 31, 2003 related to patient care and workers' compensation liability costs.  As of December 31, 2003, we recorded pre-funded amounts restricted for the payment of general and professional liability and workers' compensation claims in restricted cash accounts classified in current and non-current assets.  Upon evaluation by our independent actuaries of claim payment trends in conjunction with the twice a year evaluation of our reserves and claims exposures, the restricted cash balances are also reviewed and reconciled.



(d)   Impairment of Assets



Goodwill



Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS No. 142") established new rules on the accounting for goodwill and other intangible assets. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized; however, they are subject to annual impairment tests as prescribed by the statement. Intangible assets with definite lives continue to be amortized over their estimated useful lives.

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Pursuant to SFAS No. 142, we perform our annual goodwill impairment analysis during the fourth quarter for each reporting unit that constitutes a business for which discrete financial information is produced and reviewed by operating segment management and, with the exception of the long-term care facilities, provides services that are distinct from the other components of the operating segment. We determine impairment by comparing the net assets of each reporting unit to their respective fair values. We determine the estimated fair value of each reporting unit using a discounted cash flow analysis. In the event a unit's net assets exceed its fair value, an implied fair value of goodwill must be determined by assigning the unit's fair value to each asset and liability of the unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss is measured by the difference between the goodwill carrying value and the implied fair value.



For the ten months ended December 31, 2002, we recorded a goodwill impairment of $231.1 million within the following reporting units: (i) long-term care facilities within certain states, $104.9 million in the aggregate; (ii) SunDance Rehabilitation Corporation, which operates our therapy business, $57.0 million; (iii) SunScript Pharmacy Corporation, our pharmaceutical services operations which were sold in July 2003 and classified in other operations, $64.5 million; (iv) CareerStaff Unlimited, Inc., which operates our medical staffing business, no impairment; and (v) Shared Healthcare Systems, our software development company which was sold in November 2003 and classified in other operations, $4.7 million. We did not record a goodwill impairment for the year ended December 31, 2003.



Indefinite Life Intangibles



Pursuant to SFAS No. 142, we evaluate the recoverability of the trademarks by comparing the asset's respective carrying value to estimates of fair value. We determine the estimated fair value of each trademark through a discounted cash flow analysis.  The Reorganized Company recorded $34.6 million in trademarks under fresh-start accounting based on an independent and separate valuation report of the fair value of our intangible assets as of March 1, 2002. Our trends of financial performance subsequent to emergence from bankruptcy proceedings, the Medicare "Cliff" impact and increases in patient care liability claims and retention levels and workers' compensation insurance costs represented indicators of impairment.  As a result, we internally prepared an impairment analysis using discounted cash flows in order to estimate the fair value of Indefinite Life Intangibles. The analysis resulted in an impairment of $26.0 million for the ten months ended December 31, 2002 within the following segments: (i) $0.7 million related to SunDance Rehabilitation Corporation, which operates our therapy business, (ii) $7.2 million related to SunScript Pharmacy Corporation, our pharmaceutical services operations which were sold in July 2003 and were until such sale, classified in other operations, (iii) $0.9 million related to CareerStaff Unlimited, Inc., which operates our medical staffing business and (iv) $17.2 million within our Corporate segment.  We did not record an impairment for our Indefinite Life Intangibles for the year ended December 31, 2003.



Finite Life Intangibles



Pursuant to SFAS No. 142, we evaluate the recoverability of the favorable lease intangibles by comparing an asset's respective carrying value to estimates of undiscounted cash flows over the life of the lease. If the carrying value of the asset exceeded the undiscounted cash flows, an impairment loss was measured by comparing the estimated fair value of the asset, based on discounted cash flows, to its carrying value.  The Reorganized Company recorded $28.2 million in favorable lease intangibles under fresh-start accounting based on an independent and separate valuation report of the fair value of our

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assets and liabilities as of March 1, 2002. Our trends of financial performance subsequent to emergence from bankruptcy proceedings, the Medicare "Cliff" impact and increases in patient care liability claims and retention levels and workers' compensation insurance cost represented indicators of impairment.  As a result, at December 31, 2003 we internally prepared an impairment analysis using discounted cash flows in order to estimate the fair value of Finite Life Intangibles.  The analysis resulted in an impairment of $24.0 million and $0.5 million for the ten months ended December 31, 2002 and for the year ended December 31, 2003, respectively, within our Inpatient Services segment.



Long-Lived Assets

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



2003. During the fourth quarter of 2003, we recorded pretax charges totaling approximately $2.3 million for asset impairments in accordance with SFAS No. 144. The asset impairment charges consist of the following:



|- | $2.3 million write-down of property and equipment in our Inpatient Services segment for certain nursing facilities whose book value exceeded estimated fair value when tested for impairment, $0.2 million of which related to under-performing facilities identified for divestiture, as described below.  A substantial change in the estimated future cash flows for any of those facilities that have not yet been transitioned could materially change the estimated fair values of those assets, possibly resulting in an additional impairment.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

|- | $81.6 million write-down of property and equipment in our Inpatient Services segment for certain nursing facilities whose book value exceeded estimated fair value when tested for impairment, $53.6 million of which related to under-performing facilities identified for divestiture, as described below.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|- | $42.8 million write-down of property and equipment in our Other Operations segment which consisted of $8.7 million for Shared Healthcare Systems and $34.1 million for our corporate headquarters.
6                                                                                                        
|- | $2.3 million write-down of property and equipment in our Pharmaceutical and Medical Supply Services segment.                                                                                                                                                                                                

The October 1, 2002 elimination of certain funding under the Medicare program and the increase in our patient care liability costs affected our 2002 and future cash flows, and therefore, the fair values of each of our asset groups. This event led to an impairment assessment on each of our asset groups, including:

|- | estimating the undiscounted cash flows to be generated by each of the asset groups over the remaining life of the primary asset; and                                                                                                                      
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|- | reducing the carrying value of the asset to estimated fair value when the total estimated undiscounted future cash flows were less than the current book value of the long-lived assets (excluding goodwill and other indefinite lived intangible assets).



In estimating the undiscounted cash flows for the 2002 impairment assessment, we primarily used our internally prepared budgets and forecast information including adjustments for the following items: Medicare and Medicaid funding; overhead costs; capital expenditures and patient care liability costs.  We also considered our plans to transition under-performing long-term care facilities, which accounted for approximately 56% of our facilities, to new operators.  Since indicators of impairment were present and the undiscounted cash flows were not sufficient to recover the assets' carrying amounts, the impairment loss was measured by comparing the estimated fair value of the assets to their carrying amount.  In order to estimate the fair values of the entities, we used a discounted cash flow approach. That assessment resulted in an impairment related to the under-performing facilities of approximately $53.6 million.

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



LongLived Assets to be Disposed Of



SFAS No. 144 requires that long-lived assets to be disposed of be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations.  Therefore, discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred.  SFAS No. 144 also broadens the reporting of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. Depreciation is discontinued once an asset is classified as held for sale.  During the two month period ended February 28, 2002, the Predecessor Company presented the operating results of all facilities identified for sale or disposition in discontinued operations in the consolidated statement of operations.  From March 1, 2002 to December 31, 2002, the Reorganized Company had a limited number of facilities disposed of or transferred to assets held for sale.  These facilities' operating results are included in continuing operations and are immaterial to our consolidated financial position and results of operations.

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Results of Operations



We have changed the composition of our segments and therefore restated the previously reported segment information related to the Reorganized Company (see "Note 16 - Segment Information" in our consolidated financial statements.)  The change since the last annual SEC filing includes new segments for Medical Staffing, Home Health, Laboratory and Radiology which previously were categorized in the Other segment and removal of the Pharmaceutical Services, International and Other segments as they have been sold.  The following tables set forth the amount and percentage of certain elements of total net revenues for the following years ended December 31, (in thousands):





|                                                | Reorganized Company  | Reorganized and Predecessor CompanyCombined | Predecessor Company
|----------------------------------------------- | -------------------- | ------------------------------------------- | -------------------
|                                                | 2003                 | 2002                                        | 2001               
|Inpatient Services                              | $        572,957     |                                             | 68.7               
|Rehabilitation and Respiratory Therapy Services | 167,656              |                                             | 20.1               
|Medical Staffing                                | 61,824               |                                             | 7.4                
|Home Health                                     | 55,533               |                                             | 6.7                
|Laboratory and Radiology                        | 43,767               |                                             | 5.2                
|Pharmaceutical and Medical Supply               | -                    |                                             | -                  
|International                                   | -                    |                                             | -                  
|Other                                           | -                    |                                             | -                  
|Corporate                                       | 73                   |                                             | -                  
|Intersegment eliminations                       | (67,767              | )                                           | (8.1               
|                                                |                      |                                             |                    
|Total Net Revenues                              | $            834,043 |                                             | 100.0              
|                                                | ======               |                                             | ===                

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Inpatient services revenues for long-term care, subacute care and assisted living services include revenues billed to patients for therapy, medical staffing, and laboratory and radiology provided by our affiliated operations.  The following tables set forth a summary of the intersegment revenues for the years ended December 31, (in thousands):





|                                                   | Reorganized Company             |   | Reorganized and Predecessor CompanyCombined |   | Predecessor Company   
|-------------------------------------------------- | ------------------------------- | - | ------------------------------------------- | - | ----------------------
|                                                   | 2003                            |   | 2002                                        |   | 2001                  
|Inpatient Services                                 | $                          (600 | ) | $
            (551                          | ) | $
           (526)    
|Rehabilitation and Respiratory Therapy
   Services | 59,543                          |   | 93,568                                      |   | 99,549                
|Medical Staffing                                   | 7,216                           |   | 4,078                                       |   | -                     
|Laboratory and Radiology                           | 1,608                           |   | 6,396                                       |   | -                     
|Pharmaceutical and Medical Supply                  | -                               |   | 8,325                                       |   | 62,209                
|Other                                              | -                               |   | 1,489                                       |   | 9,005                 
|Total Affiliated Revenue                           | $            67,767             |   | $              113,305                      |   | $              170,237
|                                                   | =======                         |   | ======                                      |   | ======                

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



|                                                | ReorganizedCompany    |   | Reorganized and Predecessor CompanyCombined |   |     | PredecessorCompany |  
|----------------------------------------------- | --------------------- | - | ------------------------------------------- | - | --- | ------------------ | -
|                                                | 2003                  |   | 2002                                        |   | |   | 2001               |  
|                                                |                       |   |                                             |   | |   |                    |  
|Inpatient Services                              | $              16,754 |   | $            (2,010                         | ) | |   | $         (20,006  | )
|Rehabilitation and Respiratory Therapy Services | 14,575                |   | 24,616                                      |   | |   | 12,691             |  
|Medical Staffing                                | 1,285                 |   | 4,588                                       |   | |   | -                  |  
|Home Health                                     | 3,765                 |   | 3,531                                       |   | |   | -                  |  
|Pharmaceutical and Medical Supply Services      | -                     |   | 2,719                                       |   | |   | 4,235              |  
|Laboratory and Radiology                        | 633                   |   | 2,160                                       |   | |   | -                  |  
|International Operations                        | -                     |   | -                                           |   | |   | (249               | )
|Other Operations                                | -                     |   | 808                                         |   | |   | (9,469             | )
|Net segment income (loss) before Corporate      | 37,012                |   | 36,412                                      |   | |   | (12,798            | )
|                                                |                       |   |                                             |   | |   |                    |  
|Corporate                                       | (57,817               | ) | (75,646                                     | ) | |   | 16,663             |  
|Net segment (loss) income                       | $            (20,805  | ) | $         (39,234                           | ) | |
| | $            3,865 |  
|                                                | ========              |   | =======                                     |   | |   | =======            |  



Inpatient Services



Rehabilitation and Respiratory Therapy Services.  The decrease in net income for this segment resulted primarily from:



- the loss of revenues from the inpatient services facilities that were divested in 2003 that used services provided by this segment;



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- the Medicare Part B therapy cap that, although now under a moratorium, that decreased revenues by $4.7 million; and
- approximately $2.0 million in bad debt collections in 2002 that was not repeated in 2003.



Medical Staffing. The year over year decrease in this segment was primarily driven by two factors:



- the economic downturn in the nursing component of this segment across the industry as more long-term facilities and hospitals utilized less contract labor in efforts to contain costs; and
- start-up costs for 12 new offices, associated with expansion of this segment, and shut-down costs for closures of 14 offices, associated with under-performing locations.



Home Health. Driven by increases in home care visits seen industry-wide in 2003, this segment performed well when compared to 2002.  Two agencies were opened in 2003 also attributed to the slight increase in net income.



Laboratory and Radiology.  The unfavorable comparison of 2003 to 2002 net income for this segment is attributable primarily to:



- adverse accounts receivable collection performance and increased bad debt expense, coupled with
- increased operating costs associated with wage inflation for technicians and radiologists.



Corporate. The decrease in net losses in 2003 from 2002 for this segment were primarily the result of the restructuring initiatives we undertook in 2003 with personnel reductions that resulted in lower salaries and wages and general and administrative costs.



The following table reconciles net segment (loss) income to consolidated income (loss) before income taxes and discontinued operations:





|                                                                   | ReorganizedCompany        |   | Reorganized and Predecessor CompanyCombined |   |   | PredecessorCompany             |  
|------------------------------------------------------------------ | ------------------------- | - | ------------------------------------------- | - | - | ------------------------------ | -
|                                                                   | 2003                      |   | 2002                                        |   | | | 2001                           |  
|                                                                   |                           |   |                                             |   | | |                                |  
|Net segment (loss) income                                          | $
                (20,805 | ) | $  
          (39,234                       | ) | | | $                        3,865 |  
|Loss on asset impairment                                           | (2,774                    | ) | (279,022                                    | ) | | | (18,825                        | )
|Legal and regulatory matters, net                                  | -                         |   | -                                           |   | | | (11,000                        | )
|Restructuring costs, net                                           | (14,676                   | ) | -                                           |   | | | (1,064                         | )
|Gain on sale of assets, net                                        | 3,897                     |   | 8,714                                       |   | | | 825                            |  
|Gain on extinguishment of debt, net                                | -                         |   | 1,498,360                                   |   | | | -                              |  
|Reorganization gain (costs), net                                   | -                         |   | 1,483                                       |   | | | (42,917                        | )
|(Loss) income before income taxes and

    discontinued operations | $                 (34,358 | ) | $         1,190,301                         |   | | | $              (69,116         | )
|                                                                   | =========                 |   | =======                                     |   | | | ========                       |  



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

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



The following discussions of the "Year Ended December 31, 2003 compared to the Year Ended December 31, 2002" and the "Year Ended December 31, 2002 compared to the Year Ended December 31, 2001" are based on the financial information presented in "Note 16 - Segment Information" in our consolidated financial statements.



Year Ended December 31, 2003 Compared to Year Ended December 31, 2002



Results of Operations



Due to the number of Inpatient Services facilities divested during 2003, a "same store" basis is included for comparison purposes.  A same store basis includes only facilities operated for the full period in the comparison of the operations activity, which represents 109 facilities.



We reported a net income for the year ended December 31, 2003 of $0.4 million compared to a net income of $1,047.4 million for the prior year. The net income for the year ended December 31, 2003 included the following:



|- | net income from discontinued operations of $35.4 million, primarily driven by the gain on sale of our pharmacy operations in July 2003;                                         
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                 
|- | a gain from the sale of assets of $3.9 million related primarily to the sale of land and buildings of our software development company that was sold in November 2003; offset by
|  |                                                                                                                                                                                 
|- | restructuring costs of $14.7 million related to our reorganization efforts, primarily to the reshaping of our portfolio of skilled nursing facilities; and                      
|  |                                                                                                                                                                                 
|- | an asset impairment charge of $2.8 million.                                                                                                                                     

The net income for the prior year included a gain on extinguishment of debt of $1,498.4 million related to our emergence from bankruptcy in early 2002, an asset impairment charge of $407.8 million, a pre-tax charge of $20.0 million related to an increase in patient care liability costs for prior policy years based on the results of the actuarial analysis prepared as of September 30, 2002 within our inpatient services operation, a favorable adjustment of $6.0 million related to workers' compensation insurance costs primarily related to our inpatient services operation, and a $8.7 million gain on sale of assets, net, primarily due to the reversal of prepetition liabilities related to disposed facilities.

11

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Net Revenues



Our net revenues were $834.0 million during the year ended December 31, 2003 compared to $980.9 million for the prior year. The decrease in net revenues of approximately $146.9 million for the year ended December 31, 2003, as compared to the prior year, primarily consisted of the following:



|- | a $132.8 million decrease within our pharmaceutical services operations, primarily due to the classification within operations revenues for January and February 2002 that, for the ten months ended December 31, 2002 and for the year ended December 31, 2003, are included in discontinued operations; and
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                              
|- | a decrease of $11.3 million in our rehabilitation services operations as a result of the inpatient facility divestitures. These decreases were partially offset by:                                                                                                                                          
|  |                                                                                                                                                                                                                                                                                                              
|- | an increase of $21.9 million due to increased revenues from facilities in our same store inpatient services operations which we operated during the year ended December 31, 2003 and 2002;                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                              
|- | an increase of  $7.2 million due to the acquisition of one skilled nursing facility in March 2003; and                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                              
|- | an increase of $1.5 million in our home health operations due to organic growth in existing offices.                                                                                                                                                                                                         

The increase in net revenues of $21.9 million from our inpatient services operations on a same store basis for the year ended December 31, 2003, as compared to the year ended December 31, 2002, was primarily due to the following:



|- | an increase in Medicaid revenues of $18.9 million primarily due to higher reimbursement rates;                                                                                                                                                                                
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                               
|- | an increase of $1.3 million in commercial revenue primarily due to higher census; and                                                                                                                                                                                         
|  |                                                                                                                                                                                                                                                                               
|- | a $1.6 million net increase in Medicare revenues, which was comprised of a $24.1 million decrease in Medicare rates, an increase of $16.0 million due to improved Medicare mix, a market basket increase of $6.2 million and higher Medicare Part B revenues of  $0.3 million.



Operating Salaries and Benefits



Operating salaries and benefits for the year ended December 31, 2003 were $528.0 million as compared to $620.0 million for the year ended December 31, 2002.  The decrease of $92.0 million was primarily the result of personnel cost reductions that occurred commensurate with the inpatient facility divestitures.



Self-Insurance for Workers' Compensation and General and Professional Liability



With an increase of $0.4 million for the year ended December 31, 2003 as compared to the year ended December 31, 2002, costs related to workers' compensation and general and professional liability insurance costs remained essentially flat year over year; however, the 2002 expenses were inflated with a net $14.0 million charge recorded in third quarter of 2002 for prior year policy exposures.



Rent Expense

We reported rent expense of $49.6 million in 2003
as compared to $68.4 million in 2002. For the year

12

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ended December 31, 2003, rent expense for our inpatient
services operation was approximately $41.2 million compared to $60.0 million for
the same period ended December 31, 2002 due primarily to lease terminations and
divestitures of inpatient facilities during 2003. On a same store basis in the
year over year comparison, rent expense decreased $2.3 million to $40.8 million
compared to $43.1 million in 2002 due to the renegotiation of leases of during
the restructuring of our portfolio of skilled nursing facilities in 2003.



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



We reported other operating expenses, other corporate general and administrative expenses and provision for losses on accounts receivable of $214.4 million for the year ended December 31, 2003 compared to $256.6 million for the same period in 2002.  The decrease of approximately $42.2 million consisted of the following:

|- | a decrease of $38.4 million and $5.8 million in our inpatient services operation and our rehabilitation therapy services operations, respectively, due to the cost reductions as a result of our restructuring;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                
|- | a decrease of $8.7 million in non-operating corporate overhead due to our reorganization efforts; offset by                                                                                                    
|  |                                                                                                                                                                                                                
|- | an increase of $7.4 million and $3.3 million in our home health, laboratory and radiology and medical staffing operations, respectively, due to growth and expansion in 2003.                                  

The decrease in other operating and administrative expenses and provision for losses of $38.4 million from our inpatient services operations included an increase in our same store operations of $2.0 million for the year ended December 31, 2003 as compared to the same period in 2002.  The $2.0 million increase was comprised of:



|-                                                      | an increase of $3.0 million, net, in legal costs associated with increases in patient care liability cases and other litigation; and          
|------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------
|                                                      
|-                                                      | an increase of $3.9 million in liability insurance costs due to increased patient care liability cases industry-wide.                         
|                                                       |                                                                                                                                               
|These increases were offset in part, by the following:
|                                                       |                                                                                                                                               
|-                                                      | a decrease of $10.7 million in contract labor costs due to our efforts to offer competitive wages and benefits to attract permanent staff; and
|                                                       |                                                                                                                                               
|-                                                      | an decrease of $0.7 million of wages and benefits due to stabilization of our workforce.                                                      

Interest Expense, Net



Interest expense, net, increased to $16.9 million for the year ended December 31, 2003, as compared to $15.2 million for the same period in 2002, a $1.7 million increase. $2.4 million of the increase was due primarily to the recognition of interest expense at a higher effective interest rate for our term loan offset by a $0.7 million decrease related to lower interest charges incurred due to lower carrying values on our debt instruments during 2003 as compared to 2002.  While we were under bankruptcy protection through

13

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the two months ended February 28, 2002, we did not record interest on essentially all of our prepetition debt.  Had we not been under bankruptcy protection, our interest expense, net, for the year ended December 31, 2002 would have been $38.9 million.



Depreciation and Amortization



Depreciation and amortization expense decreased to $7.5 million for the year ended December 31, 2003, as compared to $21.9 million for the same period in 2002.  The decrease was attributable to decreases in property carrying amounts as a result of the impairment recorded in the fourth quarter of 2002.



Income Taxes



We recorded a provision for income taxes of approximately $1.3 million, of which $0.6 million was related to discontinued operations, for the year ended December 31, 2003, primarily related to state income taxes. We increased our valuation allowance on our deferred tax assets by $93.3 million during 2003 to $708.8 million as of December 31, 2003. This valuation allowance is required under the guidance in Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes, " due to our historical operating performance and our cumulative net losses. Our realization of the deferred tax benefits primarily associated with our net operating losses ("NOL")  is dependent upon our achieving sufficient future pre-tax income. Under federal income tax law, we have up to 20 years to generate sufficient taxable income to realize the deferred benefits from NOLs.  Given the size of our pre-tax loss, a valuation allowance is considered appropriate under the accounting standards.



At December 31, 2003, we have Federal NOL carryforwards of $1.0 billion with expiration dates from 2004 through 2023. Various subsidiaries have state NOL carryforwards totaling $939.5 million with expiration dates through the year 2023. In addition, we have capital loss carryforwards of $272.6 million, of which $10.1 million will expire in 2004 and $260.4 million will expire in 2006 and $2.1 million will expire in 2007. Our alternative minimum tax credit carryforward of $4.3 million has no expiration date. Our $7.2 million of other tax credit carryforwards will expire in years 2004 through 2022.



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

Results of Operations



We reported a net income for the year ended December 31, 2002 of $1,047.4 million compared to a net loss of $69.4 million for the prior year.  The net income for the year ended December 31, 2002 included the following:



|- | a gain on extinguishment of debt of $1,498.4 million;                                                                                                                                                                                  
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                        
|- | an asset impairment charge of $407.8 million, $128.8 million of which has been classified into loss from discontinued operations according to SFAS No. 144;                                                                            
|  |                                                                                                                                                                                                                                        
|- | a $20.0 million charge for patient care liability costs related to our inpatient services operation;                                                                                                                                   
|  |                                                                                                                                                                                                                                        
|- | a $2.8 million increase in reimbursement reserve accounts due to the Medicaid reserves related to our inpatient services operation;                                                                                                    
|  | 14                                                                                                                                                                                                                                     
|- | an $8.7 million gain on sale of assets, net primarily due to the reversal of accrued prepetition liabilities related to disposed facilities; and                                                                                       
|  |                                                                                                                                                                                                                                        
|- | a gain from reorganization activities of $1.5 million resulting from the reversal of losses that were booked in connection with the anticipated divestiture of long-term care facilities that we subsequently determined to not divest.

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



Net Revenues



After adjusting for the impact of SFAS No. 144 for the loss from discontinued operations, our net revenues for the year ended December 31, 2002  were $980.9 million compared to $2,075.2 million for the prior year. The decrease in net revenues of approximately $1,094.3 million for the year ended December 31, 2002, as compared to the prior year, primarily consisted of the following:



|- | a decrease of $919.1 million due to the SFAS No. 144 reclassification for 2002 of discontinued operations, primarily in our inpatient services operations;                                                                             
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                        
|- | decreases of $122.4 million, $23.9 million and $17.7 million due to dispositions in our inpatient, international and ancillary operations, respectively; and                                                                           
|  |                                                                                                                                                                                                                                        
|- | a decrease of $34.8 million from facilities in our inpatient services operations which we operated during each year ended December 31, 2002 and 2001 ("same store operations"); offset in part by                                      
|  |                                                                                                                                                                                                                                        
|- | an increase of $14.2 million caused by an increase in non affiliated revenue due to the divestiture of inpatient facilities;                                                                                                           
|  |                                                                                                                                                                                                                                        
|- | a net increase of $3.6 million in our other operations segment, which is comprised of our temporary medical staffing operations, our mobile radiology, medical laboratory and home healthcare services and our software subsidiary; and
|  |                                                                                                                                                                                                                                        
|- | an increase of $1.3 million in our pharmaceutical and medical supply services operations.                                                                                                                                              



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



|- | an increase of $12.2 million in Medicare revenue due to slightly higher Medicare rates that existed for all but the last three months of 2002;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                               
|- | an increase of $7.1 million in Medicaid revenues driven by a slight increase in Medicaid census and rates, offset in part by                  
|  | 15                                                                                                                                            
|- | a decrease of $2.0 million in private, commercial and other revenue caused by a decrease in census.                                           



Operating Salaries and Benefits



Operating salaries and benefits for the year ended December 31, 2002 were $620.0 million as compared to $1,114.5 million for the year ended December 31, 2001.  The decrease of $494.5 million was primarily the result of lease terminations and facility divestitures in our inpatient services operations.  For the ten months ended December 31, 2002, costs associated with divested facilities have been reclassified into discontinued operations.  For the year ended 2001, these costs were included in results of operations.



Self-Insurance for Workers' Compensation and General and Professional Liability



We reported self-insurance costs of $38.0 million for the year ended December 31, 2002 as compared to $113.0 million for the year ended December 31, 2001.  The decrease of $75.0 million is primarily related to the lease terminations and facility divestitures in our inpatient services operations and the impact of the reclassification of such costs in the ten month period ended December 31, 2002 for discontinued operations per SFAS No. 144.



Rent Expense

We reported rent expense of $68.4 million in 2002 as compared to $171.5 million in 2001.  Excluding the impact of SFAS No. 144, on a same store basis in the year over year comparison, rent expense decreased $4.3 million to $43.1 million compared to $47.4 million in 2001 due to the renegotiation of leases and facility divestitures during the restructuring of our portfolio of skilled nursing facilities in 2002.



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



We reported other operating expenses, other general and administrative expenses and provision for losses on accounts receivable of $256.6 million during the year ended December 31, 2002 compared to $627.1 million during the prior year. The decrease in expenses of $370.5 million primarily consisted of the following:



|-                                       | decreases of $137.6 million, $23.0 million and $20.0 million due to dispositions in our inpatient, international and ancillary operations, respectively;                                                                    
|--------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                        |                                                                                                                                                                                                                             
|-                                       | a decrease of $8.7 million in our other segment primarily caused by the capitalization of certain costs for our software development subsidiary, which has achieved technical feasibility for its main software product; and
|                                        |                                                                                                                                                                                                                             
|-                                       | a decrease $8.9 related to our efforts to reduce overhead and streamline general and administrative costs, primarily salaries.                                                                                              
|                                        |                                                                                                                                                                                                                             
|These decreases were offset in part by:
|                                        |                                                                                                                                                                                                                             
|-                                       | an increase of $31.4 million due to same store operations in our inpatient services operations;                                                                                                                             
|                                        | 16                                                                                                                                                                                                                          
|-                                       | an increase of $14.2 million caused by an increase in non affiliated revenue due to the divestiture of inpatient facilities;                                                                                                
|                                        |                                                                                                                                                                                                                             
|-                                       | a higher cost of goods sold of  $3.6 million at our pharmacy operation caused by a higher mix of branded prescriptions of $9.9 million; and                                                                                 
|                                        |                                                                                                                                                                                                                             
|-                                       | an increase of $3.2 million in our rehabilitation and respiratory therapy services operations primarily driven by higher salaries expense.                                                                                  



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



|-                                       | an increase of $5.0 million in purchased services; and                                                   
|--------------------------------------- | ---------------------------------------------------------------------------------------------------------
|                                        |                                                                                                          
|-                                       | an increase of $4.9 million in paid time off expense.                                                    
|                                        |                                                                                                          
|These increases were offset in part by:
|                                        |                                                                                                          
|-                                       | decreased supplies expense of $6.7 million as a result of more monitoring of our purchasing activity; and
|                                        |                                                                                                          
|-                                       | lower contract labor of $4.8 million due to more effective controls and more competitive wages.          



Interest Expense, net



Interest expense of $7.7 million, after the reclassification of $8.4 million to loss from discontinued operations as required by SFAS No. 144, was recorded in the year ended December 31, 2002 compared to $12.6 million in the prior year.  The increase of $3.5 million in interest was due primarily to the recognition of interest for all of our debt instruments.  While we were under bankruptcy protection for two months in 2002 we did not record interest expense on essentially all of our prepetition debt.  Had we not been under bankruptcy protection in 2002, our interest expense, net for the year 2001 would have been $155.4 million.



Depreciation and Amortization



Depreciation and amortization expense was flat compared to the prior year with $32.9 million for 2002, excluding the impact of SFAS No. 144 that required the reclassification of $11.0 million to loss from discontinued operations in 2002, compared to $32.8 million for 2001.



Income Taxes



We recorded a provision for income taxes of approximately $0.6 million for the year ended December 31, 2002, primarily related to state income taxes. We increased our valuation allowance on our deferred tax assets by $139.4 million during 2002 to $615.5 million as of December 31, 2002. This valuation allowance is required under the guidance in Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes, " due to our historical operating performance and our cumulative net losses. Our realization of the deferred tax benefits primarily associated with our net operating losses ("NOL")  is dependent upon our achieving sufficient future pre-tax income. Under federal income tax law, we have up to 20 years to generate sufficient taxable income to realize the deferred benefits from

17

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NOLs. Given the size of our pre-tax loss, a valuation allowance is considered appropriate under the accounting standards.



Liquidity and Capital Resources



For the year ended and as of December 31, 2003, our net income was $0.4 million and our working capital deficit was $57.4 million. Our working capital position was significantly improved as a result of the net proceeds of $52.3 million received from our private placement of our common stock and warrants in February 2004, even after paying off the outstanding loan balance under our revolving senior loan agreement. We anticipate that our working capital position will be further improved by, among other things, refinancing $21.2 million of mortgage debt that matures on May 1, 2004, which is classified as a current liability. We are currently in negotiation to refinance these mortgages and expect the $21.2 million to be refinanced and/or retired in part with the remaining balance reclassified as long- term debt.



As of March 1, 2004, we had cash and cash equivalents of approximately $40.1 million, no outstanding balance under our revolving loan agreement and approximately $31.0 million of funds available for borrowing under our revolving senior loan agreement. We believe that our existing cash reserves and availability for borrowing under our loan agreement will provide sufficient funds for our operations, capital expenditures and regularly scheduled debt service payments through the next twelve months.



We have reached agreement with substantially all of our landlords regarding the disposition of past due rent on our divested or to be divested facilities.  On March 1, 2004, we entered into an Amended and Restated Master Lease Agreement with Omega Healthcare Investors, Inc. and various of its affiliates ("Omega").  Prior to our portfolio restructuring, we leased 51 facilities from Omega.  Pursuant to the new Master Lease, we will continue to operate 30 facilities (including 23 long-term care facilities, two rehabilitation hospitals, and five behavioral facilities). Approximately $7.8 million of accrued past due rent as of March 1, 2004 and future rent obligations that would otherwise have become due under the existing master leases will be combined into "deferred base rent".  That deferred base rent will bear interest at a floating rate equal to 375 basis points over the one year LIBOR rate, subject to a floor of 6% per annum.  Interest will not be payable until January 2008, at which time interest thereafter accruing will be payable monthly in arrears.  Omega has the right to convert the deferred base rent and accrued interest into 800,000 shares of our common stock, subject to anti-dilution adjustments for sales of shares we make at less than fair market value at the time of sale.  We have the right to pay cash in an amount equal to the value of the stock in lieu of issuing the stock to Omega.  If the average value of the common stock issuable to Omega under the new Master Lease exceeds 140% of the deferred base rent and interest accrued thereon over a period of 30 business days, we can require Omega to convert the deferred base rent into our common stock.



As of September 5, 2003, we entered into a Loan and Security Agreement with CapitalSource Finance LLC, as collateral agent, and certain other lenders (the "Revolving Loan Agreement").  The Revolving Loan Agreement is a $75.0 million two-year revolving line of credit that is secured by our accounts receivable, inventory, equipment and other assets, and the stock of our subsidiaries.  Pursuant to the Revolving Loan Agreement, we are paying interest (i) for Base Rate Loans at the greater of (a) prime plus 1.0% or (b) 5.25%, and (ii) for LIBOR Loans at the greater of (a) the London Interbank
Offered Rate plus 3.75% or (b) 5.25%. The effective interest rate as of December
31, 2003 on borrowings under the Revolving Loan Agreement was approximately
5.25%. The weighted average borrowing interest rate for the period from
September 5, 2003 through December 31, 2003 was 5.25%. Our borrowing
availability under the Revolving Loan Agreement is generally limited to up to
eighty-five percent (85%) of the value of Eligible Receivables plus eighty-five
percent (85%) of the value of Eligible Divested Company Receivables, but not to
exceed $75.0 million. The defined borrowing base as of December 31,

18

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2003 was $47.6 million, net of specified reserves of $15.0
million. The availability of amounts under our Revolving Loan Agreement is also
subject to our compliance with certain financial ratios. As of December 31,
2003, we were in compliance with these ratios. As of December 31, 2003, we had
borrowed approximately $13.1 million, which included $1.1 million of prepaid
finance fees that will be amortized over the next nine months and does not count
against availability, and we had issued approximately $21.7 million in letters
of credit, leaving approximately $13.9 million available for additional
borrowing. We have classified our Revolving Loan Agreement as a long-term
liability at December 31, 2003. In connection with entering into the Revolving
Loan Agreement, we incurred deferred financing costs of $2.6 million, which are
amortized using the effective interest method over the life of the loan
agreement.



On February 20, 2004, we completed a private placement of our common stock and warrants to purchase common stock to investors.  We received net proceeds of approximately $52.3 million in the private placement.  We sold approximately 4.4 million shares of our common stock, and warrants to purchase approximately 1.8 million shares of our common stock (inclusive of warrants paid to the placement agent).  The price paid by investors was $12.70 per unit, except for 155,400 units sold at $12.87 per unit. Each unit consisted of one share of common stock and a warrant to purchase 0.4 shares of common stock with a warrant exercise period of five years.



On July 15, 2003, we sold the assets of our pharmaceutical services operations, including substantially all of the assets of SunScript Pharmacy Corporation, to Omnicare, Inc. for $90.0 million, of which $75.0 million was received in cash at closing with up to $15.0 million in additional purchase price, payable to us on or before July 15, 2005 subject to fulfillment of the conditions described below. We simultaneously entered into agreements pursuant to which Omnicare would provide pharmacy services to our inpatient facilities (the "Pharmacy Agreements").  The $15.0 million holdback portion is subject to reduction in the event that prior to payment: (i) we reject or modify one or more Pharmacy Agreements in a bankruptcy proceeding; (ii) the new operator of any of our divested facilities does not assume the same contract with Omnicare; and/or (iii) we breach the Pharmacy Agreements.  On July 15, 2003, we used $39.5 million to pay off a prior term loan (including the $3.7 million discounted interest), $33.9 million to partially reduce our borrowing under our prior revolving loan agreement and $1.6 million for professional fees related to the sale.



We have substantially completed our restructuring efforts, including the restructuring of the portfolio of leases under which we operate most of our long-term care facilities. Through December 31, 2003, we had divested 127 facilities and had identified nine facilities that we would seek to transition to new operators.  During the year ended December 31, 2003 we withheld approximately $28.0 million in accrued rent payments and $0.7 million of mortgage payments on facilities that we identified for transfer to new operators.  Through December 31, 2003, we were released of our obligations to pay approximately $13.5 million of the withheld rent and $20.4 million of future mortgage debt.  These amounts were recorded in our net gain on disposal in discontinued operations.  The gain was significantly offset by the increase of accounts receivable allowances of $24.6 million recorded in 2003 related to the divestiture of the 127 facilities and amounts recorded to reduce remaining facility assets to net realizable value, netting to a gain of $5.8 million through December 31, 2003.  The remaining amounts that we withheld and that were not released are classified as current obligations at December 31, 2003.



We incurred total capital expenditures related primarily to improvements at
existing facilities, as reflected in the segment reporting, of $13.6 million,
$34.7 million, $4.0 million and $30.3 million for year ended December 31, 2003,
the ten months ended December 31, 2002, the two months ended February 28, 2002,
and the year ended December 31, 2001, respectively. These capital expenditures
include those related to discontinued operations of $3.8 million and $13.8
million, respectively, for the

19

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year ended December 31, 2003 and the ten month period
ended December 31, 2002. We had construction commitments as of December 31, 2003
under various contracts of approximately $0.8 million related to improvements at
facilities.

On February 28, 2002, we delivered a promissory note to the United States of America as part of our settlement agreement with the federal government and $8.0 million remains outstanding under the note. The outstanding payments coming due under the promissory note are payable as follows:  $2.0 million on February 28, 2005; and $3.0 million on each of February 28, 2006 and 2007.  Interest under the promissory note is based upon the weekly average one-year constant maturity treasury yield.  The effective interest rate as of December 31, 2003 was approximately 2.2%.



We continue to negotiate settlements of bankruptcy claims for periods prior to October 14, 1999 that were filed by various State Medicaid agencies. We expect to pay in excess of approximately $3.6 million to the State Medicaid agencies to resolve these claims. The payments are expected to be made partly in cash, partly with promissory notes and potentially netted against reimbursements payable to us.  We currently have $4.0 million reserved against our borrowing base agreement relating to these payments.



Obligations and Commitments



The following table provides information about our contractual obligations and commitments in future years as of December 31, 2003 (in thousands):

|                                                   | Payments Due by Period
|-------------------------------------------------- | ----------------------
|                                                   | Total                 
|Contractual Obligations:                           |                       
|Debt (excluding capital 
   lease obligations) (1) | $         103,973     
|Capital lease obligations                          | 364                   
|Construction commitments                           | 782                   
|Purchase obligations                               | 2,500                 
|Operating leases                                   | 341,973               
|Total                                              | $       449,592       
|                                                   | =======               



|                              |                        |                                           
|----------------------------- | ---------------------- | ------------------------------------------
|                              |                        | Amount of Commitment Expiration Per Period
|                              | Total
AmountsCommitted | 2004                                      
|Other Commercial Commitments: |                        |                                           
|Letters of credit             | $21,720                | $21,720                                   
|Total                         | $       21,720         | $  21,720                                 
|                              | ======                 | =====                                     



|    |                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes total interest on debt of $25.1 million based on contractual rates, of which $3.5 million is attributed to variable interest rates determined using the weighted-average method.



20

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Actual letters of credit outstanding as of December 31, 2003 were $39.4 million, however approximately $17.7 million were duplicative and required to replace existing letters of credit when our prior loan agreement was refinanced such that our total exposure for letters of credit under our credit facility was $21.7 million.



Effects of Inflation



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

21

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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/ Richard K. Matros    
| | Richard K. Matros              
| | Chairman of the Board and Chief
| | Executive Officer              

June 22, 2004





22

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EXHIBIT INDEX





|ExhibitNumber | Description of Exhibits                                                                         
|------------- | ------------------------------------------------------------------------------------------------
|              |                                                                                                 
|31.1          | Section 302 Sarbanes-Oxley Certifications by Chief Executive Officer and Chief Financial Officer
|              |                                                                                                 
|32.1          | Section 906 Sarbanes-Oxley Certifications by Chief Executive Officer and Chief Financial Officer