SUN HEALTHCARE GROUP INC - 10-K Annual Report

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

FORM 10-K
(Mark One)

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

For the fiscal year ended December 31, 2000

o 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 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 x No o

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 March 30, 2001, Sun Healthcare Group, Inc. had 63,017,316 outstanding
shares of Common Stock. Of those, 62,819,036 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 March 28, 2001 was approximately $4,397,333.

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 o No o N/A x No plan of reorganization has been filed with the bankruptcy
court as of this date.

1

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

FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

INDEX

PAGE

PART I

Item 1. Business....................................................................................... 3
Item 2. Properties..................................................................................... 21
Item 3. Legal Proceedings.............................................................................. 23
Item 4. Submission of Matters to a Vote of Security Holders............................................ 23

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.......................... 23
Item 6. Selected Financial Data........................................................................ 24
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 26
Item 7A. Quantitative and Qualitative Disclosure About Market Risk...................................... 57
Item 8. Financial Statements and Supplementary Data.................................................... 57
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.......... 57

PART III

Item 10. Directors and Executive Officers of the Registrant............................................. 58
Item 11. Executive Compensation......................................................................... 62
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 66
Item 13. Certain Relationships and Related Transactions................................................. 67

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................ 68
Signatures..................................................................................... 75

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

PART I
ITEM 1. BUSINESS

GENERAL

Sun Healthcare Group, Inc., ("Sun") through its direct and indirect
subsidiaries (collectively referred to herein with Sun as the "Company"), is one
of the largest providers of long-term, subacute and related specialty healthcare
services in the United States. The Company currently operates through three
principal business segments: (i) inpatient services, (ii) rehabilitation and
respiratory therapy services, and (iii) pharmaceutical services. 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 U.S. Bankruptcy Court for the District of Delaware (see
"Reorganization - Bankruptcy"). The following is a description of the Company's
current and former 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, 2000, Sun operated 303 long-term,
subacute care and assisted living facilities (consisting of 285 skilled nursing
facilities, 2 assisted living facilities and 16 hospitals) in 26 states with
33,363 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. Not included in these 303
facilities are 35 facilities with 4,071 licensed beds that the Company intends
to divest in 2001. The Company is reviewing its portfolio of facilities and
intends to divest marginal and unprofitable facilities prior to emerging from
bankruptcy. See "Reorganization - 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" 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, 2000, Sun provided
therapy services and supplies to 942 facilities in 41 states, 652 of which were
operated by nonaffiliated parties. The Company is currently soliciting offers to
purchase its SunCare respiratory therapy supply operations. See "Reorganization
- - Divestitures" herein and "Note 7 - Impairment of Long-Lived Assets and Assets
Held for Sale" in the Company's consolidated financial statements.

PHARMACEUTICAL SERVICES. The Company provides pharmaceutical services
through SunScript Pharmacy Corporation ("SunScript"). 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, 2000, Sun operated 33 regional pharmacies, seven 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 1,520 long-term and subacute care facilities in 39 states, 1,196 of
which were operated by nonaffiliated parties. The Company previously provided
medical supplies to nonaffiliated and affiliated parties through SunChoice
Medical Supply, Inc. ("SunChoice"). In January 2001, the Company completed the
sale of substantially all of the operating assets of SunChoice. See
"Reorganization - Divestitures" herein and "Note 7 - Impairment of Long-Lived
Assets and Assets Held for Sale" in the Company's consolidated financial
statements.

3

INTERNATIONAL OPERATIONS. As of December 31, 2000, the Company held a
majority interest in Heim Plan-Uternehmensgruppe, an operator of 18 long-term
care facilities in Germany with 1,468 licensed beds. In addition, the Company
provides pharmaceutical services in Germany. The Company entered into a purchase
agreement in December 2000 to sell its operations in Germany yet can give no
assurances that the sale will be completed. See "Note 7 - Impairment of
Long-Lived Assets and Assets Held For Sale" in the Company's consolidated
financial statements.

The Company's operations in Australia were placed in receivorship by its
secured creditors in September 2000. At the time the Australia operations were
placed in receivorship, the Company held 38.2% of the equity of Alpha Healthcare
Limited ("Alpha"), a publicly held acute care provider in Australia that
operated 10 facilities with 629 licensed beds. The Company also operated five
hospitals with 335 licensed beds in Australia. The Company sold its operations
in Spain in October 2000 consisting of 11 facilities with 1,688 beds. The
Company sold its operations in the United Kingdom in February 2001 consisting of
146 inpatient facilities with 8,326 licensed beds. See "Reorganization -
Divestitures" and "Note 24 - Subsequent Events" in the Company's consolidated
financial statements.

OTHER OPERATIONS. The Company is a nationwide provider of temporary medical
staffing through CareerStaff Unlimited, Inc. ("CareerStaff"). Careerstaff
derives approximately 50% of its revenues from skilled nursing facilities, 30%
from schools and governmental agencies and 20% from hospitals and other
providers. 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, 2000, CareerStaff had 24 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.

Through SunAlliance Healthcare Services, Inc. ("SunAlliance") and SunPlus
Home Health Services, Inc. ("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.

CORPORATE HEADQUARTERS. 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.

REORGANIZATION

BANKRUPTCY. On October 14, 1999, Sun 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 obtained debtor-in-possession financing
and is currently operating its business as a debtor-in-possession subject to the
jurisdiction of the Bankruptcy Court. 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 Company's consolidated financial
statements.

4

DIVESTITURES. During the years ended December 31, 2000 and 1999, Sun
divested 49 and 49 skilled nursing facilities and 20 and 12 assisted living
facilities, respectively. The aggregate cash consideration received was
approximately $1.6 million in 2000 and $4.1 million in 1999 for the assisted
living facilities. The Company did not receive any cash consideration from the
skilled nursing facility divestitures. The aggregate net operating losses of the
skilled nursing facilities and the assisted living facilities were approximately
$5.7 million and $3.2 million in 2000 and $12.5 million and $0.1 million in
1999, respectively. See "Note 7 - Impairment of Long-Lived Assets and Assets
Held for Sale" in the Company's consolidated financial statements. During the
period of January 1, 2001 through March 15, 2001, Sun divested 10 skilled
nursing facilities. The aggregate net operating losses of these facilities
during 2000 were $3.2 million and $1.3 million respectively. See "Note 24 -
Subsequent Events" in the Company's consolidated financial statements.

In January 2001, the Company sold the assets of its SunChoice medical
supplies operations to Medline Industries, Inc. ("Medline"). The Company
received proceeds of $16.6 million in exchange for the SunChoice assets,
including SunChoice's accounts receivable. In the event that Medline collects
less from the SunChoice accounts receivable by July 2001 than it paid to the
Company for the receivables, the Company must pay the deficiency to Medline.
Therefore, it is possible that the Company would be required to repay Medline a
portion of the SunChoice purchase price.

In February 2001, the Company sold its subsidiaries that operated in the
United Kingdom. Those operations included 146 long-term care facilities with
8,326 licensed beds. The Company did not receive any material cash payments in
exchange for these operations, but the Company was released from approximately
$112.9 million of aggregate debt, capital lease obligations, notes payable and
other liabilities upon consummation of the sale. See "Note 24 - Subsequent
Events" in the Company's consolidated financial statements.

In June 2000, the Company sold 18 pharmacies which operated in the United
Kingdom. Cash consideration received for these pharmacies was approximately $9.7
million and a gain on sale of assets of approximately $1.0 million was recorded.

In October 2000, the Company divested its operations in Spain for
approximately $7.6 million in cash. Also, in September 2000, the Company's
operations in Australia were placed in receivorship by its secured creditors.
Under Australian receivorship procedures, the assets will be sold and the
proceeds used to pay the secured creditors, and then any remaining value would
be distributed to its unsecured creditors, which includes the Company. No
assurance can be given that the Company will receive any proceeds from the sale
of the Australia operations.

The Company sold its therapy equipment manufacturing operations in the
third quarter of 2000. Under the agreement, the Company transferred most assets
of the business, including equipment and accounts receivable, to the purchaser.
However, the Company retained some assets for its use in providing therapy
services. The Company received no cash consideration from this sale. Instead,
consideration for the sale was the settlement of certain prepetition claims the
purchaser held against the Company.

5

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 operations in Germany and
certain non-core businesses, including the sale of its SunCare respiratory
therapy supply business. 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's restructuring began in 1998 and is continuing
during its bankruptcy cases. The number of full and part-time employees of the
Company worldwide has decreased from 80,700 on February 20, 1999 to 57,100 on
March 31, 2000, and to 42,032 on February 28, 2001. The decrease in 1999 was
primarily attributable to the elimination of rehabilitation therapy employees
through attrition, layoffs and 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
decreases in 2000 and early 2001 primarily resulted from the disposition of the
Company's international operations, medical supplies operations and inpatient
facilities. See "Employees."

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 (in thousands):

Years Ended December 31
Sources of Revenues 2000 1999 1998 1997
- ------------------- --------------------------------------------------------------

Medicaid . . . . . . . . . . . . . . . . $1,025,600 $ 1,041,662 $ 957,058 $ 583,583

Medicare . . . . . . . . . . . . . . . . 515,492 446,820 834,200 479,201

Private pay and other (1) . . . . . . . . 652,334 743,651 1,011,935 749,881

___________________

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

6

The Medicare Part A program provides reimbursement for extended care
services furnished to Medicare beneficiaries who are admitted to skilled 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 or have exhausted
their Part A benefits. Medicaid is a state-administrated program that provides
assistance to the indigent and certain other eligible persons. Private pay
patients typically have financial resources (including managed care insurance
coverage) to pay for their care and do not rely on government programs for
financial support.

Congress has enacted three major laws during the past five years that have
significantly altered payment for nursing home and medical ancillary services.
The Balanced Budget Act of 1997 (the "BBA"), signed into law in August 1997,
reduced federal spending on the Medicare and Medicaid programs. The Medicare
Balanced Budget Refinement Act ("BBRA"), enacted in November 1999, addressed a
number of the funding difficulties caused by the BBA. A second enactment, the
Benefits Improvement and Protection Act of 2000 ("BIPA"), enacted in December
2000, further modified the law and restored additional funding.

BBA. In the 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. 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 costs, including nursing, ancillary and
capital-related costs for Medicare beneficiaries receiving skilled services.
Under the BBA, 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 RUG category with 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 is critical to the
Company's success. Prior to the implementation of PPS, the costs of many of such
services were directly reimbursed.

During the PPS phase-in, payments are generally 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 as of
April 1, 2000; (iii) year three, 25% historical cost and 75% federal rate, and
(iv) year four and thereafter, 100% federal rate. The Company's skilled nursing
facilities will be fully phased-in and subject to the 100% federal rate by
January 1, 2002.

7

Effective January 1, 1999, Medicare Part B 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 sought 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 implementation, 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.

BBRA. The BBRA was designed to mitigate the adverse effects of 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 until the Health Care Financing Administration ("HCFA") has
adopted refinements to the RUG system as of April 1, 2000; (iii) a 4% increase
in the federal adjusted per diem rates for all 44 RUG categories for the period
October 1, 2000 through September 30, 2002; and (iv) a 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, the Health Care Financing Administration ("HCFA")
released its proposed refinements to PPS. The proposed changes included the
following: (i) the number of RUG categories would increase from 44 to 178; (ii)
the BBRA's temporary 20% add-on 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. HCFA postponed consideration of the proposed
refinements in July 2000.

BIPA. BIPA increased the nursing component of PPS rates by approximately
16.7% for the period from April 1, 2001 through September 30, 2002. The
legislation will also change the 20% add-on to three of the 14 rehabilitation
RUG categories to a 6.7% add-on to all 14 rehabilitation RUG categories
beginning April 1, 2001. The Part B consolidated billing provision of BBRA will
be repealed except for Medicare Part B therapy services, and the moratorium on
the $1,500 therapy caps will be extended through calendar year 2002. The Company
is unable to fully predict the effect BIPA will have on its operating results.

8

The Company's revenues from its inpatient facilities have been
significantly affected by the 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 2000,
1999, 1998 and 1997:

Average Medicare Part A
Revenue Per Patient, Per Day(1)(2)
----------------------------------

2000 $358.94
1999 338.29
1998 466.23
1997 472.90
____________________

(1) Includes estimated adjustments for routine cost limit ("RCL") exception
revenue.
(2) The year-to-year comparisons are not on a same-store basis due to
acquisitions and divestitures, which occurred between January 1997 and
December 2000.

The volatility of the average Medicare Part A revenue per patient per day
from 1997 to 2000 was driven by the change in reimbursement rates with the
implementation of PPS in 1999 and also by the change in the number of Medicare
days in the Company's long-term care facilities as a result of the Regency
Acquisition in 1997 wherein the Company acquired 110 Medicare-certified
facilities.

In addition, the Company's average annual Medicare Part B revenue per
facility decreased approximately [83% from 1997 to 1999] [67% from 1997 to
2000]. 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 the pricing for
the provision of Part B therapy decreased when Part B reimbursement changed to a
procedure code payment system.

The implementation of PPS also 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 therapy services, respiratory therapy supplies 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.

9

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 and 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.

RELATED PARTY RULE. 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 that 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 goods and 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 goods and services provided by the
Company's ancillary service subsidiaries at the rates applicable to goods and
services provided to nonaffiliated entities. The related party regulations do
not indicate a specific level of services that must be provided to nonaffiliated
entities in order to satisfy the "substantial part" requirement of this
exception. In instances where this issue has been litigated by others, no
consistent standard has emerged as to the appropriate threshold necessary to
satisfy the "substantial part" requirement.

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 for the Company's skilled
nursing facilities and hospitals and will also affect Medicare cost reports for
hospitals until 2002. The Company's net revenues from rehabilitation therapy
services, including net revenues from temporary therapy staffing services,
provided to nonaffiliated facilities represented 57%, 56% and 56% of total
rehabilitation services net revenues for the years ended December 31, 2000, 1999
and 1998, respectively. Respiratory therapy services provided to nonaffiliated
facilities represented 66%, 52% and 46% of total respiratory therapy services
net revenues for the years ended December 31, 2000, 1999 and 1998, respectively.
Net revenues from pharmaceutical services billed to nonaffiliated facilities
represented 70%, 74% and 70% of total pharmaceutical services revenues for the
years ended December 31, 2000, 1999 and 1998, respectively. The Company uses
certain variables such as percent of revenue derived from nonaffiliated parties
and associated service charges to determine whether it has met the requirements.
For cost reports filed for the years ending December 31, 1998 and December 31,
1999, the Company met the appropriate thresholds to satisfy the "substantial
part" requirement of the related party exception. For cost reports to be filed
for the year ending December 31, 2000, the Company's respiratory therapy and
pharmaceutical services operations met the related party exception allowing for
reimbursement of their charges to the inpatient facilities division. However,
the rehabilitation therapy services operations including the temporary medical
staffing services, the medical supplies division and the software development
division did not meet the standards allowing for the related party exception for
2000. The Company will be required to reflect adjustments on the cost reports
decreasing the charges to the inpatient facilities of the services during 2000
from these divisions to the cost-basis of those services. The Company has
determined that the impact of these cost report adjustments on the Medicare
revenues recorded for the year ended December 31, 2000 is not significant. If
the Company were deemed not to have satisfied these regulations, the
reimbursement that the Company receives for goods and services provided to its
own facilities could be significantly reduced, which could 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.

10

GOVERNMENT REGULATION

REGULATORY REQUIREMENTS. The Company's subsidiaries, including those that
provide subacute and long-term care, rehabilitation therapy and pharmaceutical
services and respiratory therapy supplies, 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.

Long-term care facilities must comply with certain requirements to
participate in Medicare or Medicaid. Regulations promulgated pursuant to the
Omnibus Budget Reconciliation Act of 1987 obligate facilities to demonstrate
compliance with requirements relating to resident rights, resident assessment,
quality of care, quality of life, physician services, nursing services,
infection control, physical environment and administration. Regulations
governing survey, certification and enforcement procedures to be used by state
and federal survey agencies to determine facilities' level of compliance with
the participation requirements for Medicare and Medicaid were adopted 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 monetary penalties of up to
$10,000 per day; facility closure and/or transfer of residents in emergencies;
denial of payment for new or all admissions; directed plans of correction; and
directed in-service training. Failure to comply with certain standards as a
condition to participate in 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 first 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.

11

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 known filing of a false claim or the known 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."

In December 2000, the federal government released the final privacy rules
of the Health Insurance Portability and Accountability Act of 1996 ("HIPAA").
The rules provide for, among other things, (i) giving consumers the right and
control over the release of their medical information, (ii) the establishment of
boundaries for the use of medical information, and (iii) penalties for violation
of an individual's privacy rights. The Company is not required to comply with
the HIPAA privacy rules until 2003, but the Company will require substantial
efforts and resources to prepare for compliance.

ENFORCEMENT ACTIVITY. Pursuant to HIPAA, Congress has provided additional
funding to the Department of Health and Human Services/Office of Inspector
General ("HHS/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.

The HHS/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.

12

On July 21, 1998, President Clinton 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, President Clinton announced that his 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 HHS/OIG,
HCFA, DOJ and state and local prosecutors would 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 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
focuses on a wide range of health care fraud and abuse policy issues, particular
attention is 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; and analysis of the applicable state laws and
improved inter-agency and governmental coordination, use of data and services to
victims.

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 reviews, 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 the 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.
Challenging and appealing notices of noncompliance can require significant legal
expenses and management attention.

13

The Company believes that enforcement activities at both the federal and
state levels and QUI TAM actions brought by private parties have increased over
the past five years. 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. There can be no assurance that substantial amounts will
not be expended by the Company to cooperate with any 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 nursing 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. From time to time federal and state survey
agencies impose 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 in contesting such terminations.

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.

14

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 February 28, 2001, the Company had 42,032 full-time and part-time
employees. Of this total, there were 32,164 employees at the long-term and
subacute care facilities, 3,296 employees involved in providing rehabilitation
therapy services, 1,284 employees in the pharmaceutical services operations,
1,367 employees in the temporary therapy staffing business, 216 employees in the
respiratory therapy services business, 1,014 employees at the corporate and
regional offices, 859 employees involved in providing long-term care services in
Germany, and 10 employees in the foreign corporate offices and 1,822 employees
in other health care services in the United States.

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.

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:

15

EFFECT OF BANKRUPTCY REORGANIZATION ON COMMON STOCK AND DEBT SECURITIES.
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. As of October 1, 2000, the
parties to the agreement in principle have the right to withdraw from the
agreement in principle, and several bank lenders and note holders have
withdrawn. The Company and its significant creditor constituents are presently
negotiating amendments to the agreement in principle that will form the basis
for a plan of reorganization. It is anticipated that any plan of reorganization
confirmed in the chapter 11 cases will provide that Sun's outstanding
convertible subordinated debt, convertible trust issued preferred securities and
common stock will effectively be canceled without any recoveries to the holders
of such debt and securities.

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
described above. 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. The
Company entered into a Revolving Credit Agreement with certain lenders and CIT
Group/Business Credit, Inc. and Heller Healthcare Finance, Inc. as agents to
provide the Company in debtor-in-possession financing (the "DIP Financing
Agreement"). The DIP Financing Agreement provides for maximum borrowings by the
Company up to $200.0 million, not to exceed 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 February 28,
2001, approximately $139.5 million was available to the Company under the DIP
Financing Agreement, of which amount the Company had borrowed approximately
$63.4 million and had issued approximately $35.2 million in letters of credit.

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. 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.

16

In July 2000, the Company obtained waivers from the DIP Lenders on several
defaults under the DIP Financing Agreement. In February and March 2001, the
Company obtained a Forbearance Agreement from the DIP Lenders pursuant to which
the DIP Lenders agreed to forbear from exercising any remedies available to them
under the DIP Financing Agreement and to continue to extend credit to the
Company until April 23, 2001. The Company and the DIP Lenders are negotiating an
amendment to the DIP Financing Agreement, which would revise the covenants that
the Company has violated or may violate. If the Company is unable to enter into
this amendment or fails to comply with the amended covenants contained in the
DIP Financing Agreement and is unable to obtain a waiver of any such future
covenant violation or to amend the DIP Financing Agreement to cure the future
default, 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
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources" and "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 ("PPS"). For a
description of certain risks related to PPS, see "Reimbursement from Medicare
and Medicaid."

17

RISKS RELATED TO INVESTIGATIONS AND LEGAL PROCEEDINGS. The Company's
subsidiaries are engaged in healthcare 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/OIG and the
DOJ periodically investigate matters that have come to their attention
concerning the Company, including cost reporting matters. 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.

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. The existence of regulatory investigations has
previously 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. Under cost-based reimbursement plans, payors may
disallow, in whole or in part, requests for reimbursement based on
determinations that certain costs are not reimbursable or reasonable or because
additional supporting documentation is necessary. 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 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 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 at least through 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. Unless otherwise agreed to with HHS, 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 HHS if the Company believes
that such funds exceed the claims that HHS has against the Company. As of
December 31, 2000 the Company estimated that it had net Medicare accounts
receivable of approximately $80.1 million that were being withheld by HHS
pursuant to this agreement. Of that amount, the Company has agreed to release
its claims to $17.1 million related to divested facilities, and there is a
substantial likelihood that the Company will not recover any of the remaining
$63.0 million.

18

Payment of amounts due to the Company by 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, 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 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.

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. The Company does not know how
long it will be necessary to continue this program. 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. The Company's allowance for
doubtful accounts has increased from approximately $79.0 million at December 31,
1998 to approximately $151.8 million at December 31, 1999, to approximately
$128.1 million at December 31, 2000. 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. 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 paid 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.

19

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 the Company'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 - Government 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."

20

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. Many
states have recently increased minimum staffing standards, and HCFA is studying
whether minimum staffing standards should be imposed on skilled nursing
facilities. 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. There can be no assurance that Sun will be able to retain its
executive officers and key employees and continue to hire and retain a
sufficient number of qualified personnel to operate the Company effectively. See
"Business - Employees."

ITEM 2. PROPERTIES

FACILITIES IN THE UNITED STATES. The Company operated an aggregate of 303
long-term care, subacute care and assisted living facilities in the U.S. as of
February 28, 2001, 285 of which were subject to long-term operating leases or
subleases and 18 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%, 87% and 87%
in the U.S. for the years ended December 31, 1998, 1999 and 2000, 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.

21

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 2001. Included in the table are 303
facilities (285 skilled nursing facilities, 2 assisted living facilities and 16
hospitals) that are included in the inpatient services segment. Not included in
the table are 35 facilities that the Company intends to divest in 2001.

NUMBER OF FACILITIES
NUMBER OF --------------------
STATE LICENSED BEDS(1) LEASED OWNED TOTAL
- ----- ---------------- ------ ----- -----

California 8,760 88 2 90
Massachusetts 4,508 32 2 34
Texas 2,245 18 - 18
Georgia 1,933 11 7 18
Connecticut 1,769 11 1 12
Washington 1,652 17 1 18
Tennessee 1,559 13 1 14
Florida 1,458 11 - 11
Arizona 1,200 7 - 7
North Carolina 1,141 9 - 9
New Hampshire 985 9 - 9
Alabama 783 7 - 7
Idaho 761 8 1 9
West Virginia 739 7 - 7
New Jersey 580 5 - 5
Ohio 575 4 1 5
Virginia 494 2 1 3
Illinois 469 5 - 5
Maryland 343 2 - 2
Colorado 341 7 1 8
Louisiana 308 2 - 2
New Mexico 286 4 - 4
Kentucky 137 2 - 2
Oklahoma 135 2 - 2
Missouri 103 1 - 1
Indiana 99 1 - 1
-- - -
Total 33,363 285 18 303
====== === == ===

(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.

INTERNATIONAL LONG-TERM CARE FACILITIES. The Company operated 18 facilities
with 1,468 beds in Germany as of February 28, 2001.

Pharmaceutical Services. As of February 28, 2001, the Company operated 33
regional pharmacies, 7 in-house long-term care pharmacies and 1 pharmaceutical
billing and consulting center in the United States.

22

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 or throughout 2000.

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:
HIGH LOW
---- ---
2000
First Quarter . . . . . . . . . . $ 0.08 $ 0.07
Second Quarter . . . . . . . . . . . 0.08 0.07
Third Quarter . . . . . . . . . . 0.07 0.05
Fourth Quarter . . . . . . . . . . . 0.07 0.06

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

There were 6,919 holders of record as of February 28, 2001 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."

The Company anticipates that the Company's plan of reorganization will
provide for no recovery to the holders of outstanding equity securities,
including common stock and options to acquire common stock. See Item 1 -
"Certain Additional Business Risks - Effect of Bankruptcy Reorganization on
Common Stock and Debt Securities."

23

ITEM 6. SELECTED FINANCIAL DATA

The following Selected Consolidated Financial Data for the years ended
December 31, 2000, 1999, 1998, 1997, and 1996 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, (in thousands,
except per share data):

YEARS ENDED DECEMBER 31
-----------------------
2000(1) 1999(2) 1998(3) 1997(4) 1996(5)
------- ------- ------- ------- -------

Total net revenues................... $ 2,458,928 $ 2,529,039 $ 3,088,460 $ 2,010,820 $ 1,316,308
--------------- ------------------ ------------------ ----------------- ---------------
Earnings (losses) before income
taxes, extraordinary loss and
cumulative effect of change in
accounting principle............... (545,455) (1,076,481) (689,842) 95,882 52,466
--------------- ------------------ ------------------ ----------------- ---------------
Earnings (losses) before
extraordinary loss and cumulative
effect of change in accounting (545,711) (1,076,642) (743,419) 54,729 21,536
principle..........................
Extraordinary loss................... - - (10,274) (19,928) -
Cumulative effect of change in
accounting principle............... - (12,816) - - -
--------------- ------------------ ------------------ ----------------- ---------------
Net earnings (losses)................ $ (545,711) $ (1,089,458) $ (753,693) $ 34,801 $ 21,536
=============== ================== ================== ================= ===============
Net earnings (losses) per common and
common equivalent share:
Net earnings (losses) before
extraordinary loss and cumulative
effect of change in accounting
principle:
Basic.............................. $ (9.04) $ (18.40) $ (14.29) $ 1.18 $ 0.46
=============== ================== ================== ================= ===============
Diluted............................ $ (9.04) $ (18.40) $ (14.29) $ 1.06 $ 0.46
=============== ================== ================== ================= ===============
Net earning (losses):
Basic.............................. $ (9.04) $ (18.62) $ (14.49) $ 0.75 $ 0.46
=============== ================== ================== ================= ===============
Diluted............................ $ (9.04) $ (18.62) $ (14.49) $ 0.67 $ 0.46
=============== ================== ================== ================= ===============
Weighted Average number of common
and common equivalent shares:
Basic.............................. 60,347 58,504 52,008 46,329 46,360
=============== ================== ================== ================= ===============
Diluted............................ 60,347 58,504 52,008 51,851 46,868
=============== ================== ================== ================= ===============
Working Capital (Deficit)............ $ (161,620) $ (17,282) $ (539,636) $ 307,025 $ 211,582
=============== ================== ================== ================= ===============
Total Assets......................... $ 849,988 $ 1,438,488 $ 2,468,038 $ 2,579,236 $ 1,229,426
=============== ================== ================== ================= ===============
Liabilities subject to compromise.... $ 1,529,928 $ 1,558,518 $ - $ - $ -
=============== ================== ================== ================= ===============
Long-term debt (6)................... $ 140,250 $ 145,541 $ 1,518,274 $ 1,545,678 $ 512,435
=============== ================== ================== ================= ===============
Stockholder's equity (deficit)....... $ (1,545,338) $ (1,023,000) $ 33,759 $ 617,053 $ 572,137
=============== ================== ================== ================= ===============

24

(1) Results for the year ended December 31, 2000 include a non-cash impairment
charge of $191.3 million related to the Company's estimate of goodwill and
other long-lived assets (see "Note 7 - Impairment of Long-Lived Assets and
Assets Held for Sale" in the Company's consolidated financial statements),
a net non-cash gain on sale of assets of $21.4 million due to the
prepetition termination of certain facility lease agreements, the sale of
certain other facilities, and reduction of 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 $1.1 million non-cash recovery of previously recorded cost for corporate
and financial restructuring (see "Note 4 - Restructuring Costs" in the
Company's consolidated financial statements), a $2.5 million charge for
legal and regulatory charges due to the Company's chapter 11 filings (see
"Note 2 - Petitions for Reorganization under Chapter 11" in the Company's
consolidated financial statements) and a $335.9 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).

(2) 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).

(3) 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.

25

(4) 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.

(5) 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.

(6) Long-term debt as of December 31, 2000 does not include $1,529.9 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 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").

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

Sun Healthcare Group,Inc. ("Sun") through its direct and indirect
subsidiaries (collectively referred to herein with Sun as the "Company"), is one
of the largest providers of long-term, subacute and related specialty healthcare
services in the United States. The Company also had operations in Germany,
Spain, Australia and the United Kingdom in 1998 and 1999 and during most of
2000. 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. During
2000 and 1999, the Company operated through four principal business 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 assistants. As of December 31, 2000, the Company operated 303 inpatient
facilities with 33,363 licensed beds compared to 354 facilities with 39,867
licensed beds as of December 31, 1999. Included in the December 31, 2000 amounts
are 35 skilled nursing facilities with 4,071 licensed beds that the Company
intends to divest through foreclosure sales, lease terminations through mutual
agreements with the lessors or by transferring operations to successor
operators. See "Note 7 - Impairment of Long-Lived Assets and Assets Held for
Sale" and "Note 24 - Subsequent Events" in the Company's consolidated financial
statements.

26

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, 2000, the Company's
rehabilitation and respiratory therapy services segment provided services to 942
facilities in 41 states, of which 652 were operated by nonaffiliated parties
compared to 1,531 facilities in 37 states as of December 31, 1999, of which
1,158 were operated by nonaffiliated parties. During the first quarter of 2000,
the Company began pursuing the disposition of its respiratory therapy business.
The Company recorded a loss to reduce the carrying value of its respiratory
therapy business to the Company's estimate of selling value less selling costs.
See "Note 2 - Petitions for Reorganization under Chapter 11" in the Company's
consolidated financial statements.

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
consultant pharmacist services. The medical supply subsidiary primarily provided
medical supplies to long-term care and subacute care facilities. The
pharmaceutical and medical supply subsidiaries provided pharmaceutical products
and services and medical supplies to 1,520 long-term and subacute care
facilities, including 1,196 nonaffiliated facilities, as of December 31, 2000.
As of December 31, 1999, pharmaceutical products and services were provided to
approximately 885 facilities, including 550 nonaffiliated facilities. On January
19, 2001, the Company sold its medical supply operations.

INTERNATIONAL OPERATIONS: During 1999 and through the fourth quarter of
2000, this segment included long-term care facilities in the United Kingdom and
Germany. During 1999 and through the fourth quarter of 2000, the Company also
provided pharmaceutical services in Germany. As of December 31, 2000, the
Company operated 146 inpatient facilities with 8,326 licensed beds in the United
Kingdom and 18 facilities with 1,468 licensed beds in Germany compared to 145
facilities with 8,320 licensed beds in the United Kingdom and 17 facilities with
1,217 licensed beds in Germany as of December 31, 1999.

In June of 2000, Sun divested a total of 18 pharmacies in the United
Kingdom. The Company divested its operations in Spain in October 2000, which
consisted of 11 inpatient facilities with 1,688 licensed beds. The Company's
operations in Australia were placed in receivorship by its secured creditors in
September 2000. At the time the Australia operations were placed in
receivorship, the Company held 38.2% of the equity in Alpha Healthcare Limited,
a publicly held acute care provider in Australia that operated 10 facilities
with 629 licensed beds. The Company also operated five hospitals with 335
licensed beds in Australia. The Company is soliciting offers to purchase its
operations in Germany. No assurance can be given that the Company will
successfully divest its operations in Germany. In February 2001, the Company
divested its operations in the United Kingdom. See "Note 7 - Impairment of
Long-Lived Assets and Assets Held for Sale" and "Note 24 - Subsequent Events" in
the Company's consolidated financial statements.

27

OTHER OPERATIONS

During 1999 and through the fourth quarter of 2000, the Company's other
operations included temporary medical staffing services, home health, software
development and other ancillary services. The Company divested its hospice
operations in the fourth quarter of 1999 and most of its assisted living
operations in the fourth quarter of 1999 and the first half of 2000. See "Note 7
- - Impairment of Long-Lived Assets and Assets Held for Sale" in the Company's
consolidated financial statements and "Liquidity and Capital Resources". The
Company's temporary medical staffing service operations provided 777,181
temporary therapy staffing hours and 482,303 non-therapy hours to nonaffiliates
for the twelve months ended December 31, 2000 compared to 969,977 temporary
medical staffing hours and 180,055 non-therapy hours for the twelve months ended
December 31, 1999.

The following table sets forth certain operating data for the Company as of
the dates indicated:

DECEMBER 31
2000 1999 1998
---- ---- ----

Inpatient Services:
Facilities 303 354 397
============== ============== =============
Licensed beds 33,363 39,867 44,941
============== ============== =============

Rehabilitation and Respiratory Therapy Services:
Nonaffiliated facilities served 652 1,158 1,294
Affiliated facilities served 290 373 421
-------------- -------------- -------------
Total 942 1,531 1,715
============== ============== =============

Pharmaceutical and Medical Supply Services:
Nonaffiliated facilities served 1,196 1,805 2,099
Affiliated facilities served 324 702 936
-------------- -------------- -------------
Total 1,520 2,507 3,035
============== ============== =============

International Operations:
Facilities
United Kingdom 146 145 155
Other foreign 18 33 31
-------------- -------------- -------------
Total 164 178 186
============== ============== =============

Licensed beds
United Kingdom 8,326 8,320 8,705
Other foreign 1,468 3,192 3,048
-------------- -------------- -------------
Total 9,794 11,512 11,753
============== ============== =============

28

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 the Company's accounting principles
generally accepted in the United States applicable to a going concern, which
principles, except as otherwise disclosed, assume that the Company's assets will
be realized and the Company's liabilities will be discharged in the normal
course of business. The Company's 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, 2000 and
1999 balance sheets 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."

29

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):

2000 % 1999 % 1998 %
---- - ---- - ---- -

Inpatient Services........................... $ 1,718,178 69.9 $1,697,518 67.1 $ 2,045,270 66.2
Rehabilitation and Respiratory Therapy 204,367 8.3 234,008 9.3 678,803 22.0
Services...................................
Pharmaceutical and Medical Supply Services... 299,897 12.2 300,959 11.9 254,455 8.2
International Operations..................... 265,501 10.8 296,906 11.7 285,267 9.2
Other Operations............................. 182,809 7.4 222,219 8.8 283,326 9.2
Corporate.................................... 1,381 0.1 - - - -
Intersegment Eliminations.................... (213,205) (8.7) (222,571) (8.8) (458,661) (14.8)
-------------- --------- ------------ --------- ------------ ---------
Total Net Revenues........................... $ 2,458,928 100.0% $2,529,039 100.0% $3,088,460 100.0%
============== ========= ============ ========= ============ =========

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 $113.9
million, $127.6 million and $344.1 million for the years ended December 31,
2000, 1999 and 1998, respectively. Revenues for pharmaceutical and medical
supply services provided to domestic affiliated facilities were approximately
$88.3 million, $80.9 million and $78.9 million for the years ended December 31,
2000, 1999 and 1998, respectively. Revenues for services provided by other
non-reportable segments to affiliated facilities were approximately $11.0
million, $14.1 million and $35.6 million for the years ended December 31, 2000,
1999 and 1998, respectively.

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

2000 1999 1998
---- ---- ----

Inpatient Services............................... $ (29,339) $ (245,254) $ (109,722)
Rehabilitation and Respiratory Therapy Services.. 16,391 (43,820) 159,844
Pharmaceutical and Medical Supply Services....... (5,448) (29,633) (9,729)
International Operations......................... (21,521) (41,878) (43,906)
Other Operations................................. (14,682) (51,547) (17,769)
--------------- ------------- --------------
Losses before income taxes, corporate allocation
of interest and management fees................ (54,599) (412,132) (21,282)
Corporate........................................ 16,325 (50,216) (37,849)
Intersegment eliminations........................ - - -
--------------- ------------- --------------
Net segment losses............................... $ (38,274) $ (462,348) $ (59,131)
=============== ============= ==============

30

The net segment loss 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 statements of losses. As a
result, net segment 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 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 losses. The amortization of debt discounts and deferred
issuance costs prior to the Filing Date are included in net segment 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, 2000 compared to
the Year Ended December 31, 1999" and the "Year Ended December 31, 1999 compared
to the Year Ended December 31, 1998" is based on the financial information
presented in "Note 21 - Segment Information" in the Company's consolidated
financial statements.

YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999

INPATIENT SERVICES

Net revenues, which includes revenues from therapy and pharmaceutical
services provided at the Inpatient Services facilities, increased approximately
$19.8 million from $1,698.4 million at December 31, 1999 to $1,718.2 million at
December 31, 2000. On a same store basis, net revenues increased approximately
$167.9 million from $1,420.0 million for the year ended December 31, 1999 to
$1,587.9 million for the year ended December 31, 2000, a 11.8% increase. Net
revenues for 1999 include negative revenue adjustments of approximately $105.0
million. Excluding the negative revenue adjustments for 1999, on a same store
basis, net revenues increased $62.8 million or 4.1% for the year ended December
31, 2000. This increase is primarily the result of improved Medicaid rates
during 2000.

31

On a same store basis, operating expenses, which include rent expense of
$166.2 million and $160.1 million for the year ended December 31, 1999 and 2000,
respectively, increased 2.5% from $1,421.9 million for the year ended December
31, 1999 to $1,457.9 million for the year ended December 31, 2000. Operating
expenses as a percentage of net revenues, excluding the negative revenue
adjustments for 1999, decreased from 93.2% for the year ended December 31, 1999
to 91.8% for the year ended December 31, 2000. The decrease in operating
expenses as a percentage of revenue is primarily due to an increase in revenues
combined with decreases in administrative costs associated with the divestitures
of skilled nursing facilities during 2000.

On a same store basis, corporate general and administrative expenses, which
include regional costs related to the supervision of operations, were $28.7
million and $39.8 million for the years ended December 31, 1999 and December 31,
2000, respectively. Excluding the effect of the negative revenue adjustments for
1999, as a percentage of net revenues, corporate general and administrative
expenses were 1.9% and 2.5% for the years ended December 31, 1999 and December
31, 2000, respectively. The change is primarily due to an increase in the
corporate overhead allocation partially offset by a reduction in regional
overhead due to skilled nursing facility divestitures.

On a same store basis, provision for losses on accounts receivable
decreased 66.7% from $40.6 million for the year ended December 31, 1999 to $13.5
million for the year ended December 31, 2000. Excluding the effect of the
negative revenue adjustments for 1999, as a percentage of net revenues,
provision for losses on accounts receivable decreased from 2.7% for the year
ended December 31, 1999 to 0.9% for the year ended December 31, 2000. During
1999, the Company increased its reserves due to a deterioration in the aging of
certain accounts receivable. An equivalent increase was not necessary in 2000.

On a same store basis, depreciation and amortization decreased 23.2% from
$25.0 million for the year ended December 31, 1999 to $19.2 million for the year
ended December 31, 2000. Excluding the effect of the negative revenue
adjustments for 1999, as a percentage of net revenues, depreciation and
amortization expense decreased from 1.6% for the year ended December 31, 1999 to
1.2% for the year ended December 31, 2000. The decreases are primarily the
result of the determination in 1999 that certain of the Company's long-lived
assets were impaired, which resulted in write-downs of certain long-lived assets
pursuant to the 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).

On a same store basis, net interest expense increased 35.8% from $6.7
million for the year ended December 31, 1999 to $9.1 million for the year ended
December 31, 2000. The increase is primarily due to interest charges incurred
related to the late filing of certain Medicare cost reports.

32

REHABILITATION AND RESPIRATORY THERAPY SERVICES

The Company's rehabilitation therapy services division experienced a high
level of management turnover in late 2000. Historically, the disruption of
management can negatively affect the stability of maintaining existing contracts
as well as obtaining additional contracts. In November 2000 a new management
team was put in place within the rehabilitation therapy services division and
the structure and management of the sales team were overhauled. New models for
facility revenue proformas, pricing strategies and floor pricing were
established.

Net revenues from rehabilitation and respiratory therapy services decreased
$29.9 million, or 12.7%, from $234.1 million for the year ended December 31,
1999 to $204.2 million for the year ended December 31, 2000. Revenues from
services provided to affiliated facilities decreased $13.6 million, or 10.7%,
from $126.9 million for the year ended December 31, 1999 to $113.3 million for
the year ended December 31, 2000. Revenues from services provided to
nonaffiliated facilities decreased approximately $16.2 million, or 15.1%, from
$107.2 million for the year ended December 31, 1999 to $91.0 million for the
year ended December 31, 2000. These decreases are primarily the 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 therapy
models in an effort to better control costs under a fixed reimbursement system.
This was especially existent with respiratory therapy as this service was not
covered under the ancillary component of the PPS rate structure. The decline in
net revenues has continued, with a significant reduction in contracts from 1999
to 2000. Specifically, there were 1,153 affiliated and nonaffiliated contracts
as of December 31, 1999 compared to 942 affiliated and nonaffiliated contracts
as of December 31, 2000. During the year of 2000, the Company terminated certain
nonaffiliated contracts based on issues related to customer's creditworthiness
and contract profitability. In addition, certain nonaffiliated contracts were
terminated in the ordinary course of business. The Company's divestitures of
inpatient facilities in 1999 and 2000 contributed to the decrease in affiliated
revenues.

Operating expenses decreased $54.2 million, or 25.3%, from $214.1 million
for the year ended December 31, 1999 to $159.9 million for the year ended
December 31, 2000. The decrease resulted primarily from the decline in the
demand for the Company's therapy services resulting in a reduction in the number
of therapists employed by the Company's therapy services subsidiary. Operating
expenses as a percentage of net revenues decreased from 91.5% for the year ended
December 31, 1999 to 78.3% for the year ended December 31, 2000. This decrease
is attributable to reductions in cost structure. The Company's rehabilitation
subsidiary went through a significant restructuring in the first quarter of 1999
which continued to dramatically reduce its cost structure during 2000 by
reducing overhead costs through the reduction of regional offices. In addition,
new operating models were put in place to improve the productivity of the
therapists. Equipment rental costs decreased approximately $11.4 million from
1999 to 2000 primarily due to the Company shutting down its therapy equipment
manufacturing operations.

33

Corporate general and administrative expenses, which include regional costs
related to the supervision of operations, were approximately $4.3 million for
the year ended December 31, 2000. Corporate general and administrative expenses
as a percentage of net revenues were 2.1% for the year ended December 31, 2000.
The Company did not allocate corporate general and administrative expenses to
the Rehabilitation and Respiratory Therapy Services segment during the year
ended December 31, 1999. The Company began allocating costs directly
attributable to the segment in January 2000.

Provision for losses on accounts receivable decreased $27.7 million, or
81.2%, from $34.1 million for the year ended December 31, 1999 to $6.4 million
for the year ended December 31, 2000. As a percentage of net revenues, provision
for losses on accounts receivable decreased from 14.6% for the year ended
December 31, 1999 to 3.1% for the year ended December 31, 2000. During the
fourth quarter of 1999, the Company increased its reserves due to the impact of
PPS, which for certain nonaffiliated customers negatively affected their cash
flows, which adversely affected the collectibility of amounts due to the
Company. An equivalent increase in reserves for year ended December 31, 2000 was
not necessary.

Depreciation and amortization decreased 58.3% from $7.2 million for the
year ended December 31, 1999, to $3.0 million for the year ended December 31,
2000. As a percentage of net revenues, depreciation and amortization expense
decreased from 3.1% for the year ended December 31, 1999 to 1.5% for the year
ended December 31, 2000, respectively. The decrease is primarily a result of the
write-downs during 1999 of goodwill and certain other long-lived assets pursuant
to SFAS 121.

PHARMACEUTICAL AND MEDICAL SUPPLY OPERATIONS

Net revenues from pharmaceutical and medical supply services decreased $1.1
million, or 0.4%, from $301.0 million for the year ended December 31, 1999 to
$299.9 million for the year ended December 31, 2000. Pharmaceutical services'
net revenues increased approximately $4.4 million, or 2.0%, from $224.3 million
for the year ended December 31, 1999 to $228.7 million for the year ended
December 31, 2000. The increase is primarily due to an increase in the average
price per prescription. Medical supply services' net revenues from nonaffiliated
parties decreased approximately $14.4 million, or 27.5%, while net revenues from
affiliated parties increased approximately $8.9 million, or 36.5%. The Company
experienced a reduction in nonaffiliated contracts when sales personnel left the
Company and certain of their customers ceased doing business with the Company.
The increase in affiliated revenues is a result of an increase in sales to the
Company's Inpatient Services segment.

Operating expenses decreased $0.5 million, or 0.2%, from $272.2 million for
the year ended December 31, 1999 to $271.7 million for the year ended December
31, 2000. As a percentage of net revenues, operating expenses increased from
90.4% for the year ended December 31, 1999 to 90.6% for the year ended December
31, 2000. Pharmaceutical services' operating expenses increased approximately
$4.8 million, or 2.4%. The increase in the pharmaceutical services' operating
expenses is primarily attributed to increases in labor, benefit and insurance
costs along with an increase in cost of goods sold based on an increase in
sales. Medical supply services' operating expenses decreased 7.4% from $71.7
million for the year ended December 31, 1999 to $66.4 million for the year ended
December 31, 2000. The decrease in medical supply services' cost of goods sold
is a result of the decrease in sales.

34

Corporate general and administrative expenses, which include regional costs
related to the supervision of operations, were approximately $5.2 million for
the year ended December 31, 2000. Corporate general and administrative expenses
as a percentage of net revenues were 1.7% for the year ended December 31, 2000.
The Company did not allocate corporate general and administrative expenses to
the Pharmaceutical and Medical Supply Services segment during the year ended
December 31, 1999. The Company began allocating costs directly attributable to
the segment in January 2000.

Provision for losses on accounts receivable decreased 79.2% from $26.9
million for the year ended December 31, 1999 to $5.6 million for the year ended
December 31, 2000. As a percentage of net revenues, the provision for losses on
accounts receivable decreased from 8.9% for the year ended December 31, 1999 to
1.9% for the year ended December 31, 2000. During 1999, the Company increased
its reserves due to a deterioration in the aging of certain accounts receivable.
An equivalent increase was not necessary in 2000.

Depreciation and amortization decreased 15.7% from $7.0 million for the
year ended December 31, 1999 to $5.9 million for the year ended December 31,
2000. As a percentage of net revenues, depreciation and amortization expense was
approximately 2.3% and 2.0% for the years ended December 31, 1999 and 2000,
respectively. The decrease is primarily a result of the write-downs of certain
long-lived assets during 1999 in accordance with SFAS 121.

INTERNATIONAL OPERATIONS

Revenues from international operations decreased $31.4 million from $296.9
million for the year ended December 31, 1999 to $265.5 million for the year
ended December 31, 2000. The decrease was primarily due to the fact that the
Australian subsidiaries were placed in receivorship during the third quarter of
2000 and no revenue was recorded subsequently. Additionally, 18 pharmacies
operating in the United Kingdom were divested in June 2000 and the operating
division in Spain was sold in October 2000.

Operating expenses which include rent expense of $41.1 million and $40.5
million for the years ended December 31, 1999 and December 31, 2000,
respectively, decreased approximately 9.9% from $275.9 million for the year
ended December 31, 1999 to $248.8 million for the year ended December 31, 2000.
This decrease is a result of the same factors which led to a decrease in revenue
as discussed above. As a percentage of revenues, operating expenses increased
from 92.9% for the year ended December 31, 1999 to 93.7% for the year ended
December 31, 2000.

Corporate general and administrative expenses were $14.4 million and $13.0
million for the years ended December 31, 1999 and December 31, 2000,
respectively. As a percentage of revenues, corporate, general and administrative
expenses were 4.9% for the years ended December 31, 1999 and 2000.

Depreciation and amortization for international operations was $12.8
million and $2.5 million for the years ended December 31, 1999 and 2000,
respectively. In accordance with SFAS 121, depreciation and amortization are no
longer recognized after operations are placed for sale. Therefore, depreciation
and amortization was significantly reduced in 2000.

35

Net interest expense was $13.2 million for the year ended December 31, 1999
and $13.0 million for the year ended December 31, 2000. Net interest expense as
a percentage of revenues increased from 4.4% for the year ended December 31,
1999 to 4.9% for the year ended December 31, 2000.

OTHER NONREPORTABLE SEGMENTS AND CORPORATE GENERAL AND ADMINISTRATIVE
DEPARTMENTS

Nonreportable segments include temporary medical staffing, home health,
assisted living, software development and other ancillary services. Revenues
from other nonreportable segments decreased 16.8% from $221.3 million for the
year ended December 31, 1999 to $184.2 million for the year ended December 31,
2000. Operating expenses decreased 23.7% from $220.7 million for the year ended
December 31, 1999 to $168.5 million for the year ended December 31, 2000. Total
revenues and operating expenses for nonreportable segments represent less than
10.0% 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 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 subsidiary, Shared Healthcare Systems. 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 is not expected to reach the
stage under which capitalization is permitted until the middle of 2001.

Corporate general and administrative costs not directly attributed to
segments decreased 22.0% from $116.5 million for the year ended December 31,
1999 to $90.9 million at December 31, 2000. As a percentage of consolidated net
revenues of $2,529.0 million and $2,458.9 million for the years ended December
31, 1999 and 2000, respectively, corporate general and administrative expenses
not directly attributed to segments decreased from 4.6% to 3.7%, respectively.

Net interest expense not directly attributed to segments decreased 90.0% or
$95.0 million from $105.5 million for the year ended December 31, 1999 to $10.5
million for the year ended December 31, 2000. As a percentage of consolidated
net revenues, interest expense was 4.2% for the year ended December 31, 1999 and
0.4% for the year ended December 31, 2000. The majority of the decrease is
related to Sun discontinuing charging Mediplex for interest during 2000 due to
the Company's chapter 11 filing.

36

DIVIDENDS ON CONVERTIBLE PREFERRED STOCK

In May 1998, a statutory business trust, all of whose common securities are
owned by the Company, issued $345.0 million of 7.0% CTIPS with a liquidation
amount of $25.00 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).
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 continue to accrue.

During 2000, approximately $26.9 million of CTIPS were converted into
approximately 1.3 million shares of common stock. During 1999, $22.0 million of
CTIPS were converted into approximately 1.1 million shares of common stock. See
"Note 14 - Convertible Trust Issued Preferred Securities" in the Company's
consolidated financial statements.

The Company's agreement in principle with representatives of its bank
lenders and other creditors indicated that the CTIP holders will receive no
recovery in connection with the Company's restructuring, which adversely
impacted the fair value of the CTIPS. The Company's 2000 statement of losses
excludes the dividends as the fair value of the dividends was immaterial.

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 segments. The 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.

During 2000, the Company recorded a non-cash impairment charge of
approximately $191.3 million related to the Company's estimate of goodwill and
other long-lived assets. This charge included approximately $189.3 million
related to 141 of its inpatient facilities segment and $2.0 million to its
pharmaceutical and other operations segments.

FINANCIAL RESTRUCTURING

During 1999, the Company recorded financial restructuring costs of $16.0
million, primarily professional fees, related to the Company's activities in
preparation for its filing for protection under Chapter 11 of the U. S.
Bankruptcy Code. See "Liquidity and Capital Resources". During 2000, the Company
recovered approximately $1.1 million of previously recorded 1999 financial
restructuring costs.

37

REORGANIZATION COSTS

The Company recorded net reorganization costs of $48.1 million and $335.9
million for the years ended December 31, 1999 and 2000, respectively. See "Note
2 - Petitions for Reorganization under Chapter 11" in the Company's consolidated
financial statements.

LEGAL AND REGULATORY

In August 2000, the Bankruptcy Court approved an agreement entered into
between the Company and the U.S. Departments of Justice and Health and Human
Services pursuant to which the Company paid the U.S. government approximately
$1.2 million. The payment was in consideration of the government's agreement to
allow the Company to transfer certain of its facilities to new operators without
pursuing the new operators for alleged claims against the Company for
pre-transfer overpayment liabilities, and for the release and waiver of certain
pre-transfer claims against the Company related to the facilities to be
transferred to new operators. The Company recorded approximately $2.5 million
during 2000 related to the transfer of certain of its facilities to new
operators.

OTHER LONG-LIVED ASSETS

Gain on Sale of Assets

During the year ended December 31, 2000, the Company recorded gains on the
sale of assets of approximately $25.1 million. Approximately $21.4 million and
$3.7 million is recorded in gain on sale of assets and reorganization costs,
net, respectively in the Company's consolidated statements of losses. See "Note
2 - Petitions for Reorganization under Chapter 11" and "Note 7 - Impairment of
Long-Lived Assets and Assets Held for Sale" in the Company's consolidated
financial statements.

Loss on Sale of Assets

During 1999, the Company recorded a net non-cash charge of approximately
$85.7 million due to the anticipated and/or completed termination of certain
facility lease agreements and to further reduce the carrying amount of certain
assets that the Company determined were 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.

During 2000, a net non-cash charge of approximately $310.1 million was
recorded to reduce the carrying amount of the medical supply operations and
certain domestic inpatient facilities which are classified as assets held for
sale in the Company's 2000 consolidated balance sheet as of December 31, 2000.
Additionally, a charge of $26.6 million was recorded to reduce the carrying
amount of the corporate headquarters building currently under construction at
the Company's main campus. The building is classified as an asset held for sale
at December 31, 2000. The charges are recorded in reorganization costs, net, in
the Company's consolidated statements of losses. See "Note 7 - Impairment of
Long-Lived Assets and Assets Held for Sale" and "Note 24 - Subsequent Events" in
the Company's consolidated financial statements.

38

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 $545.7 million for the year ended December 31, 2000.
The loss before considering impairment loss, gain or loss on sale of assets,
net, reorganization costs, net, restructuring costs, loss on termination of
interest rate swaps, cumulative effect of change in accounting principle and
income taxes was $462.4 million for the year ended December 31, 1999 compared to
a loss of $40.8 million before considering reorganization costs, net, impairment
loss, restructuring costs, gain on sale of assets, net and income taxes for the
year ended December 31, 2000. The net loss during the years ended December 31,
1999 and 2000 is primarily due to the implementation of PPS and the related
continuing adverse impact on the demand for the Company's ancillary services.

In accordance with SOP 90-7, no interest has been paid or accrued on
prepetition debt, classified as liabilities subject to compromise in the
Company's consolidated balance sheets and the CTIPS since the Filing Date.
Contractual interest expense not paid or accrued was $30.5 million and $146.4
million for the years ended December 31, 1999 and December 31, 2000,
respectively.

The contractual dividends that were accrued to the holders of the
trust-issued preferred securities had an immaterial fair value due to the
Company's agreement in principle with the senior creditors, which provides no
future payment on securities of the Company upon emergence for such CTIP
holders.

Income tax expense for the year ended December 31, 1999 and for the year
ended December 31, 2000 was $0.2 million and $0.3 million, respectively. For
both years, the Company increased its valuation allowance for the deferred tax
assets resulting from its net operating losses which may not be realizable.
incurred.

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 17.0%
decrease. Net revenues were negatively impacted in 1998 and 1999 by certain
changes in accounting estimates for third party settlements (see "Effects from
Changes in Reimbursement" and "Note 3 - Summary of Significant Accounting and
Financial Reporting Policies" in the Company's consolidated financial statements
for information regarding the Company's revenue recognition policy).

In 1998, the Company recorded negative revenue adjustments totaling
approximately $22.3 million. The negative revenue adjustments included
approximately $12.4 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.

39

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."

Excluding the effect of the negative revenue adjustments of approximately
$22.3 million and $105.0 million in 1998 and 1999, respectively, and $119.9
million and $196.7 million of net revenues in 1998 and 1999, 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 $217.8 million and $207.0
million for the years ended December 31, 1998 and 1999, 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 $126.3 million
and $194.3 million of operating expenses for 1998 and 1999, 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.

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 effect 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 effect 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.

40

Excluding the effect of the negative revenue adjustment and the effect of
the RCA Acquisition, depreciation and amortization decreased 26.6% 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%.

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.

41

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.

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.

42

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. 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
its 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
7.1% from the year ended December 31, 1998 to 4.4% for the year ended December
31, 1999.

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 92.2% and 98.8% for the
years ended December 31, 1998 and 1999, 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.

43

Corporate general and administrative costs not directly attributed to
segments decreased 11.8% 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 4.3%
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) 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 $345.0 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, the Company 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 Preferred Securities" in the Company's
consolidated financial statements.

The Company does not expect to make principal or interest payments on the
CTIPS in the future. As of December 31, 1999, the amount of accrued and deferred
interest was approximately $18.3 million.

44

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 facilities services 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.

45

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.

46

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.

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 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 $300.0 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, 1998 was $753.7 million
compared to a net loss of $1,089.5 million for the year ended December 31, 1999.
The net losses before extraordinary losses and cumulative effect of change in
accounting principle for the year ended December 31, 1998 was $743.4 million
compared to $1,076.6 million for the year ended December 31, 1999. 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.

47

Income tax expense for the year ended December 31, 1998, was $53.6 million
compared to $0.2 million for the year ended December 31, 1999. In 1998, the
Company increased the valuation allowance by $115.5 million for deferred tax
assets which may not be realized. 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 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 valuation 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.

LIQUIDITY AND CAPITAL RESOURCES

On October 14, 1999, Sun 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 debtor-in-possession financing. The Revolving Credit
Agreement was amended as of September 21, 2000 (as amended, the "DIP Financing
Agreement"). The DIP Financing Agreement provides for maximum borrowings by the
Company of $200.0 million, but not to exceed the sum of (i) up to 85.0% of the
then outstanding domestic eligible accounts receivable and (ii) the lessor of
$10.0 million or 50.0% of the aggregate value of eligible inventory.

As of December 31, 2000, approximately $138.7 million was available to the
Company under the DIP Financing Agreement, of which amount the Company had
borrowed approximately $67.0 million and had issued approximately $34.7 million
in letters of credit. In addition to the available funds under the DIP Financing
Agreement, the Company had cash book balances at December 31, 2000 of
approximately $37.6 million. The combination of the Company's cash balances and
available funds, less borrowings and letters of credit, under the DIP Financing
Agreement was $74.6 million and $160.8 million as of December 31, 2000 and 1999,
respectively. This decrease in liquidity is due primarily to the losses that the
Company's operations have incurred in 2000, which have been adversely affected
by the slower than expected pace of divesting non-profitable facilities in 2000
and costs incurred associated with the Company's reorganization.

49

In July 2000 and February and March 2001, the Company obtained waivers on
several defaults under the DIP Financing Agreement, including the EBITDA
financial covenant. If the Company is unable to comply with the covenants
contained in the amended DIP Financing Agreement or is unable to obtain a waiver
of any future covenant violation, then the Company would lose its ability to
borrow under the amended 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 amended 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.

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. As of
October 1, 2000, the parties to the agreement in principle have the right to
withdraw from the agreement in principle, and several bank lenders and note
holders have withdrawn. The Company and its significant creditor constituents
are presently negotiating amendments to the agreement in principle that will
form the basis for a plan of reorganization. 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 agreed to with the significant creditor
constituents.

The Company's exclusive period to file a plan of reorganization has been
extended to May 8, 2001 and to solicit acceptances of the plan has been extended
to July 8, 2001.

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
accounting principles generally accepted in the United States 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.

50

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 Company's 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 "liabilities subject to compromise" at December 31, 2000 and
December 31, 1999 in the Company's consolidated balance sheets. At December 31,
2000, the Company had a working capital deficit of $161.6 million and cash and
cash equivalents of $37.6 million as compared to a working capital deficit of
$17.3 million and cash and cash equivalents of $25.0 million at December 31,
1999.

The Company believes that it will have sufficient liquidity to meet its
operational needs for the next 12 months assuming that (i) the Company is
successful in amending the DIP Financing Agreement and maintains its ability to
borrow under the DIP Financing Agreement until emergence from bankruptcy, (ii)
if the Company has not emerged from bankruptcy by September 30, 2001 that it is
able to extend the DIP Financing Agreement or enter into a new DIP financing
agreement under substantially similar terms, and (iii) the Company does not
experience any material and adverse decrease in its results of operations. This
is a "forward-looking statement" within the meaning of the Private Securities
Litigation Reform Act of 1995 and is subject to a number of factors, including,
but not limited to, the Company's ability to divest unprofitable facilities,
operate its business consistent with plan, comply with the covenants of the DIP
Financing Agreement, negotiate a Plan of Reorganization and emerge from
bankruptcy, and negotiate an acceptable global settlement with the federal
government.

51

For the year ended December 31, 2000, net cash used for operating
activities was approximately $1.7 million compared to net cash provided by
operating activities for the year ended December 31, 1999 of approximately $7.3
million. The decrease in net cash used for operating activities for the year
ended December 31, 2000 is primarily from the disbursement of reorganization
costs upon approval from the Bankruptcy Court as well as the slower than
expected pace of the divestitures of unprofitable facilities.

The Company incurred approximately $55.4 million in capital expenditures
during the year ended December 31, 2000. Expenditures related primarily to the
construction of a corporate office building and routine capital expenditures.
The Company had construction commitments as of December 31, 2000, under various
contracts of approximately $1.0 million in the United States. These include
contractual commitments to improve existing facilities and to complete
construction on a corporate office building.

The Company recorded net reorganization costs of $335.9 million for the
year ended December 31, 2000. Included in these charges at December 31, 2000 are
approximately $313.8 million for loss on sale of assets related to the
divestiture of under-performing assets, approximately $27.8 million for
professional fees relating to the legal consideration of the bankruptcy filing
and a gain on sale of assets of approximately $3.7 million. See "Note 2 -
Petitions for Reorganization under Chapter 11" in the Company's consolidated
financial statements.

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 coverage for exposure
above these levels. This plan was continued in January 2001. There can be no
assurance that this self-funded insurance program will not have a material
adverse impact on the Company's financial condition and results of operations.
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. The provision for such risks for the years ended
December 31, 2000 and 1999 were approximately $33.8 million and $23.9 million,
respectively. The expense recorded in the Company's statements of losses for the
years ended December 31, 2000 and 1999 were approximately $35.3 million and
$23.9 million, respectively. Claims paid under the professional liability for
the year ended December 31, 2000 were immaterial.

Subsequent to December 31, 1998, the Company decided to dispose of several
non-core businesses, including assisted living facilities, rehabilitation
hospitals, certain inpatient facilities and other non-core businesses. The fair
value of these assets held for sale was based on the Company's estimates of
selling value less selling costs. The Company recorded a loss of approximately
$206.2 million in 1998 to reduce the carrying amount of the non-core businesses
identified for disposal. During 1999, the Company recognized additional losses
of $97.1 million on certain inpatient and assisted living facilities and certain
non-core businesses. The losses included amounts to reduce the carrying amount
of the facilities and non-core businesses based upon estimates of selling value
less selling costs and amounts related to the sale leaseback to the Company of
facilities in the United Kingdom. The charges were recorded in loss on sale of
assets, net, in the Company's consolidated statement of losses. See "Note 7 -
Impairment of Long-Lived Assets and Assets Held for Sale" in the Company's
consolidated financial statements.

52

During 2000, the Company began pursuing the disposition of certain
inpatient facilities, other non-core businesses including SunCare, its
respiratory therapy business, and its international operations. The Company
recognized losses of approximately $58.3 million within its consolidated
financial statements. No purchase agreement has been entered into and the
Company cannot predict when or if its respiratory therapy business, SunCare,
will be sold. During 1999, the Company decided not to dispose of certain
non-core businesses previously recorded as assets held for sale at December 31,
1998. The reversal of losses on assets held for sale of approximately $7.0
million were recorded in the first quarter of 1999. See "Note 7 - Impairment of
Long-Lived Assets and Assets Held for Sale" in the Company's consolidated
financial statements.

Also during 2000, the Company sold 20 assisted living facilities. The net
loss recorded was approximately $71.2 million, of which $17.4 million was
charged in 1999 and $53.8 million was charged in 1998. The cash consideration
received for these facilities was approximately $1.2 million. In addition, the
Company obtained a note receivable of approximately $0.5 million. The Company
transferred two remaining assisted living facilities from the other operations
segment to the inpatient services segment. A parcel of land acquired through the
sale of certain of the Company's assisted living facilities was sold for cash
proceeds of approximately $1.4 million.

Within the International Operations segment, the Company divested 18
pharmacies in the United Kingdom for an aggregate cash consideration of
approximately $9.7 million. The Company divested its operations in Spain for
approximately $7.6 million. The operations in Australia were placed in
receivorship by its secured creditors in September 2000. Under Australian
receivorship procedures, the assets will be sold and the proceeds used to pay
the secured creditors and then any remaining value will be distributed to its
unsecured creditors, which includes the Company. No assurance can be given that
the Company will receive any proceeds from the sale of the Australia operations.
The Company is also seeking to divest its operations in Germany but cannot give
any assurance that the Company will successfully divest its operations in
Germany.

Through December 31, 2000 the Company had identified an additional 35
skilled nursing facilities and other noncore operations for disposal. The
Company has decided to sell a portion of its corporate headquarters campus in
Albuquerque, New Mexico. The loss recorded at December 31, 2000 for the
headquarters campus was approximately $26.6 million. The Company is unable to
determine the amount of proceeds it could receive if such a sale is completed.
See "Note 7 - Impairment of Long-Lived Assets and Assets Held for Sale".

During the first quarter of 2001, Sun divested its operations in the United
Kingdom consisting of 146 long-term care facilities. No cash consideration was
associated with the sale as the purchasing group, comprised of members of the
management team of the Company's international business segment, assumed $112.9
million of debt and other liabilities associated with the operations. The
Company divested its domestic medical supply services company, SunChoice, in
January 2001 for cash proceeds of $16.6 million in exchange for assets,
including accounts receivable. SunChoice operated 8 warehouse distribution
centers within the United States for which the operating leases were terminated
upon the effective sale date.

53

During the first quarter of 2001, the Company also eliminated SunSolution,
a provider of ancillary services at a fixed fee to non-affiliated parties. The
net revenues associated with this division were immaterial.

On June 30, 1998, a wholly owned subsidiary of the Company merged with RCA,
an operator of skilled nursing 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, 2000
and December 31, 1999, the Company's purchase liabilities reserve balance was
approximately $12.0 million and $15.5 million, respectively.

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 $12.0
million) and (ii) average net income after taxes for the past three years (less
than $0.6 million). 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 U.S. Bankruptcy Court for the District of Delaware (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, except that the parties have agreed to conduct limited
discovery. In September 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 extension of the bar date for
their class members and to conduct limited discovery. Plaintiffs filed claims in
the pending Chapter 11 cases in the amount of $780.0 million in the SunDance
Action and $242.0 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.

54

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. Pursuant to an agreement among the parties, the Company was
dismissed without prejudice in December 2000. Although the Company intends to
vigorously defend the individual defendants in this matter who are indemnified
by the Company, 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.

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.

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
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 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.

55

Various government agencies and the Company have been having ongoing
discussions and the Company expects to enter into a global settlement of these
investigations. As part of such settlement, the DOJ and HCFA are seeking, among
other things, (i) a monetary payment to the government, (ii) the Company's
release of all claims for reimbursement against the government for services
rendered prior to October 14, 1999, which is estimated to be approximately $80.1
million, of which amount the Company has agreed to the release of $17.1 million
of claims related to divested facilities and (iii) a corporate integrity
agreement between the Company and 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. The Company is unable to determine at this time whether a
settlement, if any, or any other outcome of the investigations will have a
material adverse effect on the Company's financial condition or results of
operations.

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.

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.

56

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.

57

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The directors and executive officers of Sun as of March 31, 2001 were:

NAME POSITION WITH SUN
---- -----------------

Mark G. Wimer Chief Executive Officer, President and Director
Robert D. Woltil Chief Financial Officer and Director
Warren C. Schelling Senior Vice President Ancillary Services
Robert F. Murphy General Counsel and Secretary
Chauncey Hunker Corporate Compliance Officer
Matthew G. Patrick Vice President and Treasurer
Jack V. Tindal Chief Administrative Officer
Jennifer L. Botter Vice President and Corporate Controller
John E. Bingaman Director
Martin G. Mand Director
Lois E. Silverman Director
James R. Tolbert, III Chairman of the Board of Directors
R. James Woolsey Director

Set forth below are the names of the executive officers and directors of
Sun and their ages as of March 31, 2001. The Bylaws of Sun provide that the
Board of Directors shall be 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. However, during Sun's bankruptcy
case, Sun has not held an annual meeting of stockholders. Sun does not currently
intend to hold an annual meeting of stockholders until Sun emerges from
bankruptcy. Upon emergence from bankruptcy, Sun expects that its Board of
Directors will be reconstituted. 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, Chauncey Hunker and
Jennifer L. Botter, were Directors or executive officers of the Company on the
date of the bankruptcy filing.

Mark G. Wimer, age 47, has been a director of the Company since 1993, Chief
Executive Officer of the Company since July 2000 and the President of the
Company since September 1997. Mr. Wimer had previously served as Senior Vice
President for Inpatient Services from 1996 until September 1997, and as the
President of SunBridge Healthcare Corporation ("SunBridge"), 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.

58

Robert D. Woltil, age 46, has been a director and the Chief Financial
Officer of the Company since 1996. From 1995 until 1996, Mr. Woltil was
President and Chief Executive Officer of Pharmacy Corporation of America, a
subsidiary of Beverly Enterprises, Inc. ("Beverly"), a healthcare services
provider. Mr. Woltil is also a certified public accountant. 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. From 1982 to
1996, Mr. Woltil served in various capacities for Beverly.

Warren C. Schelling, age 47, has been Senior Vice President of Ancillary
Services since November 2000 and President and Chief Operating Officer of Sun
Healthcare Group International since 1999. Previously, Mr. Schelling was the
Senior Vice President for Pharmaceuticals of the Company from 1996 to 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.

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, including most recently as Vice President and
Associate General Counsel. Prior to 1986, Mr. Murphy was in private practice for
several years.

Chauncey Hunker, age 50, has been Corporate Compliance Officer of the
Company since August 2000. From 1996 to August 2000, Mr. Hunker served as Vice
President of Continuous Quality Improvement of the SunDance Rehabilitation
Corporation, the Company's rehabilitation therapy subsidiary ("SunDance"). From
1995 to 1996, he was Clinical Director of SunDance, and from 1992 to 1995 he was
Regional Vice President of Learning Services - Midwestern Regional Facility in
Madison, Wisconsin. Mr. Hunker has also served as Adjunct Assistant Professor,
Department of Neurology, at the University of Wisconsin Medical School since
1989.

Matthew G. Patrick, age 41, 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.

59

Jack V. Tindal, age 46, 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.

Jennifer L. Botter, age 38, has been Vice President and Corporate
Controller of the Company since January 2000. From 1998 to 1999, Ms. Botter held
various positions within the Company. From 1996 to 1998, she was Director of
Finance for Fulcrum Direct, Inc., a manufacturer and cataloguer of children's
apparel. Ms. Botter holds a Masters of Business Administration degree. From 1984
to 1996 she held financial consulting and accounting positions in the high
technology and manufacturing industries.

John E. Bingaman, age 54, has been a director of the Company since 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 64, has been a director of the Company since 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 60, has been a director of the Company since 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
Simmons College and Brandeis University, and a Director of Immunetics.

James R. Tolbert, III, age 65, has been Chairman of the Board since July
2000 and a director of the Company since 1995. Mr. Tolbert was Lead Independent
Director of the Board of Directors from 1998 to July 2000. 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.

60

R. James Woolsey, age 59, has been a director of the Company since 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.

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 2000 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 R. James Woolsey, who reported a transaction that
occurred in July 2000 on a Form 5 in February 2001 due to an oversight.

61

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, 2000, (i) the
individuals who served as chief executive officer and (ii) the other four most
highly compensated executive officers of the Company:

LONG-TERM
COMPENSATION
AWARDS
SECURITIES
NAME AND ANNUAL COMPENSATION UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#) COMPENSATION($)
------------------ ---- --------- -------- ---------- ---------------

Mark G. Wimer 2000 $596,255 - - $ 2,092 (1)
Chief Executive 1999 450,008 - 16,960 (2) 3,313
Officer and 1998 443,274 - 25,000 9,424
President

Robert D. Woltil 2000 425,022 - - 1,797 (3)
Chief Financial 1999 425,022 - 14,000 (2) 1,810
Officer 1998 418,288 - 25,000 10,069

Warren C. Schelling 2000 320,008 $150,000 (4) - 780 (5)
Senior Vice 1999 320,008 - 13,600 (2) 1,587
President Ancillary 1998 277,892 - 30,000 4,848
Services

Robert F. Murphy 2000 285,012 - - 1,097 (6)
General Counsel and 1999 285,012 - 11,200 (2) 2,458
Secretary 1998 280,973 - 30,000 5,872

Andrew L. Turner(7) 2000 509,177 - - 1,128 (8)
Former Chief 1999 700,024 - 38,000 (2) 6,998
Executive Officer 1998 659,634 - 50,000 26,873

Alan J. Zampini(9) 2000 295,690 58,870 (10) - 1,983 (11)
Former President of 1999 282,311 29,000 (10) 16,500 (2) 1,889
SunBridge Healthcare 1998 211,855 58,500 12,500 1,637
Corporation
______________________

62

(1) Consists of $1,000 of matching contributions under the Company's 401(k)
Plan and the value of $1,092 of life insurance premiums paid on his behalf
by the Company.

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

(3) Consists of $1,275 of matching contributions under the Company's 401(k)
Plan and the value of $522 of life insurance premiums paid on his behalf by
the Company.

(4) Retention payments paid pursuant to Mr. Schelling's Incentive Bonus and
Severance Agreement.

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

(6) Consists of $743 of matching contributions under the Company's 401(k) Plan
and the value of $354 of life insurance premiums paid on his behalf by the
Company.

(7) Mr. Turner resigned from the Company in August, 2000.

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

(9) Mr. Zampini resigned from the Company in January, 2001.

(10) Retention payments paid pursuant to the Company's employee retention
program.

(11) Consists of $1,275 of matching contributions under the Company's 401(k)
Plan and the value of $708 of life insurance premiums paid on his behalf by
the Company.

63

FISCAL YEAR-END OPTION VALUES

Set forth in the table below is information concerning the value of stock
options held as of December 31, 2000 by each of the Named Executive Officers.
None of the Named Executive Officers exercised any stock options during the year
ended December 31, 2000.

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

Mark G. Wimer 5,653 11,307 $-0- $-0-
Robert D. Woltil 4,666 9,334 -0- -0-
Warren C. Schelling 4,533 9,067 -0- -0-
Robert F. Murphy 3,733 7,467 -0- -0-
Andrew L. Turner -0- -0- -0- -0-
Alan J. Zampini 22,401 11,099 -0- -0-
___________

(1) It is anticipated that any plan of reorganization confirmed in Sun's
Chapter 11 case will provide that Sun's outstanding common stock and stock
options will effectively be canceled without any recoveries to the holders
of common stock or stock options. See Item 1 - "Certain Additional Business
Risks - Effect of Bankruptcy Reorganization on Common Stock and Debt
Securities."

(2) The last reported sales price of the Common Stock, as reported on the
Over-The-Counter Bulletin Board, at December 31, 2000 was less than the
exercise price of all stock options.

COMPENSATION OF DIRECTORS

Non-employee directors of the Company, other than the Chairman of the
Board, are entitled to receive: (i) an annual fee of $24,000, which is payable
in four equal quarterly installments, (ii) $1,750 for each Board of Directors
meeting attended in person, (iii) an additional $500 for each subsequent meeting
attended that same day, and (iv) $500 for any meetings attended by telephone. In
addition, each Chairperson of a committee of the Board of Directors is entitled
to receive an additional annual fee of $4,000, payable in four equal quarterly
installments.

The Chairman of the Board of Directors is entitled to an annual fee of
$144,000, which is payable in four equal quarterly installments, and
reimbursement for $3,000 monthly of clerical and office support costs in his
office in Oklahoma City. Sun will also pay the Chairman of the Board a $50,000
bonus contingent upon bankruptcy court approval of a plan of reorganization.
Each of the non-employee directors is reimbursed for out-of-pocket expenses for
attendance at Board and committee meetings.

64

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. Wimer, Woltil and Murphy will receive incentive payments on the
effective date of a plan of reorganization in the amounts of $425,000, $297,500
and $170,000, respectively, if they remain employees of the Company on that
date.

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.

Mr. Woltil entered into an agreement with the Company in October 1999
whereby, in return for a commitment to remain employed until December 31, 2000,
he would be entitled to receive a payment equal to 12 months of his current
salary (the "Voluntary Severance Payment") if he voluntarily terminated his
employment with the Company at the end of such period. In December 2000, Mr.
Woltil and the Company agreed to defer the Voluntary Severance Payment until he
voluntarily terminates his employment on the earlier of (i) 30 days after the
effective date of the Company's Chapter 11 plan of reorganization or (ii) 30
days after he gives written notice of the occurrence of a Termination Event, as
defined in the agreement.

One of the Company's non-domestic subsidiaries (which is not in bankruptcy)
entered into an Incentive Bonus and Severance Agreement with Mr. Schelling on
July 31, 2000. The agreement provides Mr. Schelling with a similar severance and
fringe benefits as described above for Messrs. Wimer, Woltil and Murphy.
Pursuant to the agreement, Mr. Schelling received retention payments of $75,000
on September 30, 2000 and January 1, 2001, from the non-domestic subsidiary, and
would be entitled to receive an incentive payment of up to $200,000 on
completion of the sale of the Company's international division.

65

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 30, 2001 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. It is anticipated that any plan of reorganization
confirmed in Sun's chapter 11 case will provide that Sun's outstanding common
stock and stock options will effectively be canceled without any recoveries to
the holders of common stock or stock options. See Item 1 - "Certain Additional
Business Risks - Effect of Bankruptcy Reorganization on Common Stock and Debt
Securities."

SHARES PERCENT OF
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED(1) CLASS(1)(%)
------------------------ --------------------- -----------

John E. Bingaman 193,860 (2)(3) *
Martin G. Mand 12,479 (2)(4) *
Robert F. Murphy 26,241 (5) *
Warren C. Schelling 9,067 (6) *
Lois E. Silverman 14,710 (2)(7) *
James R. Tolbert, III 14,416 (2)(7) *
Andrew L. Turner - *
Mark G. Wimer 11,307 (8) *
Robert D. Woltil 16,834 (9) *
R. James Woolsey 11,416 (2)(7) *
Alan J. Zampini - *
All directors and executive officers
as a group (13 persons, including 317,567 (10) *
those named above)
Peter C. Kern 3,502,777 (11) 5.7%
206 St. Johns Road
Pilot Point, TX 76258
___________

* Less than 1.0%

(1) Beneficial ownership is determined in accordance with the rules of the
Commission and generally includes voting or investment power with respect
to securities. Options exercisable within 60 days of March 30, 2001 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.

66

(2) Includes 3,333 restricted shares awarded under the Company's 1997
Non-Employee Directors' Plan which may be subject to a substantial risk of
forfeiture.

(3) Includes currently exercisable options to purchase 44,833 shares of common
stock.

(4) Includes currently exercisable options to purchase 7,083 shares of common
stock.

(5) Includes currently exercisable options to purchase 7,467 shares of common
stock.

(6) Consists of currently exercisable options to purchase 9,067 shares of
common stock.

(7) Includes currently exercisable options to purchase 8,083 shares of common
stock.

(8) Consists of currently exercisable options to purchase 11,307 shares of
common stock.

(9) 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 9,334 shares of common stock.

(10) Includes an aggregate of 119,287 shares of common stock issuable upon the
exercise of options that are currently exercisable and 16,665 restricted
shares subject to a substantial risk of forfeiture.

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

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

As of December 31, 2000, SunBridge was a lessee or assignee of seven
facilities from partnerships in which Mr. John Bingaman, a current director of
the Company, has an equity interest of greater than ten percent. All of the
leases terminate in 2001, unless renewed by the Company. Renewal options can
contain varying extension terms depending upon the facility lease. The Company
continues to evaluate its portfolios of facilities in conjunction with the
ongoing lease negotiations under the bankruptcy procedures. The aggregate lease
payments, including base rents, contingent rents and other miscellaneous
payments in connection with these leases, totaled approximately $2.5 million in
2000.

The Company believes the terms 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.

67

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, 2000 and
1999

Consolidated Statements of Losses for the years ended December 31,
2000, 1999 and 1998

Consolidated Statements of Stockholders' Equity (Deficit) for the
years ended December 31, 2000, 1999 and 1998

Consolidated Statements of Cash Flows for the years ended December 31,
2000, 1999 and 1998

Notes to Consolidated Financial Statements

(ii) Financial Statement Schedules:

Report of Independent Public Accountants

Schedule II Valuation and Qualifying Accounts for the years ended
December 31, 2000, 1999 and 1998

(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

None

(c) Exhibits

68

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

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

69

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 (9 3/8%
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

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

70

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 Nonqualified 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* Letter Agreement regarding Employment Arrangements dated December 28,
2000 by and between Robert D. Woltil and Sun Healthcare Group, Inc.

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)

71

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 (9 3/8% 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.

10.30(26) Settlement Agreement between Andrew Turner and the Company dated July
13, 2000.

10.31(26) Expense Indemnification Agreement between Andrew Turner and the
Company dated July 13, 2000.

10.32(27) First Amendment to Revolving Credit Agreement dated as of September
21, 2000 among the Company and each of its subsidiaries which are borrowers
under the Financing Agreement, and the lenders named therein. The CIT
Group/Business Credit, Inc. as Lenders' Agent and Heller Healthcare
Finance, Inc. as Collateral Agent.

21* Subsidiaries of the Registrant

23* Consent of Arthur Andersen LLP

______________________
* Filed herewith.

72

(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.

(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.

73

(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.

(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.

(26) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended March 31, 2000.

(27) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended June 30, 2000.

74

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
Chief Executive Officer and President

March 31, 2001

75

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
or her behalf, individually and in the capacity stated below, and to file all
supplements and amendments to this Report and any and all instruments or
documents filed as a part of or in connection with this Report or any amendment
or supplement thereto, and any such attorney-in-fact may make such changes and
additions to this Report as such attorney-in-fact may deem necessary or
appropriate.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant on March 30, 2001 in the capacities indicated.

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

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

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

Vice President and Corporate Controller
/s/ Jennifer L. Botter (Principal Accounting Officer)
- ----------------------
Jennifer L. Botter

Chairman of the Board
- ------------------------
James R. Tolbert III

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

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

/s/ Lois E. Silverman Director
- ---------------------
Lois E. Silverman

Director
- --------------------
R. James Woolsey

76

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

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2000

PAGE
----

Report of Independent Public Accountants......................................................... F-2

Consolidated Balance Sheets as of December 31, 2000 and 1999..................................... F-4

Consolidated Statements of Losses for the years ended December 31, 2000,
1999 and 1998................................................................................. F-6

Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31,
2000, 1999 and 1998........................................................................... F-7

Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999
and 1998...................................................................................... F-8

Notes to Consolidated Financial Statements....................................................... F-9

F-1

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

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

We have audited the accompanying consolidated balance sheets of Sun
Healthcare Group, Inc. (Debtor-in-Possession) (a Delaware corporation) and
subsidiaries as of December 31, 2000 and 1999, and the related consolidated
statements of losses, stockholders' equity (deficit) and cash flows for each of
the three years in the period ended December 31, 2000. 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 - Other Events" to the consolidated financial statements for further
information regarding these matters.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Sun
Healthcare Group, Inc. (Debtor-in-Possession) and subsidiaries as of December
31, 2000 and 1999, and the results of their operations and their cash flows for
the three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States.

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

F-2

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. On October 14, 1999, the Company and
substantially all of its domestic subsidiaries filed separate voluntary
petitions for relief under Chapter 11 of the U.S. Bankruptcy Code and continue
to operate under the protection of Chapter 11. As discussed in Note 2 to the
consolidated financial statements, the Company incurred net losses for the years
ended December 31, 2000 and 1999 of $545.7 million and $1,089.5 million,
respectively. As of December 31, 2000, the Company had a stockholders' deficit
of $1,545.3 million and a working capital deficiency of $161.6 million. The
Company was not in compliance with certain covenants of the Debtor-in-Possession
Revolving Credit Agreement (the "DIP Agreement") as of December 31, 2000. In
addition, the Company believes that it will not be able to achieve certain
financial covenants of the DIP Agreement in 2001. Subsequent to December 31,
2000, the Company and the DIP Agreement Lenders have entered into a forbearance
agreement, which provides that the DIP Agreement Lenders will not take any
actions through April 23, 2001, related to the Company's non-compliance with
certain covenants of the DIP Agreement. The forbearance agreement also states
that the Company and the DIP Agreement Lenders will negotiate revised future
financial covenants, which are expected to be consistent with the Company's
revised fiscal 2001 operating plan. The Company's financial liquidity is
dependent upon the successful negotiation of the future financial DIP Agreement
covenants and the Company's compliance with the terms of the forbearance
agreement. Also, the DIP Agreement expires on October 14, 2001. If the Company
continues to operate under the protection of Chapter 11 on that date, it will
need to reach an agreement with the DIP Agreement Lenders to extend the DIP
Agreement or replace the DIP Agreement with a new credit agreement in order to
maintain financial liquidity. Management's plans in regard to these matters,
including its intent to amend the DIP Agreement financial covenants and 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 that 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 consolidated 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
March 30, 2001

F-3

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

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 2000 AND 1999
(IN THOUSANDS)

2000 1999
---- ----
ASSETS

Current assets:
Cash and cash equivalents.............................................................. $ 37,589 $ 25,047
Accounts receivable, net of allowance for doubtful accounts of $128,106 and
$151,841 at December 31, 2000 and 1999, respectively................................. 195,362 254,464
Inventory, net......................................................................... 22,676 42,983
Prepaids and other assets.............................................................. 4,693 15,087
Other receivables, net................................................................. 6,896 15,916
--------------- ----------------
Total current assets................................................................... 267,216 353,497

Goodwill, net........................................................................... 188,005 475,567
Property and equipment, net............................................................. 180,285 446,176
Assets held for sale.................................................................... 156,342 70,609
Notes receivable, net of allowance of $1,979 and $6,556 at December 31, 2000 and 1999,
respectively.......................................................................... 14,554 22,698
Other assets, net....................................................................... 43,586 69,941
--------------- ----------------
Total assets.......................................................................... $ 849,988 $ 1,438,488
=============== ================

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

F-4

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

CONSOLIDATED BALANCE SHEETS (CONTINUED)

AS OF DECEMBER 31, 2000 AND 1999
(IN THOUSANDS EXCEPT SHARE DATA)

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

2000 1999
---- ----

Current liabilities:
Accrued compensation and benefits..................................................... $ 101,977 $ 84,117
Current portion of long-term debt..................................................... 86,039 44,776
Accrued self-insurance obligations.................................................... 50,737 59,075
Accounts payable...................................................................... 37,526 53,787
Income taxes payable.................................................................. 13,328 9,130
Accrued interest...................................................................... 7,788 2,972
Current portion of obligations under capital leases................................... 248 433
Other accrued liabilities............................................................. 131,193 116,489
---------------- ----------------
Total current liabilities............................................................. 428,836 370,779

Liabilities subject to compromise (see Note 2).......................................... 1,529,928 1,558,518
Long-term debt, net of current portion.................................................. 54,211 100,765
Obligations under capital leases, net of current portion................................ 53,553 65,675
Other long-term liabilities............................................................. 26,737 36,794
---------------- ----------------
Total liabilities..................................................................... 2,093,265 2,132,531
Commitments and contingencies
Minority interest....................................................................... 5,960 5,979
Company-obligated mandatorily redeemable convertible preferred securities of a
subsidiary trust holding solely 7% convertible junior subordinated debentures of the 296,101 322,978
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, 64,911,264
and 63,937,302 shares issued and outstanding as of December 31, 2000
and 1999, respectively.............................................................. 649 639
Additional paid-in capital............................................................ 825,147 798,305
Accumulated deficit................................................................... (2,331,218) (1,785,507)
Accumulated other comprehensive loss ................................................. (12,483) (5,017)
---------------- ----------------
(1,517,905) (991,580)
Less:
Unearned compensation............................................................. - (3,966)
Common stock held in treasury, at cost, 2,212,983 shares as of December 31,
2000 and 1999................................................................... (27,376) (27,376)
Grantor stock trust, at market, 1,915,935 shares as of December 31, 2000 and 1999. (57) (78)
---------------- ----------------
Total stockholders' deficit .......................................................... (1,545,338) (1,023,000)
---------------- ----------------
Total liabilities and stockholders' deficit........................................... $ 849,988 $ 1,438,488
================ ================

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

F-5

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

CONSOLIDATED STATEMENTS OF LOSSES

FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(IN THOUSANDS EXCEPT PER SHARE DATA)

2000 1999 1998
---- ---- ----

Total net revenues............................................................... $ 2,458,928 $ 2,529,039 $ 3,088,460
------------- -------------- ---------------
Costs and expenses:
Operating costs................................................................ 2,230,423 2,477,713 2,629,485
Impairment losses.............................................................. 191,316 457,449 397,492
Corporate general and administrative........................................... 153,133 159,671 180,934
Depreciation and amortization.................................................. 45,881 81,325 102,515
Interest, net (contractual interest expense of $146,406 and $30,546 at
December 31, 2000 and 1999, respectively).................................. 34,269 129,054 135,411
Provision for losses on accounts receivable.................................... 33,496 123,217 83,083
Legal and regulatory matters, net.............................................. 2,480 38 22,456
Loss on termination of interest rate swaps..................................... - 2,488 -
Restructuring costs............................................................ (1,090) 27,353 4,558
(Gain) loss on sale of assets, net............................................. (21,400) 78,673 206,205
------------- -------------- ---------------
Total costs and expenses before reorganization items........................... 2,668,508 3,536,981 3,762,139
Dividends on convertible preferred securities of subsidiary ..................... - 20,407 16,163
------------- -------------- ---------------
Losses before reorganization costs, income taxes, extraordinary loss and cumulative
effect of change in accounting principle....................................... (209,580) (1,028,349) (689,842)
Reorganization costs, net........................................................ 335,875 48,132 -
------------- -------------- ---------------
Losses before income taxes, extraordinary loss and cumulative effect of change in
accounting principle........................................................... (545,455) (1,076,481) (689,842)
Income tax provision............................................................. 256 161 53,577
------------- -------------- ---------------
Losses before extraordinary loss and cumulative effect of change in accounting (545,711) (1,076,642) (743,419)
principle......................................................................
Extraordinary loss from early extinguishment of debt, net of income tax benefit of
$3,700 in 1998................................................................. - - (10,274)
Cumulative effect of change in accounting principle.............................. - (12,816) -
------------- -------------- ---------------
Net losses....................................................................... $ (545,711) $(1,089,458) $ (753,693)
============= ============== ===============
Net losses per common and common equivalent share:
Losses before extraordinary loss and cumulative effect of change in accounting
principle
Basic.......................................................................... $ (9.04) $ (18.40) $ (14.29)
============= ============== ===============
Diluted........................................................................ $ (9.04) $ (18.40) $ (14.29)
============= ============== ===============
Net losses:
Basic.......................................................................... $ (9.04) $ (18.62) $ (14.49)
============= ============== ===============
Diluted........................................................................ $ (9.04) $ (18.62) $ (14.49)
============= ============== ===============
Weighted average number of common and common equivalent shares outstanding:
Basic.......................................................................... 60,347 58,504 52,008
============= ============== ===============
Diluted........................................................................ 60,347 58,504 52,008
============= ============== ===============

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

F-6

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

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(IN THOUSANDS)

2000 1999 1998
---------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------

COMMON STOCK
Issued and outstanding at beginning of year................. 63,937 $ 639 61,930 $ 619 51,698 $ 517
Issuance of common stock for employee benefits.............. - - - - 37 -
Conversion of 61/2% Convertible Subordinated Debentures due - - 774 8 2 -
2003......................................................
Conversion of 7% Convertible Trust Issued Preferred Securities 1,335 13 1,094 11 - -
Cancellation of Restricted Stock Awards..................... (361) (3) (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....................... 64,911 649 63,937 639 61,930 619
------- ----------- -------- ----------- ---------- ----------

ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year................................ 798,305 774,860 639,637
Issuance of common stock for employee benefits.............. - - 522
Tax benefit of stock options exercised...................... - - 57
Conversion of 61/2% Convertible Subordinated Debentures due - 12,626 33
2003......................................................
Conversion of 7% Convertible Trust Issued Preferred Securities 26,863 22,011 121
Adjustment to market value of common stock held by the
Grantor Stock Trust....................................... (21) (12,512) (26,895)
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................... 825,147 798,305 774,860
----------- ----------- ----------
RETAINED EARNINGS
Balance at beginning of year................................ (1,785,507) (696,049) 57,114
Net losses.................................................. (545,711) (1,089,458) (753,693)
Common stock issued in connection with immaterial poolings.. - - 530
----------- ----------- ----------
Retained deficit at end of year............................. (2,331,218) (1,785,507) (696,049)
----------- ----------- ----------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of year................................ (5,017) 2,902 1,766
Foreign currency translation adjustment, net of tax......... (7,466) (7,919) 1,136
----------- ----------- ----------
Accumulated other comprehensive income (loss) at end of year (12,483) (5,017) 2,902
----------- ----------- ----------
Total....................................................... (1,517,905) (991,580) 81,713
------------ ----------- ----------
UNEARNED COMPENSATION
Balance at beginning of year................................ (3,966) (8,552) (14,203)
Issuance of shares of restricted common stock............... - - (564)
Cancellation of Restricted Stock Awards .................... 3,966 260 -
Amortization of stock issued under restricted stock option
plan...................................................... - 4,326 6,215
----------- ----------- ----------
Unearned compensation at end of year........................ - (3,966) (8,552)
----------- ----------- ----------
COMMON STOCK IN TREASURY
Balance at beginning of year................................ 2,213 (27,376) 2,125 (26,967) 2,053 (25,574)
Acquired at cost............................................ 88 (409) 72 (1,393)
------- ----------- -------- ----------- ---------- ----------
Common stock in treasury at end of year..................... 2,213 (27,376) 2,213 (27,376) 2,125 (26,967)
------- ----------- -------- ----------- ---------- ----------
GRANTOR STOCK TRUST
Balance at beginning of year................................ 1,916 (78) 1,989 (13,054) 2,178 (42,204)
Issuance of common stock from the Grantor Stock Trust....... - - - 464 (189) 1,692
Issuance of shares of restricted common stock............... - - 563
Adjustment to market value of common stock held by the
Grantor Stock Trust....................................... - 21 (73) 12,512 26,895
------- ----------- -------- ----------- ---------- ----------
Grantor stock trust at end of year.......................... 1,916 (57) 1,916 (78) 1,989 (13,054)
------- ----------- --------- ----------- ---------- ---------
Total stockholders' equity (deficit)........................ $(1,545,338) $(1,023,000) $ 33,759
============ =========== =========

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

F-7

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

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(IN THOUSANDS)

2000 1999 1998
---- ---- ----

CASH FLOWS FROM OPERATING ACTIVITIES:
Net losses..................................................................... $ (545,711) $ (1,089,458) $ (753,693)
--------------- -------------- ------------
Adjustments to reconcile net losses to net cash provided by (used for) operating
activities:
Extraordinary loss........................................................... - - 10,274
(Gain) loss on sale of assets, net........................................... (21,400) 78,673 206,205
Impairment loss.............................................................. 191,316 457,449 397,492
Cumulative effect of change in accounting principle.......................... - 12,816 -
Reorganization costs, net.................................................... 335,875 48,132 -
Depreciation and amortization................................................ 45,881 81,325 102,515
Provision for losses on accounts receivable.................................. 33,496 123,217 83,083
Legal and regulatory costs................................................... 1,245 - -
Other, net................................................................... (20,186) 18,055 9,068
Changes in operating assets and liabilities:
Accounts receivable.......................................................... (18,720) 160,864 (61,679)
Other current assets......................................................... 11,029 8,412 (19,557)
Other current liabilities.................................................... 859 72,607 (41,530)
Income taxes payable......................................................... 2,115 35,430 22,242
--------------- -------------- ------------
Net cash provided by (used for) operating activities before reorganization costs. 15,799 7,522 (45,580)
Net cash paid for reorganization costs........................................... (17,520) (269) -
--------------- -------------- ------------
Net cash provided by (used for) operating activities............................. (1,721) 7,253 (45,580)
--------------- -------------- ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net...................................................... (55,366) (102,453) (160,416)
Acquisitions, net of cash acquired............................................. (974) (5,731) (60,641)
Proceeds from sale of assets held for sale..................................... 24,980 8,735 -
Decrease (increase) in long-term notes receivable.............................. (6,088) 15,857 (5,977)
Decrease (increase) in other assets............................................ 5,536 45,179 6,794
Proceeds from sale and leaseback of property and equipment..................... - 38,600 134,375
--------------- -------------- ------------
Net cash provided by (used for) investing activities........................ (31,912) 187 (85,865)
--------------- -------------- ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under Revolving Credit Agreement (postpetition) ................ 54,901 12,125 -
Long-term debt borrowings...................................................... 9,667 126,062 248,818
Long-term debt repayments (prepetition)........................................ (14,663) (92,502) (438,607)
Principal payments on prepetition debt authorized by Bankruptcy Court.......... (3,406) (36,118) -
Conversion of Mediplex 6.5% Convertible Subordinated Debentures due 2003....... - (6,649) -
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
Purchases of treasury stock.................................................... - (409) (1,393)
Other financing activities..................................................... (4) (14,480) (8,151)
--------------- -------------- ------------
Net cash provided by (used for) financing activities....................... 46,495 (10,187) 137,048
--------------- -------------- ------------
Effect of exchange rate on cash and cash equivalents............................. (320) 290 881
--------------- -------------- ------------
Net increase (decrease) in cash and cash equivalents............................. 12,542 (2,457) 6,484
Cash and cash equivalents at beginning of year................................... 25,047 27,504 21,020
--------------- -------------- ------------
Cash and cash equivalents at end of year......................................... $ 37,589 $ 25,047 $ 27,504
=============== ============== ============

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

F-8

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2000

(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 and Germany. The Company sold its operations in Spain in October 2000.
The operations in Australia were placed in receivorship by its secured creditors
in September 2000. See Notes 7 and 24, which describe certain operations that
the Company has sold or is planning to sell.

(2) PETITIONS FOR REORGANIZATION UNDER CHAPTER 11

The Company incurred net losses of $545.7 million and $1,089.5 million in
2000 and 1999, respectively. At December 31, 2000, the Company had a working
capital deficiency of $161.6 million and a stockholders' deficit of $1,545.3
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 accounting principles generally accepted in the United States
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 note holders of
approximately two-thirds of its outstanding senior subordinated bonds on the
terms of an overall restructuring of the Company's capital structure. As of
October 1, 2000, the parties to the agreement in principle have the right to
withdraw from the agreement in principle, and several bank lenders and note
holders have withdrawn. The Company and its significant creditor constituents
are presently negotiating amendments to the agreement in principle that will
form the basis for a plan of reorganization. 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 agreed to with the significant creditor
constituents.

F-9

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

The Company's exclusive period to file a plan of reorganization has been
extended to May 8, 2001 and to solicit acceptances of the plan has been extended
to July 8, 2001.

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 accompanying
consolidated balance sheets 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 accompanying consolidated balance sheets and included in "liabilities
subject to compromise" 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.

December 31, 2000 December 31, 1999
(in thousands) (in thousands)
------------------------- --------------------------

Revolving Credit Facility $ 433,319 $ 427,271
Credit Facility Term Loans 358,981 358,981
Senior Subordinated Notes dues 2007 250,000 250,000
Senior Subordinated Notes due 2008 150,000 150,000
Interest payable 102,094 102,467
Convertible Subordinated Debentures due 2004 83,300 83,300
Prepetition trade and other miscellaneous claims 65,834 79,948
Mortgage notes payable due at various dates through 2005 46,214 47,703
Other long-term debt 15,984 21,200
Industrial Revenue Bonds 8,620 10,935
Capital leases 8,039 19,170
Senior Subordinated Notes due 2002 6,161 6,161
Convertible Subordinated Debentures due 2003 1,382 1,382
------------------------- --------------------------
Total liabilities subject to compromise $ 1,529,928 $ 1,558,518
========================= ==========================

F-10

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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, 2000 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-possession financing (the "DIP Financing Agreement"), holders of
administrative expense claims, holders 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.
See Note 8.

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.

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.

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 debtor-in-possession financing. The Revolving Credit
Agreement was amended as of September 21, 2000 (as amended, the "DIP Financing
Agreement"). The DIP Financing Agreement provides for maximum borrowings by the
Company of $200.0 million, but not to exceed the sum of (i) up to 85.0% of the
then outstanding domestic eligible accounts receivable and (ii) the lessor of
$10.0 million or 50.0% of the aggregate value of eligible inventory.

F-12

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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. 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.

As of December 31, 2000, approximately $138.7 million was available to the
Company under the DIP Financing Agreement, of which amount the Company had
borrowed approximately $67.0 million and had issued approximately $34.7 million
in letters of credit. In addition to the available funds under the DIP Financing
Agreement, the Company had cash book balances at December 31, 2000 of
approximately $37.6 million. The combination of the Company's cash balances and
available funds, less borrowings and letters of credit, under the DIP Financing
Agreement was $74.6 million and $160.8 million as of December 31, 2000 and 1999,
respectively. This decrease in liquidity is due primarily to the losses that the
Company's operations have incurred in 2000, which have been adversely affected
by the slower than expected pace of divesting non-profitable facilities in 2000
and costs incurred associated with the Company's reorganization.

In July 2000 and February and March 2001, the Company obtained waivers on
several defaults under the DIP Financing Agreement including the EBITDA
financial covenant. If the Company is unable to comply with the covenants
contained in the amended DIP Financing Agreement or is unable to obtain a waiver
of any future covenant violation, then the Company would lose its ability to
borrow under the amended 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 amended 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.

The Company believes that it will have sufficient liquidity to meet its
operational needs for the next 12 months assuming that (i) the Company is
successful in amending the DIP Financing Agreement and maintains its ability to
borrow under the DIP Financing Agreement until emergence from bankruptcy, (ii)
if the Company has not emerged from bankruptcy by September 30, 2001 that it is
able to extend the DIP Financing Agreement or enter into a new DIP financing
agreement under substantially similar terms, and (iii) the Company does not
experience any material and adverse decrease in its results of operations.

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-13

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

For the period from the Filing Date through December 31, 2000,
reorganization costs, net, were a total of $384.0 million. The components are as
follows:

December 31, 2000 December 31, 1999
(in thousands) (in thousands)
------------------------- -------------------------

Loss on sale of assets $ 313,781 $ 7,085
Professional fees 27,756 4,115
Other 866 -
Write-off of debt discounts and deferred issuance costs - 37,614
Interest earned on accumulated cash (2,807) (682)
Gain on sale of assets (3,721) -
------------------------- -------------------------
Total $ 335,875 $ 48,132
========================= =========================

(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 filings in 1999, the non-filing subsidiaries of
the Company fully reserved for their intercompany receivables from the filing
subsidiaries. These amounts were not material.

(B) CASH AND 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, which approximates fair value.

F-14

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(C) NET REVENUES

Net revenues consist of long-term and subacute care revenues, temporary
medical 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 year ended December 31, 1998, net
revenues included amounts related to exceptions to the RCLs of approximately
$30.9 million. These amounts reflected management's estimate of the amounts that
would ultimately be approved and paid by HCFA related to the requests for
exceptions to the RCLs based on its prior experience with the Medicare Program's
regulations and the Company's records of services provided.

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. In 1999, the Company
established a reserve of approximately $67.7 million related to these denials.
The reserve, which is included in accounts receivable as of December 31, 2000
and 1999, was recorded as an adjustment to net patient revenues.

(D) ACCOUNTS RECEIVABLE

The Company's accounts receivable relates 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 provide services to patients in unaffiliated
long-term, rehabilitation and acute care facilities. The billings for those
services are submitted to the unaffiliated facilities. Many of the unaffiliated
long-term care facilities receive a majority of their revenues from the Medicare
and state Medicaid programs. See Note 18.

(E) INVENTORIES

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

F-15

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(F) PROPERTY AND EQUIPMENT

Property and equipment is stated at cost. Property and equipment held under
capital lease is stated at the net present value of future minimum lease
payments. Major renewals or improvements are capitalized whereas ordinary
maintenance and repairs are expensed as incurred. Depreciation 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; and equipment - 3 to 20 years. The
Company capitalizes interest directly related to the development and
construction of new facilities as a cost of the related asset.

(G) GOODWILL

The excess of the purchase price over the fair value of the net assets of
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 $242.7 million and $91.7 million as of December 31, 2000 and
1999, 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) ACCRUED SELF-INSURANCE OBLIGATIONS

It is the Company's policy to self-insure for certain insurable risks,
including general and professional liability and workers' compensation through
the use of self-insurance or retrospective and high deductible insurance 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 therefrom are reflected in
current earnings. Claims are paid over varying periods, which generally range
from one to five years. Future payments may be different than the estimated
exposure. Accrued liabilities for future claims are not discounted.

F-16

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(J) 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 losses.

(K) 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.

(L) 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. Statements of 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).

(M) 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" in the Company's
consolidated financial statements).

(N) NET LOSSES PER SHARE

Diluted net 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,
2000, 1999 and 1998. See "Note 16 - Earnings Per Share" for calculation of
losses per share data for the years ended December 31, 2000, 1999 and 1998.

F-17

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(O) 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 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.

(P) FINANCIAL STATEMENT PREPARATION AND PRESENTATION

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

Certain amounts in the 1999 and 1998 Consolidated Financial Statements and
notes thereto have been reclassified to conform to the 2000 presentation.

(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. 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
consisted of approximately $3.7 million related to employee terminations and
approximately $0.9 million related to lease termination costs. As of December
31, 2000, approximately 0.7 million of the approximate $2.0 million 1998
corporate restructuring costs reserve balance remains and is comprised of
prepetition severance accruals that are classified as "liabilities subject to
compromise" in the Company's consolidated balance sheets. The Company's 1998
corporate restructuring plan was substantially complete in 1999.

F-18

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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. The 1999 corporate restructuring plan included the
termination of approximately 3,000 employees, primarily in its rehabilitation
and respiratory therapy services operations, and the closure of approximately 23
divisional and regional offices. Relocation of the management of the Company's
medical supply subsidiary and temporary medical staffing services subsidiary to
the Company's corporate headquarters in Albuquerque, New Mexico was also
included.

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. As of December 31, 1999, the Company's 1999 corporate restructuring
plan was complete. During the last half of 2000, the Company reversed
approximately $1.1 million of reserves related to the 1999 corporate
restructuring plan. The reserves were considered no longer necessary.

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

The effects of the Company's acquisitions during 2000 and 1999,
individually and in the aggregate, are immaterial to the operating results of
the Company, and therefore, pro forma information is not provided. 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 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 the Company's 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.

F-19

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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 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 and related items and the shut down of certain facilities
in connection with the purchase, respectively. 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.

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.

(6) PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

December 31, 2000 December 31, 1999
(in thousands) (in thousands)
---------------------- ---------------------

Land................................................................ $ 22,311 $ 40,486
Buildings and improvements.......................................... 69,804 177,951
Leasehold improvements.............................................. 57,785 50,498
Equipment........................................................... 124,639 140,013
Construction in progress............................................ 19,341 46,549
Assets held under capital leases.................................... 964 49,587
---------------------- ---------------------

Total............................................................. 294,844 505,084
Less accumulated depreciation....................................... (113,998) (49,961)
Less accumulated amortization on assets held under capital leases... (561) (8,947)
---------------------- ---------------------

Property and equipment, net....................................... $ 180,285 $ 446,176
====================== =====================

Amortization of assets held under capital lease agreements of $0.6 million,
$3.5 million and $6.1 million in 2000, 1999 and 1998, respectively, was recorded
in depreciation and amortization expense in the Company's consolidated
statements of losses.

F-20

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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

(A) IMPAIRMENT OF LONG-LIVED ASSETS

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 reduction 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
analysis served as an indication to the Company that the carrying values of the
long-lived assets of Inpatient Services Division, Rehabilitation and Respiratory
Therapy Services Division and Pharmaceutical and Medical Supply Services
Division were impaired.

As events warrant, the Company evaluates if its facilities are impaired
through the review of historical results, creation of future projected cash
flows and awareness of the future reimbursement and regulatory environment in
which the Company operates. During the fourth quarter of 2000, the Company
identified several factors that adversely impacted the future projections of net
operating income (loss) and net cash flows for certain facilities, primarily in
the Inpatient Services division of the Company. These factors were (i) the
continuation of the tight labor market that increased the Company's use of
contract and temporary staffing; (ii) additional regulatory pressures within the
healthcare industry including new laws in California that specify the labor
dollars spent on patient care and increased the operating costs at a significant
number of the Company's facilities; and (iii) additional staffing and other
overhead within the Company's long-term care division to respond to survey
results. During 2000, the Inpatient Services Division, which operates long-term
care facilities, recognized an impairment of $189.3 million related to 141 of
the 303 facilities it operates in the United States. The impairment was caused
primarily due to the decrease of revenues as compared with profitability
projections for each facility.

During the second quarter of 1999, the Company revised its projections of
future cash flows for its various business units due to the fact that actual
operating results were below expectations. The significant write-down of
goodwill and other long-lived assets is the result of lower cash flows
experienced by the Company due to 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 had not
achieved profitability targets established upon their acquisition. 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.

In the fourth quarter of 1998, due to the implementation of the Balanced
Budget Act of 1997, a new Medicare PPS for skilled nursing facilities was
established. PPS was implemented on July 1, 1998 at the facilities acquired
during the RCA Acquisition in 1997. Management determined that the anticipated
reductions in revenue related to PPS would have a material adverse impact on the
1999 net revenues of the Company and that the decline would not be temporary.
This determination was an indication that the carrying values of the assets of
its Inpatient Services Division, its Rehabilitation and Respiratory Therapy
Services Division and its Pharmaceutical and Medical Supply Services Division
would be greater than the expected undiscounted future cash flows of those
divisions. The Company recognized an impairment charge of $397.5 million for the
year ended December 31, 1998.

F-21

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

The following is a summary of the impairment loss by segment for the years
ended December 31 (in thousands):

PROPERTY
AND OTHER
GOODWILL EQUIPMENT ASSETS TOTAL
-------- --------- ------ -----

2000:
Inpatient Services................................... $130,148 $ 58,712 $ 448 $ 189,308
Pharmaceuticals and Medical Supply Services.......... - 42 - 42
Other Operations..................................... 1,000 953 13 1,966
------------- --------------- -------------- --------------
$ 131,148 $ 59,707 $ 461 $ 191,316
============= =============== ============== ==============

PROPERTY
AND OTHER
GOODWILL EQUIPMENT ASSETS TOTAL
-------- --------- ------ -----

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 TOTA
-------- --------- ------ -----

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

F-22

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(B) ASSETS HELD FOR SALE

SFAS 121 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.

During the 12 months ended December 31, 2000, the Company divested 49
skilled nursing facilities and 20 assisted living facilities. The net revenues
and net operating losses for the twelve months ended December 31, 2000 for these
69 facilities were approximately $132.3 million and $9.0 million, respectively.
The aggregate net loss on disposal during the 12 months ended December 31, 2000
for these divestitures was approximately $1.7 million recorded in (gain) loss on
sale of assets, net, and $21.1 million which was included in reorganization
costs, net, in the Company's 2000 consolidated statements of losses. In 2000,
the Company decided not to divest 23 skilled nursing facilities and 6 outpatient
rehabilitation facilities. A reversal of approximately $34.8 million was
recorded in reorganization costs, net, in the Company's 2000 consolidated
statement of losses.

As of December 31, 2000, the Company had identified 35 skilled nursing
facilities with 4, 071 licensed beds and 5 parcels of land acquired in the sale
of assisted living facilities during 1999 and early 2000 for disposal. The
Company had previously recorded losses of $29.9 million on certain of these
assets. The net revenues and aggregate net operating losses for the twelve
months ended December 31, 2000 for the 35 skilled nursing facilities were $
150.1 million and $ 4.8 million, respectively. The book value of the land
parcels is approximately $ 7.9 million.

Of the 20 assisted living facilities identified above, the Company sold 16
assisted living facilities for a total consideration of $67.3 million. The cash
consideration received was approximately $1.2 million, and the Company received
a note receivable of approximately $0.5 million. In addition, the aggregate
debt, capital leases and other liabilities assumed by the purchaser totaled
approximately $65.6 million. The Company previously recorded the anticipated
loss on the sale of approximately $71.4 million in 1999. During 2000, the
Company reversed approximately $1.5 million of the loss recorded in 1999. The
reversal of the loss is recorded in gain on sale of assets in the Company's
consolidated statements of losses. During 2000, the Company divested 4 assisted
living facilities. No material cash consideration was received for these
facilities, but the Company was released from approximately $6.9 million of
aggregate debt. The Company recorded a gain of $4.9 million, net, in gain on
sale of assets in the Company's 2000 consolidated statement of losses. In
addition, the Company transferred its two remaining assisted living facilities
from its Other Operations segment to its Inpatient Services segment. In December
2000, the Company sold a parcel of land for cash consideration of approximately
$1.4 million. The land was received in the sale of the assisted living
facilities.

F-23

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

During the first quarter of 2000, the Company began soliciting offers to
purchase its international operations. The Company recorded a loss of
approximately $168.6 million in 2000 to reduce the carrying value of its
international operations to the Company's estimate of selling value less selling
costs. The charge was recorded in reorganization costs, net, in the Company's
2000 consolidated statement of losses. See "Note 2 - Petitions for
Reorganization under Chapter 11."

The Company's operations in Australia were placed in receivorship in 2000
because their financial results were below certain financial covenants of their
debt agreements, which resulted in a default under those agreements. The
Company's operations in Spain were sold for approximately $7.6 million in
October 2000. The Company also sold 18 pharmacies in the United Kingdom for
approximately $14.4 million in 2000.

In 2000, the Company began pursuing the disposition of certain non-core
businesses, including its respiratory therapy business. The Company recorded a
loss of approximately $6.3 million in 2000 to reduce the carrying value of its
respiratory therapy business to the Company's estimate of selling value less
selling costs. The charges were recorded in reorganization costs, net, in the
Company's consolidated statements of losses. No purchase agreement has been
negotiated for this business, and the Company cannot predict when, or if, this
business will be sold. See "Note 2 - Petitions for Reorganization under Chapter
11."

In December 2000, the Company entered into agreements to divest its
operations in the United Kingdom and Germany. The sale of the United Kingdom
facilities, consisting of 146 inpatient facilities with 8,326 licensed beds, was
completed in January 2001. No material cash consideration was received for these
operations, but the Company was released from approximately $112.9 million of
aggregate debt, capital lease obligations, notes payable and other liabilities
upon the sale. The sale of the German operations has not been completed as of
March 30, 2001, and there can be no assurance that the Company will successfully
divest its operations in Germany.

Included in the Other Operations Division is the corporate management
division of the Company. Based on an overall reduction in the demand for the
Company's services and long-term care facilities, the Company concluded that it
will sell a portion of its headquarters campus and recorded a loss on assets
held for sale of $26.6 million in 2000.

F-24

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

During 2000, the Company decided to sell its medical supplies operations,
SunChoice. The Company recorded a loss of approximately $59.4 million to reduce
the carrying value of its medical supplies operations to the Company's estimate
of the selling value less selling costs. The charge was recorded in
reorganization costs, net, in the Company's 2000 consolidated statement of
losses. In January 2001, the Company sold the assets of SunChoice, to Medline
Industries, Inc. ("Medline"). The Company received proceeds of $16.6 million in
exchange for the SunChoice assets, including the SunChoice account receivables.
In the event that Medline collects less from the SunChoice accounts receivable
by July 2001 than it paid to the Company for the receivables, the Company must
pay the deficiency to Medline. Therefore, it is possible that the Company would
need to repay Medline a portion of the SunChoice purchase price. See "Note 2 -
Petitions for Reorganization under Chapter 11" and "Note 10(b) - Commitments and
Contingencies".

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 million and $2.2 million 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 in which it had held a
ten-percent equity interest. 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 in loss on sale of
assets, net, in 1999 and 1998, respectively.

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.

F-25

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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 the related building and
leasehold improvements, equipment and goodwill.

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.

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.

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.

F-26

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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 are 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 and $11.4 million during 1999 and
1998, 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 are not material.

The following is a summary of the carrying amounts of assets held for sale
at December 31, 2000 and 1999 and the loss on sales of assets and assets held
for sale, net, for the years ended December 31, 2000, 1999 and 1998. The loss on
sales of assets recorded subsequent to the Company's chapter 11 filings in the
years ended December 31, 2000 and 1999 includes approximately $310.1 and $7.1
million, respectively, recorded as reorganization cost in the Company's
consolidated statements of losses.

CARRYING AMOUNT
2000 1999
---- ----

Assisted living facilities............................... $ - $ 67,116
Rehabilitation hospitals and other inpatient facilities.. - -
International operations................................. 138,775 -
Other non-core businesses................................ 17,567 3,493
------------- ------------
Total.................................................. $ 156,342 $ 70,609
============= ============

F-27

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

LOSS AMOUNT
2000 1999 1998
---- ---- ----

Assisted living facilities............................... $ (7,979) $ 41,667 $ 97,298
Rehabilitation hospitals and other inpatient facilities.. 35,430 15,132 95,367
International operations................................. 168,609 - -
Other non-core businesses................................ 92,600 28,959 13,540
------------- ------------- -------------
Total.................................................. $ 288,660 $ 85,758 $ 206,205
============= ============= =============

(8) DEBTOR-IN-POSSESSION FINANCING

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 Interbank Borrowing
Offered Rate ("LIBOR") plus 2.75% and is payable in arrears on each Interest
Payment Date. The one-month LIBOR was approximately 6.6% at December 31, 2000
and 5.8% at December 31, 1999. 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 2.0% and is payable daily. The ABR was approximately 9.4%
and 8.6% at December 31, 2000 and 1999, respectively.

The obligations of the Company under the DIP Financing Agreement are
jointly and severally guaranteed by each to 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
order 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.

F-28

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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.

At December 31, 2000, approximately $138.7 million was available under the
DIP Financing Agreement of which the Company had borrowed $67.0 and had issued
letters of credit of approximately $34.7 million. At December 31, 1999,
approximately $140.5 million was available under the DIP Financing Agreements of
which the Company had borrowed $12.1 million and had issued letters of credit
outstanding of approximately $7.9 million. Peak borrowings under the agreement
during 2000 and 1999 were $86.1 and $56.7 million, respectively, with an
effective interest rate during 2000 and 1999 of approximately 9.4% and 8.8%,
respectively.

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.

Capital Expenditures Aggregate Limitations on Corporate Headquarters:

$ 6,000,000 During each fiscal year until maturity

Capital Expenditures on Domestic Healthcare Facilities:

$ 49,300,000 During each fiscal year until maturity

Minimum cumulative EBITDA at month end for preceding continuous six month
period:

January 2001 28,700,000
February 31,300,000
March 34,000,000
April 36,700,000
May 39,300,000
June 42,000,000

It would be an event of default if cumulative EBITDA for any continuous
six-month period beginning with or after July 2001 is less than $42,000,000.

F-29

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

The Company believes that it will have sufficient liquidity to meet its
operational needs for the next 12 months assuming that (i) the Company is
successful in amending the DIP Financing Agreement and maintains its ability to
borrow under the DIP Financing Agreement until emergence from bankruptcy, (ii)
if the Company has not emerged from bankruptcy by September 30, 2001 that it is
able to extend the DIP Financing Agreement or enter into a new DIP financing
agreement under substantially similar terms, and (iii) the Company does not
experience any material and adverse decrease in its results of operations. This
is a "forward-looking statement" within the meaning of the Private Securities
Litigation Reform Act of 1995 and is subject to a number of factors, including,
but not limited to, the Company's ability to divest unprofitable facilities,
operate its business consistent with plan, comply with the covenants of the DIP
Financing Agreement, negotiate a Plan of Reorganization and emerge from
bankruptcy, and negotiate an acceptable global settlement with the federal
government.

(9) LONG-TERM DEBT

As a result of the chapter 11 filing, substantially all short and long-term
debt at the Filing Date 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.

F-30

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

Long-term debt at December 31 consisted of the following (in thousands):

2000 1999
---- ----

Senior Credit Facility:
Revolving Credit Facility (see below)................................................ $ 433,319 (1) $ 427,271 (1)
Credit Facility Term Loans (see below)............................................... 358,981 (1) 358,981 (1)
9 1/2% Senior Subordinated Notes due 2007............................................... 250,000 (1) 250,000 (1)
9 3/8% Senior Subordinated Notes due 2008............................................... 150,000 (1) 150,000 (1)
Convertible Subordinated Debentures due 2004, interest at 6.0% per annum................ 83,300 (1) 83,300 (1)
DIP Financing Agreement................................................................. 67,027 12,126
Mortgage notes payable due at various dates through 2014, interest at rates from 8.0%
to 11.4%, collateralized by various facilities........................................ 53,517 (2) 63,578 (2)
Mortgage notes payable in pounds sterling due at various dates in 2015 and 2016,
interest at 9.5 % per annum, collateralized by various facilities in the United
Kingdom............................................................................... 31,354 4,795
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........ 12,980 13,841
Industrial Revenue Bonds................................................................ 8,785 (3) 63,660 (3)
Mortgage notes payable in German marks due at various dates through 2003, interest at
rates from 6.3% to 6.8%, collateralized by various facilities in Germany.............. 7,978 6,899
Senior Subordinated Notes due 2002, interest at 11 3/4% per annum....................... 6,161 (1) 6,161 (1)
Convertible Subordinated Debentures due 2003, interest at 6 1/2% per annum.............. 1,382 (1) 1,382 (1)
Mortgage notes payable in Spanish pesetas due at various dates through 2017, interest
at rates from 5.0% to 14.0%, collateralized by various facilities in Spain............ - 13,977
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
Other long-term debt.................................................................... 29,427 (4) 41,604 (4)
----------------- ----------------
Total long-term debt.................................................................... 1,494,211 1,502,476
Less long-term debt subject to compromise............................................... (1,353,961) (1,356,935)
Less amounts due within one year........................................................ (86,039) (44,776)
----------------- ----------------
Long-term debt, net of current portion.................................................. $ 54,211 $ 100,765
================= ================

F-31

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

Long-term debt at December 31, 2000 includes amounts owed under the DIP
Financing Agreement, one fully secured mortgage notes payable, certain
Industrial Revenue Bonds and other debt, of which approximately $85.4 million
was assumed by the purchaser in a Bankruptcy Court approved sales transaction
subsequent to December 31, 2000 and the Company's foreign debt obligations.

Long-term debt at December 31, 1999 includes amounts owed under the DIP
Financing Agreement, one fully secured mortgage note payable, certain Industrial
Revenue Bonds and other debt, of which approximately $55.3 million was assumed
subsequent to December 31, 1999 by the purchaser in a Bankruptcy Court approved
sales transaction and the Company's foreign debt obligations.

(1) Classified as "liabilities subject to compromise" in the Company's
consolidated balance sheets as of December 31, 2000 and December 31, 1999.

(2) Approximately $46,214 and $47,703 are classified as "liabilities subject to
compromise" in the Company's consolidated balance sheets as of December 31,
2000 and December 31, 1999, respectively.

(3) Approximately $8,620 and $10,935 are classified as "liabilities subject to
compromise" in the Company's consolidated balance sheets as of December 31,
2000 and December 31, 1999, respectively.

(4) Approximately $15,984 and $21,200 are classified as "liabilities subject to
compromise" in the Company's consolidated balance sheets as of December 31,
2000 and December 31, 1999, respectively.

The scheduled maturities of long-term debt, (not including that which is
subject to compromise) as of December 31, 2000 is as follows (in thousands):

2001........................................... $ 86,039
2002........................................... 13,744
2003........................................... 25,014
2004........................................... 848
2005........................................... 5,474
Thereafter..................................... 9,131
----------------------
$ 140,250
======================

F-32

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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.

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.

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 had 36 facility leases with Meditrust which are in default due to
cross-default provisions with the Meditrust mortgages and leases.

(10) COMMITMENTS AND CONTINGENCIES

(A) PREPETITION ACCOUNTS RECEIVABLE

In certain instances, the collection of amounts due 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 the timing of third-party
payments. Pursuant to an agreement between the Company and the Department of
Health and Human Services ("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 HHS has against the Company. As of February 29,
2000, the Company estimated that it had net Medicare accounts receivable of
approximately $80.1 million that were being withheld by HHS pursuant to this
agreement. It is unlikely that the Company will recover any of these
receivables. Payment of amounts due to the Company by HHS for services provided
on or after October 14, 1999 (post-bankruptcy) is largely unaffected by the
Company's bankruptcy filings. 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,
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
HHS upon the occurrence of certain events, including the confirmation of a plan
of reorganization. The amount of such repayment, if any, is not known at this
time.

F-33

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(B) ACCOUNTS RECEIVABLE

The sale of the assets of the Company's medical supplies operations,
SunChoice, to Medline included SunChoice's accounts receivable of $4.7 million.
The purchase agreement stipulates that in the event that Medline collects less
from the SunChoice accounts receivable by July 2001 than it paid to the Company
for the receivables, the Company would be required to repay Medline a portion of
the SunChoice purchase price. Management believes it is unlikely that Medline
will not collect the value of the accounts receivable included in the purchase
price. If this occurs, the Company would have to pay Medline the difference. At
this time the Company estimates that any reimbursement to Medline would be less
than $2.0 million.

(C) 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, 2000, the Company had rejected
approximately $13.0 million in equipment lease agreements and approximately
$317.6 million in inpatient real estate lease agreements since the Filing Date.
Future minimum lease payments under noncancelable leases as of December 31 are
as follows (in thousands):

CAPITAL OPERATING
LEASES LEASES
------ ------

2001...................................................................... $ 7,778 $ 149,111
2002...................................................................... 5,819 145,688
2003...................................................................... 5,387 142,106
2004...................................................................... 5,390 134,172
2005...................................................................... 5,012 121,733
Thereafter................................................................ 61,990 393,291
----------------- -----------------
Total minimum lease payments.............................................. 91,376 $ 1,086,101
=================
Less amount representing interest......................................... 29,536
-----------------
Present value of net minimum lease payments under capital leases.......... $ 61,840
=================

F-34

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

Rent expense under operating leases totaled approximately $237.6 million
$267.5 million, and $251.3 million in 2000, 1999 and 1998, respectively. As of
December 31, 2000, the Company leased or subleased seven facilities from
affiliates of a director of the Company, which are included in the information
above. The aggregate lease expense for these seven facilities was approximately
$2.5 million, $2.4 million and $2.7 million in 2000, 1999 and 1998,
respectively. Future minimum lease commitments related to the facilities the
Company leases from affiliates of the director total approximately $2.5 million
at December 31, 2000. The Company's management believes the terms of all the
foregoing leases are as favorable to the Company as those that could have been
obtained from non-related parties.

As of December 31, 2000 and 1999, the Company was not in compliance with
financial covenants contained in master lease agreements for 96 long-term care
facilities in the United States and the United Kingdom. The Company was also in
cross-default on leases of 14 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.

(D) INSURANCE

In the past, the Company has insured certain risks, including general and
professional liability and workers' compensation through the use of
self-insurance, retrospectively rated premium, high deductible and other hybrid
policies which varied 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 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 no longer provide 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. 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
unlimited in 1999 and $8.0 million in 1998. In 2000 and 2001, 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 $36.0 million and $33.0 million in 2000 and
2001, respectively. Annual reviews of the actuarial determinations are performed
to determine variations from this expected loss amount, and any adjustments are
made to the reserve 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 that the event occurred. The reserve for such risks is
approximately $32.9 million and $22.8 million as of December 31, 2000 and 1999,
respectively. Provisions for such risks were approximately $35.3 million, $23.9
million and $14.6 million for the years ended December 31, 2000, 1999 and 1998,
respectively, and are included in operating expenses and corporate general and
administrative expenses. The Company pre-funded the trust $20.0 million in 2000.

F-35

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

For the years ended December 31, 1999 and 1998, the workers' compensation
insurance was a guaranteed cost program, and thus, after payment of the premium
in those years, risk was fully transferred to the third party insurance carrier.
Subsequent to December 31, 1999, 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 2001 and 2000 policies provide coverage above $250,000 per claim. An
actuarial analysis of losses at this retention amount was completed. The
expected losses were funded on a quarterly basis in full during 2000 and are
expected to be funded on a quarterly basis during 2001. Total undiscounted
expected losses and costs under this retention level were determined to be
approximately $32.0 million as of December 31, 2000. For years prior to 1998 in
which the Company carried various forms of workers' compensation insurance,
aggregate losses are provided on a fully developed basis, including any incurred
but not reported claims. The reserve for such workers' compensation risks is
approximately $14.2 million and $25.9 million as of December 31, 2000 and 1999,
respectively. Provisions for such risks totaled approximately $27.4 million,
$30.9 million and $27.8 million for the years ended December 31, 2000, 1999 and
1998, respectively, and are included in operating expenses and corporate general
and administrative expenses. Cash paid for claims during 2000 was approximately
$15.3 million.

(E) CONSTRUCTION COMMITMENTS

As of December 31, 2000, the Company had construction commitments under
various contracts of approximately $1.0 million under various contracts in the
United States. These items 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, 2000.

(F) 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)).

F-36

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(11) INCOME TAXES

Income tax expense (benefit) on losses before extraordinary loss consists
of the following for the years ended December 31 (in thousands):

2000 1999 1998
---- ---- ----

Current:
Federal........................................................... $ - $ (4,913) $ 10,009
State............................................................. 256 120 6,470
Foreign........................................................... - 41 (323)
--------------- -------------- -------------
256 (4,752) 16,156
--------------- -------------- -------------
Deferred:
Federal........................................................... - 4,076 19,653
State............................................................. - 837 19,926
Foreign........................................................... - - (2,158)
--------------- -------------- -------------
- 4,913 37,421
--------------- -------------- -------------
Total............................................................. $ 256 $ 161 $ 53,577
=============== ============== =============

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

2000 1999 1998
---- ---- ----

Computed expected tax benefit..................................... $ (190,909) $ (381,254) $ (241,445)
Adjustments in income taxes resulting from:
Amortization of goodwill........................................ 2,067 5,036 9,439
Impairment loss................................................. 31,641 94,978 89,333
Increase in valuation allowance................................. 88,889 311,708 115,478
Loss on sale of subsidiary stock................................ - - 4,340
Legal and regulatory matters.................................... 3,261 - 5,847
Loss (loss reversal) on planned asset dispositions.............. 81,257 (21,236) 59,714
State income tax (benefit) expense, net of Federal income tax
impact........................................................ (18,795) (12,863) 4,044
Other........................................................... 2,845 3,792 6,827
---------------- ---------------- --------------
$ 256 $ 161 $ 53,577
================ ================ ==============

F-37

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

Deferred tax assets (liabilities) were comprised of the following as of
December 31 (in thousands):

2000 1999
---- ----

Accounts and notes receivable............................................... $ 72,679 $ 78,117
Accrued liabilities......................................................... 56,655 54,002
Property and equipment...................................................... 71,232 100,928
Intangible assets........................................................... 69,120 76,938
Carryforward of deductions limited by Internal Revenue Code
Section 382............................................................. 6,250 6,250
Write-down of assets held for sale.......................................... 69,967 13,591
Deferred income............................................................. 1,374 1,118
Partnership investments..................................................... 4,229 5,505
Alternative minimum tax credit.............................................. 7,873 5,712
Jobs and other tax credit carryforwards..................................... 6,517 6,075
Capital loss carryforwards.................................................. 19,272 4,127
Federal net operating loss carryforwards.................................... 162,061 126,844
State net operating loss carryforwards...................................... 44,570 25,609
United Kingdom trading loss carryforwards................................... 14,846 12,911
United Kingdom capital loss carryforwards................................... 1,142 1,238
Property and equipment attributable to United Kingdom operations............ 3,851 4,175
Other....................................................................... 4,323 4,157
--------------- ----------------
615,961 527,297
--------------- ----------------
Less valuation allowance:
Federal..................................................................... (492,472) (420,215)
State....................................................................... (99,914) (85,064)
United Kingdom.............................................................. (21,854) (20,072)
--------------- ----------------
(614,240) (525,351)
--------------- ----------------
Total deferred tax assets..................................................... 1,721 1,946
--------------- ----------------
Deferred tax liabilities:
Changes in certain subsidiaries' methods of accounting for income taxes (1,721) (1,936)
Other....................................................................... - (10)
--------------- ----------------
(1,721) (1,946)
--------------- ----------------
Deferred taxes, net........................................................... $ - $ -
=============== ================

F-38

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

The Company has Federal net operating loss ("NOL") carryforwards of $463.0
million with expiration dates from 2004 through 2020. Various subsidiaries have
state NOL carryforwards totaling $933.1 million with expiration dates through
the year 2020. In addition, the Company has capital loss carryforwards of $55.7
million, of which $5.1 million will expire in 2001 and $50.6 million will expire
in 2004. The United Kingdom trading loss carryforwards of $49.5 million and the
alternative minimum tax credit carryforwards of $7.9 million have no expiration
dates. The $6.5 million of other tax credit carryforwards will expire in years
2001 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 2000 and 1999, the Company increased the valuation allowance by $88.9
million and $311.7 million, respectively, to fully reserve for deferred tax
assets which may not be realized. The increase to the valuation allowance in
1999 included $32.5 million 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 this acquisition.

(12) SUPPLEMENTARY INFORMATION RELATING TO STATEMENTS OF CASH FLOWS

Supplementary information for the consolidated statements of cash flows is
set forth below for the years ended December 31 (in thousands):

2000 1999 1998
---- ---- ----

Cash paid during the year ended December 31 for:
Interest, net of $82, $1,124 and $1,792 capitalized during
2000, 1999 and 1998, respectively.................................. $ 29,826 $ 49,710 $ 143,850
Income taxes paid (refunded)....................................... (3,022) (47,974) 23,869

The Company's acquisitions during 2000, 1999 and 1998
involved the following for the years ended December 31 (in thousands):

2000 1999 1998
---- ---- ----

Fair value of assets acquired....................................... $ 29,475 $ 6,781 $ 578,333
Liabilities assumed................................................. (28,501) (1,050) (356,268)
Fair value of stock and warrants issued............................. - - (161,424)
--------- -------- ---------
Cash payments made, net of cash received from others................ $ 974 $ 5,731 $ 60,641
========= ======== =========

F-39

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(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):

2000 1999
---- ----
Carrying Carrying
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------

Cash and cash equivalents.......................... $ 37,589 $ 37,589 $ 25,047 $ 25,047
Long-term debt including current portion and
amounts subject to compromise:
Practicable to estimate fair value............... 1,494,211 550,161 1,502,476 539,536
Convertible Trust Issued Preferred Securities (CTIPS) 296,101 - 322,978 -

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 CTIPS 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% CTIPS with a liquidation
amount of $25.00 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, the Company exercised its right to defer cash
distributions. As cash distributions are deferred, dividends on the CTIPS will
continue to accrue.

During 2000, approximately $26.9 million of CTIPS were converted into
approximately 1.3 million shares of common stock. During 1999, $22.0 million of
CTIPS were converted into approximately 1.1 million shares of common stock.

The Company's agreement in principle with representatives of its bank
lenders and other creditors indicated that the CTIP holders will receive no
recovery in connection with the Company's restructuring, which adversely
impacted the fair value of the CTIPS. The Company's 2000 statement of losses
excludes the dividends as the fair value of the dividends was immaterial.

F-40

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(15) CAPITAL STOCK

(A) COMMON STOCK REPURCHASE

In 1999 and 1998, the Company repurchased 88,669 and 71,661 shares of its
outstanding common stock at a cost of $0.4 million and $1.4 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.

(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 vest 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 are accounted for as variable options.

As of December 31, 2000, options for 862,603 shares were outstanding,
options for 544,436 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. As of December 31, 2000 all
RCA and Contour stock options for shares expired.

No restricted stock awards were made in 2000 or 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.

F-41

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

DIRECTOR STOCK PLANS

The Company had stock plans for nonemployee directors, which provided for
grants of nonqualified options and stock awards. Between 1997 and 2000,
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 2000 and 1999 as annual meetings were not held during 2000 and
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 2000 or
1999. As of December 31, 2000, options for 93,000 shares were outstanding and
options for 81,752 shares vested.

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, 2000, 1999 and 1998, and changes during the years ended (shares in
thousands):

2000 1999 1998
---------------------------- ----------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
------ -------------- ------ -------------- ------ --------------

Outstanding at beginning of year 1,368 $9.00 4,748 $16.75 3,339 $16.90
Granted:
Price equals fair value.......... - - 910 1.91 2,781 15.54
Exercised.......................... - - - - (37) 13.96
Cancelled.......................... (512) 10.14 (4,290) 15.92 (1,335) 14.44
--------- ---------- ----------

Outstanding at year-end............ 856 8.25 1,368 9.00 4,748 16.75
========= ========== ==========

Options exercisable at year-end 544 11.43 591 15.01 2,334 17.17
========= ========== ==========

Options available for future grant 10,905 10,393 7,013
========= ========== ==========

Weighted average fair value of
options granted during the year N/A $ 1.00 $ 8.02
========= ========== ==========

F-42

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

No options were granted in 2000. The fair value of each option granted in
1999 and 1998 is estimated at the date of grant using the Black-Scholes option
pricing model with the following weighted-average assumptions:

1999 1998
---- ----

Expected Life (in years).......................................................... 4 4
Risk-free Interest Rate........................................................... 5.4% 5.5%
Expected Volatility............................................................... 76.0% 66.0%
Dividend Yield.................................................................... - -

Had compensation cost for the Company's 1999 and 1998 option grants been
determined consistent with SFAS 123 (see Note 3, which describes that SFAS 123
establishes fair value as the measurement basis for stock-based awards), the
Company's net losses and net losses per share for 2000, 1999 and 1998 would
approximate the pro forma amounts below (in thousands, except per share data):

2000 1999 1998
---------------------------------------------------------------------------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- --------- ----------- ---------

Net losses................ $ (545,711) $ (547,039) $(1,089,458) $(1,091,129) $ (753,693) $ (759,169)
Net losses per share:
Basic................... $ (9.04) $ (9.06) $ (18.40) $ (18.28) $ (14.29) $ (14.40)
Diluted................. $ (9.04) $ (9.06) $ (18.62) $ (18.65) $ (14.49) $ (14.60)

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.

F-43

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

The following table summarizes information about stock options outstanding
as of December 31, 2000 (shares in thousands):

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

$ 1.06 - $ 9.50........ 508 7.86 $ 2.47 223 $ 3.87
11.00 - 15.84........ 136 4.08 13.02 134 13.01
16.44 - 19.44........ 144 5.79 17.59 119 17.73
20.13 - 24.00........ 68 5.35 22.04 68 22.04
----------- ----------
856 544
=========== ==========

(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 of the Company's common stock
as of December 31, 2000 and 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 confirmed by the Bankruptcy
Court provides that the Trust will hold the new equity to be issued pursuant to
the plan of reorganization, the Trust will most likely be terminated. Upon the
termination of the Trust, the debt it owes to the Company will be forgiven.

F-44

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(16) EARNINGS PER SHARE

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, include 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, 2000, 1999 and 1998, the Company's stock
options and convertible debentures were anti-dilutive.

F-45

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

2000 1999 1998
---- ---- ----

BASIC:
Losses before extraordinary loss and cumulative effect of
change in accounting principle............................... $ (545,711) $ (1,076,642) $ (743,419)
Extraordinary loss............................................. - - (10,274)
Cumulative effect of change in accounting principle............ - (12,816) -
-------------- ------------- -------------
Net losses..................................................... (545,711) (1,089,458) (753,693)
============== ============= =============
Weighted average shares outstanding............................ 60,347 58,504 52,008
============== ============= =============
Losses per share:
Net losses before extraordinary loss and cumulative effect
of change in accounting principle.......................... $ (9.04) $ (18.40) $ (14.29)
Extraordinary loss............................................. - - (0.20)
Cumulative effect of change in accounting principle............ - (0.22) -
-------------- ------------ ------------
Net losses................................................... $ (9.04) $ (18.62) $ (14.49)
============== ============ ============
DILUTED:
Losses before extraordinary loss and cumulative effect of
change in accounting principle used in basic calculation..... $ (545,711) $ (1,076,642) $ (743,419)
Extraordinary loss............................................. - - (10,274)
Cumulative effect of change in accounting principle............ - (12,816) -
---------------- --------------- ---------------
Net losses..................................................... $ (545,711) $(1,089,458) $ (753,693)
================ =============== ===============
LOSSES PER SHARE:
Losses before extraordinary loss and cumulative effect
of change in accounting principle.......................... $ (9.04) $ (18.40) $ (14.29)
Extraordinary loss............................................. - - (0.20)
Cumulative effect of change in accounting principle............ - (0.22) -
---------------- --------------- ---------------
Net losses................................................... $ (9.04) $ (18.62) $ (14.49)
================ =============== ===============

Weighted average shares used in basic calculation.............. 60,347 58,504 52,008
---------------- --------------- ---------------
Weighted average common and common equivalent shares
outstanding used in dilutive calculation..................... 60,347 58,504 52,008
================ =============== ===============

F-46

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(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 15.0% or more of the
Company's outstanding 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
Company's outstanding common stock. The Rights may be redeemed by the Company at
a price of $.001 per Right before their expiration on June 2, 2005.

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 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 will be cancelled along with the existing common
stock.

(18) OTHER EVENTS

(A) LITIGATION

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 U.S. Bankruptcy Court for the District of
Delaware (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.

F-47

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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, except that the parties have agreed to conduct limited
discovery. In September 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 extension of the bar date for
their class members. Plaintiffs filed claims in the pending Chapter 11 cases in
the amount of $780.0 million in the SunDance Action and $242.0 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.

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. Pursuant to an agreement among the parties, the Company was
dismissed without prejudice in December 2000. Although the Company intends to
vigorously defend the individual defendants in this matter who are indemnified
by the Company, 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.

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
treatments 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-48

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

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
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 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.

Various government agencies and the Company have been having ongoing
discussions and the Company expects to enter into a global settlement of these
investigations. As part of such settlement, the DOJ and HCFA are seeking, among
other things, (i) a monetary payment to the government, (ii) the Company's
release of all claims for reimbursement against the government for services
rendered prior to October 14, 1999, which is estimated to be approximately $80.1
million, of which amount the Company has agreed to the release of $17.1 million
of claims related to divested facilities and (iii) a corporate integrity
agreement between the Company and 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. The Company is unable to determine at this time whether a
settlement, if any, or any other outcome of the investigations will have a
material adverse effect on the Company's financial condition or results of
operations.

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-49

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(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):

AS OF DECEMBER 31
2000 1999
---- ----

Current assets.................................................... $ 73,060 $ 78,726
Noncurrent assets................................................. 76,668 145,922
Current liabilities............................................... 8,720 8,765
Noncurrent liabilities............................................ 50,632 53,130
Due to parent..................................................... 231,487 291,150

F-50

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

YEAR ENDED DECEMBER 31
-------------------------------------------------
2000 1999 1998
---- ---- ----

Net revenues................................................... $ 441,929 $ 442,914 $ 581,288
Costs and expenses............................................. (438,707) (426,418) (546,833)
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. 3,222 (73,822) (113,535)
Intercompany charges (1)....................................... (15,939) (94,759) (75,376)
--------------- --------------- -------------
Losses before income taxes..................................... (12,717) (168,581) (188,911)
Income tax benefit (expense)................................... - (32) 3,619
--------------- --------------- -------------
Net income (losses)............................................ $ (12,717) $ (168,613) $(185,292)
=============== =============== =============

(1) Through various intercompany agreements entered into by the Company and
Mediplex, the Company provides management services, licenses the use of its
trademarks and acts on behalf of Mediplex to make financing available for
its operations. The Company charged Mediplex for management services
totaling approximately $13.4 million, $14.9 million and $23.0 million for
the years ended December 31, 2000, 1999 and 1998, respectively. Royalty
fees charged to Mediplex for the years ended December 31, 1999 and 1998,
for the use of the Company's trademarks were approximately $7.0 million and
$10.8 million, respectively. The Company discontinued charging Mediplex for
royalty fees as of December 31, 1999. Intercompany interest charged to
Mediplex for the years ended December 31, 2000, 1999 and 1998, for advances
from the Company was approximately $2.6 million, $72.9 million and $41.6
million, respectively. The Company discontinued charging Mediplex for
interest during 2000 due to the chapter 11 filing.

F-51

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(20) QUARTERLY FINANCIAL DATA (UNAUDITED)

The following tables reflects unaudited quarterly financial data for fiscal
years 2000 and 1999 (in thousands per share data):

YEAR ENDED DECEMBER 31, 2000
-------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------

Total net revenues........................................ $ 637,992 $ 620,954 $ 607,722 $ 592,260
=============== ============== ============== ============
Losses before income taxes and cumulative effect of
change in accounting principle.......................... $ (165,607) $ (31,387) $ (132,250) $(216,214)
=============== ============== ============== ============
Net losses before cumulative effect of change in
accounting principle.................................... $ (165,661) $ (31,445) $ (132,360) $(216,245)
=============== ============== ============== ============

Cumulative effect of change in accounting principle....... $ - $ - $ - $ -
=============== ============== ============== ============
Net losses............................................... $ (165,661) $ (31,445) $ (132,360) $(216,245)
=============== ============== ============== ============
Net losses per common and common equivalent share:
Net losses before cumulative effect of change in
accounting principle (1):
Basic................................................... $ (2.78) $ (0.54) $ (2.18) $ (3.56)
=============== ============== ============== ============
Diluted................................................. $ (2.78) $ (0.54) $ (2.18) $ (3.56)
=============== ============== ============== ============

Net losses (1):
Basic................................................... $ (2.78) $ (0.54) $ (2.18) $ (3.56)
=============== ============== ============== ============
Diluted................................................. $ (2.78) $ (0.54) $ (2.18) $ (3.56)
=============== ============== ============== ============

F-52

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

YEAR ENDED DECEMBER 31, 1999
-------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------

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)
=============== ============== ============== ============
__________

(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").

F-53

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(21) SEGMENT INFORMATION

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 provided services in 2000,
1999 and 1998 to the United Kingdom, Spain, Germany and Australia.

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.

At December 31, 2000, the Company operated 303 long-term care facilities
with 33,363 licensed beds as compared with 354 facilities with 39,867 licensed
beds at December 31, 1999. At December 31, 2000, the Company had identified 35
facilities with 4,071 licensed beds for divestiture in 2001.

REHABILITATION AND RESPIRATORY THERAPY SERVICES: This segment provides,
among other services, physical, occupational, speech and respiratory therapy
supplies and services to affiliated and nonaffiliated skilled nursing
facilities.

At December 31, 2000, this segment provided services to 942 facilities, 652
nonaffiliated and 290 affiliated, as compared to 1,531 facilities at December
31, 1999, of which 1,158 were nonaffiliated and 373 were affiliated.

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. The Company is currently soliciting offers for its respiratory
therapy services.

This segment provided services to 1,520 facilities at December 31, 2000
compared with 2,507 facilities at December 31, 1999. Of the 1,520 facilities in
2000, 1,196 were nonaffiliated facilities and 324 were affiliated as compared to
1,805 nonaffiliated facilities and 702 affiliated facilities in 1999.

INTERNATIONAL OPERATIONS: This segment consists of long-term care
facilities in the United Kingdom and Germany. This segment also provides
pharmaceutical services in the United Kingdom and Germany. The Company sold
certain of the Canadian operations in 1998 and the remainder in the first
quarter of 1999. During 2000, the Company sold 18 pharmacies in the United
Kingdom and its operations in Spain.

F-54

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

In June 2000, the Australian business division was placed in receivorship
by its secured creditors. The Company no longer has management authority over
the operating unit. At the time of receivorship, the Company held a 38.2% equity
interest in Alpha Healthcare Limited, a publicly held acute care provider in
Australia that operated 10 facilities with 629 licensed beds. The Company also
operated 5 hospitals with 335 licensed beds in Australia. In February 2001, the
operations in the United Kingdom were sold to a group comprised of certain
former members of the Company's international senior management team.

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

The accounting policies of the segments are the same as those described in
the Note 3 - "Summary of Significant Accounting 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 the 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 and restructuring costs 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 estimated 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.

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-55

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

The following tables summarize, for the years indicated, operating results
and other financial information, by business segment (in thousands):

REHABILITATION PHARMACEUTICAL
AND AND
RESPIRATORY MEDICAL
INPATIENT THERAPY SUPPLY INTERNATIONAL OTHER INTERSEGMENT
SERVICES SERVICES SERVICES OPERATIONS OPERATIONS CORPORATE ELIMINATIONS CONSOLIDATED
-------- -------- -------- ---------- ---------- --------- ------------ ------------

FOR THE YEAR ENDED DECEMBER 31, 2000
Total Net Revenues......... $1,718,178 $ 204,367 $ 299,897 $ 265,501 $ 182,809 $ 1,381 $(213,205) 2,458,928
Operating expenses,
corporate general and
administrative expenses,
and provision for losses 1,649,920 170,722 282,443 261,814 181,056 84,171 (213,074) 2,417,052
on accounts receivable...
Depreciation and 20,192 3,023 5,931 2,502 4,010 10,354 (131) 45,881
amortization.............
Interest, net.............. 10,567 188 56 12,989 1,417 9,052 - 34,269
Dividends on Preferred
Securities - - - - - - - -
---------- ------------- --------------- ----------- ---------- ---------- ----------- ----------
Losses before corporate 37,499 30,434 11,467 (11,804) (3,674) (102,196) - (38,274)
allocations..............
Corporate interest 24,443 8,946 9,799 7,902 6,602 (57,692) - -
allocation...............
Corporate management fees.. 42,395 5,097 7,116 1,815 4,406 (60,829) - -
---------- ------------- --------------- ----------- ---------- ---------- ----------- ----------
Net segment losses......... $(29,339) $ 16,391 $ (5,448) $ (21,521) $(14,682) $ 16,325 $ - $ (38,274)
========== ============= =============== =========== ========== ========== =========== ==========
Intersegment revenues...... $ 601 $ 113,265 $ 88,295 $ - $ 10,716 $ 328 $(213,205) $ -
Identifiable segment assets $ 234,735 $ 48,018 $ 40,785 $ 83,826 $ 80,211 $1,011,775 $(649,362) $ 849,988
Segment capital
expenditures, net.......... $ 24,781 $ 289 $ 994 $ 4,590 $ 3,172 $ 21,540 $ - $ 55,366

FOR THE YEAR ENDED DECEMBER 31, 1999
Total Net Revenues.........$1,697,518 $ 234,008 $ 300,959 $ 296,906 $ 222,219 $ - $(222,571) $2,529,039
Operating expenses,
corporate general and
administrative expenses,
and provision for losses
on accounts receivable... 1,789,570 248,027 299,068 290,272 237,054 116,315 (219,705) 2,760,601
Depreciation and 29,025 7,173 7,043 12,805 12,911 12,584 (216) 81,325
amortization.............
Interest, net.............. 9,773 305 76 13,191 6,902 98,807 - 129,054
Dividends on Preferred
Securities - - - - - 20,407 - 20,407
---------- ------------- --------------- ----------- ---------- ---------- ----------- ----------
Earnings (losses) before
corporate allocations.... (130,850) (21,497) (5,228) (19,362) (34,648) (248,113) (2,650) (462,348)
Corporate interest
allocation............... 42,793 12,868 12,613 19,550 10,166 (97,990) - -
Corporate management fees.. 71,611 9,455 11,792 2,966 6,733 (99,907) (2,650) -
---------- ------------- --------------- ----------- ---------- ---------- ----------- ----------
Net segment earnings
(losses).................$(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) $3,088,460
Operating expenses,
corporate general and
administrative expenses,
and provision for losses
on accounts receivable... 1,970,887 458,464 232,219 264,927 280,000 137,809 (450,804) 2,893,502
Depreciation and
amortization............. 41,223 9,727 10,755 19,296 8,968 12,546 - 102,515
Dividends on Preferred
Securities - - - - - 16,163 - 16,163
Interest, net.............. 6,422 (18) 409 19,412 3,853 105,333 - 135,411
---------- ------------- --------------- ----------- ---------- ---------- ----------- ----------
Earnings (losses) before
corporate allocations.... 26,738 210,630 11,072 (18,368) (9,495) (271,851) (7,857) (59,131)
Corporate interest 49,683 16,300 10,653 22,844 8,992 (108,472) - -
allocation...............
Corporate management fees
allocation............... 86,777 34,486 10,148 2,694 (718) (125,530) (7,857) -
---------- ------------- --------------- ----------- ---------- ---------- ----------- ----------
Net segment earnings
(losses).................$(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

F-56

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

The following tables reconcile net segment losses to consolidated losses
before reorganization items, income taxes, extraordinary items and cumulative
effect of change in accounting principle:

FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
----------------- ----------------- -----------------

Net segment losses............................... $ (38,274) $ (462,348) $ (59,131)
Legal and regulatory matters, net................ (2,480) (38) (22,456)
Gain (loss) on sale of assets, net............... 21,400 (78,673) (206,205)
Loss on termination of interest rate swaps....... - (2,488) -
Impairment losses................................ (191,316) (457,449) (397,492)
Restructuring costs.............................. 1,090 (27,353) (4,558)
Reorganization costs, net........................ (335,875) (48,132) -
---------------------- --------------------- --------------------
Losses before income taxes, extraordinary loss and
cumulative effect of change in accounting principle $ (545,455) $(1,076,481) $(689,842)
====================== ===================== ====================

(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-57

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

Through various intercompany agreements entered into by the Company, the
Guarantors and certain of the non-Guarantor subsidiaries, the Company 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 $118.9 million, $99.2 million and $124.9 million for the years
ended December 31, 2000, 1999 and 1998, respectively. The Company charged the
non-Guarantor subsidiaries for management services totaling approximately $3.6
million, $1.1 million and $4.4 million for the years ended December 31, 2000,
1999 and 1998, respectively. Intercompany interest charged to the Guarantors for
the years ended December 31, 1999 and 1998 for advances from the Company were
approximately $78.0 million and $190.5 million, respectively. Intercompany
interest charged to the non-Guarantor subsidiaries for the years ended December
31, 1999 and 1998 for advances from the Company was approximately $0.4 million
and $3.8 million, respectively. The Company did not charge the Guarantors
intercompany interest during 2000 due to the Chapter 11 filings.

F-58

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 2000
(IN THOUSANDS)

COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------- ------------ ------------ ----------- ------------

Current assets:
Cash and cash equivalents................... $ 31,319 $ 938 $ 5,332 $ - $ 37,589
Accounts receivable, net.................... - 189,216 7,485 (1,339) 195,362
Inventory, net.............................. - 22,389 287 - 22,676
Prepaids and other assets................... 367 4,198 128 - 4,693
Other receivables, net...................... 291,679 (186,677) (98,106) - 6,896
--------------- --------------- ---------------- ------------- --------------
Total current assets......................... 323,365 30,064 (84,874) (1,339) 267,216
Goodwill, net.................................. - 187,781 224 - 188,005
Property and equipment, net.................... 63,643 100,888 15,754 - 180,285
Assets held for sale........................... - 17,567 138,775 - 156,342
Notes receivable, net.......................... - 14,554 - - 14,554
Other assets, net.............................. 13,968 26,951 2,667 - 43,586
Investment in subsidiaries..................... (1,711,962) - - 1,711,962 -
--------------- --------------- ---------------- ------------- --------------
Total assets................................. $ (1,310,986) $ 377,805 $ 72,546 $ 1,710,623 $ 849,988
=============== =============== ================ ============= ==============

Current liabilities:
Accrued compensation and benefits........... $ 25,640 $ 60,461 $ 15,876 $ - $ 101,977
Current portion of long-term debt........... 67,027 187 18,825 - 86,039
Accrued self-insurance obligations.......... (5,429) 54,315 1,851 - 50,737
Accounts payable............................ 10,835 17,006 11,024 (1,339) 37,526
Income taxes payable........................ 21,562 (8,159) (75) - 13,328
Accrued interest............................ - 7,437 351 - 7,788
Current portion of obligations under capital
leases.................................... - (28) 276 - 248
Other accrued liabilities................... 50,712 68,322 12,159 - 131,193
--------------- --------------- ---------------- ------------- --------------
Total current liabilities.................... 170,347 199,541 60,287 (1,339) 428,836
Liabilities subject to compromise (see Note 2). 1,426,821 103,008 99 - 1,529,928
Long-term debt, net of current portion......... - 6,797 47,414 - 54,211
Obligations under capital leases, net of current
portion...................................... - 91 53,462 - 53,553
Other long-term liabilities.................... - 25,953 784 - 26,737
--------------- --------------- ---------------- ------------- --------------
Total liabilities............................ 1,597,168 335,390 162,046 (1,339) 2,093,265
Intercompany payables/(receivables)............ (1,683,881) 1,710,218 (26,337) - -
Commitments and contingencies
Minority interest.............................. - 6,062 (102) - 5,960
Company-obligated manditorily redeemable
convertible preferred securities of a
subsidiary trust holding solely 7% convertible
junior subordinated debentures of the Company 296,101 - - - 296,101
Total stockholders' equity (deficit)........... (1,520,374) (1,673,865) (63,061) 1,711,962 (1,545,338)
--------------- --------------- ---------------- ------------- --------------
Total liabilities and stockholders' equity
(deficit).................................... $ (1,310,986) $ 377,805 $ 72,546 $ 1,710,623 $ 849,988
=============== =============== ================ ============= ==============

F-59

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)

COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------- ------------ ------------ ----------- ------------

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 - 107 326 - 433
leases.......................................
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 322,978 - - - 322,978
Total stockholders' equity (deficit)........... (1,023,000) (1,316,682) 74,369 1,242,313 (1,023,000)
--------------- --------------- ---------------- ------------- --------------
Total liabilities and stockholders' equity
(deficit).................................... $ (785,192) $ 741,046 $ 242,260 $ 1,240,374 $ 1,438,488
=============== =============== ================ ============= ==============

F-60

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, 2000
(IN THOUSANDS)

COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------- ------------ ------------ ----------- ------------

Total net revenues.......................... $ 881 $ 2,143,507 $ 322,650 $ (8,110) $ 2,458,928
--------------- --------------- ---------------- --------------- ---------------
Costs and expenses:
Operating costs.......................... - 1,931,628 306,905 (8,110) 2,230,423
Impairment loss.......................... - 191,199 117 - 191,316
Corporate general and administrative..... 82,239 56,452 14,442 - 153,133
Depreciation and amortization............ 9,515 33,698 2,668 - 45,881
Interest, net (contractual interest
expense of $146,406)................... 8,503 12,300 13,466 - 34,269
Provision for losses on accounts
receivable............................. - 32,639 857 - 33,496
Legal and regulatory matters, net........ 15 2,465 - - 2,480
Restructuring costs...................... (400) (690) - - (1,090)
(Gain) loss on sale of assets, net....... (1,026) (20,380) 6 - (21,400)
Equity interest in losses of subsidiaries 487,149 - - (487,149) -
Intercompany interest expense (income) .. (49,786) 48,696 1,090 - -
--------------- --------------- ---------------- --------------- ---------------
Total costs and expenses before
reorganization items................... 536,209 2,288,007 339,551 (495,259) 2,668,508
--------------- --------------- ---------------- --------------- ---------------

Intercompany charges........................ (72,797) 70,244 2,553 - -
--------------- --------------- ---------------- --------------- ---------------
Losses before reorganization costs and
income taxes.............................. (462,531) (214,744) (19,454) 487,149 (209,580)
Reorganization costs, net................... 82,953 142,470 110,452 - 335,875
Income taxes................................ 227 - 29 - 256
=============== =============== ================ =============== ===============

Net losses............................... $ (545,711) $ (357,214) $ (129,935) $ 487,149 $ (545,711)
=============== =============== ================ =============== ===============

F-61

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)

COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------- ------------ ------------ ----------- ------------

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)
=============== =============== ================ =============== ===============

F-62

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, 1998
(IN THOUSANDS)

COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------- ------------ ------------ ----------- ------------

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
administrative.................. 122,081 41,144 17,709 - 180,934
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)
============ ============== ================ ============== ==============

F-63

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, 2000
(IN THOUSANDS)

COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------- ------------ ------------ ----------- ------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net losses.................................... $ (545,711) $ (357,214) $ (129,935) $ 487,149 $ (545,711)
Adjustments to reconcile net losses to net
cash provided by (used for) operating
activities:
Equity interest in losses of subsidiaries 487,149 - - (487,149) -
Impairment loss......................... - 191,199 117 - 191,316
Depreciation and amortization........... 9,515 33,698 2,668 - 45,881
Provision for losses on accounts
receivable............................. - 32,639 857 - 33,496
Legal and regulatory costs.............. - 1,245 - - 1,245
(Gain) Loss on sale of assets, net...... (1,026) (20,380) 6 - (21,400)
Reorganization costs, net............... 96,963 128,460 110,452 - 335,875
Other, net.............................. 36,014 (86,056) 29,856 - (20,186)
Changes in operating assets and liabilities:
Accounts receivable........................ - (8,699) (10,021) - (18,720)
Other current assets....................... 25,043 21,638 (35,652) - 11,029
Other current liabilities.................. (3,203) 11,514 (7,452) - 859
Income tax payables........................ 4,064 895 (2,844) - 2,115
-------------- --------------- ----------------- ---------------- --------------
Net cash provided by (used for) operating
activities before reorganization costs...... 108,808 (51,061) (41,948) - 15,799
Net cash paid for reorganization costs........ - (17,520) - - (17,520)
-------------- --------------- ----------------- ---------------- --------------
Net cash provided by (used for) operating
activities.................................. 108,808 (68,581) (41,948) - (1,721)
-------------- --------------- ----------------- ---------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures, net..................... (21,540) (26,696) (7,130) - (55,366)
Acquisitions, net of cash acquired............ - 2,987 21,993 - 24,980
Proceeds from sale of assets held for sale.... - (974) - - (974)
(Increase) Decrease in long-term notes - (7,479) 1,391 - (6,088)
receivable..................................
Decrease in other assets...................... 5,536 - - - 5,536
-------------- --------------- ----------------- ---------------- --------------
Net cash provided by (used for) investing
activities.................................. (16,004) (32,162) 16,254 - (31,912)
-------------- --------------- ----------------- ---------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under Revolving Credit
Agreement (postpetition) ................... 54,901 - - - 54,901
Long-term debt borrowings..................... 6,103 - 3,564 - 9,667
Long-term debt repayments (prepetition)....... - - (14,663) - (14,663)
Principal payments on prepetition debt
authorized by Bankruptcy Court.............. (56) (3,350) - - (3,406)
Other financing activities.................... (6) 34 (32) - (4)
Intercompany advances......................... (135,156) 98,304 36,852 - -
-------------- --------------- ----------------- ---------------- --------------
Net cash (used for) provided by financing
activities.................................. (74,214) 94,988 25,721 - 46,495
-------------- --------------- ----------------- ---------------- --------------
Effect of exchange rate on cash and cash
equivalents................................. (320) - - - (320)
-------------- --------------- ----------------- ---------------- --------------
Net increase (decrease) in cash and cash
equivalents................................. 18,270 (5,755) 27 - 12,542
Cash and cash equivalents at beginning of
period...................................... 13,049 6,693 5,305 - 25,047
-------------- --------------- ----------------- ---------------- --------------
Cash and cash equivalents at end of period.... 31,319 938 5,332 - 37,589
============== =============== ================= ================ ==============

F-64

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)

COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------- ------------ ------------ ----------- ------------

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) -
Loss on sale of assets, net............. 9,760 52,131 16,782 - 78,673
Cumulative effect of change in 3,069 9,351 396 - 12,816
accounting principle.................
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 1,911 120,820 486 - 123,217
receivable............................
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 44,641 (30,414) 1,630 - 15,857
receivable..................................
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
============== =============== ================= ================ ==============

F-65

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)

COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------- ------------ ------------ ----------- ------------

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

F-66

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 2000
(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 the years ended after the Filing
Date:

ASSETS
FILERS NON-FILERS ELIMINATION CONSOLIDATED
------ ---------- ----------- ------------

Current assets:
Cash and cash equivalents................................... $ 32,600 $ 4,989 $ - $ 37,589
Accounts receivable, net.................................... 188,366 7,415 (419) 195,362
Inventory, net.............................................. 21,726 950 - 22,676
Prepaids and other assets................................... 4,653 40 - 4,693
Other receivables, net...................................... 104,808 (97,912) - 6,896
------------- ------------ ------------- --------------
Total current assets........................................ 352,153 (84,518) (419) 267,216

Goodwill, net................................................. 187,781 224 - 188,005
Property and equipment, net................................... 164,433 15,852 - 180,285
Assets held for sale.......................................... 17,567 138,775 - 156,342
Notes receivable, net......................................... 14,554 - - 14,554
Other assets, net............................................. 38,385 5,201 - 43,586
Investment in subsidiaries.................................... (57,143) - 57,143 -
------------- ------------ ------------- --------------
Total assets................................................ $ 717,730 $ 75,534 $ 56,724 $ 849,988
============= ============ ============= ==============

F-67

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 2000
(IN THOUSANDS EXCEPT SHARE DATA)

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

FILERS NON-FILERS ELIMINATION CONSOLIDATED
------ ---------- ----------- ------------

Current liabilities:
Accrued compensation and benefits............................. 86,259 15,718 - 101,977
Current portion of long-term debt............................. $ 67,208 $ 18,831 $ - $ 86,039
Accrued self-insurance obligations............................ 50,125 612 - 50,737
Accounts payable.............................................. 26,736 11,209 (419) 37,526
Income taxes payable.......................................... 13,328 - - 13,328
Accrued interest.............................................. 7,438 350 - 7,788
Current portion of obligations under capital leases........... - 248 - 248
Other accrued liabilities..................................... 118,853 12,340 - 131,193
------------- -------------- ------------- ---------------
Total current liabilities..................................... 369,947 59,308 (419) 428,836

Liabilities subject to compromise (see Note 2).................. 1,529,928 - - 1,529,928
Long-term debt, net of current portion.......................... 6,797 47,414 - 54,211
Obligations under capital leases, net of current portion........ - 53,553 - 53,553
Other long-term liabilities..................................... 25,953 784 - 26,737
------------- -------------- ------------- ---------------
Total liabilities............................................. 1,932,625 161,059 (419) 2,093,265

Commitments and contingencies
Minority interest............................................... 3,146 2,814 - 5,960
Company-obligated mandatorily redeemable convertible preferred
securities of a subsidiary trust holding solely 7%
convertible junior subordinated debentures of the Company..... 296,101 - - 296,101
Intercompany.................................................... 31,164 (31,195) 31 -
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 64,911,264
outstanding as of December 31, 2000........................... 649 2,568 (2,568) 649
Additional paid-in capital.................................... 825,147 273,696 (273,696) 825,147
Accumulated deficit........................................... (2,331,218) (320,893) 320,893 (2,331,218)
Accumulated other comprehensive loss.......................... (12,483) (12,483) 12,483 (12,433)
------------- -------------- ------------- ---------------
Less:
Common stock held in treasury, at cost, 2,212,983
shares as of December 31, 2000......................... (27,344) (32) - (27,376)
Grantor stock trust, at market, 1,915,935 shares as of
December 31, 2000...................................... (57) - - (57)
------------- -------------- --------------- -------------
Total stockholders' equity (deficit) ......................... (1,545,306) (57,144) 57,112 (1,545,338)
------------- -------------- ------------- ---------------
Total liabilities and stockholders' equity (deficit).......... $ 717,730 $ 75,534 $ 56,724 $ 849,988
============= ============== ============= ===============

F-68

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 the years ended after the Filing
Date:

ASSETS

FILERS NON-FILERS ELIMINATION CONSOLIDATED
------ ---------- ----------- ------------

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

F-69

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)

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

FILERS NON-FILERS ELIMINATION CONSOLIDATED
------ ---------- ----------- ------------

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..... 322,978 - - 322,978
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.................................... 798,305 263,250 (263,250) 798,305
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) ......................... (1,023,000) 69,230 (69,230) (1,023,000)
------------- -------------- ------------- ---------------

Total liabilities and stockholders' equity (deficit).......... $1,227,743 $ 281,003 $ (70,258) $ 1,438,488
============= ============== ============= ===============

F-70

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, 2000
(IN THOUSANDS)

FILERS NON-FILERS ELIMINATION CONSOLIDATED
------ ---------- ----------- ------------

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

F-71

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)

FILERS NON-FILERS ELIMINATION CONSOLIDATED
------ ---------- ----------- ------------

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) -
ntercompany interest expense (income) ......................... 10 (10) - -
-------------- ------------- -------------- ---------------
Total costs and expenses before reorganization items............ 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, net......................................... 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)
============== ============= ============== ===============

F-72

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, 2000
(IN THOUSANDS)

FILERS NON-FILERS ELIMINATION CONSOLIDATED
------ ---------- ----------- ------------

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

F-73

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)

FILERS NON-FILERS ELIMINATION CONSOLIDATED
------ ---------- ----------- ------------

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 costs................................. (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
=============== ============= ============= ============

F-74

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000

(24) SUBSEQUENT EVENTS

From January 2001 through March 15, 2001, the Company divested 10 skilled
nursing facilities with 916 licensed beds. No cash consideration was given to
the Company for these facilities. The aggregate net revenues and aggregate net
operating losses for the twelve months ended December 31, 2000 for the 10
skilled nursing facilities were $41.2 million and $4.4 million, respectively.
See "Note 7 - Impairment of Long-Lived Assets and Assets Held for Sale" in the
Company's consolidated financial statements.

In January 2001, the Company initiated a corporate reorganization plan
focused primarily on reducing the operating expenses related to its headquarters
operations. With consent from the Company's creditors committee, external
consultants were retained to assist in evaluating various functional areas and
identifying opportunities for improvement. Related to this reorganization plan,
the Company had a reduction in force in February 2001, which included the
elimination of approximately 140 positions, primarily in the Company's
Albuquerque-based workforce. Included in the plan was the elimination of
SunSolution, an operating division that provided fee-based consulting services
to nonaffiliated parties and internal consulting to affiliated parties. The
reorganization charges related to this plan through February 2001 were $0.9
million for severance and benefits termination costs.

In January 2001, the Bankruptcy Court, at the request of the Company's
largest stockholder, directed the U.S. Trustee to appoint an examiner to review
the Company's revenue enhancement programs and cost efficiency strategies. The
examiner's scope is to: (i) analyze the revenue projections and reports prepared
for the Company and provide a preliminary report to the Bankruptcy Court on
whether any additional analysis is recommended, and (ii) prepare a plan for the
Company to cut expenses in its business divisions without endangering the health
and safety of any patients or risking the violation of any legal or regulatory
requirements applicable to the Company. The examiner's review is ongoing as of
March 30, 2001.

F-75

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

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

We have audited in accordance with auditing standards generally accepted in
the United States the consolidated financial statements of Sun Healthcare Group,
Inc. (Debtor-in-Possession) and subsidiaries in this Form 10-K and have issued
our report thereon dated March 30, 2001. Our report on the consolidated
financial statements includes an explanatory paragraph with 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
March 30, 2001

SCHEDULE II

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

VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- -------- -------- -------- --------
BALANCE AT CHARGED TO ADDITIONS BALANCE AT
BEGINNING COSTS AND CHARGED TO DEDUCTIONS END OF
DESCRIPTION OF PERIOD EXPENSES OTHER ACCOUNTS OTHER PERIOD
- ----------- --------- -------- -------------- ----- ------

Year ended December 31, 2000:
Allowance for doubtful accounts.... $ 151,841 $ 33,496 (3) $ $ (57,231) $ 128,106
================ ============== ================= ============= ===============
Notes receivable reserve........... $ 6,556 $ $ $ (4,577) $ 1,979 (4)
================ ============== ================= ============= ===============
Reserve for assets held for sale... $ 84,522 $ 288,660 $ $ (139,436) $ 233,746
================ ============== ================= ============= ===============
1998 corporate restructure reserve. $ 1,964 $ (1,090) $ $ (145) $ 729
================ ============== ================= ============= ===============

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 (3)$ 4,844 (3) $ - $ - $ 6,556
================ ============== ================= ============= ===============
Reserve for assets held for sale... $ 159,828 $ 85,758 $ - $ (161,064) $ 84,522
================ ============== ================= ============= ===============
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 business... $ 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 corproate restructure reserve. $ - $ 4,558 $ - $ (1,420) $ 3,138
================ ============== ================= ============= ===============

(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.

(4) Included in the note receivable reserve are the following: $1,351 recorded
as allowance for other recievables, net, current; and $628 recorded as
allowance for note receivable long-term