FORM 10-K

(Mark One)

Commission file number 1-12040

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

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

     Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 [  ]

     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.     [X]

     On March 18, 2002, Sun Healthcare Group, Inc. had 8,949,977 outstanding shares of Common Stock. Of those, 6,769,976 shares of Common Stock were held by nonaffiliates. As of March 28, 2002, there was no established trading market for the Common Stock.

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

Documents Incorporated by Reference: None

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     Sun Healthcare Group, Inc. through its direct and indirect subsidiaries (collectively referred to herein as "Sun" or the "Company"), is one of the largest providers of long-term, subacute and related specialty healthcare services in the United States. The Company currently operates through three principal business segments: (i) inpatient services, (ii) rehabilitation therapy services, and (iii) pharmaceutical services. The following is a description of the Company's current 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. As of March 1, 2002, Sun operated 247 long-term, subacute care and assisted living facilities (consisting of 229 skilled nursing facilities, nine assisted living facilities and nine acute rehabilitation hospitals) in 25 states with 27,954 licensed beds in the United States through its wholly owned subsidiary, SunBridge Healthcare Corporation and other direct and indirect subsidiaries (collectively, "SunBridge"). The Company intends to divest 13 skilled nursing facilities with 1,764 licensed beds during 2002. The Company's long-term and subacute care facilities provide inpatient skilled nursing and custodial services as well as rehabilitative, restorative and transitional medical services. The Company provides 24-hour nursing care in these facilities by registered nurses, licensed practical nurses and certified nursing aides.

     The long-term care industry encompasses a broad range of related specialty healthcare services provided to the elderly and to other patients with medically complex needs who can be cared for outside of the acute care hospital environment but who generally cannot be efficiently and effectively cared for at home. Long-term and subacute care facilities offer skilled nursing care, routine rehabilitation therapy and other support services, primarily to elderly patients. Long-term and subacute care facilities may also provide a broad range of specialized healthcare services such as care for patients with Alzheimer's disease and subacute needs. Subacute care includes those services provided to patients with medically complex conditions who require ongoing medical and nursing supervision and access to specialized equipment and services, but do not require many of the other services provided by an acute care hospital. Services in this category include ventilator and oxygen care, HIV care, intravenous therapy, complex wound care, traumatic brain injury care, post-stroke care and hospice care. The facilities also provide a broad range of support services including rehabilitation therapy, dietary services, therapeutic recreational activities, social services, housekeeping and laundry services and pharmaceutical and medical supplies.

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

     Rehabilitation Therapy Services. Sun provides rehabilitation therapy services primarily through its wholly-owned subsidiary, SunDance Rehabilitation Corporation ("SunDance"). As of March 1, 2002, SunDance provided rehabilitation therapy services to 553 facilities in 40 states, 335 of which were operated by nonaffiliated parties. The Company provides a broad array of rehabilitation therapy services, including speech pathology, physical therapy and occupational therapy. These services are provided by

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approximately 3,000 licensed rehabilitation therapists and assistants employed or contracted by SunDance.

     Pharmaceutical Services. The Company provides pharmaceutical services primarily through its wholly-owned subsidiary, SunScript Pharmacy Corporation ("SunScript"). Pharmaceutical services include dispensing pharmaceuticals for such purposes as infusion therapy, oral medication, pain management, antibiotic therapy and parenteral nutrition. Additional services include providing consultant pharmacists. SunScript services are typically provided to nonaffiliated and affiliated facilities, including subacute and skilled nursing care facilities, assisted living facilities, group houses, correctional facilities, mental health facilities and home healthcare companies. As of March 1, 2002, SunScript operated 32 regional pharmacies, 11 in-house long-term care pharmacies and one pharmaceutical billing and consulting center, which together provided pharmaceutical products and services to a total of 651 long-term and subacute care facilities in 21 states, 436 of which were operated by nonaffiliated parties.

     Other Operations. The Company is a nationwide provider of temporary medical staffing primarily through its wholly-owned subsidiary, CareerStaff Unlimited, Inc. ("CareerStaff"). CareerStaff derives approximately 46% of its revenues from schools and governmental agencies, 43% from hospitals and other providers and 11% from skilled nursing facilities. CareerStaff provides (i) licensed therapists skilled in the areas of physical, occupational and speech therapy, (ii) nurses, (iii) pharmacists, pharmacist technicians and medical imaging technicians and (iv) related medical personnel. As of March 1, 2002, CareerStaff had 25 division offices which provided temporary therapy and nursing staffing services in major metropolitan areas and one division office which specialized in the placement of temporary traveling therapists in smaller cities and rural areas.

     Through the Company's wholly-owned subsidiaries, SunAlliance Healthcare Services, Inc. ("SunAlliance") and SunPlus Home Health Services, Inc. ("SunPlus"), the Company provides mobile radiology, medical laboratory and home healthcare services in certain locations. Through its majority-owned subsidiary, 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.

     General Information. Sun Healthcare Group, Inc. was incorporated in 1993. The Company's principal executive offices are located at 101 Sun Avenue, NE, Albuquerque, NM 87109, and its telephone number is (505) 821-3355. The Company maintains a web site at www.sunh.com.

     Emergence from Chapter 11 Bankruptcy Proceedings. 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). On February 6, 2002, the Bankruptcy Court approved the Company's joint plan of reorganization (the "Plan") and on February 28, 2002 the Company consummated the Plan. The principal provisions of the Plan are set forth below:

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See "Note 2 - Emergence from Chapter 11 Bankruptcy Proceedings" and "Note 23 -Subsequent Events" in the Company's consolidated financial statements.

     New Management Team. In November 2001, Richard K. Matros was appointed as Chief Executive Officer. Also, in November 2001, the then remaining members of the Board of Directors of the Company resigned and Mr. Matros, Gregory S. Anderson, Bruce C. Vladeck, Steven L. Volla and Milton J. Walters were appointed to the Board. In February 2002, John W. Adams, Charles W. McQueary, John F. Nickoll and Sanjay H. Patel were added to the Board. Kevin W. Pendergest was appointed as the Company's Chief Financial Officer and William A. Mathies was appointed as the President of SunBridge in March 2002 and Heidi J. Fisher was appointed Senior Vice President of Human Resources in February 2002. See "Item 10 - Directors and Executive Officers of the Registrant."

     New Loan Agreements. On February 28, 2002, the Company entered into (i) a Loan and Security Agreement with certain lenders, led by Heller Healthcare Finance, Inc. as collateral agent, and Citicorp USA, Inc., as administrative agent (the "Revolving Loan Agreement") and (ii) a Term Loan and Note Purchase Agreement with certain lenders, led by U.S. Bank National Association as administrative and collateral agent (the "Term Loan Agreement," and together with the Revolving Loan Agreement, the "Loan Agreements"). The Revolving Loan Agreement is a $150.0 million three-year revolving line of credit that is secured by the Company's accounts receivable, inventory, equipment and other assets, a first priority pledge of the stock of the Company's subsidiaries, other than those subsidiaries providing pharmaceutical services, and a second priority pledge of the pharmaceutical services subsidiaries. The Company's borrowing availability under the Revolving Loan Agreement is limited to up to 85% of the Company's net eligible accounts receivable and up to 50% of the Company's net eligible inventory, but not to exceed $150.0 million. As of March 1, 2002, there was $39.9 million available to the Company for

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     The Term Loan Agreement is comprised of a three-year $20 million term loan (the "Term Loan") and a three-year $23.7 million original issue discount note (the "Discount Note" and together with the Term Loan, the "Term Debt"). The Term Debt is secured primarily by a first priority pledge of the stock of the Company's subsidiaries that provide pharmaceutical services and a second priority security interest in substantially all of the Company's other assets. Under the Discount Note, the Company's borrowing availability is approximately $20.0 million. Provided that an event of default has not occurred, interest accrues on the Term Loan at the greater of (i) prime (or, if higher, the federal funds rate plus 0.50%) plus 4.00% or (ii) 9.00%. The Company will pay interest on the Discount Note for base rate borrowings a rate of interest equal to the greater of (i) prime (or, if higher, the federal funds rate plus 0.50%) or (ii) 2.65% and for Eurodollar borrowings a rate of interest equal to the Adjusted Eurodollar Rate (as defined in the Term Loan Agreement) plus 0.50%.

     Divestitures. During the years ended December 31, 2001 and 2000, Sun divested 43 and 49 skilled nursing facilities in the United States, respectively. In addition, Sun divested 20 assisted living facilities during 2000. The Company did not receive cash consideration from the skilled nursing facility divestitures during 2001 or 2000. The Company received cash consideration of approximately $1.2 million in 2000 for the 20 divested assisted living facilities. The aggregate net operating losses of the skilled nursing facilities and the assisted living facilities were approximately $7.5 million in 2001 and $5.7 million and $3.2 million in 2000, 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, 2002 through March 1, 2002, no skilled nursing facilities were divested.

     During January 2001, the Company sold substantially all of the assets of its SunChoice medical supplies operations to Medline Industries, Inc. The Company received proceeds of $16.6 million in exchange for the SunChoice assets.

     During February 2001, the Company sold its operations 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, however 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. The Company's operations in Australia were liquidated in July 2001 and the Company received liquidation proceeds of approximately $0.9 million. The Company divested its long-term care and pharmacy operations in Germany in February 2001 for approximately $3.5 million. The Company sold its long-term care operations in Spain in October 2000 for approximately $7.6 million. At December 31, 2001, the Company had no operations outside of the U.S.

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

     Restructuring. The Company's restructuring began in 1998. The approximate number of full and part-time employees of the Company worldwide has decreased from approximately 80,700 on February 20, 1999 to 57,100 on March 31, 2000, to 42,000 on February 28, 2001 and to 36,000 on March 1, 2002. 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 its management structure. The

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     Revenue Sources. The Company receives revenues from Medicare, Medicaid, private insurance, self-pay residents, other third party payors and long term care facilities which utilize the Company's specialty medical services. The healthcare industry is experiencing the effects of the trend toward cost containment as federal and state governments and other third party payors seek to impose lower reimbursement and negotiate reduced payment schedules with providers. These cost containment measures, combined with the increasing influence of managed care payors and competition for patients, generally have resulted in reduced rates of reimbursement for services provided by the Company.

     The sources and amounts of the Company's inpatient services revenues are determined by a number of factors, including the number of licensed beds and occupancy rates of the Company's facilities, the acuity level of patients and the rates of reimbursement among payors. Likewise, payment for ancillary medical services, including the institutional pharmacy services of SunScript and the therapy services provided by SunDance, will vary based upon payor and payment methodologies. Changes in the case mix of the patients, as well as payor mix among private pay, Medicare, and Medicaid will significantly affect the Company's profitability.

     The following table sets forth the total revenues and percentage of revenues by payor source for the Company's U.S. operations only for the years indicated (in thousands):

     Medicare and Medicaid. The Health Insurance for Aged and Disabled Act, known as "Medicare," has made available to nearly every United States citizen 65 years of age and older a broad program of health insurance designed to help the nation's elderly meet hospital, hospice, home health and other health care costs. Health insurance coverage has been extended to certain persons under age 65 qualifying as disabled and those having end-stage renal disease. Medicare includes three related health insurance programs: (i) hospital insurance ("Part A"); (ii) supplementary medical insurance ("Part B"); and (iii) a managed care option for beneficiaries who are entitled to Part A and enrolled in Part B ("Medicare+Choice" or "Medicare Part C"). The Medicare program is currently administered by fiscal intermediaries (for Part A and some Part B services) and carriers (for Part B) under the direction of the Centers for Medicare and Medicaid Services ("CMS") (formerly the Health Care Finance Administration), a division of the Department of Health and Human Services ("HHS").

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     The following table sets forth the approximate average amounts of Medicare Part A revenues per patient per day recorded by the Company's long-term care facilities for the years indicated ended December 31:

(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.
(3)  Includes a significant rate increase during 2001 of approximately 10.0%.
(4)  Excludes approximately $52.1 million of excess reserves reversed into net patient revenues
      due to the Settlement Agreement.  See "Item 3 - Legal Proceedings" for a description
      of the Settlement Agreement.

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

     The Company is subject to periodic audits by the Medicare and Medicaid programs, which have various rights and remedies against the Company if they assert that the Company has overcharged the programs or failed to comply with program requirements. These rights and remedies may include requiring the repayment of any amounts alleged to be overpayments or in violation of program requirements, or making deductions from future amounts due to the Company. Such programs may also impose fines, criminal penalties or program exclusions. Other third party payor sources also reserve rights to conduct audits and make monetary adjustments.

     Congress has enacted three major laws since 1997 that have significantly altered payment for nursing home and medical ancillary services. The Balanced Budget Act of 1997 (the "1997 Act"), signed into law on August 5, 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 1997 Act. The Benefits Improvement and Protection Act of 2000 ("BIPA"), was enacted on December 15, 2000, further modifying the law and restoring additional funding. The following provides a brief summary of these laws and an overview of the impact of these enactments on the Company's services.

     Under the 1997 Act, participating skilled nursing facilities are reimbursed under a prospective payment system ("PPS") for inpatient Medicare Part A covered services. The PPS system commenced with a facility's first cost reporting period beginning on or after July 1, 1998. Under PPS, nursing

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facilities are paid a predetermined amount per patient, per day ("per diem") based on the anticipated costs of treating patients. The per diem rate is determined by classifying each patient into one of forty-four resource utilization groups ("RUG") using the information gathered during a minimum data set assessment. There is a separate per diem rate for each of the RUG classifications. The per diem rate also covers rehabilitation and non-rehabilitation ancillary services. The law phased in PPS over a three-year period, during which the rate was based on a blend of the facility's adjusted historical 1995 costs and the federally established per diem rate. As of January 1, 2002, all of the Company's facilities are subject to 100% of the federal rate.

     In November 1999, the BBRA was passed in Congress. This enactment provided relief for certain reductions in Medicare reimbursement caused by the 1997 Act. For covered skilled nursing facility services furnished on or after April 1, 2000, the federal per diem rate was increased by 20.0% for 15 RUG payment categories. While this provision was initially expected to adjust payment rates for only six months, CMS withdrew proposed RUG refinement rules. These payment add-ons will continue until CMS completes certain mandated recalculations of current RUG weightings. For fiscal years 2001 and 2002, the BBRA mandated federal per diem rates for all RUG categories be increased by an additional 4% over the required market basket adjustment. The law provided that certain specific services (such as prostheses and chemotherapy drugs) would be reimbursed separately from, and in addition to, the federal per diem rate. A provision was included that provided for cost report years beginning on or after January 1, 2000, skilled nursing facilities could waive the PPS transition period and elect to receive 100% of the federal per diem rate. The enactment also lifted for two years a $1,500 cap on rehabilitation therapy services provided under Medicare Part B.

     On December 15, 2000, Congress passed BIPA, which increased the nursing component of Federal PPS rates by approximately 16.7% for the period from April 1, 2001 through September 30, 2002. The legislation also changed the 20.0% 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 was repealed except for Medicare Part B therapy services and the moratorium on the $1,500 therapy caps was extended through calendar year 2002. These changes have had a positive impact on operating results.

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funding provisions on September 30, 2002 or the implementation of the changes sought in the 2003 budget proposal would likely cause the Company to fail to meet financial covenants contained in its Loan Agreements if the Company's overall payor mix, case mix, and customer base are not sufficiently able to offset this impact.

     The 1997 Act contains provisions that have affected amounts paid to the Company's ancillary medical operations services. Reimbursement for certain products covered under Medicare Part B is limited to 95% of the "average wholesale price." The move to PPS under the 1997 Act has made pricing a more mportant consideration in the selection of pharmacy providers. Also, Congress included provisions in the 1997 Act that would require nursing facilities to submit all claims for Medicare-covered services that their residents receive, both Medicare Part A and Part B, even if such services are provided by outside suppliers, including but not limited to pharmacy and rehabilitation therapy providers, except for certain excluded services. The BIPA, enacted in December 2000, repealed this provision, except for therapy services.

     The 1997 Act included several provisions affecting Medicaid. The 1997 Act repealed the Boren Amendment federal payment standard for Medicaid payments to nursing facilities effective October 1, 1997. The Boren Amendment required that Medicaid payments to certain healthcare providers be reasonable and adequate in order to cover the costs of efficiently and economically operated healthcare facilities. Under the 1997 Act, states must now use a public notice and comment period in order to determine rates and provide interested parties a reasonable opportunity to comment on proposed rates and the justification for and the methodology used in calculating such rates. With the repeal of the federal payment standards, there can be no assurances that budget constraints or other factors will not cause states to reduce Medicaid reimbursement to nursing facilities and pharmacies or that payments to nursing facilities and pharmacies will be made on a timely basis. The 1997 Act also grants greater flexibility to states to establish Medicaid managed care projects without the need to obtain a federal waiver. Although these projects generally exempt institutional care, including nursing facilities and institutional pharmacy services, no assurances can be given that these projects ultimately will not change the reimbursement methodology for nursing facility services or institutional pharmacy services from fee-for-service to managed care negotiated or capitated rates. The Company anticipates that federal and state governments will continue to review and assess alternative health care delivery systems and payment methodologies.

     The BIPA enactment mandates a phase out of intergovernmental transfer transactions by states. In states which have artificially inflated payments to certain public facilities to increase federal matching funds, this action may reduce federal support for a number of state Medicaid plans. The reduced federal payments may impact aggregate available funds requiring states to further limit payments to providers such as the Company.

     Recent data compiled by the National Conference of State Legislatures indicate that the recent economic downturn has had a detrimental affect on state revenues. Historically these budget pressures have translated into reductions in state spending. Given that Medicaid outlays are a significant component of state budgets, the Company expects continuing cost containment pressures on Medicaid outlays for nursing homes and pharmacy services in the states in which the Company operates. The reimbursement rates for pharmacy services under Medicaid are determined on a state-by-state basis subject to review by CMS and applicable federal law. In most states, pharmacy services are priced at the lower of "usual and customary" charges or cost (which generally is defined as a function of average wholesale price and may include a profit percentage) plus a dispensing fee. Certain states have "lowest charge legislation" or "most favored nation provisions" which require the Company's institutional pharmacy to charge Medicaid no more than its lowest charge to other consumers in the state.

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     Pharmacy coverage and cost containment are important policy debates at both the federal and state levels. Congress has considered proposals to expand Medicare coverage for outpatient pharmacy services. Enactment of such legislation could affect institutional pharmacy services. Likewise, a number of states have proposed cost containment initiatives pending. Changes in payment formulas and delivery requirements could impact SunScript. See "Certain Additional Business Risks."

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

     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 reimbursement that the Company's skilled nursing facilities are entitled to receive for certain goods and services provided by the Company's ancillary subsidiaries. An exception to the related party regulations is available provided that, among other things, a substantial part of the services of the relevant subsidiary supplier be transacted with nonaffiliated entities. When that exception applies, the skilled nursing facility may receive reimbursement for goods and services provided by the Company's ancillary subsidiaries at the rates applicable to goods and services provided to nonaffiliated entities. The related party regulations do not indicate a specific level of services that must be provided to nonaffiliated entities in order to satisfy the "substantial part" requirement of this exception. In instances where 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 corresponding fee schedules have significantly reduced the Medicare impact of the related party rule, but the related party rule continues to affect certain Medicaid cost reports for the Company's skilled nursing facilities and hospitals and will also affect Medicare cost reports for hospitals for cost reporting years ended December 31, 2001. The Company's net revenues from rehabilitation therapy services, including net revenues from temporary medical staffing services, provided to nonaffiliated facilities represented 58%, 56% and 56% of total rehabilitation services net revenues for the years ended December 31, 2001, 2000 and 1999, respectively. Respiratory therapy

     Regulatory Requirements. The Company's subsidiaries that provide long-term care, rehabilitation therapy and pharmaceutical services are engaged in industries that are extensively regulated. As such, in the ordinary course of business, the operations of these subsidiaries are continuously subject to state and federal regulatory scrutiny, supervision and control. Such regulatory scrutiny often includes inquiries, investigations, examinations, audits, site visits and surveys, some of which may be non-routine. In addition to being subject to the direct regulatory oversight of state and federal regulatory agencies, these industries are frequently subject to the regulatory supervision of fiscal intermediaries. If a provider is ever found by a court of competent jurisdiction to have engaged in improper practices, it could be subject to civil, administrative or criminal fines, penalties or restitutionary relief, and reimbursement authorities could also seek the suspension or exclusion of the provider or individuals from participation in their program. If a facility is decertified by CMS 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 in 1995. These regulations require that surveys focus on residents' outcomes of care and state that all deviations from participation requirements will be considered deficiencies. A facility may have deficiencies and still be in substantial compliance with the regulations. The regulations identify alternative remedies against facilities and

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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 the Medicare and Medicaid programs may result in termination of the provider's Medicare and Medicaid provider agreements.

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

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

     False claims are prohibited pursuant to criminal and civil statutes. Criminal provisions prohibit filing false claims or making false statements to receive payment or certification under Medicare or Medicaid or failing to refund overpayments or improper payments; violation of these provisions are felonies punishable by up to five years imprisonment and/or $25,000 fines. Civil provisions prohibit the knowing filing of a false claim or the knowing use of false statements to obtain payment; penalties for violations are fines of not less than $5,000 nor more than $10,000, plus treble damages, for each claim filed. Suits alleging false claims can be brought by individuals, including employees and competitors. Allegations have previously been made under the civil provisions of the statute in certain qui tam actions that the Company has filed false claims. The Company is not aware of any pending qui tam actions against the Company. See "Note 18 - Other Events" in the Company's consolidated financial statements.

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

     These privacy regulations apply to "protected health information," which is defined generally as individually identifiable health information transmitted or maintained in any form or medium, excluding certain education records and student medical records. The privacy regulations seek to limit the use and disclosure of most paper, oral and electronic communications regarding an individual's past, present or future physical or mental health or condition, or relating to the provision of healthcare to the individual or payment for that healthcare, if the individual can or may be identified by such information. HIPAA provides for the imposition of civil or criminal penalties if protected health information is improperly disclosed. The Company is not required to comply with the HIPAA privacy rules until April 2003, but the Company will require substantial efforts and resources to prepare for meeting the compliance deadline and for continued compliance thereafter. No assurance can be given that the Company will meet the April 2003 deadline. See "Certain Additional Business Risks."

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     HIPAA's security regulations have not yet been finalized. The proposed security regulations specify administrative procedures, physical safeguards and technical services and mechanisms designed to ensure the privacy of protected health information. The Company will be required to comply with the security regulations 26 months after the regulations become final.

     In addition, HIPAA also mandates the adoption of regulations aimed at standardizing transaction formats and billing codes for documenting medical services, dealing with claims submissions and protecting the privacy and security of individually indentifiable health information. HIPAA regulations that standardize transactions and code sets became final in the fourth quarter of 2000. These regulations do not require healthcare providers to submit claims electronically, but require standard formatting for those that do. The Company currently submits some of its claims electronically to Medicare and Medicaid through its fiscal intermediary and will continue to do so. The Company will be required to comply with HIPAA transaction and code set standards by October 2003.

     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 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.

     The Company believes that enforcement activities at both the federal and state levels and qui tam actions brought by private parties have increased since 1997. In addition, during the Company's bankruptcy proceedings, the Company experienced a further increase in regulatory oversight from both federal and state regulatory bodies. The Company may be required to expend substantial amounts 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.

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additional facilities of the Company from the Medicare and Medicaid programs, or that the Company will contest and be successful in contesting such decertifications.

     The Company entered into a Corporate Integrity Agreement ("CIA") with the Office of the Inspector General ("OIG") of the Department of Health and Human Services ("HHS") effective February 28, 2002 to promote the Company's compliance with the requirements of Medicare, Medicaid, and all other federal healthcare programs. The CIA is patterned after OIG compliance guidance but sets specific requirements intended to demonstrate adherence to the compliance program elements. Under the CIA, the Company is implementing comprehensive internal quality improvement programs and a system of internal financial controls in the Company's nursing homes, hospitals, and ancillary entities. Furthermore, it requires external oversight and reporting requirements to validate compliance.

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

Written Policies, Procedures and Standards of Conduct

     The Company's subsidiaries that provide patient care and products have extensive policies and procedures ("P&Ps") which are modeled after applicable laws, regulations, government manuals and industry practices and customs. The P&Ps govern the clinical and operational aspects of each regulated subsidiary. For instance, the Company's P&Ps require that a reasonable and prudent background investigation be completed on every new employee. To emphasize adherence to its P&Ps, the Company publishes and distributes a Code of Conduct and each subsidiary publishes and distributes an employee handbook.

Designated Compliance Officer and Compliance Committee

     In August 2000, the Company appointed a Corporate Compliance Officer. The responsibilities of the Corporate Compliance Officer include, among other things: (i) overseeing the Compliance Process; (ii) ensuring compliance with the CIA and functioning as the liaison with the external monitors and federal government on matters related to the Compliance Process and CIA; (iii) reporting to the Board of Directors and senior corporate managers on the status of the Compliance Process; and (iv) overseeing the coordination of a comprehensive education and training program which focuses on the elements of the Compliance Process.

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

Effective Training and Education

     The Company continues to develop and implement regular training and education programs for all employees. Training programs include the Compliance Process, the CIA, Code of Conduct, applicable provisions of the Medicare and Medicaid laws, including fraud and abuse laws and reimbursement P&Ps

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that reflect current legal and program standards.

Effective Lines of Communication

     During employee training, employees are encouraged to report issues of concern without fear of retaliation using a Four Step Reporting Process, which includes the toll-free "Sun Quality Line." The Four Step Reporting Process encourages employees to discuss clinical, ethical, or financial concerns with supervisors and local management since these individuals will be most familiar with the laws, regulations, and policies that impact their concern. The telephone number for the Sun Quality Line is posted prominently in places that are accessible to employees in all of the Company's facilities. Internal independent reviews of the Sun Quality Line ensure that proper follow-up is conducted.

Internal Monitoring and Auditing

     The Company employs a number of licensed professionals who monitor compliance with P&Ps, including registered nurses, dietitians and program analysts for the skilled nursing facility operations. For the Company's hospitals, each hospital employs a Quality Improvement Nurse who is responsible for monitoring the Company's clinical standards. The Company's rehabilitation therapy operations employ Compliance Directors, each of whom is a licensed therapist. Vice Presidents of Compliance are responsible for all compliance activity within the Company's pharmacy operations and home health, home pharmacy, and laboratory and radiology services operations.

Enforcement of Standards Through Well-Publicized Disciplinary Guidelines

     The Company's P&Ps, the Code of Conduct and the Employee Handbook as well as all associated training materials clearly indicate that violators of the Company's policies and procedures will be subjected to discipline. Sanctions include oral warnings, to suspensions, and termination of employment.

Responses to Detected Offenses and Development of Corrective Actions

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

     The long-term 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

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attracting patients from large referral sources.

     The Company also competes with other companies in providing rehabilitation therapy services and pharmaceutical products and services to the long-term care industry and in employing and retaining qualified therapists and other medical personnel. Many of these competing companies have greater financial and other resources than the Company. There can be no assurance that Sun will not encounter increased competition in the future that would adversely affect its financial condition and results of operations.

     As of March 1, 2002, the Company had approximately 36,000 full-time and part-time employees. Of this total, there were approximately 28,000 employees in the Company's long-term and subacute care facilities, 3,000 employees in the rehabilitation therapy services, 1,000 employees in the pharmaceutical services operations, 1,000 employees in the temporary staffing business, 150 employees in the respiratory therapy business, 850 employees at the corporate and regional offices and 2,000 employees in other health care services.

     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.

     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, 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 below and elsewhere herein:

     The Company's borrowing capacity under its Loan Agreements may be insufficient to fund the Company's operations until it achieves positive cash flows or obtains additional financing. The Company's Revolving Loan Agreement provides for maximum borrowings by the Company of up to $150.0 million, but not to exceed a defined borrowing base, which was $111.0 million on March 1, 2002. The Company's Term Loan Agreement provides for maximum borrowings of $40.0 million. As of March 1, 2002, the Company had borrowed approximately $66.8 million and had issued approximately $44.3 million in letters of credit under the Loan Agreements, leaving approximately $39.9 million available to the Company for additional borrowing. The Company had cash flows provided by (used for) operating activities of $24.4 million, $(1.7) million and $7.3 million for the years ended December 31, 2001, 2000 and 1999, respectively. Until the Company is able to consistently generate substantial positive cash flow

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from operations or obtain additional financing, the Company will be required to rely on its available borrowing capacity to fund its ongoing operations. There can be no assurance that the amount available to the Company under the Loan Agreements will be sufficient for these purposes. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."

     The financial covenants in the Loan Agreements will be difficult to achieve and if not achieved could result in a lack of funding. The Company must achieve significant improvements in its results of operations in order to comply with the financial covenants contained in the Loan Agreements. If the Company's results of operations do not significantly improve, the Company would likely be in default under the Loan Agreements. If the Company fails to comply with the covenants in its Loan Agreements and is unable to obtain a waiver of any such covenant violation, then the Company would lose its ability to borrow under the Loan Agreements 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 Loan Agreements is repaid. In such event, the Company would be unable to fund its ongoing operations without obtaining additional financing. Furthermore, upon a payment default of the Revolving Loan Agreement, the Term Loan Agreement lenders have the right to purchase the portion of the Revolving Loan Agreement debt relating to the Company's pharmacy operations and then sell these operations in a foreclosure sale. There can be no assurance that the Company will meet required financial and operating covenants under the Loan Agreements. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - - Liquidity and Capital Resources."

     The Company's Medicare reimbursements may materially and adversely decline after September 30, 2002. A number of provisions of the BBRA and BIPA enactments providing additional funding for Medicare participating skilled nursing facilities expire on September 30, 2002. Expiring provisions are estimated to, on average, reduce the Company's per beneficiary per diems by approximately $36.00 (as compared to $376.78 in 2001), although the reduction could be greater than anticipated. Moreover, the Centers for Medicare and Medicaid Services ("CMS") has indicated its desire to complete refinements to the case mix classification system as part of the Fiscal 2003 rule-making. Under the law, when these refinements are implemented, the add-on's authorized by the BBRA and BIPA will expire. As a result of the combination of these factors, the Medicare skilled nursing facility sector is faced with an estimated 10.4% reduction in the average median per diems. A 10.4% decline in the Company's current average Medicare rate per patient day would result in an estimated annual reduction in Medicare revenues of approximately $35.0 million, which would have a material adverse effect on the Company's financial position, results of operations and cash flows. In addition, President Bush's fiscal year 2003 budget proposal assumes that CMS will refine the per diem system by October 2002 in order to reduce Medicare payments to skilled nursing facilities by $5.6 billion over the next five years. Taken together with the expiration of the additional funding provisions on September 30, 2002, the Company estimates that its average Medicare payments would decrease approximately $63.00 per patient per day, although the reduction could be greater than anticipated. If the refinements sought by President Bush are implemented, the loss of an estimated $60.4 million in revenues would have a material adverse effect on the Company's financial position, results of operations and cash flows. The expiration of additional funding provisions on September 30, 2002 or the implementation of the changes sought in the 2003 budget proposal would likely cause the Company to fail to meet financial covenants contained in its Loan Agreements if the Company's overall payor mix, case mix, and customer base are not sufficiently able to offset this impact.

     The Company is continuously subject to federal and state regulatory scrutiny. The Company's subsidiaries are engaged in healthcare industries which are extensively regulated. As such, in the ordinary course of business, the operations of these subsidiaries are continuously subject to state and

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federal regulatory scrutiny, including inquiries, investigations, examinations, audits, site visits and surveys. If any of the Company's subsidiaries are 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 Department of Health and Human Services - Office of Inspector General and the Department of Justice periodically investigate matters that have come to their attention concerning the Company. The existence of regulatory investigations has previously hindered or prevented the Company from pursuing certain business opportunities. There can be no assurance that the outcome of any pending or future proceedings or investigations will not have a material adverse effect on the results of operations and financial condition of the Company. See "Note 18 - Other Events" in the Company's consolidated financial statements.

     The Company is subject to numerous lawsuits. In recent years, there has been a dramatic increase in the number and size of lawsuits filed against nursing home operators alleging negligence resulting in injury or death to residents of the homes. The Company currently has numerous patient care lawsuits pending against it, as well as other types of lawsuits. As a result, general and professional liability costs have increased and are expected to continue to increase. There can be no assurance that the outcome of any patient care lawsuits individually or in the aggregate will not have a material adverse effect on the Company's results of operations or financial condition.

     The Company's general and professional liability risk is generally self-funded. The Company's insurance carriers declined to renew the Company's general and professional liability insurance policies that expired on December 31, 1999. Several major insurance companies no longer provide this type of coverage to long-term care providers. Beginning 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. If the Company's self-funded insurance reserves are insufficient to fund any future judgments or settlements resulting from litigation against the Company, such deficiency could have a material adverse impact on the Company's financial condition and results of operations. 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.

     The Company could be required to return inpatient facility revenues as a result of retroactive adjustments. 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. There can be no assurance that the Company will not be required to negatively adjust prior earnings as a result of future settlements with payors.

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     The inability to collect accounts receivable has in the past, and may in the future, have a material adverse effect on the Company. The Company's bad debt expense for the years ended December 31, 2001, 2000 and 1999 was $26.0 million, $33.5 million and $123.2 million, respectively. The Company's allowance for doubtful accounts at December 31, 2001 was $73.8 million. The Company believes that the implementation of PPS for certain customers of the Company's ancillary services operations negatively affected their cash flows and in many instances caused them to file for bankruptcy. If certain Medicare Part A enactments expire on September 30, 2002 (see above), or other healthcare reform proposals are adopted which decrease Medicare or Medicaid payments to skilled nursing facilities, then the Company's ancillary services operations would experience a significant increase in bad debts. The Company's financial condition and results of operation could be materially adversely affected by the inability to collect its accounts receivable.

     The Company may not be in compliance with the HIPAA privacy rules by April 2003. The HIPAA privacy regulations seek to limit the use and disclosure of most paper, oral and electronic communications regarding an individual's past, present or future physical or mental health or condition, if the individual can be identified by such information. HIPAA provides for the imposition of civil or criminal penalties if protected health information is improperly disclosed. There can be no assurance that the Company's business will not be materially adversely affected if it is unable to meet the compliance deadline of April 2003. See "Government Regulation."

     The Company has limited operational flexibility because it leases substantially all of its inpatient facilities. The Company leases 235 of the 247 inpatient facilities that it operates. These leases generally limit or restrict the Company's ability to assign the lease to another party. The Company's failure to comply with the terms of the leases could result in an event of default and subject the Company to material damages. Given these restrictions, the Company may be forced to continue operating non-profitable facilities to avoid defaults under the leases.

     If the Company fails to comply with its Corporate Integrity Agreement, it could be subject to severe sanctions. Under the Corporate Integrity Agreement, the Company must have a comprehensive internal quality improvement program and a system of internal financial controls in its nursing facilities, hospitals and regional and corporate offices. A breach of the Corporate Integrity Agreement could subject the Company to substantial monetary penalties and exclusion from participation in Medicare and Medicaid programs. Any such sanctions could have a material adverse effect on the Company's financial condition and results of operations. See "Business - Corporate Compliance Process."

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

     Efforts of third party payors to control cost may adversely affect the Company's revenues and operating margins. The Company receives approximately 28% of its revenues from private insurance, long-term care facilities which utilize the Company's specialty medical services, self-pay facility residents, and other third party payors. These private third party payors are continuing their efforts to control healthcare costs through direct contracts with healthcare providers, increased utilization review and greater enrollment in managed care programs and preferred provider organizations. These private

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     Further consolidation of managed care organizations and other third party payors may adversely affect the Company's operating results. Managed care organizations and other third party payors have continued to consolidate in order to enhance their ability to influence the delivery of healthcare services. Consequently, the healthcare needs of a large percentage of the United States population is increasingly served by a smaller number of managed care organizations. These organizations generally enter into service agreements with a limited number of providers for needed services. To the extent such organizations terminate the Company as a preferred provider and/or engage its competitors as a preferred or exclusive provider, this source of revenues would be lost. In addition, private payors, including managed care payors, increasingly are demanding discounted fee structures or the assumption by healthcare providers of all or a portion of the financial risk through prepaid capitation arrangements.

     Future healthcare reform could adversely affect the Company's business. In recent years, a 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. 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.

     Changes in revenue sources could adversely affect the Company's business. Changes in the mix of patients among the Medicaid, Medicare Part A and private pay categories, and among different types of private pay sources, could significantly affect the revenues and results of operations. The Company's current payor or revenue mix could change. The Company's percentage of revenues attributable to private pay residents has decreased from 33.3% in 1999 to 28.1% in 2001. In addition, the Company cannot be certain 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 reduce the Company's revenues and adversely affect its results of operations.

     The Company expects that it will continue to experience a shortage of qualified personnel to staff its facilities and increasing labor costs. The Company and other providers in the long-term care industry have had and continue to have difficulties in retaining 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. The labor costs are higher for temporary employees than for full-time employees. In addition, many states have increased minimum staffing standards and CMS is also studying whether minimum staffing standards should be imposed on skilled nursing facilities. As minimum staffing standards are increased, the Company may be required to retain additional staffing. In addition, 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 to increase staffing levels in its long-term and subacute care facilities. Sun may not be able to continue to hire and retain a sufficient number of qualified personnel to operate its inpatient facilities.

     The Company's success is substantially dependent on the leadership and performance of its new management team. The Company's Chief Executive Officer, Chief Financial Officer, President of SunBridge Healthcare Corporation, Senior Vice President of Human Resources and its entire Board of

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Directors have all joined the Company since November 2001. As such, there will be a period of transition in which the new management team implements new business strategies, policies and practices.

     Inpatient Facilities. The Company operated an aggregate of 247 long-term care, subacute care and assisted living facilities in the U.S. as of March 1, 2002, 235 of which were subject to long-term operating leases or subleases and 12 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 most of the leases generally increases based on a fixed percentage or increases in the U.S. Consumer Price Index. Many of the leases contain renewal options to extend the term. Substantially all of the Company's leasehold interests serve as collateral for its obligations under its Credit Agreements.

     The Company calculated its aggregate occupancy percentages for all of its long-term care, subacute care and assisted living facilities on a same store basis as 89%, 90% and 91% in the U.S. for the years ended December 31, 2001, 2000 and 1999, respectively. However, the Company believes that occupancy percentages, either individually or in the aggregate, should not be relied upon alone to determine the performance 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 computes occupancy percentages by dividing the average daily number of beds occupied by the total number of available beds for use during the periods indicated.

     The following table sets forth certain information concerning the long-term care, subacute care and assisted living facilities leased or owned by the Company in the United States as of March 1, 2002. Included in the table are 247 facilities (229 skilled nursing facilities, nine assisted living facilities and nine hospitals) that are included in the inpatient services segment. Also, included in the table are 13 facilities with 1,764 licensed beds that the Company intends to divest during 2002.

(1)  "Licensed Beds" refers to the number of beds for which a license has been issued, which may vary in some instances from licensed beds available for use.

     Rehabilitation Services. As of March 1, 2002, the Company leased office space in 22 locations in 16 states to operate its rehabilitation therapy business.

     Pharmaceutical Services. As of March 1, 2002, the Company operated 32 regional pharmacies, 11 in-house long-term care pharmacies and one pharmaceutical billing and consulting center, which together provided pharmaceutical products and services in 21 states. All of these locations were leased.

     Other Operations. As of March 1, 2002, the Company leased approximately 64 locations in 22 states to operate its other businesses, including temporary medical staffing (CareerStaff), home health care (SunPlus) and mobile radiology and medical laboratory (SunAlliance). The Company owns its corporate headquarters buildings in Albuquerque, New Mexico. In January 2002, the Company entered into an agreement to sell two of its headquarters buildings.  The sale is expected to be completed in April 2002, although no assurance can be given that the sale will be completed.

     In May and August 1999, former employees of two of the Company's subsidiaries, SunBridge Healthcare Corporation and SunDance Rehabilitation Corporation, filed proposed class action complaints in the Western District of Washington. The plaintiffs sought to represent certain current and former employees of SunBridge and SunDance who were allegedly not paid appropriate wages under federal and state law since May and August 1996, respectively. Plaintiffs filed claims in the chapter 11 cases in the amount of approximately $780.0 million in the SunDance action and $242.0 million in the SunBridge action. Although the Company disputed these claims, the parties executed a stipulation of settlement which was signed by the judge presiding over the chapter 11 cases in the United States Bankruptcy Court for the District of Delaware. The settlement provides a general unsecured claim in the chapter 11 cases of up to an aggregate $3.0 million for the claimants, the payment of claimants' attorney's fees up to $300,000, and the payment of up to $500,000 to cover the cost of notice to prospective claimants in the class and claims administration. The settlement terms remain subject to court approval.

     In March and April 1999, class action lawsuits were filed against the Company and three individuals who were at that time officers of the Company in the United States District Court for the District of New Mexico. These actions have been consolidated as In re Sun Healthcare Group, Inc. Securities and Litigation Master, File No. Civ. 99-269. The lawsuits allege, among other things, that 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. On January 31, 2002, the District Court dismissed the lawsuit with prejudice and entered judgment in favor of the defendants. On February 14, 2002, the plaintiffs filed a Motion to Amend the Judgment and to File an Amended Complaint. The Company intends to vigorously defend the individual defendants in this matter, who are indemnified by the Company and covered by the Company's insurance.

      The United States Department of Health & Human Services ("HHS") and the United States Department of Justice ("DOJ") periodically investigate matters that come to their attention concerning the Company, including cost reporting matters. Several years ago, to expedite resolution of any outstanding investigations, the Company requested that HHS and DOJ inform it of any such investigations or outstanding concerns. In response, DOJ informed the Company of the existence of a number of outstanding inquiries, several of which were prompted by the filing of eleven qui tam lawsuits by private individuals ("Relators") pursuant to the False Claims Act. HHS had also asserted claims against the Company for overpayments in connection with Medicare reimbursement for services performed prior to the implementation of the Medicare prospective payment system, and HHS and DOJ also asserted claims for violations of the False Claims Act. The Company denied any violations and asserted claims against HHS for underpayments in connection with services performed for Medicare beneficiaries for the same periods which HHS disputes.

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     In February 2002, the Company, HHS, CMS, DOJ, the Tricare Management Activity Support Office ("TMA"), and the Relators in eight of the qui tam cases signed a comprehensive settlement agreement which resolved all the claims of the parties. The Bankruptcy Court has approved the settlement. The settlement agreement provided for, among other things, a release of pre-petition claims of HHS, DOJ, TMA and the Relators against the Company. The settlement agreement also provided for a release of substantially all the claims of the Company against HHS for the same period; the Company previously reserved all such claims due to the uncertainty of the Company recovering such amounts. The settlement agreement required the Company to pay $1,000,000 in cash and deliver a promissory note for $10,000,000. The Relators in the remaining three qui tam cases previously separately entered into settlement agreements with the Company resolving all of their claims against the Company.

     In contemplation of a settlement with HHS, the Company entered into a corporate integrity agreement with the HHS' Office of Inspector General in July 2001. The agreement officially took effect upon the Company's emergence from bankruptcy. Under the terms of this agreement, the Company implemented 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 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.

     No matters were submitted to a vote of security holders during the fourth quarter of 2001.

     The Company began issuing new common stock on February 28, 2002 as part of its Plan of Reorganization. The new common stock has CUSIP number 866933 40 1. The Company's old common stock which was issued and outstanding as of February 28, 2002 was cancelled as part of the Plan of Reorganization. The old common stock had CUSIP number 866933 10 4. See "Item 1. - Business - Reorganization."

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     The Company's new common stock has been given the symbol "SUHGV.OB" on the Over-the-Counter ("OTC") Bulletin Board.  However, as of March 28, 2002, there was no established trading market for the Company's common stock.

     There were approximately 50 holders of record of the Company's common stock as of March 18, 2002. The number of record holders and the number of shares outstanding will increase as the Company continues issuing its new common stock pursuant to the Plan of Reorganization. The Company has never paid nor declared any dividends on its common stock. The Company's Credit Agreements restrict the Company's ability to pay dividends.

     The following selected consolidated financial data for the years indicated 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):

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     The Company is one of the largest providers of long-term, subacute and related specialty healthcare services in the United States. The Company operates through three principal business segments: inpatient services, rehabilitation therapy services and pharmaceutical services.

     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, 2001, the Company operated 247 inpatient facilities with 27,954 licensed beds compared to 303 facilities with 33,363 licensed beds as of December 31, 2000. Included in the December 31, 2001 amounts are seven skilled nursing facilities with 1,021 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. As of March 1, 2002, the Company has identified a total of 13 skilled nursing facilities with 1,764 licensed beds for disposal. See "Note 7 - Impairment of Long-Lived Assets and Assets Held for Sale" in the accompanying consolidated financial statements.

     Rehabilitation Therapy Services: This segment provides, among other things, physical, occupational and speech therapy services to affiliated and nonaffiliated skilled nursing facilities. As of December 31, 2001, the Company's rehabilitation therapy services segment provided services to 859 facilities in 42 states, of which 622 were operated by nonaffiliated parties compared to 942 facilities in 41 states as of December 31, 2000, of which 652 were operated by nonaffiliated parties.

     Pharmaceutical Services: This segment provides pharmaceutical products primarily to long-term and subacute care facilities 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. The pharmaceutical subsidiary provided pharmaceutical products and services to 654 long-term and subacute care facilities, including 439 nonaffiliated facilities, as of December 31, 2001. As of December 31, 2000, pharmaceutical products and services were provided to approximately 1,506 facilities, including 1,217 nonaffiliated facilities.

     Other Operations: From 1999 through 2001, the Company's other operations included temporary medical staffing services, home health, software development and other ancillary services.

     Divested Operations: The Company divested its respiratory therapy operations in March 2002. These operations were previously included with the rehabilitation therapy services segment.

     The Company divested its medical supplies operations in January 2001. These operations were previously included within the pharmaceutical services segment.

     In February 2001, the Company sold its operations in the United Kingdom. In April 2001, the Company sold its operations in Germany. In July 2001, the Company's Australian operations were sold. Prior to the divestitures of its international operations, the Company reported them as a fourth business segment. See "Item 1 - Business - Reorganization" and "Note 7 - Impairment of Long-lived Assets and Assets Held for Sale" in the Company's consolidated financial statements.

     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. These operations were previously reported under "Other Operations."

     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"). On February 6, 2002, the Bankruptcy Court approved the Company's joint plan of reorganization (the "Plan") and on February 28, 2002 the Company consummated the Plan. See "Item 1 - Business - Reorganization."

     The Company's future financial condition and operating results will be affected by a number of factors, including but not limited to the following, each of which is more fully described under "Item 1 - Business - Certain Additional Business Risks:"

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

     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.

     Under chapter 11, certain claims against the Company in existence prior to the Filing Date were stayed while the Company continued its operations as a debtor-in-possession. These claims are reflected in the December 31, 2001 and 2000 balance sheets as "liabilities subject to compromise." 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." As part of the Company's emergence from chapter 11 proceedings, all of the "liabilities subject to compromise" have been discharged, reinstated or repaid.

     The Company has determined that, generally, the fair market value of the collateral was less than the principal amount of its secured prepetition debt obligations; accordingly, the Company discontinued accruing interest on many of these obligations as of the Filing Date.

(a)  Net Revenues

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

     In February 2002, the Company, HHS, CMS, DOJ, the Tricare Management Activity Support Office ("TMA"), and the Relators in eight qui tam cases, entered into a comprehensive settlement agreement (the "Settlement Agreement"). Under the Settlement Agreement, the Company and the above mentioned parties agreed to mutually release each other from substantially all prepetition claims. The Settlement Agreement requires the Company to pay $1.0 million in cash and deliver a promissory note for $10.0 million, plus interest to CMS over the next five years.

     Since 1999, the Company recorded various reserves due to the uncertainty of the reimbursement adjustments that might have been required to settle the matters raised by the parties of the Settlement Agreement, including a reserve of approximately $31.0 million recorded in 1999 for routine cost limit exception payments previously paid to the Company. Such amounts totaled a net reserve of $52.1 million. As a result of the Settlement Agreement, the Company reversed the $52.1 million of net excess reserved exposures and reflected it as a component of net patient revenue in the 2001 consolidated statement of operations.

(b)  Accounts Receivable

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

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

(c)  Impairment of Long-Lived Assets

     The Company evaluates the carrying value of long-lived assets, including goodwill, in relation to the future projected 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"). Those projected future undiscounted cash flows require significant assumptions about future operations, such as reimbursement rates for Medicaid and Medicare patients, occupancy rates, wage rates, workers compensation costs and professional liability costs. Under SFAS 121, an impairment loss is recognized if the sum of the future net expected cash flows is less than the carrying amount of the long-lived assets being evaluated. The difference between the carrying amount of the 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 that it intends to retain based on anticipated future cash flows discounted at rates commensurate with the risks involved.

(d)  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 liability through the use of self-insurance or retrospective and high deductible insurance policies and other hybrid policies, which vary among 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 periodically, 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 expense. Accrued liabilities for future claims are not discounted.

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     In June 2001 the FASB issued SFAS No. 141, "Business Combinations" ("SFAS 141") which provides that all business combinations should be accounted for using the purchase method of accounting and establishes criteria for the initial recognition and measurement of goodwill and other intangible assets recorded in connection with a business combination. The provisions of SFAS 141 apply to all business combinations initiated after June 30, 2001 and to all business combinations accounted for by the purchase method that are completed after June 30, 2001.

     In addition, in June 2001 the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," ("SFAS 142") which establishes the accounting for goodwill and other intangible assets following their recognition. SFAS 142 applies to all goodwill and other intangible assets whether acquired singly, as part of a group, or in a business combination. SFAS 142 also applies to goodwill recognized in accordance with SOP 90-7. The new pronouncement provides that goodwill should not be amortized but should be tested for impairment annually using a fair-value based approach. In addition, SFAS 142 provides that intangible assets other than goodwill should be amortized over their useful lives and reviewed for impairment in accordance with existing guidelines. SFAS 142 will become effective for the Company beginning on January 1, 2002. The Company's application of fresh-start accounting, in connection with the Company's emergence from bankruptcy is expected to result in goodwill, however, the amount of goodwill has not currently been determined. See "Note 23 - Subsequent Events" in the accompanying consolidated financial statements. The Company has not determined the impact that the adoption of this accounting standard will have on its consolidated financial statements.

     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.

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

     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 $99.5 million, $113.3 million and $126.9 million for the years ended December 31, 2001, 2000 and 1999, respectively. Revenues for pharmaceutical and medical supply services provided to domestic affiliated facilities were approximately $62.2 million, $88.3 million and $80.9 million for the years ended December 31, 2001, 2000 and 1999, respectively. Revenues for services provided by other non-reportable segments to affiliated facilities were approximately $9.0 million, $10.7 million and $10.0 million for the years ended December 31, 2001, 2000 and 1999, respectively.

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

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

     The Company's subsidiaries which operate inpatient facilities have historically used and continue to use pharmaceutical and rehabilitation services that are provided by separate subsidiaries of the Company, SunScript and SunDance, respectively. Effective on January 1, 2002, the rates charged by SunScript and SunDance to the Company's inpatient facilities were adjusted to more accurately reflect competitive, national market rates. While the change in these rates will not impact the Company's consolidated results, the Company expects that on a segment basis the pharmaceutical services and rehabilitation therapy services segments' net income in 2002 will decrease by approximately $7.6 million and $3.5 million, respectively, and the inpatient ancillary services expenses to decrease by approximately $11.1 million in 2002.

     In accordance with SOP 90-7, items of expense or income that are incurred or realized by the Company because it was in reorganization are classified as reorganization costs in the Company's consolidated statements of losses. As a result, net segment income/(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 income/(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 income/(losses).  The amortization of debt discounts and deferred issuance costs prior to the Filing Date are included in net segment income/(losses). Losses on sales of assets and professional fees related to the reorganization incurred subsequent to the Filing Date are excluded from net segment income/(losses) 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 intersegment 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, 2001 compared to the Year Ended December 31, 2000" and the "Year Ended December 31, 2000 compared to the Year Ended December 31, 1999" are based on the financial information presented in "Note 21 - Segment Information" in the Company's consolidated financial statements.

     Due to the number of Inpatient Service facilities being divested during the time periods being compared, a "same store" basis is also included for comparison purposes.

     Net revenues, which includes revenues from therapy and pharmaceutical services provided at the Inpatient Services facilities, decreased approximately $108.8 million from $1,718.2 million for the year ended December 31, 2000 to $1,609.4 million for the year ended December 31, 2001. On a same store basis, net revenues increased approximately $122.0 million from $1,407.0 million for the year ended December 31, 2000 to $1,529.0 million for the year ended December 31, 2001, an 8.7% increase. This increase was primarily the result of increased Medicaid and Medicare reimbursement rates during 2001.

     Operating expenses, which include rent expense of approximately $181.0 million and $149.3 million for the years ended December 31, 2000 and December 31, 2001, respectively, decreased $83.0 million, or 5.2%, from $1,594.8 million for the year ended December 31, 2000 to $1,511.8 million for the year ended December 31, 2001. The decrease resulted primarily from the divestiture of facilities during 2001. On a same store basis, operating expenses, which include rent expense of $142.4 million and $143.4 million for the years ended December 31, 2000 and 2001, respectively, increased 11.1% from $1,276.6 million for the year ended December 31, 2000 to $1,418.2 million for the year ended December 31, 2001. On a same store basis, operating expenses as a percentage of net revenues increased from 90.7% for the year ended December 31, 2000 to 92.8% for the year ended December 31, 2001. The increase in operating expenses as a percentage of revenue was primarily due to increased labor costs as a result of the competition for staff and contract personnel within the industry and the subsequent pressure on labor rates. Various federal, state and local regulations impose, depending upon the services provided, a variety

36

of regulatory standards for the quality and level of personnel required to provide care or services. These requirements have an impact on staffing level and mix which therefore impact costs and expenses.

     Corporate general and administrative expenses, which include regional costs related to the supervision of operations, were $39.8 million and $34.2 million for the years ended December 31, 2000 and December 31, 2001, respectively. The decrease was primarily due to head count reduction following divestitures of inpatient facilities during 2001. On a same store basis, as a percentage of net revenues, corporate general and administrative expenses were 2.8% and 2.2% for the years ended December 31, 2000 and December 31, 2001, respectively.

     Depreciation and amortization decreased approximately $7.6 million from $20.2 million for the year ended December 31, 2000 to $12.6 million for the year ended December 31, 2001. On a same store basis, depreciation and amortization decreased 30.3% from $17.8 million for the year ended December 31, 2000 to $12.4 million for the year ended December 31, 2001. On a same store basis, as a percentage of net revenues, depreciation and amortization expense decreased from 1.3% for the year ended December 31, 2000 to 0.8% for the year ended December 31, 2001. The decreases are primarily the result of the determination that certain of the Company's long-lived assets were impaired, which resulted in write-downs during 2000 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). These write-downs reduced the depreciable basis of the long-lived assets which caused depreciation and amortization expenses to be reduced in 2001.

     The provision for losses on accounts receivable increased 1.9% from approximately $15.4 million for the year ended December 31, 2000 to approximately $15.7 million for the year ended December 31, 2001. On a same store basis, provision for losses on accounts receivable increased 34.3% from $10.8 million for the year ended December 31, 2000 to $14.5 million for the year ended December 31, 2001. On a same store basis, as a percentage of net revenues, provision for losses on accounts receivable increased from 0.8% for the year ended December 31, 2000 to 0.9% for the year ended December 31, 2001. The increases were primarily due to the aging of receivables which require a higher level of reserves against them.

     Net interest expense decreased approximately $7.8 million from $10.6 million for the year ended December 31, 2000 to $2.8 million for the year ended December 31, 2001. On a same store basis, net interest expense decreased 68.2% from $8.8 million for the year ended December 31, 2000 to $2.8 million for the year ended December 31, 2001. The decreases were primarily due to the determination in 2001 that certain debt obligations which existed prior to the Company's bankruptcy filing were subject to compromise; as a result, the Company stopped recording interest expense in 2001.

     Net revenues from rehabilitation and respiratory therapy services decreased $29.2 million, or 14.3%, from $204.4 million for the year ended December 31, 2000 to $175.2 million for the year ended December 31, 2001. Revenues from services provided to affiliated facilities decreased $13.8 million, or 12.2%, from $113.3 million for the year ended December 31, 2000 to $99.5 million for the year ended December 31, 2001. Revenues from services provided to nonaffiliated facilities decreased approximately $15.5 million, or 17.0%, from $91.1 million for the year ended December 31, 2000 to $75.6 million for the year ended December 31, 2001. These decreases were primarily the result of the Company's termination of certain nonaffiliated contracts based on issues related to customers' credit-worthiness and contract profitability. In addition, certain nonaffiliated contracts were terminated in the ordinary course

37

of business. The Company's divestitures of inpatient facilities in 2000 and 2001 also contributed to the decrease in affiliated revenues.

     In March 2002, the Company sold its respiratory therapy operations. The net revenues and the segment loss for these operations for the year ended December 31, 2001 were $14.8 million and $2.3 million, respectively.

     Operating expenses decreased $15.3 million, or 9.6%, from $159.8 million for the year ended December 31, 2000 to $144.5 million for the year ended December 31, 2001. 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 increased from 78.2% for the year ended December 31, 2000 to 82.5% for the year ended December 31, 2001. This increase was attributable to the decline in average revenue per therapy service while salaries and wage costs per service decreased by a smaller percentage.

     Depreciation and amortization decreased 40.0% from $3.0 million for the year ended December 31, 2000, to $1.8 million for the year ended December 31, 2001. As a percentage of net revenues, depreciation and amortization expense decreased from 1.5% for the year ended December 31, 2000 to 1.0% for the year ended December 31, 2001, respectively. The decrease was a result of the Company's classification of its respiratory therapy business as an asset held for sale in 2000. As an asset held for sale, the respiratory therapy supplies business no longer recorded depreciation or amortization.

     Provision for losses on accounts receivable decreased $5.3 million, or 79.1%, from $6.7 million for the year ended December 31, 2000 to $1.4 million for the year ended December 31, 2001. As a percentage of net revenues, provision for losses on accounts receivable decreased from 3.3% for the year ended December 31, 2000 to 0.8% for the year ended December 31, 2001. The decrease was primarily due to a change in estimate for the allowance for doubtful accounts related to the rehabilitation therapy business. Through improved management of customer accounts during 2001, the business was able to reduce reserve allowances required.  The decrease was partially offset by the reduction in revenues for the segment as discussed previously.

     Net revenues from pharmaceutical and medical supply services decreased $53.7 million, or 17.3%, from $311.3 million for the year ended December 31, 2000 to $257.6 million for the year ended December 31, 2001. Pharmaceutical services' net revenues from nonaffiliated parties increased approximately $1.2 million, or 0.6%, while net revenues from affiliated parties increased approximately $5.7 million, or 10.4%. The increase in pharmaceutical services' affiliated revenues was primarily due to emphasis within the business to market its services to the Company's inpatient services business. Medical supply services' net revenues decreased approximately $60.6 million, or 85.1%. The decrease was primarily due to the discontinuation of revenue from the Company's medical supply service business, which was sold in January 2001.

     Operating expenses decreased $53.6 million, or 19.1%, from $279.9 million for the year ended December 31, 2000 to $226.3 million for the year ended December 31, 2001. As a percentage of net revenues, operating expenses decreased from 89.9% for the year ended December 31, 2000 to 87.8% for the year ended December 31, 2001. Pharmaceutical services' operating expenses increased approximately $5.6 million, or 2.6%. The increase in the pharmaceutical services' operating expenses was 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 89.2% from $66.4

38

million for the year ended December 31, 2000 to $7.2 million for the year ended December 31, 2001. The decrease in medical supply services' cost of goods sold was a result of the decrease in sales.

     Corporate general and administrative expenses, which include regional costs related to the supervision of operations, decreased 25.0% from $5.2 million for the year ended December 31, 2000 to $3.9 million for the year ended December 31, 2001. The decrease was primarily a result of the sale in January 2001 of the Company's medical supplies services business. As a percentage of net revenues, corporate general and administrative expenses decreased from 1.7% for the year ended December 31, 2000 to 1.5% for the year ended December 31, 2001.

     Depreciation and amortization decreased 37.7% from $6.9 million for the year ended December 31, 2000 to $4.3 million for the year ended December 31, 2001. As a percentage of net revenues, depreciation and amortization expense was approximately 2.2% and 1.7% for the years ended December 31, 2000 and 2001, respectively. The decrease was primarily a result of the sale in January 2001 of the medical supplies services business for which depreciation ceased.

     Provision for losses on accounts receivable decreased 39.3% from $6.1 million for the year ended December 31, 2000 to $3.7 million for the year ended December 31, 2001. As a percentage of net revenues, the provision for losses on accounts receivable decreased from 2.0% for the year ended December 31, 2000 to 1.4% for the year ended December 31, 2001. The decrease was primarily a result of the improved collection trend within the pharmaceutical services business which allows for a decrease in the reserve. Additionally, the Company's medical supplies service business was sold in January 2001 and the provision for that business ceased.

     Revenues from international operations decreased $241.6 million from $265.5 million for the year ended December 31, 2000 to $23.9 million for the year ended December 31, 2001. The decrease was due to the sale of the United Kingdom operations in January 2001 and the divestitures of its operations in Germany in April 2001 and in Australia in July 2001.

     Operating expenses which include rent expense of $40.5 million and $4.6 million for the years ended December 31, 2000 and December 31, 2001, respectively, decreased approximately 91.5% from $248.8 million for the year ended December 31, 2000 to $21.2 million for the year ended December 31, 2001. This decrease was a result of the same factors which led to a decrease in revenue as discussed above. As a percentage of revenues, operating expenses decreased from 93.7% for the year ended December 31, 2000 to 88.7% for the year ended December 31, 2001.

     Corporate general and administrative expenses were $13.0 million and $1.7 million for the years ended December 31, 2000 and December 31, 2001, respectively. The decrease was a result of the same factors which led to a decrease in revenue as discussed above.

     Depreciation and amortization for international operations was $2.5 million for the year ended December 31, 2000. International operations were classified as an asset held for sale in the first quarter of 2000 which requires that depreciation and amortization cease on the operations.

     Net interest expenses were $13.0 million and $1.2 million for the years ended December 31, 2000 and December 31, 2001, respectively. The decrease in expense was a result of the same factors which led to a decrease in revenue as discussed above.

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     The Company sold its remaining international operations in Germany in April 2001 and in Australia in July 2001. The Company recorded a charge of approximately $141.1 million in the first quarter of 2000 to reduce the carrying value of its international operations to its estimate of selling value less costs to sell. The charge was recorded in reorganization costs in the Company's consolidated statements of losses. At December 31, 2001, the Company had no operations outside of the United States. See "Note 7 - Impairment of Long-Lived Assets and Assets Held for Sale" in the Company's consolidated financial statements.

     Nonreportable segments include temporary therapy and nursing staffing, home health, assisted living, software development and other ancillary services. Revenues from other nonreportable segments increased 3.9% from $172.8 million for the year ended December 31, 2000 to $179.5 million for the year ended December 31, 2001. The Company's temporary therapy staffing business' revenue increased $10.9 million from $62.5 million for the year ended December 31, 2000 to $73.4 million for the year ended December 31, 2001. The increase was primarily due to continuing growth in demand for labor across the industry. The Company's laboratory business' revenue increased $5.3 million from $28.3 million for the year ended December 31, 2000 to $33.6 million for the year ended December 31, 2001. The increase was primarily due to an additional revenue stream for mobile radiology developed within the business coupled with efforts by new management personnel within the organization to realize opportunities for growth. The assisted living revenue for the year ended December 31, 2000 was $7.2 million. During 2000, the Company divested 20 assisted living facilities. The Company transferred its two remaining assisted living facilities from its other operations segment to its Inpatient Services segment during 2000. Total revenues and operating expenses for nonreportable segments represents less than 10% of the consolidated Company's results.

     The Company's temporary therapy staffing business' operating expense increased $10.3 million from $53.6 million for the year ended December 31, 2000 to $63.9 million for the year ended December 31, 2001. The increase was primarily due to the increase in revenue which resulted in an increase in labor and other staffing costs to support the business. The Company's laboratory business' operating expenses increased $4.3 million from $24.0 million for the year ended December 31, 2000 to $28.3 million for the year ended December 31, 2001. The increase was primarily due to the increase in revenue which was supported partially with an increase in labor and associated costs.

     The Company's assisted living operating expenses decreased $6.5 million from $6.6 million for the year ended December 31, 2000 to $0.1 million for the year ended December 31, 2001. The decrease in expense is a result of the same factors which led to a decrease in revenue as discussed above. The Company's software development business' operating expenses decreased $4.9 million from $16.6 million for the year ended December 31, 2000 to $11.7 million for the year ended December 31, 2001. The decrease is primarily due to restructuring efforts during 2001 which reduced operating structures and staff within the business. Operating expenses for the Company's corporate segment decreased $4.7 million from $0.7 million for the year ended December 31, 2000 to $(4.0) million for the year ended December 31, 2001. The decrease was primarily due to infrastructure reorganization charges made while under bankruptcy protection that streamlined overhead.

     Corporate general and administrative costs not directly attributed to segments decreased 34.0% from $90.9 million for the year ended December 31, 2000 to $60.0 million at December 31, 2001. As a percentage of consolidated net revenues of $2,458.9 million and $2,075.2 million for the years ended December 31, 2000 and 2001, respectively, corporate general and administrative expenses not directly attributed to segments decreased from 3.7% to 2.9%, respectively. The decrease was primarily the result of

40

the reorganization changes made within the corporate division to streamline overhead and contain costs.  This effort reduced the number of employees in the division which correlated to a reduction in administrative and salary and benefit costs.

     Depreciation and amortization expense not directly attributed to segments increased 5.2% or $0.7 million from $13.4 million for the year ended December 31, 2000 to $14.1 million for the year ended December 31, 2001. The increase was primarily due to an increase in property and equipment within the temporary therapy staffing business to which depreciation was charged.

     Net interest expense not directly attributed to segments decreased 17.1% or $1.8 million from $10.5 million for the year ended December 31, 2000 to $8.7 million for the year ended December 31, 2001. As a percentage of consolidated net revenues, interest expense was 0.4% for the year ended December 31, 2000 and 2001. The decrease was primarily due to the determination in 2001 that certain debt obligations which existed prior to the Company's bankruptcy filing were subject to compromise; as a result, the Company stopped recording interest expense in 2001. For the year ended December 31, 2001, the Company did not pay or accrue approximately $142.8 million of interest expense in accordance with SOP 90-7.

     The corporate segment management fee increased 40.0% or $24.3 million from $60.8 million for the year ended December 31, 2000 to $85.1 million for the year ended December 31, 2001. The increase was primarily attributable to the assessment of additional management fees as specified in the settlement provision of the management agreement between the corporate division and the operating divisions.

     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. The Company 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 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.

     During 2001, the Company recorded restructuring costs of $1.1 million in its software development division. The restructuring plan included reductions of staff and other overhead expenses and a streamlining of the management structure.

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     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 2001, the Company recorded a non-cash impairment charge of approximately $18.8 million. The impairment was primarily due to the decrease of revenues as compared with profitability projections for each facility. This charge included approximately $14.5 million to its inpatient facilities segment and $4.3 million related to the Company's software development business.

     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 were classified as assets held for sale in the Company's consolidated 2000 balance sheet. Additionally, a charge of $26.6 million was recorded to reduce the carrying amount of the corporate headquarters building. The building was classified as an asset held for sale at December 31, 2000 and 2001. 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" in the Company's consolidated financial statements.

Gain on Sale of Assets

     During the year ended December 31, 2001, the Company recorded a net gain on the sale of assets of approximately $0.8 million due primarily to decisions of the Company during 2001 to keep inpatient facilities previously classified as assets held for sale.

     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 was recorded in gain on sale of assets and reorganization costs, net, respectively in the Company's consolidated statements of losses. See "Note 2 - Emergence from Chapter 11 Bankruptcy Proceedings" and "Note 7 - Impairment of Long-Lived Assets and Assets Held for Sale" in the Company's consolidated financial statements.

     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's facilities 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 in expenses during 2000 related to the transfer of certain of its facilities to new operators, which includes the $1.2 million payment described above.

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     The Company recorded net reorganization costs of $335.9 million and $42.9 million for the years ended December 31, 2000 and 2001, respectively. See "Note 2 - Emergence from Chapter 11 Bankruptcy Proceedings" in the Company's consolidated financial statements.

     The net loss for the year ended December 31, 2000 was $545.7 million compared to a net loss of $69.4 million for the year ended December 31, 2001. The loss before considering impairment loss, legal and regulatory matters, net, restructuring costs, gain (loss) on sale of assets, net, reorganization costs, net, and income taxes was $38.3 million for the year ended December 31, 2000 compared to earnings of $3.9 million for the year ended December 31, 2001. The net loss during the year ended December 31, 2000 is primarily due to the implementation of PPS and the continuing adverse impact on the demand for the Company's ancillary services. The net earnings for the year ended December 31, 2001 were primarily due to the Company's efforts while under bankruptcy protection to divest under-performing facilities, mainly in the inpatient services business, and to manage the business to maximize revenue opportunities while controlling costs and expenses.

     In accordance with SOP 90-7, no interest was paid or accrued on prepetition debt, classified as liabilities subject to compromise in the Company's consolidated balance sheets, and on the CTIPS since the Filing Date. These claims were discharged as part of the Company's emergence from bankruptcy in February 2002. Contractual interest expense not paid or accrued was $146.4 million and $142.8 million for the years ended December 31, 2000 and December 31, 2001, respectively.

     Income tax expense was $0.3 million for each of the years ended December 31, 2000 and 2001. For the year ended December 31, 2000, the Company increased its valuation allowance for the deferred tax assets resulting from its net operating losses which may not be realizable depending upon whether the Company generates future taxable income.

Year Ended December 31, 2000 Compared to Year Ended December 31, 1999

     Due to the number of Inpatient Service facilities being divested during the time periods being compared, a "same store" basis is also included for comparison purposes.

     Net revenues, which include revenues generated from therapy and pharmaceutical services provided at the Inpatient Services facilities, increased approximately $13.8 million from $1,704.4 million for the year ended December 31, 1999, to $1,718.2 million for the year ended December 31, 2000, a 0.8% increase. On a same store basis, net revenues increased approximately $152.7 million from $1,254.3 million for the year ended December 31, 1999 to $1,407.0 million for the year ended December 31, 2000, a 12.2% increase. Net revenues for 1999 include negative revenue adjustments of approximately $105.0 million related to reserves established for cost reports which, after audit, may require adjustments to revenues. Excluding the negative revenue adjustments for 1999, on a same store basis, net revenues increased $47.7 million or 3.5% for the year ended December 31, 2000. This increase was primarily the result of improved Medicaid rates during 2000.

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     On a same store basis, operating expenses, which include rent expense of $146.1 million and $142.4 million for the years ended December 31, 1999 and 2000, respectively, increased 1.8% from $1,254.0 million for the year ended December 31, 1999 to $1,276.6 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 92.3% for the year ended December 31, 1999 to 90.7% for the year ended December 31, 2000. The decrease in operating expenses as a percentage of revenue was 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 for the supervision of operations, increased 38.7% from $28.7 million for the year ended December 31, 1999, to $39.8 million for the year ended December 31, 2000. Excluding the effect of the negative revenue adjustments, corporate general and administrative expenses were 2.1% and 2.8% of the net revenues for the years ended December 31, 1999 and 2000, respectively. The change was primarily due to an increase in the corporate overhead allocation partially offset by a reduction in regional overhead to skilled nursing facility divestitures.

     On a same store basis, depreciation and amortization decreased 19.5% from $22.1 million for the year ended December 31, 1999 to $17.8 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 1.3% for the year ended December 31, 2000. The decreases were primarily the result of the determination 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, provision for losses on accounts receivable decreased 71.2% from $37.5 million for the year ended December 31, 1999, to $10.8 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 2.8% for the year ended December 31, 1999, to 0.8% for the year ended December 31, 2000. During 1999 the Company increased its provision for losses on accounts receivable in response to deterioration in the aging of the accounts receivable. An equivalent increase was not necessary in 2000.

     On a same store basis, net interest increased 33.3% from $6.6 million for the year ended December 31, 1999 to $8.8 million for the year ended December 31, 2000. The increase was primarily due to interest charges incurred related to the late filing of certain Medicare cost reports.

     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 12.7% from $234.1 million for the year ended December 31, 1999 to $204.4 million for the year ended December 31, 2000. Revenues from services provided to affiliated facilities decreased from $126.9 million for the year ended December 31, 1999 to $113.3 million for the year ended

     Operating expenses decreased $54.3 million, or 25.4%, from $214.1 million for the year ended December 31, 1999 to $159.8 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 78.2% for the year ended December 31, 2000. This decrease was 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.

     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.

     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 was primarily a result of the write-downs during 1999 of goodwill and certain other long-lived assets pursuant to SFAS 121.

     Provision for losses on accounts receivable decreased $27.4 million, or 80.4%, from $34.1 million for the year ended December 31, 1999 to $6.7 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 3.3% 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 had negatively affected cash flows adversely affecting the collectibility of amounts due the Company. An equivalent increase in reserves for year ended December 31, 2000 was not necessary.

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     Net revenues from pharmaceutical and medical supply services decreased $5.6 million, or 1.8%, from $316.9 million for the year ended December 31, 1999 to $311.3 million for the year ended December 31, 2000. Pharmaceutical services' net revenues decreased approximately $0.1 million from $240.2 million for the year ended December 31, 1999 to $240.1 million for the year ended December 31, 2000. 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 loss 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 was a result of an increase in sales to the Company's Inpatient Services segment.

     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.

     Depreciation and amortization decreased 16.9% from $8.3 million for the year ended December 31, 1999 to $6.9 million for the year ended December 31, 2000. As a percentage of net revenues, depreciation and amortization expense was approximately 2.6% and 2.2% for the years ended December 31, 1999 and 2000, respectively. The decrease was primarily a result of the write-downs of certain long-lived assets during 1999 in accordance with SFAS 121.

     Provision for losses on accounts receivable decreased 78.6% from $28.5 million for the year ended December 31, 1999 to $6.1 million for the year ended December 31, 2000. As a percentage of net revenues, the provision for losses on accounts receivable decreased from 9.0% for the year ended December 31, 1999 to 2.0% 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.

     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

46

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 9.8% from $275.9 million for the year ended December 31, 1999 to $248.8 million for the year ended December 31, 2000. This decrease was 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 year ended December 31, 1999 and 2000, respectively. In accordance with SFAS 121, depreciation and amortization were no longer recognized after operations were placed for sale. Therefore, depreciation and amortization was significantly reduced in 2000.

     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.

     Non-reportable segments include temporary therapy and nursing staffing, home health, assisted living, software development and other ancillary services. Revenues from other non-reportable segments decreased 13.3% from $199.3 million for the year ended December 31, 1999, to $172.8 million for the year ended December 31, 2000. Operating expenses decreased 23.2% from $208.9 million for the year ended December 31, 1999, to $160.4 million for the year ended December 31, 2000. Operating expenses as a percentage of revenues were 104.8% and 92.8% for the years ended December 31, 1999 and 2000, respectively. Total revenues and operating expenses for non-reportable segments represent less than 10% of the consolidated Company's results. The decrease in revenues and operating expenses was primarily a result of the sale of 20 assisted living facilities during 2000. Additionally, the hospice operations were divested during the fourth quarter of 1999. 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 were 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 were not expected to reach the stage under which capitalization is permitted until sometime in 2002.

     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 for the year ended 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% in 1999 to 3.7% in 2000.

     Net interest expense not directly attributed to segments decreased 90.0% 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 decreased from 4.2% for the year ended December 31,

     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. 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.

     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. During 2000, the Company reversed a non-cash reserve of $1.1 million previously recorded in restructuring costs during 1999.

     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.

     During 2001, the Company recorded a non-cash impairment charge of approximately $18.8 million related to the Company's estimate of goodwill and other long-lived assets.  This charge included approximately $14.5 million to its inpatient facilities segment and $4.3 million related to the Company's software development business.

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 - Emergence from Chapter 11 Bankruptcy Proceedings" 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

48

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 consolidated balance sheets. Additionally, a charge of $26.6 million was recorded to reduce the carrying amount of the corporate headquarters building. The building is classified as an asset held for sale at December 31, 2001. The charges were 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".

     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 - Emergence from Chapter 11 Bankruptcy Proceedings" in the Company's consolidated financial statements.

     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 for the year ended December 31, 2000. The net loss during the years ended December 31, 1999 and 2000 was primarily due to the implementation of PPS and the continuing adverse impact on the demand for the Company's ancillary services.

     In accordance with SOP 90-7, no interest was 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.

     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 the year ended December 31, 1999, the Company increased its valuation allowance for the deferred tax assets resulting from its net operating losses which may not be realizable, depending upon whether the Company generates future taxable income.

     New Loan Agreements. On February 28, 2002, the Company entered into (i) a Loan and Security Agreement with certain lenders, led by Heller Healthcare Finance, Inc. as collateral agent, and Citicorp USA, Inc., as administrative agent (the "Revolving Loan Agreement") and (ii) a Term Loan and Note Purchase Agreement with certain lenders, led by U.S. Bank National Association as administrative and collateral agent (the "Term Loan Agreement"), and together with the Revolving Loan Agreement, (the "Loan Agreements"). The Revolving Loan Agreement is a $150.0 million three-year revolving line of credit that is secured by the Company's accounts receivable, inventory, equipment and other assets, a first priority pledge of the stock of the Company's subsidiaries other than those subsidiaries providing pharmaceutical services, and a second priority pledge of the stock of the Company's pharmaceutical services subsidiaries. The Company's borrowing availability under the Revolving Loan Agreement is limited to up to 85% of the Company's net eligible accounts receivable and up to 50% of the Company's net eligible inventory, but not to exceed $150.0 million. Under the Revolving Loan Agreement, dependingupon the type of loan made and provided that an event of default has not occurred, the Company will pay interest at either (i) prime (or, if higher, the  federal funds rate plus 0.50%) plus 2.75% (subject to certain adjustments) or (ii) the London Interbank Offered Rate plus 3.75% (subject to certain adjustments).

     The Term Loan Agreement is comprised of a three-year $20.0 million term loan (the "Term Loan") and a three-year $23.7 million original issue discount note (the "Discount Note" and together with the Term Loan, the "Term Debt"). The Term Debt is secured primarily by a first priority pledge of the stock of the Company's subsidiaries that provide pharmaceutical services and a second priority security interest in substantially all of the Company's other assets. Under the Discount Note, the Company's borrowing availability is approximately $20.0 million. Provided that an event of Default has not occurred, interest accrues on the Term Loan at the greater of (i) prime (or, if higher, the federal funds rate plus 0.50%) plus 4.00% and (ii) 9.00%. The Company will pay interest on the Discount Note for base rate borrowings at a rate of interest equal to the greater of (i) prime (or, if higher, the federal funds rate plus 0.50%) and (ii) 2.65% and for Eurodollar borrowings a rate of interest equal to the Adjusted Eurodollar Rate (as defined in the Term Loan Agreement) plus 0.50%.

     As of March 1, 2002, the Company's gross borrowing availability under the Loan Agreements was approximately $111.0 million. As of March 1, 2002, the Company had borrowed approximately $66.8 million and had issued approximately $44.3 million in letters of credit under the Loan Agreements, leaving a net amount of approximately $39.9 million for additional borrowing. In addition to the available funds under the Loan Agreements, the Company had cash and cash equivalents book balances at March 1, 2002 of approximately $73.6 million. The combination of the Company's cash balances and available borrowing capacity was $113.5 million and $54.6 million as of March 1, 2002 and December 31, 2001, respectively.

     In February 2002, the Company developed a restructuring plan to reduce overhead expenses across all businesses during 2002. The Company estimates annual savings of approximately $25.0 million as a result of the restructuring primarily related to salaries and benefits, although the savings could be less than anticipated. The Company recorded approximately $5.1 million as a restructuring reserve primarily for severance benefits under a severance program that the Company has implemented in conjunction with the plan. 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 operate its business consistent with the plan and other factors set forth in "Item 1 - Business - Certain Additional Business Risks."

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     The Company's revenues will be adversely affected if enactments providing for additional funding expire as currently scheduled. A number of provisions of the BBRA and BIPA enactments providing additional funding for Medicare participating skilled nursing facilities expire on September 30, 2002. In addition, President Bush's fiscal year 2003 budget proposal assumes that CMS will refine the per diem system by October 2002 in order to reduce Medicare payments to skilled nursing facilities. For a discussion regarding the effects of the expiration of the enactment and the proposed 2003 budget, see "Item 1 - Business - Certain Additional Business Risks - The Company's Medicare reimbursements may materially and adversely decline after September 30, 2002."

     The Company believes that it will have sufficient liquidity to meet its operational needs for the next 12 months assuming that (i) the Company maintains its ability to borrow under its Loan Agreements, (ii) the Company achieves its 2002 budgeted results of operations, (iii) the Company does not experience any material and adverse decrease in its results of operations and (iv) Medicare and Medicaid reimbursement rates do not decrease. 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 Credit Agreement, and other risks described elsewhere. See "Item 1 - Business - Certain Additional Business Risks".

     For the year ended December 31, 2001, net cash provided by operating activities was approximately $24.4 million compared to net cash used for operating activities for the year ended December 31, 2000 of approximately $1.7 million. The increase in net cash provided by operating activities for the year ended December 31, 2001 was primarily from the improved collection of accounts receivable.

     The Company incurred approximately $30.3 million, $55.4 million and $102.5 million in capital expenditures during the years ended December 31, 2001, 2000 and 1999, respectively The significant decreases were primarily due to divestitures during 1999 and 2000. In 2001, expenditures related primarily to improvements at existing facilities and routine capital expenditures. The Company had construction commitments of approximately $0.7 million as of December 31, 2001 under various contracts to improve existing facilities. The decrease from 2000 to 2001 was primarily related to the Company reaching a stage of construction completion for the corporate headquarters.

     The Company recorded net reorganization costs of $42.9 million for the year ended December 31, 2001. Included in these charges at December 31, 2001 are approximately $15.3 million for loss on sale of assets related to the divestiture of under-performing assets and approximately $25.8 million for professional fees relating to the legal consideration of the bankruptcy filing. See "Note 2 - Emergence from Chapter 11 Bankruptcy Proceedings" in the Company's consolidated financial statements.

     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. The Company's insurance carriers declined to renew the Company's general and professional liability insurance policies that expired on December 31, 1999. Several major insurance companies no longer provide this type of coverage to long-term care providers due to general underwriting issues with the long-term care industry. Prior to January 2000, the Company's insurance companies paid substantially more to third parties under its policies than the Company paid in insurance premiums and deductibles. There can be no assurance that this self-funded insurance program and any excess insurance coverage will be sufficient to fund any future judgements or settlement resulting from litigation against the Company.   The provision recorded in the Company's statements of losses for the years ended December 31, 2001, 2000 and 1999 were approximately $58.1 million, $35.3 million and $23.9 million, respectively. During 2000, the Company

51

pre-funded $22.2 million for general and professional liability claims into a cash collateral trust account held by the Company's insurance carrier.  The Company funded an additional $5.0 million into the trust account in 2001.  The combined pre-funding will be used to pay claims for policy years 2000 through 2002.  Claims paid from the trust account were immaterial in 2000 and were $5.8 million for the year ended December 31, 2001.

     For the year ended December 31, 1999, the workers' compensation insurance was a guaranteed cost program, and thus, after payment of the premium, 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 acturial analysis prepared in the current year determined the undiscounted expected losses and costs under this retention level to be approximately $35.5 million as of December 31, 2001 and $36.0 million as of December 31, 2000. The Company has pre-funded cash collateral trust accounts with its insurance carrier in the amount of $26.8 million and $32.4 million as of December 31, 2001 for the 2001 and 2000 policy years, respectively. Claims paid from the 2001 policy year trust account were $4.7 million, and claims paid from the 2000 policy year trust account were $12.5 million and $5.7 million as of December 31, 2001 and 2000, respectively. The accounts were established to fund the Company's ultimate estimated exposure and will be adjusted retrospectively based on revisions to the estimates. 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 was approximately $29.5 million and $14.2 million as of December 31, 2001 and 2000, respectively. Provisions for such risks totaled approximately $54.9 million, $27.4 million and $30.9 million for the years ended December 31, 2001, 2000 and 1999, respectively, and were included in operating expenses and corporate general and administrative expenses.

     On June 30, 1998, a wholly owned subsidiary of the Company merged with Retirement Care Associates, Inc. ("RCA"), an operator of skilled nursing and assisted living facilities 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, 2001 and December 31, 2000, the Company's purchase liabilities reserve balance was approximately $7.0 million and $12.0 million, respectively.

     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.

     The Company's long-term debt that was outstanding as of December 31, 2001 was generally either canceled as part of its Plan of Reorganization or paid off on February 28, 2002. The Company's Revolving Loan Agreement and Term Loan Agreement entered into on February 28, 2002, are sensitive to changes in interest rates.

     The Revolving Loan Agreement is a $150.0 million three-year revolving line of credit. The Company's borrowing availability under the Revolving Loan Agreement is limited to up to 85% of the

52

Company's net eligible accounts receivable and up to 50% of the Company's net eligible inventory, but not to exceed $150 million. Under the Revolving Loan Agreement, depending upon the type of loan made and provided that an event of default has not occurred, the Company will pay interest at either (i) prime (or, if higher, the federal funds rate plus 0.50%) plus 2.75% (subject to certain adjustments) or (ii) the London Interbank Offered Rate plus 3.75% (subject to certain adjustments). For each additional percentage point increase in the LIBOR, assuming an outstanding balance of $100.0 million, the Company will incur additional interest expense of approximately $1.0 million annually.

     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.

     None.

The directors and executive officers of Sun as of March 1, 2002 were:

     Richard K. Matros, age 48, has been the Chairman of the Board and Chief Executive Officer of the Company since November 2001. Mr. Matros served as Chief Executive Officer and President of Bright Now! Dental from 1998 to 2000. He served Regency Health Services, Inc., a publicly held long-term care operator, as Chief Executive Officer from 1995 to 1997, as President and a director from 1994 to 1997, and as Chief Operating Officer from 1994 to 1995. He served Care Enterprises, Inc. as Chief Executive Officer during 1994, as President, Chief Operating Officer and a director from 1991 to 1994, and as Executive Vice President - Operations from 1988 to 1991. Mr. Matros currently serves on the board of directors of Bright Now! Dental, Care Meridian LLC, Geriatrix and Protocare, Inc.

     Kevin W. Pendergest, age 48, has been an Executive Vice President and the Chief Financial Officer of the Company since March 1, 2002. Mr. Pendergest was the President and owner of Strategic Alliance Network, a healthcare services advisory firm, from 1995 to February 2002. From 1990 to 1995 he was Executive Vice President and Chief Financial Officer of GranCare, Inc., a publicly held long-term care company. From 1981 to 1989, Mr. Pendergest held various positions with Deloitte Haskins & Sells, most recently as Partner in Charge of Healthcare Consulting for the Western Region of the United States.

     Wallace E. Boston, Jr., age 47, has been the Principal Financial Officer of the Company since March 1, 2002. Mr. Boston was the Chief Financial Officer of the Company from August 2001 until March 2002. Mr. Boston served Neighborcare Pharmacies, an institutional pharmacy company, as President and Chief Executive Officer from 1999 to 2001 and as Executive Vice President and Chief Operating Officer from 1998 to 1999. He served Manor Care Health Services, Inc., a long-term care company, as Senior Vice President-Acquisitions & Development from 1996 to 1998 and as Vice

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President-Finance from 1993 to 1996. Mr. Boston previously served as Vice President and Chief Financial Officer of Meridian Healthcare, Inc. from 1985 to 1992, as Senior Vice President and Chief Financial Officer of National Realty Services from 1983 to 1985, and with Price Waterhouse Management Advisory Services from 1978 to 1983, most recently as Manager.

     William A. Mathies, age 42, has been President of SunBridge Healthcare Corporation, an inpatient services subsidiary of the Company, since March 1, 2002. From 1995 to March 2002, Mr. Mathies served as Executive Vice President of Beverly Enterprises, Inc., a long-term care company. Most recently, he was the Executive Vice President of Innovation/Services for Beverly. He previously served Beverly as President of Beverly's Health and Rehabilitation Services, (the LTC subsidiary of Beverly) from 1995 to 2000, Vice President of Operations for California from 1988 to 1995, as a Regional Manager from 1986 to 1988 and as a facility administrator from 1981 to 1986.

     Warren C. Schelling, age 48, has been Senior Vice President of Ancillary Services of the Company since 2000. Mr. Schelling previously served the Company as President and Chief Operating Officer of its international operations from 1999 to 2001, as Senior Vice President for its pharmaceuticals division from 1996 to 1999, on the Board of Directors from 1996 to 1998 and as President of SunScript Pharmacy Corporation from 1994 to 1996. Mr. Schelling was the President and Chief Operating Officer of HPI Health Care Services, Inc., which provided pharmacy management services, from 1993 to 1994. During 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 at HPI Health Care Services, Inc. Mr. Schelling was an executive officer of the Company when it commenced its chapter 11 bankruptcy proceeding in October 1999.

     Heidi J. Fisher, age 45, has been Senior Vice President of Human Resources of the Company since February 2002. From 1998 to 2002, Ms. Fisher was Vice President Human Resources of Bright Now! Dental, a dental practice management company. From 1997 to 1998, she was Corporate director of Human Resources at Covenant Care, Inc., a long-term care company. From 1994 to 1997, Ms. Fisher was with Regency Health Services, Inc., a long-term care company, most recently with the title Senior Director of Human Resources. From 1987 to 1994, Ms. Fisher was Senior Manager of Human Resources with Volt Delta Resources, Inc.

     Robert F. Murphy, age 48, 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. Mr. Murphy was an executive officer of the Company when it commenced its chapter 11 bankruptcy proceeding in October 1999.

     Chauncey J. Hunker, Ph.D., age 51, has been Corporate Compliance Officer of the Company since 2000. From 1996 to 2000, Dr. Hunker served as Vice President of Continuous Quality Improvement of SunDance Rehabilitation Corporation, the Company's rehabilitation therapy subsidiary ("SunDance"). From 1995 to 1996, he was a Clinical Director of SunDance, and from 1992 to 1995 he was Regional Vice President of Learning Services - Midwestern Regional Facility in Madison, Wisconsin. Dr. Hunker has also served as Adjunct Assistant Professor, Department of Neurology, at the University of Wisconsin Medical School since 1989.

     Robert K. Schneider, age 54, has been a Vice President and the Treasurer of the Company since July 2001. Mr. Schneider provided investment banking consulting services from 1996 to 2001. He was Treasurer of the Hillhaven Corporation and Vencor, Inc. (after Vencor's acquisition of Hillhaven) from

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1990 to 1996. Mr. Schneider was a Vice President and Manager of Seattle First National Bank from 1974 to 1990.

     Jennifer L. Botter, age 39, has been Vice President and Corporate Controller of the Company since 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. From 1984 to 1996 she held financial consulting and accounting positions in the high technology and manufacturing industries.

     John W. Adams, age 58, has served as a Director of the Company since February 28, 2002. Mr. Adams has served as President of Smith Management, LLC, a private investment firm, since 1984. From 1972 to 1983 he was a partner at the law firm of Dillon, Bitar & Luther. Mr. Adams currently serves as Chairman of the Board of Hawaiian Airlines, a publicly held airline.

     Gregory S. Anderson, age 45, has served as a Director of the Company since November 2001. Mr. Anderson has served as the President and Chief Executive Officer of Quality Care Solutions, Inc. ("QCSI"), a publicly held provider of software and services for the healthcare industry, since 1998. Prior to 1998 Mr. Anderson was in the venture capital business. From 1993 to 1998 he was President of Anderson & Wells Co., the venture capital manager of Sundance Venture Partners and El Dorado Investment Co. Mr. Anderson currently serves on the board of directors of QCSI, American OBGYN, Inc., Glendora Hospital and Valley Commerce Bank.

     Charles W. McQueary, age 49, has served as a Director of the Company since February 28, 2002. Mr. McQueary served ProMedCo, Inc., a national medical practice management company, as Chief Executive Officer from February 2001 to December 2001 and as Senior Vice President - Operations from May 1997 to February 2001. Mr. McQueary previously served as Regional Vice President of Med Partners, Inc. from 1995 to 1997 and as Chief Operating Officer and Chief Financial Officer of Asthma & Allergy CareAmerica, Inc. from 1993 to 1995. Prior to that, he held offices with other health care companies and various positions with independent accounting firms.

     John F. Nickoll, age 67, has served as a Director of the Company since February 28, 2002. Mr. Nickoll has served as President, Chairman and Chief Executive Officer of the Foothill Group, Inc., a subsidiary of Wells Fargo, since 1970. Mr. Nickoll is also Managing General Partner of Foothill Partners, L.P., Foothill Partners II, L.P., Foothill Partners III, L.P. and Foothill Income Trust II, L.P., each of which invest in senior bank debt and other types of debt issues. Mr. Nickoll currently serves as a director of the Foothill Group, Inc. and CIM High Yield Securities, a closed end high yield bond fund.

     Sanjay H. Patel, age 41, has served as a Director of the Company since February 28, 2002. Mr. Patel has served as Co-President of GSC Partners, a private equity firm, since 1998. Mr. Patel served Goldman, Sachs & Co. as Managing Director in the Principal Investment Area from 1992 to 1998, in the Leveraged Buyout Department from 1987 to 1992 and in the Mergers and Acquisitions Department from 1983 to 1985. Mr. Patel currently serves on the Board of Directors of Project Time & Cost, Inc., ETEC Ventures, Ltd. (Mauritus), ForcesGroup, Ltd., Waddington North America, Inc., Tracmail (Bermuda) Ltd., Atlantic Express Transportation Group and GSCP Recovery, Inc.

     Bruce C. Vladeck, Ph.D., age 52, has served as a Director of the Company since November 2001. Dr. Vladeck has served as Senior Vice President for Policy for Mount Sinai NYU Health, Director of the Institute for Medicare Practice and Professor of Health Policy and Geriatrics at the Mount Sinai School of Medicine since 1998. From 1993 to 1997 Dr. Vladeck was Administrator of the Health Care Financing

     Steven L. Volla, age 55, has been a director of the Company since November 2001. Mr. Volla has served as President of Health Equities Management, Inc., an investor in and advisor to healthcare companies, since 1994. He served as Chairman of Primary Health Systems, Inc., an acute care hospital management company, from 1994 to 2001. He served as President, Chief Executive Officer and Chairman of the Board of American Healthcare Management, Inc., a publicly held hospital management company, from 1989 to 1994. He has also served Universal Health Services, Inc. as Senior Vice President - Operations and UHS Hospital Company as President. Mr. Volla currently serves on the board of directors of Pathmark Stores, Inc., a publicly held operator of supermarkets; Brown Schools, Inc., a privately held education company; and Specialty Hospital of America, a privately held long-term acute care hospital management company.

     Milton J. Walters, age 59, has been a director of the Company since November 2001. Mr. Walters has served with investment banking companies for over 30 years, including: Tri-River Capital since 1999 and from 1988 to 1997, as President; Prudential Securities from 1997 to 1999, most recently as Managing Director; Smith Barney from 1984 to 1988, most recently as Senior Vice President and Managing Director; Warburg Paribas Becker from 1965 to 1984, most recently as Managing Director. He currently serves on the Board of Directors of Quest Products Corporation, a publicly held marketing company, and as Chairman of MDHIO, Inc. Marketing, a privately held marketer of golf contests.

     Pursuant to the Company's Joint Plan of Reorganization, the Company's Board of Directors consists of nine members. The holders of the senior lender claims selected eight of the members: Messrs. Adams, Anderson, McQueary, Nickoll, Patel, Vladeck, Volla and Walters to serve on the Board for a one-year term. The Plan provides that the ninth member is the Company's Chief Executive Officer, Mr. Matros. After the initial year, the holders of Sun's common stock will elect new members to the Board.

     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"). 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 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 2001 all Section 16(a) filing requirements applicable to its directors, executive officers and greater than ten percent beneficial owners were met.

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     The following table provides information concerning employment compensation for services to the Company and its subsidiaries for the fiscal years shown for those persons (the "Named Executive Officers") who were, during the year ended December 31, 2001, (i) the individuals who served as chief executive officer, (ii) the other four most highly compensated executive officers of the Company and (iii) a former officer who would have been one of the most highly compensated officers but who was not with the Company on December 31, 2001.

                ______________________

__________________

     The Company entered into an Employment Agreement with Richard K. Matros on February 28, 2002. The agreement terminates on November 6, 2005, although the term is automatically extended for an additional year on November 6, 2004, and on each anniversary thereafter, unless the Company or Mr. Matros provides notice of non-extension. Pursuant to the agreement, Mr. Matros will receive an annual base salary of $650,000 that is subject to annual merit increases as determined by the Board of Directors. In addition to the base salary, Mr. Matros is entitled to an annual bonus for each fiscal year in which the Company achieves or exceeds certain financial performance targets. If the targets are achieved, the bonus could be 50%, 75% or 100% of base salary, depending upon how much the targets are exceeded. Mr. Matros was also awarded 150,000 shares of restricted common stock and an option to purchase 150,000 shares of common stock on February 28, 2002. The restricted stock will vest as to 60,000 shares on February 28, 2003 and 30,000 shares on each of February 28, 2004, 2005 and 2006.

     Mr. Matros' Employment Agreement provides that in the event of his termination of employment by the Company without Good Cause, by Mr. Matros for Good Reason (each as defined in the Employment Agreement), or upon the expiration of the term of the agreement following the Company's notice of non-extension, then Mr. Matros would be entitled to a lump sum severance payment in the amount equal to the greater of: (i) the unpaid and unearned portion of his base salary for the remainder of the term of the agreement, or (ii) two year's base salary or, in the event such termination occurs on or within two years following the date of a change of control (as defined in the Employment Agreement), then three year's base salary.

     The Company is currently in the process of documenting employment agreements with Kevin W. Pendergest, William A. Mathies and Heidi J. Fisher.

     The Company has entered into Severance Agreements with Mr. Schelling and Mr. Murphy pursuant to which they would receive severance payments in the event of their Involuntary Termination of employment (as defined in the Agreements). The severance payments would be equal to 24 months of their then-current salary. In addition to the severance payments, they would have the right to participate for a defined period of time in the medical, dental, health, life and other fringe benefit plans and arrangements applicable to them immediately prior to termination. Severance payments would be made in a lump sum or over a period of time at the discretion of the Company. If so elected, the Company could make the severance payments over time, which would release the executive 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 could be made in a lump sum and the executive would remain subject to certain competitive prohibitions.

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     The Company has entered into a Severance Agreement with Mr. Hunker pursuant to which he would receive severance payments in the event of his Involuntary Termination of employment (as defined in the Agreement). The severance payment would be equal to 12 months of his then-current salary, except that if the termination is the result of a Change of Control (as defined in the Agreement), the severance payments would equal 24 months of salary. In addition to the severance payment, he would have the right to participate for a defined period of time in the medical, dental, health, life and other fringe benefit plans and arrangements applicable to him immediately prior to termination. His severance payment would be made in a lump sum.

     The following table and footnotes set forth certain information regarding the beneficial ownership of Common Stock as of March 18, 2002 by (i) each director, (ii) the Named Executive Officers (as defined above) and (iii) all directors and executive officers of the Company as a group.

_____________________

     The following table and footnotes set forth certain information regarding the beneficial ownership of Common Stock as of March 18, 2002 by each person believed by the Company to be the beneficial owner of more than five percent of Common stock of the Company.

     As of December 31, 2001, SunBridge was a lessee or assignee of five facilities from partnerships in which Mr. John Bingaman, a former director of the Company, has an equity interest of greater than ten percent. The aggregate lease payments, including base rents, contingent rents and other miscellaneous payments in connection with these leases, totaled approximately $2.0 million in 2001.

     Prior to Mr. Pendergest joining the Company as Executive Vice President and Chief Financial Officer in March 2002, he served as a court appointed examiner of the Company during its chapter 11 bankruptcy proceedings. Mr. Pendergest provided these services as an independent contractor of Crossroads, LLC, of which he had no ownership interest. All of the payments made to Mr. Pendergest in his capacity as the examiner were approved by the bankruptcy court. The Company paid Crossroads a total of approximately $1,509,000 for services rendered, plus expenses, and Crossroads paid Mr. Pendergest a total of approximately $215,000 for his services, plus expenses. In addition to Mr. Pendergest, Crossroads provided other professionals and consultants to assist with the Company.

     Prior to Mr. Schneider joining the Company as Vice President and Treasurer in July 2001, he provided certain consulting services to the Company during its chapter 11 bankruptcy proceedings related to the renegotiation of various facility leases. During the year ended December 31, 2001, the Company paid Mr. Schneider an aggregate of approximately $142,000 for his consulting services, plus expenses. All of the payments to Mr. Schneider were approved by the bankruptcy court. Mr. Schneider did not provide any consulting services to the Company after he became Vice President and Treasurer.

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common stock. See "Item 10 - Directors and Executive Officers of the Registrant" and "Item 12 - Security Ownership of Certain Beneficial Owners and Management." An affiliate of GSC Partners, GSC Partners CDO Fund III, is a party to the Company's Term Loan Agreement and as of March 28, 2002 the Company was indebted to GSC Partners CDO Fund III under that agreement for approximately $11.0 million.

(a)  Financial Statements and Financial Statement Schedules

     (i)  Financial Statements:

          Consolidated Statements of Stockholders' Deficit for the years ended December 31
                2001, 2000 and 1999

           Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and
                1999

           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,
                2001, 2000 and 1999

(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

      Form 8-K dated November 7, 2001 reporting the filing of the Company's Joint Plan of
      Reorganization in the U.S. Bankruptcy Court for the District of Delaware.

(c)  Exhibits

_______________

*       Filed herewith.

(1)  Incorporated by reference from exhibits to the Company's Form 8-A filed on March 6, 2002.

(2)  Incorporated by reference from exhibits to the Company's Form 8-K dated February 28, 2002, as amended on Form 8-K/A.

     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.

March 29, 2002

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     Each person whose signature appears below hereby appoints each of Richard K. Matros 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 29, 2002 in the capacities indicated.

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

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

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

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

ARTHUR ANDERSEN LLP

Albuquerque, New Mexico
March 18, 2002

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

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

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