[ X ]     Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2003

or

[    ]     Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 0-49663

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

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

     As of May 9, 2003, there were 9,849,738 shares of the Registrant's $.01 par value Common Stock outstanding.

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2

See accompanying notes.

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See accompanying notes.

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See accompanying notes.

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 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

See accompanying notes.

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

Business

     We are a provider of long-term, subacute and related specialty healthcare services in the United States. We operate through three principal business segments: (i) inpatient services, (ii) rehabilitation therapy services, and (iii) pharmaceutical services, with inpatient services representing the most significant portion of our business. As of March 31, 2003, we operated 217 long-term care facilities in 25 states and provided rehabilitation and pharmaceutical services to both company-operated and non-affiliated facilities.

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

     We operated our business as a debtor-in-possession subject to the jurisdiction of the Bankruptcy Court from October 14, 1999 (the "Filing Date") until February 28, 2002. Accordingly, our consolidated financial statements prior to March 1, 2002 have been prepared in accordance with the American Institute of Certified Public Accountants Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7") and generally accepted accounting principles applicable to a going concern, which assume that assets will be realized and liabilities will be discharged in the normal course of business. The report of our independent auditors as of December 31, 2002 and for the ten month period then ended included an explanatory paragraph as to our ability to continue as a going concern (see our Annual Report on Form 10-K for the year ended December 31, 2002).

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

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

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

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     The accompanying unaudited consolidated financial statements do not include all of the disclosures normally required by accounting principles generally accepted in the United States or those normally required in annual reports on Form 10-K.

     The accompanying unaudited consolidated financial statements have been prepared in accordance with our customary accounting practices and accounting principles generally accepted in the United States. In the opinion of management, the accompanying interim consolidated financial statements present fairly our financial position at March 31, 2003 and December 31, 2002, the consolidated results of our operations and the consolidated cash flows for the three, one and two month periods ended March 31, 2003, March 31, 2002 and February 28, 2002, respectively. Management believes that all adjustments are of a normal and recurring nature. These statements are presented in accordance with the rules and regulations of the SEC. Accordingly, they are unaudited, and certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted, as permitted under the applicable rules and regulations. Readers of these statements should refer to our audited consolidated financial statements and notes thereto for the year ended December 31, 2002 and the two months ended February 28, 2002, which are included in our Annual Report on Form 10-K for the year ended December 31, 2002 and in our Form 8-K filed on May 31, 2002. The results of operations presented in the accompanying consolidated financial statements are not necessarily representative of operations for an entire year. Certain amounts in the 2002 consolidated financial statements and notes thereto have been reclassified to conform to the 2003 presentation.

     The consolidated balance sheet as of December 31, 2002 and the consolidated statements of operations and cash flows for the two months ended February 28, 2002 have been derived from the audited financial statements at these dates but do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

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

(2)  Basis of Reporting and Current Operating Environment

     Our consolidated financial statements as of March 31, 2003, and for the three month period then ended have been prepared under accounting principles generally accepted in the United States assuming that we will continue as a going concern. As noted in Note 1 above, the report of our independent auditors as of December 31, 2002 and for the ten month period then ended included an explanatory paragraph as to our ability to continue as a going concern. We recorded a net loss of $13.3 million for the three month period ended March 31, 2003. We have negative working capital and a stockholders' deficit of $65.5  million and $186.5 million, respectively, at March 31, 2003. Our net loss was primarily the result of reimbursement decreases and increased costs for patient liability settlements. In addition, we are not in compliance with financial covenants on certain long-term debt obligations totaling $106.9 million at March 31, 2003 (see Note 3 and 4). Accordingly, we have classified these debt obligations as current liabilities in the accompanying consolidated balance sheet as of March 31, 2003.

     In January 2003, we initiated restructuring efforts, which include an attempt to restructure the portfolio of leases under which we operate most of our long-term care facilities. We are seeking to obtain rent concessions with respect to our under-performing facilities, and if we are unable to obtain sufficient rent concessions on a facility lease, then we will seek to transition operations of that facility to a new operator so that we will no longer be burdened by the loss generated by that facility. We divested 21 skilled nursing facilities during the quarter ended March 31, 2003, and an additional 16 facilities between April 1, 2003 and April 30, 2003. As of April 30, 2003, we have identified approximately 43% of our current facilities that we would seek to transition to new operators if we are unable to restructure the applicable leases or obtain satisfactory rent concessions on the facilities. Through March 31, 2003, we have withheld approximately $18.9 million in accrued rent and mortgage payments for those facilities. They are classified as current obligations at March 31, 2003. In April 2003, we were released from paying approximately $9.4 million of the withheld payments.  See Note 12 - Subsequent Events.

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

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

     As part of our restructuring efforts we paid restructuring costs of $1.8 million during the three months ended March 31, 2003 comprised of $1.4 million of professional fees and $0.4 million in severance costs related to the termination of employees.

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

     The consolidated financial statements as of March 31, 2003, and for the three month period then ended, do not include any adjustments to reflect the possible future effects to the recoverability and classification of assets or the amounts and classification of liabilities that might result from the outcome of the uncertainty regarding our ability to continue as a going concern.

      On February 28, 2002, we entered into a Loan and Security Agreement with certain lenders, led by Heller Healthcare Finance, Inc. as collateral agent, and Citicorp USA, Inc., as administrative agent (the "Revolving Loan Agreement"). The Revolving Loan Agreement is a $150.0 million three-year revolving line of credit that is secured by our accounts receivable, inventory, equipment and other assets, a first priority pledge of the stock of our subsidiaries, other than those subsidiaries providing pharmaceutical services, and a second priority pledge of the pharmaceutical services subsidiaries. As agreed with the lenders under the Revolving Loan Agreement, we are paying interest (i) for Base Rate Loans at prime (or, if higher, the federal funds rate plus 0.5%) plus 3.5% (subject to certain adjustments) and (ii) for LIBOR Loans at the London Interbank Offered Rate plus 4.5% (subject to certain adjustments). The effective interest rate as of March 31, 2 003 on borrowings under the Revolving Loan Agreement was approximately 6.3%. The weighted average borrowing interest rate for the three month period ended March 31, 2003 was 6.5%. Our borrowing availability under the Revolving Loan Agreement is limited to up to 85% of our net eligible accounts receivable and up to 50% of our net eligible inventory, but not to exceed $150.0 million. The defined borrowing base as of March 31, 2003, was $100.2 million, net of specified reserves of $27.0 million, which includes a minimum availability reserve of $10.0 million. As of March 31, 2003, we had borrowed approximately $51.8 million and had issued approximately $26.4 million in letters of credit under the Revolving Loan Agreement, leaving approximately $22.0 million available to us for additional borrowing.

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     On February 28, 2002, we entered into a Term Loan and Note Purchase Agreement with certain lenders, led by U.S. Bank National Association as administrative and collateral agent (the "Term Loan Agreement," and together with the Revolving Loan Agreement, the "Loan Agreements"). The Term Loan Agreement is comprised of a three-year $20.0 million term loan and a three-year $23.7 million original issue discount note (the "Discount Note") of which our borrowing capacity is limited to $20.0 million. The Term Loan Agreement is secured primarily by a first security pledge of the stock of our subsidiaries that provide pharmaceutical services and a second priority security interest in substantially all of our other assets. Interest rates under the Term Loan Agreement are variable based upon either the lender's base rate (as defined) or LIBOR, plus applicable margins. The effective interest rate as of March 31, 2003 on borrowings under the Term Loan Agreement was approxi mately 9.0% inclusive of a rate of 2.7% for the Discount Note. We borrowed the maximum amount available under the Term Loan Agreement, which was $40.0 million, and we have made quarterly payments of principal of $0.8 million plus interest. The principal balance remaining on the Term Loan Agreement was approximately $36.6 million at March 31, 2003.

     For the quarter ended March 31, 2003, we were not in compliance with the following covenants under the Loan Agreements:  indebtedness to EBITDA ratio, fixed charge coverage ratio and minimum operating cash flow.  The lenders under the Term Loan Agreement have also asserted other covenant and substantive defaults. We can give no assurance that the lenders will not seek to exercise their remedies, including but not limited to declaring amounts outstanding to be immediately due and payable, acting upon their security interests, and denying us the right to additional borrowing under the Revolving Loan Agreement.

     We have classified the Revolving Loan Agreement and the Term Loan Agreement totaling $88.5 million as current obligations as of March 31, 2003. The default interest rates under the Revolving Loan Agreement and the Term Loan Agreement increase by 2.0% based on the rates in effect, which equate to default rates of 8.3% and 11.0%, respectively, as of March 31, 2003.

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

(4)  Long-Term Debt

     We are in default under mortgages for two skilled nursing facilities, and we have classified the two mortgages totaling $18.4 million as current obligations as of March 31, 2003. The lender had asserted that we are in default of the mortgages; however, on April 18, 2003, we entered into a settlement agreement with the lenders under the mortgages that provided for the transfer of the properties to the lenders in full settlement and satisfaction of the debt. See Notes 2 and 12.

     In accordance with SOP 90-7, we did not pay any principal or accrue any interest on prepetition obligations between October 14, 1999 and February 28, 2002 except for amounts related to certain Industrial Revenue Bonds, a fully-secured mortgage, certain capital equipment leases and a nominal amount related to a promissory note. The total amount of interest that was not required to be paid is parenthetically disclosed in the consolidated statements of operations.

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

     Long-term debt at March 31, 2003 and December 31, 2002 includes amounts owed under fully secured mortgage notes payable, certain Industrial Revenue Bonds and other debt.

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     The scheduled or expected maturities of long-term debt as of March 31, 2003 are as follows (in thousands):

      Long Lived Assets to be Disposed Of

     Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS No. 144"), requires that long-lived assets to be disposed of be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. Therefore, discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred. SFAS No. 144 also broadens the reporting of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. Depreciation is discontinued once an asset is classified as held for sale. During the two month period ended February 28, 2002, the Predecessor Company presented the operating results of all facilities identified for sale or disposition in discontinued operations in the consolidated statement of operations. From March 1, 2002 through December 31, 2002, the Reorganized Company had a limited number of facilities disposed of or transferred to assets held for sale. These facilities' operating results are included in continuing operations and are immaterial to our consolidated financial position and results of operations. Due to our lease restructuring initiative in 2003, we began to report our divested facilities as discontinued operations in the first quarter of 2003.

     As of March 31, 2003, assets held for sale consist of (i) five undeveloped parcels of land valued at $6.3 million and (ii) artwork valued at $1.5 million within our consolidated financial statements in our Other Operations and Corporate segments, respectively, which we expect to sell during 2003.

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(6)  Commitments and Contingencies

(a) Insurance

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

     Included in restricted cash in our consolidated balance sheet as of March 31, 2003 and December 31, 2002 is $79.9 million and $76.7 million, respectively, primarily related to our funding of self-insurance obligations and amounts to pay U.S Trustee fees. Other Assets, net, as of March 31, 2003 and December 31, 2002, includes $3.0 million and $3.6 million, respectively, of restricted cash maintained to repay a mortgage.

     As of March 31, 2003, the Reorganized Company had issued approximately 9,678,000 shares of its common stock in connection with the extinguishment of the Predecessor Company's liabilities subject to compromise and 150,000 shares of its common stock pursuant to the 2002 Management Equity Incentive Plan. As of March 31, 2003, we expected to issue up to an additional 322,000 shares of our common stock to general unsecured creditors with claims of more than $50,000 in accordance with the provisions of the Plan of Reorganization. The fair value of the additional common stock expected to be issued is approximately $8.7 million valued at $27 per share by our reorganization plan and is recorded in other long-term liabilities in the March 31, 2003 consolidated balance sheet. On May 12, 2003, the closing price of our common stock on the Over-the Counter Bulletin Board was $0.98.

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Reorganized Company Stock Option Plan

     In February 2002, we adopted the 2002 Management Equity Incentive Plan, which allows for the issuance of up to 900,000 shares of our common stock.  As of March 31, 2003, our officers held options to purchase 700,000 shares under this plan and we had issued 150,000 shares of common stock awards.

     In March 2002, we adopted the 2002 Non-employee Director Equity Incentive Plan, which, as amended in August 2002, allows for the issuance of up to 160,000 options to purchase shares of our common stock. As of March 31, 2003, our directors held options to purchase 80,000 shares under this plan.

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

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

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     Basic net (loss) income per share is based upon the weighted average number of common shares outstanding during the period. The weighted average number of common shares in the three months ended March 31, 2003 include the common shares issued in connection with emergence and 322,000 common shares outstanding to be issued once the prepetition claims are finalized.

     Diluted net (loss) income per share is based upon the weighted average number of common shares outstanding during the period plus the number of incremental shares of common stock contingently issuable upon exercise of stock options and if dilutive, include the assumption that our restricted common stock of the Reorganized Company and convertible securities of the Predecessor Company were converted as of the beginning of the period. Net earnings are adjusted for the interest on the convertible securities, net of interest related to additional assumed borrowings to fund the cash consideration on conversion of certain convertible securities and the related income tax benefits. In periods of losses, diluted net loss per share is based upon the weighted average number of common shares outstanding during the period. As we had a net loss for the three months ended March 31, 2003, our stock options were anti-dilutive. Options to purchase approximately 780,000 shares of common stock were outstanding for the three months ended March 31, 2003, but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common stock.

     The current provision for income taxes of $0.3 million, $0.1 million and $0.1 million for the three months ended March 31, 2003, one month ended March 31, 2002 and two months ended February 28, 2002, respectively, was based on estimated state income tax liabilities for these periods. These estimated state income tax liabilities resulted from the operations of profitable subsidiaries in states that do not allow combined, consolidated or unitary tax return filings. No overall tax benefits were recorded for these periods for federal purposes since the realization of net operating loss carryforwards is uncertain.

(a)  Litigation

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

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

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

     We operate predominantly in the long-term care segment of the healthcare industry. We are a provider of long-term, sub-acute and related ancillary care services to nursing home patients.

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

Inpatient Services: This segment provides, among other services, inpatient skilled nursing and custodial services as well as rehabilitative, restorative and transitional medical services. We provide 24-hour nursing care in these facilities by registered nurses, licensed practical nurses and certified nursing aides. At March 31, 2003, we operated 217 long-term care facilities with 24,274 licensed beds as compared with 244 facilities with 27,632 licensed beds at March 31, 2002. As part of our restructuring efforts, we may divest approximately 48% of those 217 skilled nursing facilities representing approximately 12,000 licensed beds. See Note 12 - Subsequent Events.

Rehabilitation and Respiratory Therapy Services: This segment provides, among other services, physical, occupational, speech and respiratory therapy supplies and services to affiliated and nonaffiliated skilled nursing facilities. At March 31, 2003, this segment provided services to 550 facilities, 335 of which are nonaffiliated and 215 were affiliated, as compared to 548 facilities at March 31, 2002, of which 329 were nonaffiliated and 219 were affiliated. In March 2002, we sold substantially all of the assets of our respiratory therapy operation.

Pharmaceutical Services: This segment provides pharmaceutical products primarily to affiliated and nonaffiliated long-term and sub-acute care facilities for such purposes as infusion therapy, pain management, antibiotic therapy and parenteral nutrition as well as providing consultant pharmacist services. This segment provided services to 665 facilities at March 31, 2003 compared with 641 facilities at March 31, 2002. Of the 665 facilities in 2003, 487 were nonaffiliated facilities and 178 were affiliated as compared to 426 nonaffiliated facilities and 215 affiliated facilities in 2002. Included in intersegment revenues in the following tables is revenue billed directly to affiliated homes.

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

     Corporate assets primarily consist of cash and cash equivalents, receivables from subsidiary segments, notes receivable and property and equipment.

     Our reportable segments are strategic business units that provide different products and services. They are managed separately because each business has different marketing strategies due to differences in types of customers, different distribution channels and different capital resource needs.

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

Segment Information (in thousands):

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     The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies (see our 2002 Form 10-K filing - Note 1). We evaluate financial performance and allocate resources primarily based on income or loss from operations before income taxes, excluding any unusual items.

     The following tables reconcile net segment (loss) income to consolidated (loss) income before income taxes, discontinued operations and extraordinary item:

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     During the period of April 1, 2003 to April 30, 2003, we divested 16 long-term care facilities. The net revenues and net income for the three month period ended March 31, 2003 for these 16 facilities were approximately $29.0 million and $1.6 million, respectively. Our pharmaceutical and rehabilitation therapy operations earned intersegment revenues of $1.1 million and $4.2 million, respectively, by providing services to these facilities during the three month period ended March 31, 2003.  The net revenues and net income for the one month period ended March 31, 2002 for these 16 facilities were approximately $9.9 million and $0.5 million, respectively. Intersegment revenues earned by our pharmaceutical and rehabilitation therapy operations were $0.4 million and $0.9 million, respectively for the same one month period.  The operating results of these April divestitures will be reported as discontinued operations for all periods presented of the Reorganized Company, beginning with the second quarter of 2003.

     As of April 30, 2003, we operated 201 long-term care facilities with 22,494 licensed beds. As part of our restructuring efforts, we may divest approximately 43% of those facilities.

     During the period of April 1, 2003 to April 30, 2003, we withheld approximately $7.1 million accrued rent and mortgage payments with respect to facilities that we may divest.

     On April 18, 2003, we entered into a settlement agreement with the lessors of 31 of the facilities that we operated and the lenders under mortgages for two other facilities that we operated (the lessors and the lenders are collectively referred to as "Care Realty"). The settlement agreement provided that we will transfer the operations of the 33 facilities to Care Realty or other licensed operators that it designates. In addition, Care Realty released us from paying past-due rents and certain future rents to Care Realty while we continue operating the facilities, and from claims for leasehold damages for periods after we cease operating the facilities. The released rents aggregated approximately $9.2 million through April 1, 2003. Through April 30, 2003, we had transferred the operations of five of the 33 facilities. The release of the rents is not reflected in our first quarter financial statements because we entered into the settlement in April 2003.

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

     Information provided in this Form 10-Q contains "forward-looking" information as that term is defined by the Private Securities Litigation Reform Act of 1995 (the "Act"). All statements regarding our expected future financial position, results of operations, cash flows, liquidity, financing plans, lease restructuring initiative, business strategy, budgets, projected costs and capital expenditures, competitive position, growth opportunities, plans and objectives of management for future operations and words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "may" and other similar expressions are forward-looking statements. The forward-looking statements are qualified in their entirety by these cautionary statements, which are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the "safe harbor" provisions of the Act. We caution investors that any forward-looking statements made by us are not guarantees of future performance and that actual results may differ materially from those in the forward-looking statements as a result of various factors, including, but not limited to, those set forth below and those referred to under the caption "Additional Business Risks" section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2002:

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

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     Current Liquidity. For the three months ended March 31, 2003, our net loss was $13.3 million. At May 8, 2003, we had cash and cash equivalents of $5.5 million and borrowing availability under our Loan Agreements of $10.0 million. That availability resulted, in part, from our ceasing to pay rent on certain of our facilities pursuant to restructuring efforts described below. The report of our independent auditors as of December 31, 2002 and for the ten month period then ended included an explanatory paragraph as to our ability to continue as a going concern (see our Annual Report on Form 10-K for the year ended December 31, 2002). Our restructuring efforts are likely to require at least nine to 12 months to complete. We will need additional liquidity during the next few months and may be required to sell additional assets during that period in order to have sufficient liquidity to operate our business as we complete the restructuring. We cannot assure that we will be able to complete sales of our assets on a timely basis to provide sufficient liquidity to complete the restructuring. It is likely that if we are unable to complete such sales or otherwise obtain additional funding, we would commence bankruptcy proceedings.

     Defaults under Loan Agreements. We were not in compliance with certain financial covenants in our Loan Agreements at March 31, 2003 and we continue not to be in compliance. The lenders under the Loan Agreements have continued lending to us in spite of the defaults, although they have reserved their rights to seek to exercise their remedies contained in the Loan Agreements. We cannot assure you that the lenders under those agreements will refrain from seeking to exercise their remedies, potentially including declaring all loan amounts outstanding to be immediately due and payable, acting upon their security interests, denying us the right to additional borrowing under the Revolving Loan Agreement and other remedies. It is likely that under those circumstances we would commence bankruptcy proceedings. We have classified the Loan Agreements as current obligations at March 31, 2003 and our liquidity remains an ongoing concern for us.

     Defaults under Leases and Mortgages. In our effort to reduce our costs, in January 2003, we initiated new restructuring efforts. Our ongoing efforts include an attempt to restructure the portfolio of leases under which we operate most of our long-term care facilities. We are seeking to obtain rent concessions with respect to our under-performing facilities, and if we are unable to obtain sufficient rent concessions on a facility lease, then we will seek to transition operations of that facility to a new operator so that we will no longer be burdened by the loss generated by that facility. During the period of January 1, 2003 to April 30, 2003, we divested 37 facilities. We are currently attempting to transition approximately 43% of our remaining long-term care facilities to new operators. As of April 30, 2003, we had withheld payment of approximately $26.0 million in accrued rent and mortgage payments with respect to those facilities. In addition, we intend to continue withholding certain rent and mortgage payments until we complete the transition of each affected facility to new operators. We cannot predict the extent to which landlords not receiving rent will seek to assert leasehold or other damages during the restructuring period. If the landlords aggressively pursue and obtain back rent and other damages, we will likely be required to commence bankruptcy proceedings prior to the completion of our restructuring.

     2003 Restructuring. Our goal is to restructure our business so that we can fund our operations and working capital requirements while remaining a significant provider of skilled nursing and other long-term care facilities. We will also seek to reduce our overhead and other expenses significantly, commensurate with reducing the size of our long-term care facility portfolio. Although we have had encouraging discussions and are making progress with many landlords from whom we are seeking to obtain rent concessions or facility lease terminations, and have reached agreements in principle or final agreements with several of our landlords, no assurance can be given that we will be successful in our restructuring efforts.

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

     Emergence from Chapter 11 Bankruptcy Proceedings. On February 28, 2002, we emerged from proceedings under Chapter 11 of the Bankruptcy Code pursuant to the terms of the Plan of Reorganization. From October 14, 1999 until February 28, 2002, we operated our businesses as a debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. Accordingly, our consolidated financial statements prior to March 1, 2002 have been prepared in accordance with SOP 90-7 and generally accepted accounting principles applicable to a going concern, which assume that assets will be realized and liabilities will be discharged in the normal course of business.

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

     With respect to reported operating results, management believes that business segment operating results of the Predecessor Company are generally comparable to that of the Reorganized Company. However, capital costs (rent, interest, depreciation and amortization) of the Predecessor Company that were based on pre-petition contractual agreements and historical costs are not comparable to those of the Reorganized Company. In addition, the reported financial position and cash flows of the Predecessor Company for periods prior to March 1, 2002 generally are not comparable to those of the Reorganized Company.

     We recorded an extraordinary gain of $1,498.4 million from the restructuring of our debt in accordance with the provisions of the Plan of Reorganization. Other significant adjustments also were recorded to reflect the provisions of the Plan of Reorganization and the fair values of the assets and liabilities of the Reorganized Company as of February 28, 2002. For accounting purposes, these transactions have been reflected in the operating results of the Predecessor Company for the two months ended February 28, 2002.

     We provide long-term care, rehabilitation therapy, pharmaceutical and other healthcare services and we are engaged in industries that are extensively regulated. As such, in the ordinary course of business, our operations are continuously subject to federal and state legislation and regulatory scrutiny, supervision and control. We entered into a corporate integrity agreement (the "CIA") with the United States Department of Health and Human Services Office of Inspector General in July 2001. The agreement officially took effect on February 28, 2002. Under the terms of the agreement, we implemented further internal controls with respect to our quality of care standards and Medicare and Medicaid billing, reporting and claims submission processes and engaged an independent third party to act as quality monitor and Independent Review Organization under the CIA.

     We derive approximately 25.5% of our revenues from Medicare and 45.9% from Medicaid. Medicare reimburses our skilled nursing facilities under a prospective payment system ("PPS") for inpatient Medicare Part A covered services. PPS was adopted pursuant to the Balanced Budget Act of 1997 (the "1997 Act"). Under PPS, facilities are paid a predetermined amount per patient, per day, based on the anticipated costs of treating patients, and such amount is determined by classifying each patient into one of 44 resource utilization groups ("RUG"). The nursing home industry came under financial pressure as a result of the implementation of PPS and other 1997 Act provisions.  As a result, Congress enacted The Balanced Budget Refinement Act of 1999 ("BBRA") and the Medicare, Medicaid and SCHIP Benefits Improvement Act of 2000 ("BIPA") to provide some relief to the industry. The BBRA and BIPA required four Medicare "add-on" payments: a 4% i ncrease in per diem rates; a 16.7% increase in the nursing component of each RUG; a 20% increase for certain categories of high cost, medically complex patients; and a 6.7% increase for rehabilitation RUGs.

     On September 30, 2002, two of the add-on provisions of the Medicare payment regulations expired: the 4% add-on for all patient categories in the RUG system and the 16.7% add-on for nursing related costs. We estimate that our Medicare revenues decreased by approximately $8.7 million ($36.98 per patient day) for the period of January 1, 2003 to March 31, 2003, and we cannot predict whether these add-ons will be restored. In addition to the elimination of the add-ons, CMS provided a 2.6% market basket increase in payments to skilled nursing facilities for the 2003 Federal fiscal year.  For the period of January 1, 2003 to March 31, 2003, we estimate that the market basket increase resulted in approximately $2.2 million ($9.49 per patient day) in revenue. The net result of the expiration of the add-ons and the market basket increase is an estimated Medicare revenue decrease of approximately $6.5 million ($27.49 per patient day) for the three months ended March 31, 2003. On May 8, 2003, CMS proposed a 2.9% market basket increase for the 2004 Federal fiscal year (October 1, 2003 through September 30, 2004). We estimate the 2.9% increase could result in an additional $10.59 per patient day for our skilled nursing facilities. The proposal is subject to a comment period and we are unable to predict whether it will become a final rule.

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     The remaining two add-on payments, the 6.7% increase for patients requiring intense rehabilitation and a 20.0% increase for patients requiring complex medical care, were scheduled to expire on the earlier of September 30, 2003 or at such time as CMS completes the case mix refinements. However, CMS has proposed an extension of the expiration date to September 30, 2004. The proposal is subject to a comment period and we are unable to predict whether it will become a final rule.  The refinements are intended to ensure nursing homes are fairly and accurately reimbursed for taking care of medically complex patients. CMS has determined that the research is not sufficiently advanced at the present time to implement the refinements in the 2004 Federal fiscal year. Although the add-ons will expire when these refinements are implemented, it is expected that the add-ons will be replaced by new payment rates that are not known at this time. If the add-ons expire and are not replaced, we estimate that our per beneficiary per diems would decrease by approximately $27.00 per patient day. The loss of these add-ons would have a material adverse effect on our financial position, results of operations and cash flows.

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

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

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

     In a notice of proposed rulemaking issued on February 10, 2003, CMS proposed a significant change for the reimbursement of Medicare Part A bad debts. The proposal would subject all providers to a 30% reduction in Medicare Part A bad debt reimbursement. CMS proposes to implement the reduction incrementally over a three year period to mitigate its impact: 10% for cost reporting periods beginning October 1, 2003, 20% for cost reporting periods beginning October 1, 2004, and 30% for cost reporting years beginning October 1, 2005 and thereafter. Based upon the estimated Medicare bad debts that we will claim on our 2002 cost reports, we estimate that our Medicare revenues would decrease by approximately $0.84 per patient day in 2004, $1.68 per patient day in 2005 and $2.52 per patient day in 2006 if the proposed changes are implemented.

     To summarize, we estimate that our Medicare revenues for our inpatient facilities will decrease by approximately $27.49 per patient day during the year ended December 31, 2003 as a result of the known changes to Medicare and assuming that we continue operating our facilities at current Medicare service levels. This decrease includes: a $36.98 per patient day decrease to inpatient revenues as a result of the expiration of the add-ons; a $9.49 per patient day increase to inpatient revenues as a result of the market basket increase; a $7.2 million decrease to therapy revenues and a $0.9 million decrease in inpatient services revenues as a result of the expiration of the therapy cap moratorium; and a $2.1 million decrease in home health revenues as a result of legislative changes.

     The recent economic downturn has had a detrimental affect on state revenues. Historically these budget pressures have translated into reductions in state spending. Given that Medicaid outlays are a significant component of state budgets, we expect continuing cost containment pressures on Medicaid outlays for nursing homes and pharmacy services in the states in which we operate. States that have recently reduced Medicaid reimbursements to long-term care facilities include Colorado, Georgia, Illinois and Massachusetts. States that are considering reducing Medicaid reimbursements to long-term care facilities include California, Connecticut, Kentucky, New Jersey, Ohio, Tennessee, Texas and Washington.

     California's proposed changes would be the most significant to us because 64 of our facilities, or 29 percent of the facilities that we operated as of April 1, 2003, were in California. California has proposed a 15% cut in Medicaid payments effective July 1, 2003 to skilled nursing facilities, and we estimate that if the proposal is implemented then our Medicaid reimbursements at our facilities in California would decrease by approximately $17.00 per patient per day.

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

     The majority of our workers' compensation risks are insured through insurance policies with third parties. Our reserves are estimated by independent actuaries beginning with the 2000 policy year and company analysis using industry development factors for prior years. Effective with the policy period beginning January 1, 2002, we discount our workers' compensation reserves based on a 4% discount rate. The discounting of these policy periods resulted in a reduction to our reserves of $3.5 million. The provision for such risks, which includes accruals for insurance premiums and claims costs, for the three months ended March 31, 2003, one month ended March 31, 2002 and two months ended February 28, 2002 were $9.8 million, $3.0 million and $3.4 million, respectively. We have recorded reserves of $65.6 million and $65.3 million, as of March 31, 2003 and December 31, 2002, respectively. We estimated our range of exposure at March 31, 2003 was $59.8 million to $73.0 million. At March 31, 2003, we had $64.2 million in pre-funded amounts restricted for payment of workers' compensation claims.

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     The following table sets forth the amount and percentage of certain elements of total net revenues in continuing operations for the periods presented (in thousands):

     The following table sets forth the amount of net segment income (loss) in continuing operations for the periods presented (in thousands):

      The net segment income (loss) amounts detailed above do not include the following items: gain (loss) on sale of assets, net; restructuring costs; reorganization costs, net; income taxes; loss from discontinued operations, and extraordinary gain on extinguishment of debt. These amounts totaled approximately $(2.9) million and $1,494.2 million in 2003 and 2002, respectively.

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

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     The following table presents the percentage of total net revenues represented by certain items for us for the periods presented: