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

For the quarterly period ended June 30, 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 August 11, 2003, there were 10,021,574 shares of the Registrant's $.01 par value Common Stock outstanding.

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Form 10-Q for the Quarter Ended June 30, 2003 

2

See accompanying notes.

3

See accompanying notes.

4

See accompanying notes.

5

See accompanying notes.

6

 SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

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) home health services. Inpatient services represents the most significant portion of our business. As of June 30, 2003, we operated 157 long-term care facilities in 20 states and provided rehabilitation and pharmaceutical services to both company-operated and non-affiliated facilities. We sold our pharmaceutical services operations in July 2003.

Reorganization

     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 a paragraph raising doubt 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 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 June 30, 2003 and December 31, 2002, the consolidated results of our operations and the consolidated cash flows for the six, four and two month periods ended June 30, 2003, June 30, 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 t hese 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 Current Report on 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, asset impairments, self-insurance obligations and loss accruals. Actual results could differ from those estimates.

     Our consolidated financial statements as of June 30, 2003, and for the six 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 on our consolidated financial statements as of December 31, 2002 and for the ten month period then ended included a paragraph raising doubt as to our ability to continue as a going concern. We recorded a net loss of $24.8 million for the six month period ended June 30, 2003. We have negative working capital and a stockholders' deficit of $69.7  million and $196.0 million, respectively, at June 30, 2003. Our net loss was primarily the result of Medicare 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 $111.2 millio n at June 30, 2003 (see Notes 3 and 4). Accordingly, we have classified these debt obligations as current liabilities in the accompanying consolidated balance sheet as of June 30, 2003, resulting in a negative working capital position.

     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 divest our under-performing facilities by transitioning operations of those facilities to new operators so that we will no longer be burdened by the losses generated by those facilities. We divested 60 skilled nursing facilities during the quarter ended June 30, 2003, and an additional 14 facilities between July 1, 2003 and July 31, 2003. Together with the 21 facilities divested during the quarter ended March 31, 2003, we have divested a total of 95 facilities as of July 31, 2003. As of July 31, 2003, we have identified approximately 30% of our remaining facilities that we would seek to transition to new operators. During the period of January 1, 2003 to June 30, 2003, we withheld approximately $22.5 million in accrued rent and mortgage payments on facilities that we identified for transfer to new operators. Through June 30, 2003, we were released from paying approximately $9.5 million of the withheld payments. The remaining amounts are classified as current obligations at June 30, 2003.

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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 to settle our other liabilities including those related to our prior year general and professional liabilities in 2003. If we are unable to generate sufficient cash flow levels, there is a substantial prospect that we, including our parent entity and/or one of more of its 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 $4.4 million during the three months ended June 30, 2003 comprised of $4.0 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 June 30, 2003, and for the three and six month periods 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. In connection with the sale of our pharmaceutical operations in July 2003, the lenders under our Revolving Loan Agreement reduced our $150.0 million revolving line to $75.0 million and reserved an additional $11.1 million against liquidity otherwise available thereunder. 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 June 30, 2003 on borrowings under the Revolving Loan Agreement was approximately 6.7%. The weighted average borrowing interest rate for the three month period ended June 30, 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, subject to the reductions and reserves noted above. The defined borrowing base as of June 30, 2003, was $93.2 million, net of specified reserves of $27.0 million, which includes a minimum availability reserve of $10.0 million. As of June 30, 2003, we had borrowed approximately $66.2 million and had issued approximately $24.7 million in letters of credit under the Revolving Loan Agreement, leaving approximately $2.3 million available to us for additional borrowing. On July 15, 2003, we paid $33.9 million of the outstanding balance under our Revolving Loan Agreement in connection with the closing of the sale of our pharmaceutical operations.

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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"). We paid the Term Loan Agreement in full on July 15, 2003. See Note 12 - Subsequent Events. The Term Loan Agreement was 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 was limited to $20.0 million. Interest rates under the Term Loan Agreement were variable based upon either the lender's base rate (as defined) or LIBOR, plus applicable margins. The effective interest rate as of June 30, 2003 on borrowings under the Term Loan Agreement was approximately 9.0% inclusive of a rate of 2.7% for the Discount Note. We borrowed the maximum amount available under the Term Loan Agree ment, which was $40.0 million, and we made quarterly payments of principal of $0.8 million plus interest. The principal balance remaining on the Term Loan Agreement at June 30, 2003 was approximately $35.8 million.

     For the quarter ended June 30, 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 asserted other covenant and substantive defaults. We can give no assurance that the lenders under the Revolving Loan Agreement 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 classified the Revolving Loan Agreement and the Term Loan Agreement totaling $102.0 million as current obligations as of June 30, 2003. The default interest rates under the Revolving Loan Agreement increase by 2.0% based on the rates in effect, which equate to default rates of 8.7% and 11.0%, respectively, as of June 30, 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

     As of June 30, 2003, the lender for one skilled nursing facility had asserted that we were in default of the mortgage and we have classified the mortgage totaling $9.3 million as a current obligation.   Effective July 31, 2003, we transferred the property 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. For the two months ended February 28, 2002, $23.7 million was not required to be paid.

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

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     Long-term debt at June 30, 2003 and December 31, 2002 includes amounts owed under fully secured mortgage notes payable, certain Industrial Revenue Bonds and other debt.

     The scheduled or expected maturities of long-term debt as of June 30, 2003 are as follows (in thousands):

     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 facilit ies 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 restructuring initiative in 2003, in the first quarter of 2003 we began to report our divested facilities as discontinued operations when the lease is terminated on a leased facility or after operations cease at that facility.

During the six months ended June 30, 2003, we divested, primarily through lease terminations and transfers, 81 skilled nursing facilities in our Inpatient Services segment. The net revenues for the three and six months ended June 30, 2003 for these 81 facilities were $94.5 million and $236.9 million, respectively, and the net loss for the three and six months ended June 30, 2003 were $3.8 million and $7.2 million, respectively, and have been reported as discontinued operations. Also reported in discontinued operations are the net revenues for the three and four month period ended June 30, 2002 for these 81 facilities, which were $148.0 million and $198.9 million, respectively, and the net income for the three and four month period ended June 30, 2002 which was $2.9 million and $4.9 million, respectively. The operating results of these 81 facilities have not been reported as discontinued operations in the consolidated financi al statements of the Predecessor Company for the period ended February 28, 2002 because a new entity was deemed to be created upon emergence. The aggregate net (loss) gain on disposal during the three and six month period ended June 30, 2003 for these divestitures was approximately $(0.3) million and $9,000 recorded in gain (loss) on disposal of discontinued operations, net, in our June 30, 2003 consolidated statement of operations. Additionally, a gain of $4.2 million and $4.5 million, primarily associated with other asset sales was recorded in gain on sale of assets, net, in our 2003 consolidated statement of operations for the three and six months ended June 30, 2003, respectively.

     On July 15, 2003, we sold the assets of our pharmaceutical services operations, including the assets of SunScript Pharmacy Corporation, to Omnicare, Inc. ("Omnicare"). The net revenues for the three and six months ended June 30, 2003 for our pharmaceutical services operations were $65.2 million and $130.0 million, respectively, including $10.8 million and $22.6 million of intersegment revenues, respectively. The net income for the three and six months ended June 30, 2003 was $2.5 million and $5.3 million, respectively, and has been reported as discontinued operations as our pharmaceutical services operations were held for sale as of June 30, 2003. Also reported in discontinued operations are the net revenues for the three and four month period ended June 30, 2002 for our pharmaceutical services operations, which were $60.9 million and $80.1 million, respectively, and the net income for the three and four month periods ended June 30, 2002 which was $3.9 million and $5.1 million, respectively. The operating results of our pharmaceutical services operations have not been reported as discontinued operations in the consolidated financial statements of the Predecessor Company for the period ended February 28, 2002 because a new entity was deemed to be created upon emergence.

     As of June 30, 2003, assets held for sale consist of (i) assets of our pharmacy services segment valued at $39.5 million; (ii) five undeveloped parcels of land valued at $6.3 million and (iii) artwork valued at $1.1 million within our consolidated financial statements in our Other Operations and Corporate segments, respectively, all of which we expect to sell during 2003.

(a) Insurance

   We self-insure for certain insurable risks, including general and professional liability, workers' compensation liability and employee health insurance liability through the use of self-insurance or retrospective and self-funded insurance policies and other hybrid policies, which vary by the states in which we operate. Provisions for estimated reserves, including incurred but not reported losses, are provided in the period of the coverage during which the event took place. These provisions are based on actuarial analyses, internal evaluations of the merits of individual claims and industry loss development factors. 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 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.

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   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 by 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 $3.8 million. The provision for such risks, which includes accruals for insurance premiums and claims costs, for the three and six months ended June 30, 2003 were $8.8 million and $18.6 million, respectively, of which $2.2 million and $5.6 million related to divested skilled nursing facilities, respectively. We have recorded reserves of $63.9 million and $65.3 million, as of June 30, 2003 and December 31, 2002, respectively, and are included in net (loss) income from discontinued operations. We estimated our range of exposure at June 30, 2003 was $57.9 million to $70.8 million and that the range will decline over time as our lease divestiture program is completed. At June 30, 2003, we had approximately $70.5 million in pre-funded amounts restricted for payment of workers' compensation claims.

(b) Restricted Cash

     Included in restricted cash in our consolidated balance sheet as of June 30, 2003 and December 31, 2002 is $79.2 million and $76.7 million, respectively, primarily related to our funding of self-insurance obligations. Other Assets, net, as of June 30, 2003 and December 31, 2002, includes $2.9 million and $3.6 million, respectively, of restricted cash maintained to repay a mortgage.

     As of June 30, 2003, the Reorganized Company had issued approximately 9,745,998 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 June 30, 2003, we expected to issue up to an additional 254,002 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 $6.9 million valued at $27 per share by our reorganization plan and is recorded in other long-term liabilities in the June 30, 2003 consolidated balance sheet. On August 11, 2003, the closing price of our common stock on the Over-the Counter Bulletin Board was $3.35.

     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 June 30, 2003, our officers held options to purchase 680,000 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 June 30, 2003, our directors held options to purchase 74,000 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.

     As of June 30, 2003, we had outstanding options covering an aggregate of 754,000 shares of our common stock to our officers and directors at a strike price of $27 per share, which price was equal to or greater than the estimated market value at date of issuance. Of those options, 450,000 vest over a four-year period, with 20% vesting upon issuance and the remaining portion vesting ratably over the first four anniversary dates. The remaining 304,000 options vest 25% per year on the first four anniversary dates. All options expire in 2009.

     Net (loss) income as reported includes amortization of unearned compensation of $0.2 million and $0.5 million for the three and six months ended June 30, 2003, respectively. For purposes of pro forma disclosures, the estimated fair market value of the stock options is amortized to expense over their respective vesting periods. The fair market value has been estimated at the date of grant using a Black-Scholes option pricing model. The following table summarizes our pro forma net (loss) income and diluted net (loss) income per share assuming we accounted for our stock option grants in accordance with SFAS No. 123, for the periods indicated (in thousands except per share amounts):

     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 and six months ended June 30, 2003 include the common shares issued in connection with emergence and 254,002 common shares outstanding to be issued once the prepetition claims are finalized.

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     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 and six months ended June 30, 2003, our stock options were anti-dilutive and therefore excluded from the weighted ave rage shares outstanding in calculating diluted loss per share. Options to purchase approximately 754,000 shares of common stock were outstanding for the six months ended June 30, 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 $0.2 million for the three months ended June 30, 2003 and 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 tax benefits associated with our net operating loss carryforwards is uncertain.

(a)  Litigation

     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 changes to reimbursement for our skilled nursing facilities under Medicare's prospective payment system 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 remaining defendants. In February 2002, the plaintiffs filed a Motion to Amend the Judgment and to File an Amended Complaint. In April 2003, the plaintiffs' Motion was denied by the United States District Court for the District of New Mexico. In May 2003, the plaintiffs filed an appeal with the United States Court of Appeals for the Tenth Circuit. We intend to defend this matter vigorously.

     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 had significant operations, including California, insurance coverage for the risk of punitive damages arising from general and professional liability litigation may not be 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.

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     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 our financial position, results of operations and cash flows.

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

     As of June 30, 2003, due to the impact of reclassifying our pharmaceutical services operations to a discontinued operation, we have changed our segments and have restated our previously reported segments for the three and four month periods ended June 30, 2002 to be the following and the following summarizes the services provided by our reportable and other segments as of June 30, 2003:

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 June 30, 2003, we operated 157 long-term care facilities with 16,897 licensed beds as compared with 243 facilities with 27,571 licensed beds at June 30, 2002. As part of our restructuring efforts, we may divest approximately 35% of those 157 skilled nursing facilities, comprising approximately 5,914 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 June 30, 2003, this segment provided rehabilitation therapy services to 516 facilities, 344 of which are nonaffiliated and 172 were affiliated, as compared to 540 facilities at June 30, 2002, of which 316 were nonaffiliated and 224 were affiliated. This segment also provides early intervention therapy services. In March 2002, we sold substantially all of the assets of our respiratory therapy operation.

Home Health: This segment provides skilled nursing care, rehabilitation therapy and home infusion services through a home health company to more than 3,000 adult and pediatric patients in California and Ohio. Additionally, the segment operates three licensed pharmacies in California.

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Other Operations: This segment primarily includes temporary medical staffing services and 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.

     We did not restate our segments for the two month period ended February 28, 2002 because a new entity was deemed to be created upon emergence. We previously operated the following segment:

Pharmaceutical Services: This segment provided 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 664 facilities at June 30, 2003 compared with 665 facilities at June 30, 2002. Of the 664 facilities in 2003, 534 were nonaffiliated facilities and 130 were affiliated as compared to 452 nonaffiliated facilities and 213 affiliated facilities in 2002. In July 2003, we sold substantially all the assets of our pharmaceutical services operations. See Note 12 - Subsequent Events.

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

Segment Information (in thousands):