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

For the quarterly period ended September 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 November 12, 2003, there were 10,042,251 shares of the Registrant's $.01 par value Common Stock outstanding.

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See accompanying notes.

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See accompanying notes.

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See accompanying notes.

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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.

     We are a provider of long-term, subacute and related specialty healthcare services in the United States. We operate through four principal business segments: (i) inpatient services, (ii) rehabilitation therapy services (iii) home health services, and (iv) other operations, including medical staffing services. Inpatient services represents the most significant portion of our business. As of September 30, 2003, we operated 124 long-term care facilities in 18 states and provided rehabilitation to both company-operated and nonaffiliated facilities. We sold our pharmaceutical services operations in July 2003.

     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 expressing doubt as to our ability to continue as a going concern (see our Annual Report on From 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 our opinion, the accompanying interim consolidated financial statements present fairly our financial position at September 30, 2003 and December 31, 2002, the consolidated results of our operations for the three months ended September 30, 2003 and 2002 and the consolidated results of our operations and the consolidated cash flows for the nine, seven and two month periods ended September 30, 2003, September 30, 2002, and February 28, 2002, respectively. We believe that all adjustments are of a normal and recurring nature. These statements 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 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 September 30, 2003 and for the nine 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. 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 expressing doubt as to our ability to continue as a going concern. We recorded net income of $14.3 million for the nine month period ended September 30, 2003. We have negative working capital and a stockholders' deficit of $36.7 million and $152.8 million, respectively, at September 30, 2003. Our net income during the nine months ended September 30, 2003 was mostly the result of gains recorded on our disposal of discontinued operations, primarily the sale of SunScript, our pharmaceutical operations.

     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 33 skilled nursing facilities during the quarter ended September 30, 2003, and an additional 5 facilities between October 1, 2003 and October 31, 2003. Together with the 114 facilities divested during the nine months ended September 30, 2003, we have divested a total of 119 facilities as of October 31, 2003. As of October 31, 2003, we have identified approximately 16% of our remaining facilities that we seek to transition to new operators. During the period of January 1, 2003 to September 30, 2003, we withheld approximately $25.9 million in accrued rent payments and $0.7 million of mortgages on facilities that we identified for transfer to new operators. Through September 30, 2003, we were released of our obligations to pay approximately $15.7 million of the withheld rent and $20.4 million of mortgages.  These amounts were recorded in our net gain on disposal of discontinued operations.  The gain was significantly offset by accounts receivable allowances recorded at the time of divestiture of the applicable facilities, netting to a gain of $12.9 million through September 30, 2003.  The remaining amounts that we withheld and that were not released are classified as current obligations at September 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 associated with the divested or to-be-divested facilites) and to settle our other liabilities, including those related to our general and professional liabilities. If we are unable to generate sufficient cash flows or obtain other financing, there is a substantial prospect that we, including our parent entity 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 $4.1 million during the three months ended September 30, 2003, comprised of $2.2 million of fees related to termination of prior debt, $1.6 million of professional fees and $0.3 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 September 30, 2003, and for the three and nine 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 "Heller Loan Agreement."). On September 5, 2003, we paid the Heller Loan Agreement in full. The Heller Loan Agreement was a $150.0 million three-year revolving line of credit. Under the Heller Loan Agreement, we were 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 September 5, 2003 on borrowings under the Heller Loan Agreement was approximately 6.35%. The weighted average borrowing interest rate for the period of July 1, 2003 to September 5, 2003 was 6.30%. The defined borrowing base as of September 5, 2003, was $55.6 million, n et of specified reserves of $38.2 million, which included a minimum availability reserve of $21.2 million. As of September 5, 2003, prior to the repayment of the Heller Loan Agreement, we had borrowed approximately $33.0 million and had issued approximately $21.9 million in letters of credit under the Heller Loan Agreement, leaving approximately $0.7 million available to us for additional borrowing.

     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"). We paid the Term Loan Agreement in full on July 15, 2003. 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 Agreement, which was $40.0 million, and we made quarterly payments of principal of $0.8 million plus interest. The outstanding principal balance on the Term Loan Agreement of approximately $35.8 million, including the discount of $3.7 million, was paid in full on July 15, 2003. In addition, $2.2 million of related deferred finance fees were expensed.

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     On September 5, 2003, we entered into a Loan and Security Agreement with CapitalSource Finance LLC, as collateral agent, and certain other lenders (the "Revolving Loan Agreement"). The Revolving Loan Agreement is a $75.0 million two-year revolving line of credit that is secured by our accounts receivable, inventory, equipment and other assets, and the stock of our subsidiaries. Pursuant to the Revolving Loan Agreement, we are paying interest (i) for Base Rate Loans at the greater of (a) prime plus 1.0% or (b) 5.25%, and (ii) for LIBOR Loans at the greater of (a) the London Interbank Offered Rate plus 3.75% or (b) 5.25%. The effective interest rate as of September 30, 2003 on borrowings under the Revolving Loan Agreement was approximately 5.25%. The weighted average borrowing interest rate for the period from September 5, 2003 through September 30, 2003 was 5.25%. Our borrowing availability under the Revolving Loan Agreement is generally limited to up to eighty-five percent (85%) of the value of Eligible Receivables plus eighty-five percent (85%) of the value of Eligible Divested Company Receivables, but not to exceed $75.0 million. The defined borrowing base as of September 30, 2003 was $67.9 million, net of specified reserves of $15.0 million. The availability of amounts under our Revolving Loan Agreement is also subject to our compliance with certain financial ratios. As of September 30, 2003, we had borrowed approximately $29.4 million, which includes $1.5 million of prepaid finance fees that will be amortized over the next twelve months and does not count against availability, and we had issued approximately $21.9 million in letters of credit leaving approximately $18.1 million available to us for additional borrowing.  We have classified our Revolving Loan Agreement as a long-term liability at September 30, 2003.

(4)  Long-Term Debt

     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):

     Long-term debt at September 30, 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 September 30, 2003, are as follows (in thousands):

(5)  Assets Held for Sale      

     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 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 or when owned assets are classified as held-for-sale.

     As of September 30, 2003, assets held for sale consisted of (i) assets of Shared Healthcare Systems, Inc. ("SHS"), a majority owned software development subsidiary, had a book value of $0.7 million, (ii) three undeveloped parcels of land valued at $4.0 million and (iii) artwork valued at $0.8 million.  (See Note 12 - Subsequent Events)

     SHS, included in the owned assets classified as held-for-sale, which are described above, reported revenues of $1.1 million and $3.8 million, respectively, for the three and nine month periods ended September 30, 2003 in discontinued operations. The net operating income of $0.1 million and net operating loss of $1.4 million, respectively, for the same periods were included in discontinued operations. Also included in discontinued operations are the net revenues of $1.5 million and $4.1 million, respectively, and net operating income of $1.0 million and net operating losses of $0.1 million, respectively, for the three and seven month periods ended September 30, 2002. We recorded a gain related to the sale of two parcels of land and a building of $0.1 million and $3.9 million for the three and nine months ended September 30, 2003, respectively, in gain on disposal of discontinued operations.  The operating results of assets held-for-sale 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.

     During the nine months ended September 30, 2003, we divested 114 skilled nursing facilities in our Inpatient Services segment primarily through lease terminations and transfers. The net revenues for the three and nine months ended September 30, 2003 for these 114 facilities were $32.7 million and $393.4 million, respectively. The net operating losses for the three and nine months ended September 30, 2003 were $3.5 million and $17.2 million, respectively, and have been reported as discontinued operations. Also reported in discontinued operations are the net revenues for the three and seven month periods ended September 30, 2002 for these 114 facilities, which were $212.8 million and $494.8 million, respectively, and net operating loss of $0.5 million and net operating income of $6.0 million, respectively, for the three and seven month periods ended September 30, 2002. The aggregate net gain on disp osal during the three and nine month periods ended September 30, 2003 for these divestitures was approximately $11.6 million and $12.9 million, recorded in gain on disposal of discontinued operations. At the time of divestiture, based upon historical collection trends, an additional accounts receivable allowance is recorded in gain or loss on disposal of discontinued operations, net. As collections are recognized, the allowance will be adjusted as appropriate.  The operating results of these 114 facilities 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.

     On July 15, 2003, we sold the assets of our pharmaceutical services operations, including the assets of SunScript Pharmacy Corporation, to Omnicare, Inc. ("Omnicare") for $90.0 million, of which $75.0 million was received in cash at closing and up to $15.0 million in additional purchase price holdback, which is to be paid to us on or before July 15, 2005 subject to fulfillment of the conditions described below. We simultaneously entered into agreements pursuant to which Omnicare would provide pharmacy services to our inpatient facilities (the "Pharmacy Agreements"). The holdback amount is subject to reduction in the event: (i) we reject or modify one or more Pharmacy Agreements in a bankruptcy proceeding; (ii) the new operator of any of our divested facilities does not assume the same contract with Omnicare; and/or (iii) we breach the Pharmacy Agreements. The holdback amount will be recorded when realized. The net revenues for our Pharm aceutical Services operations for the three and nine months ended September 30, 2003, were $10.8 million and $140.7 million, respectively, and included $1.5 million and $24.2 million of intersegment revenues, respectively, and were reported as discontinued operations. Net operating losses of $0.8 million and net operating income of $4.8 million for the three and nine months ended September 30, 2003, respectively, were reported as discontinued operations. Also reported in discontinued operations are the net revenues for the three and seven month periods ended September 30, 2002, which were $61.9 million and $140.7 million, respectively, and a net operating income of $2.9 million and $7.5 million, respectively, for the three and seven months ended September 30, 2002. The aggregate net gain on disposal during the three and nine month periods ended September 30, 2003 was approximately $45.4 million.  The operating results of our Pharmaceutical Services operations were not 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.

(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 nine months ended September 30, 2003 were $5.9 million and $24.5 million, respectively, of which $0.8 million and $9.3 million, respectively, related to divested skilled nursing facilities. The provisions for such risks for the three and seven months ended September 30, 2002 were $4.0 million and $17.6 million, (net of a $6.0 million credit recorded in the third quarter of 2002 related to decreases in our actuarially estimated exposure for prior year policies), of which $4.7 million and $10.7 million were included in net income from discontinued operations. The provision for the two month period ended February 28, 2002 was $3.4 million. We have recorded reserves of $65.3 million as of September 30, 2003 and December 31, 2002. We estimated our range of exposure at September 30, 2003 was $63.8 million to $78.0 million and that the range will decline over time as our lease divestiture program is completed. At September 30, 2003, we had approximately $71.8 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 September 30, 2003 and December 31, 2002 was $79.6 million and $76.7 million, respectively. Of the $79.6 million as of September 30, 2003, $75.0 million was related to our funding of self-insurance obligations, $2.3 million was escrowed to secure our controlled disbursement accounts, and $2.3 million covered various industrial revenue and insurance bonds. Of the $76.7 million as of December 31, 2002, $69.5 million was related to our funding of self-insurance obligations, $5.1 million to bankruptcy-related U.S. Trustee fees, and $2.1 million to cover various insurance bonds. Other Assets, net, as of September 30, 2003 and December 31, 2002 included $2.9 million and $3.6 million, respectively, of restricted cash maintained to repay a mortgage.

     As of September 30, 2003, the Reorganized Company had issued approximately 9,888,224 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 September 30, 2003, we expect to issue up to an additional 111,776 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 $3.0 million valued at $27 per share by our reorganization plan and was recorded in other long-term liabilities in the September 30, 2003 consolidated balance sheet. On November 12, 2003, the closing price of our common stock on the Over-the Counter Bulletin Board was $7.70.

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     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 September 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, amended in August 2002, which allows for the issuance of up to 160,000 options to purchase shares of our common stock. As of September 30, 2003, our directors held options to purchase 60,000 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 September 30, 2003, we had outstanding options covering an aggregate of 740,000 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 290,000 options vest 25% per year on the first four anniversary dates. All options expire in 2009.

     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 not less than 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.

     Net income (loss), as reported, included amortization of unearned compensation of $0.2 million and $0.7 million, respectively, for the three and nine months ended September 30, 2003, and $0.4 million and $0.8 million for the three and seven months ended September 30, 2002. There was no amortization of unearned compensation for the two months ended February 28, 2002.

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     For purposes of pro forma disclosures, the estimated fair market value of the stock options was 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 tables summarize our pro forma net income (loss) and basic and diluted net income (loss) 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 income (loss) 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 nine months ended September 30, 2003 include the common shares issued in connection with emergence and 111,776 common shares outstanding to be issued once the prepetition claims are finalized.

     Diluted net income (loss) 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. 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 operating loss for the three and nine months ended September 30, 2003, our stock options were anti-dilutive; therefore, we did not break out basic and diluted earnings per share separately. Options to purchase approximately 740,000 shares of common stock were outstanding for the nine months ended September 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, accordingly basic and diluted earnings per share are equivalent.

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     The current provision for income taxes of $0.8 million for each of the three month periods ended September 30, 2003 and 2002 was based on estimated state income tax liabilities for these periods. The provision for the nine months ended September 30, 2003 was $1.3 million, $0.5 million for the seven months ended September 30, 2002 and $0.1 million for the two months ended February 28, 2002. 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 plai ntiffs 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 have been and/or may in the future 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 governmental investigations of long-term care providers, particularly in the area of Medicare/Medicaid false claims, as well as an increase in enforcement actions resulting from these investigations. Adverse determinations in legal proceedings or governmental investigations, whether currently asserted or arising in the future, could have a material adverse effect on 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 September 30, 2003, due to the impact of classifying our pharmaceutical services operations as a discontinued operation, we have changed our segments and have restated our previously reported segments for the three and seven month periods ended September 30, 2002 to be the following.  The following summarizes the services provided by our reportable and other segments as of September 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 September 30, 2003, we operated 124 long-term care facilities with 12,544 licensed beds as compared with 239 facilities with 27,100 licensed beds at September 30, 2002. As part of our restructuring efforts, we may divest approximately 19% of our 124 skilled nursing facilities, comprising approximately 2,001 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 September 30, 2003, this segment provided rehabilitation therapy services to 477 facilities, 364 of which are nonaffiliated and 113 were affiliated, as compared to 531 facilities at September 30, 2002, of which 311 were nonaffiliated and 220 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.

Other Operations: This segment primarily includes medical staffing services and other ancillary services provided to affiliated and nonaffiliated facilities. We sold our software development operations in November 2003 which are therefore not reflected in our segment information set forth below, other than for the two month period ended February 28, 2002 as noted below. See Note 12 - Subsequent Events.

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     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. In July 2003, we sold substantially all the assets of our pharmaceutical services operations and such operations are therefore not reflected in our segment information set forth below, other than for the two month period ended February 28, 2002, as noted above.

     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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