SUN HEALTHCARE GROUP INC, 10-K/A, 1999-04-23

SUN HEALTHCARE GROUP INC
10-K/A, 1999-04-23
SKILLED NURSING CARE FACILITIES

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A

(Mark One)

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/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
FOR THE TRANSITION PERIOD FROM TO .

COMMISSION FILE NUMBER 1-12040
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SUN HEALTHCARE GROUP, INC.
(Exact name of registrant as specified in its charter)

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DELAWARE 85-0410612
(State of Incorporation) (I.R.S. Employer Identification No.)
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101 SUN AVENUE NE
ALBUQUERQUE, NEW MEXICO 87109
(505) 821-3355

(Address and telephone number of Registrant)

Securities registered pursuant to Section 12(b) of the Act:

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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, par value $.01 per share, and New York Stock Exchange
Preferred Stock Purchase Rights
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Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports
required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in the definitive proxy statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /

On April 19, 1999, Sun Healthcare Group, Inc. had 60,465,678 outstanding
shares of Common Stock. Of those, 53,090,200 shares of Common Stock were held by
nonaffiliates. The aggregate market value of such Common Stock held by
nonaffiliates, based on the average of the high and low sales prices of such
shares on the New York Stock Exchange on April 19, 1999, was approximately
$82,820,706.

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SUN HEALTHCARE GROUP, INC.

FORM 10-K/A

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

INDEX

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PAGE
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PART I

Item 1. Business...................................................................................... 2
Item 2. Properties.................................................................................... 11
Item 3. Legal Proceedings............................................................................. 11
Item 4. Submission of Matters to a Vote of Security Holders........................................... 11

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................... 12
Item 6. Selected Financial Data....................................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 12
Item 7A. Quantitative and Qualitative Disclosure About Market Risk..................................... 36
Item 8. Financial Statements and Supplementary Data................................................... 36
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures......... 36

PART III

Item 10. Directors and Executive Officers of the Registrant............................................ 37
Item 11. Executive Compensation........................................................................ 40
Item 12. Security Ownership of Certain Beneficial Owners and Management................................ 40
Item 13. Certain Relationships and Related Transactions................................................ 40

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................... 41

Signatures.................................................................................... 49
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SUNSOLUTION-REGISTERED TRADEMARK-, SUNDANCE-REGISTERED TRADEMARK-,
SUNSCRIPT-REGISTERED TRADEMARK-, SUNRISE CLUB-REGISTERED TRADEMARK-,
SUNCARE-REGISTERED TRADEMARK-, SUNFACTORS-REGISTERED TRADEMARK-,
SUNPLUS-REGISTERED TRADEMARK- and CAREERSTAFF UNLIMITED-REGISTERED TRADEMARK-
and related names herein are registered trademarks of Sun Healthcare Group, Inc.
and its subsidiaries.

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Sun Healthcare Group, Inc. hereby amends its Annual Report on Form 10-K for
the fiscal year ended December 31, 1998 by (i) deleting its response to Items 1
and 14 contained in its original filing and replacing them with the Items 1 and
14 contained herein and (ii) inserting responses to Items 6, 7 and 8 which were
not contained in the original filing.

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PART I

ITEM 1. BUSINESS

GENERAL

Sun Healthcare Group, Inc., through its direct and indirect subsidiaries
(collectively referred to herein as "Sun" or the "Company"), is a leading
provider of high quality and cost efficient long-term, subacute and related
specialty healthcare services in the United States and the United Kingdom. The
Company also has operations in Spain, Germany and Australia. The Company
operates through four principal business segments: (i) inpatient services (ii)
rehabilitation and respiratory therapy services, (iii) pharmaceutical and
medical supply services and (iv) international operations. The following
describes the Company's business segments and other operations. Financial
information for the business segments is set forth in footnote 19--Segment
Information in the Company's financial statements included under Item 8 herein.

INPATIENT SERVICES. At December 31, 1998, Sun owned, leased or managed 397
long-term and subacute care facilities with 44,941 licensed beds in the United
States. The Company's long-term and subacute care facilities provide inpatient
skilled nursing and custodial services as well as rehabilitative, restorative
and transitional medical services. The Company provides 24-hour nursing care in
these facilities by registered nurses, licensed practical nurses and certified
nursing aides.

REHABILITATION AND RESPIRATORY THERAPY SERVICES. Sun provides
rehabilitation therapy through SunDance Rehabilitation Corporation ("SunDance")
and respiratory therapy through SunCare Respiratory Services, Inc. ("SunCare").
At December 31, 1998, Sun provided therapy services to 1,715 facilities in 46
states, 1,294 of which were operated by nonaffiliated parties and 421 of which
were affiliated facilities.

PHARMACEUTICALS AND MEDICAL SUPPLY SERVICES. The Company provides
pharmaceutical services through SunScript Pharmacy Corporation ("SunScript") and
medical supplies through SunChoice Medical Supply, Inc. ("SunChoice").
Pharmaceutical services include dispensing pharmaceuticals for such purposes as
infusion therapy, pain management, antibiotic therapy and parenteral nutrition.
Additional services include providing consultant pharmacists and assistance in
preparation of billing documentation. These services are typically provided to
nonaffiliated and affiliated facilities, including subacute and skilled nursing
care facilities, assisted living facilities, group houses, correctional
facilities, mental health facilities and home healthcare companies. As of
December 31, 1998, Sun operated 34 pharmacies and two pharmaceutical billing and
consulting centers in the United States, which together provided pharmaceutical
products and services to a total of 930 long-term and subacute care facilities
in 21 states, 584 of which were nonaffiliated.

INTERNATIONAL OPERATIONS. Sun is the second largest operator of long-term
care facilities in the United Kingdom, operating 155 facilities with 8,705
licensed beds as of December 31, 1998. The Company holds a majority interest in
Eurosar, S.A. ("Eurosar"), a privately-owned company that, as of December 31,
1998, operated 10 long-term care facilities in Spain with 1,604 licensed beds.
Sun holds 38% of the equity of Alpha Healthcare Limited ("Alpha"), a publicly
held acute care provider in Australia that as of December 31, 1998 operated nine
facilities with 616 licensed beds. As of December 31, 1998, Sun also operated
five hospitals in Australia with 309 beds. Sun holds a majority interest in Heim
Plan-Uternehmensgruppe, an operator of 16 long-term care facilities with 1,135
licensed beds in Germany. Sun also provides pharmaceutical services in the
United Kingdom, Germany and Spain and medical supplies in Australia.

OTHER OPERATIONS. The Company is also a nationwide provider of temporary
therapy staffing through CareerStaff Unlimited, Inc. ("CareerStaff").
CareerStaff provides licensed therapists skilled in the areas of physical,
occupational and speech therapy, primarily to hospitals and nursing home
contract service providers. At December 31, 1998, CareerStaff had 31 division
offices providing temporary therapy staffing services in major metropolitan
areas and four division offices specializing in placements of temporary
traveling therapists in smaller cities and rural areas.

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Through SunBridge, Inc. ("SunBridge"), the Company also operated 31 assisted
living facilities with 3,571 beds in the United States as of December 31, 1998.
These facilities serve the elderly who do not need the full-time nursing care
provided by long-term or subacute care facilities but who do need some
assistance with the activities of daily living. The Company has announced that
it is planning to divest itself of its assisted living facilities. No agreements
have been entered into for the sale of these assets as of April 19, 1999.

SunSolution, Inc. ("SunSolution") provides ancillary services for a fixed
fee to nonaffiliated facilities. SunAlliance Healthcare Services, Inc. provides
mobile radiology and laboratory services.

RECENT DEVELOPMENTS

SIGNIFICANT ACQUISITIONS. On June 30, 1998, a wholly owned subsidiary of
the Company merged with Retirement Care Associates, Inc. ("RCA"), an operator of
98 skilled nursing facilities and assisted living centers in eight states
primarily in the southeastern United States. The Company issued approximately
7.6 million shares of its common stock in exchange for all of the outstanding
shares of capital stock of RCA and certain redeemable preferred stock. The RCA
merger was accounted for as a purchase.

RCA also owned approximately 65% of Contour Medical, Inc. ("Contour"), a
national provider of medical/surgical supplies. On June 30, 1998, the Company
acquired the remaining 35% of Contour. The Company issued approximately 1.9
million shares of its common stock in exchange for all of the remaining
outstanding capital stock of Contour. The Contour acquisition was accounted for
as a purchase.

PROSPECTIVE PAYMENT SYSTEM. In the Balanced Budget Act of 1997 (the "BBA"),
Congress passed numerous changes to the reimbursement policies applicable to
exempt hospital services, skilled nursing, therapy and other ancillary services.
The BBA mandates the implementation of a prospective payment system ("PPS") for
skilled nursing facilities. PPS became effective for the Company's facilities
acquired with RCA on July 1, 1998 and for the Company's remaining facilities on
January 1, 1999. Under PPS, Medicare pays skilled nursing facilities a fixed fee
per patient day based on the acuity level of the patient, to cover all
post-hospital extended care routine service costs (i.e., Medicare Part A
patients), including ancillary and capital related costs for beneficiaries
receiving skilled services. The per diem rate also covers substantially all
items and services furnished during a covered stay for which reimbursement was
formerly made separately under Medicare. Prior to the implementation of PPS,
costs of such services were reimbursed on a "cost-based reimbursement" basis.
During the first three years of PPS, payments will generally be based on a blend
of facility's historical costs (based on 1995 cost data) and federally
established per diem rates. Thereafter, the per diem rates will be based solely
on the federally established per diem rates.

The BBA called for consolidated billing by skilled nursing facilities. Upon
implementation payments for non-physician Part B services for beneficiaries no
longer eligible for Part A skilled nursing facility care will be made to the
facility regardless of whether the item or service was furnished by the
facility, by others under arrangement or under any other contracting or
consulting arrangements.

Sun's revenues from its inpatient facilities generally have been and will be
significantly and adversely affected by the amount of the federally established
per diem rate. The new per diem rate limits the amount of reimbursement the
government will pay per patient per day. The per diem reimbursement rate has
generally been less than the amount the Company's inpatient facilities received
on a daily basis under cost based reimbursement. Moreover, since Sun treats a
greater percentage of higher acuity patients than many nursing homes, Sun has
also been adversely impacted because the federally established per diem rates
for higher acuity patients do not adequately compensate Sun for the additional
expenses and risks for caring for such patients. The transition to PPS
negatively impacted Sun's earnings for the six months ended December 31, 1998
and is expected to negatively impact earnings at least through the first six
months of 1999. It is not clear what the long-term impact of PPS will be on Sun.
There can be no assurance that the imposition of PPS will not have a long-term
material adverse effect on the results of operations and

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financial condition of the Company. See "Item 7--Management's Discussion and
Analysis of Financial Condition and Results of Operations."

In addition, the implementation of PPS has resulted in a greater than
expected decline in demand for the Company's therapy and pharmaceutical
services. For instance, the nursing home industry has responded to the lower
reimbursement levels under PPS by, among other things, seeking lower acuity
residents who need less ancillary services and by providing therapy services
in-house, which has resulted in a significant decline in the demand for the
Company's therapy services. Prior to the implementation of PPS, Sun's ancillary
services, such as rehabilitation and respiratory therapy services and
pharmaceutical services, had significantly higher operating margins than the
margins associated with Sun's long-term and subacute care facilities and
accordingly such services provided more than half of Sun's operating profits.
Although the Company has taken and continues to take actions to reduce its costs
of providing ancillary services, there can be no assurance that the Company will
be able to maintain its prior profit margins on its ancillary services.

The Company's response to the implementation of PPS included, among other
things, the establishment of SunSolution. SunSolution provides ancillary
services for a fixed fee to nonaffiliated facilities. As of April 19, 1999,
SunSolution had secured fewer contracts with nonaffiliated facilities than
projected and the average revenue per contract was significantly less than the
Company had projected. There can be no assurance that the Company will develop a
market for the SunSolution products and services. In addition, there can be no
assurance that the costs of providing the contracted services will be less than
the fee received by SunSolution for such services.

INCREASE IN SURVEY, CERTIFICATION AND ENFORCEMENT ACTIVITIES. In the Summer
of 1998, the United States General Accounting Office released a report that was
severely critical of the California state agency that inspects nursing homes.
Following the release of that report, President Clinton, Secretary of Health and
Human Services Donna E. Shalala and several Congressmen called for an
enforcement "crackdown" against nursing home regulatory violations. Although the
crackdown ostensibly was directed against the state agencies that inspect
nursing facilities and enforce federal Medicare and Medicaid certification
requirements, the crackdown resulted in a significant increase in the number of
inspections, citations of regulatory deficiencies, and regulatory sanctions
throughout the United States including terminations from the Medicare and
Medicaid Programs, bans on Medicare and Medicaid payment for new admissions, and
civil monetary penalties.

If a facility is terminated from the Medicare and Medicaid programs, its
Medicare and Medicaid reimbursement is interrupted pending recertification, a
process that can take several months. In the interim, the facility may continue
to provide care to its residents without Medicare and Medicaid reimbursement, or
the government may involuntarily relocate Medicare and Medicaid residents to
other facilities. Terminations, bans on admission and civil monetary penalties
can cause material adverse financial and operational effects on individual
facilities.

The federal government has proposed to terminate several of the Company's
facilities from the Medicare and Medicaid programs, and has imposed bans on
admissions and civil monetary penalties against several facilities, on the basis
of alleged regulatory deficiencies. The Company typically vigorously contests
such sanctions, and in several cases has sought and obtained federal court
injunctions against proposed terminations. While the Company has been successful
to date in preventing any Medicare and Medicaid termination that it has
contested, such cases require significant legal expenses and management
attention. There can be no assurance that the federal government will not
attempt to terminate additional facilities of the Company from the Medicare and
Medicaid programs, or that the Company will continue to be successful contesting
such terminations.

While the entire nursing home industry has been subject to the enhanced
enforcement policy, the Company believes that the federal government may be
focusing particular enforcement attention on large for-profit multifacility
providers such as the Company. Such companies operate approximately 30% of the

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facilities in the industry. The federal government has indicated that it may in
the future adopt a policy to subject multifacility providers to enhanced
scrutiny and sanctions if any of the provider's facilities is cited for certain
"repeat" deficiencies. Given the large number of facilities the Company
operates, such a policy could have a material adverse impact on the Company.
Although the Company has participated in industry efforts to dissuade the
Department of Health and Human Services from adopting such a policy, no
assurance can be given that such a policy will not be adopted or, if adopted,
that it will not have a material adverse affect on the Company.

RESTRUCTURING. The Company commenced a comprehensive restructuring in 1998.
Through April 9, 1999, the restructuring included the elimination of more than
10,000 positions, primarily rehabilitation therapy employees, through attrition,
layoffs and the elimination of vacant positions. The Company also restructured
its domestic operations to more closely align the inpatient, rehabilitation and
pharmaceutical services divisions. At the same time, the Company decreased the
layers of the management structure. The Company also restructured all of its
international operations under one subsidiary, Sun Healthcare Group
International Corporation. There can be no assurance as to the impact of the
restructuring on the Company's financial results and operations.

COMPETITION

The long-term and subacute care industry is highly competitive. The nature
of competition varies by location. The Company's facilities generally operate in
communities that are also served by similar facilities operated by others. Some
competing facilities are located in buildings that are newer than those operated
by the Company and provide services not offered by the Company, and some are
operated by entities having greater financial and other resources and longer
operating histories than the Company. In addition, some facilities are operated
by nonprofit organizations or government agencies supported by endowments,
charitable contributions, tax revenues and other resources not available to the
Company. Some hospitals that either currently provide long-term and subacute
care services or are converting their under utilized facilities into long-term
and subacute care facilities are also a potential source of competition to the
Company. The Company competes with other facilities based on key competitive
factors such as its reputation for the quality and comprehensiveness of care
provided; the commitment and expertise of its staff; the innovativeness of its
treatment programs; local physician and hospital support; marketing programs;
charges for services; and the physical appearance, location and condition of its
facilities. The range of specialized services, together with the price charged
for services, are also competitive factors in attracting patients from large
referral sources.

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

EMPLOYEES

As of February 20, 1999, the Company had approximately 80,720 full-time and
part-time employees. Of this total, there were approximately 53,741 employees at
the long-term and subacute care facilities in the United States, 8,588 employees
at the long-term care facilities in the United Kingdom, 626 employees at the
long-term care facilities in Spain, 422 employees involved in providing
long-term care services in Germany, 239 employees involved in providing acute
care services in Australia, 7,873 employees involved in providing rehabilitation
therapy services in the United States, 168 employees providing rehabilitation
therapy services in Canada, 3,264 employees in the pharmaceutical services
operations in the United States, 193 employees in foreign pharmaceutical
operations, 2,852 employees in the temporary therapy staffing business, 1,158
employees of the respiratory therapy services business, 1,300 employees at the

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corporate and regional offices in the United States and 296 employees at the
corporate and regional offices in the United Kingdom.

Certain of the Company's employees in Alabama, California, Connecticut,
Georgia, Massachusetts, New Mexico, Ohio, Tennessee, Washington and West
Virginia are covered by collective bargaining contracts. The unions representing
certain of the Company's employees have from time to time gone on strike. There
can be no assurance that the unions will not go on strike in the future or that
such strikes will not have a material adverse effect on the Company's results of
operations or financial condition.

CERTAIN ADDITIONAL BUSINESS RISKS

The Company's business, financial condition and operating results can be
impacted by a number of factors, including but not limited to those set forth
below, any one of which could cause the Company's actual results to vary
materially from the Company's past results or anticipated future results.

AVAILABLE LIQUIDITY

At December 31, 1998, the Company had a working capital deficit of $539.6
million including cash and cash equivalents of $27.5 million, as compared to
positive working capital of $307.0 million, including cash and cash equivalents
of $21.0 million at December 31, 1997. The 1998 working capital deficit is due
to the classification of the Company's Senior Credit Facility as a current
liability as a result of the Company's non-compliance with certain financial
covenants contained in its Senior Credit Facility. As a result, the lenders
("the Lenders") under the Senior Credit Facility have the right to require
repayment of all amounts outstanding under the Senior Credit Facility. The
Company does not have sufficient cash reserves to repay all amounts outstanding
under the Senior Credit Facility. The Company's liquidity position has been
negatively affected by, among other things, the implementation of PPS and
negative accounts receivable trends. See "Recent Developments--PPS" and
"--Collectability of Certain Accounts Receivable." For the year ended December
31, 1998, net cash used for operations was $45.6 million compared to net cash
provided by operations for the year ended December 31, 1997 of $21.7 million.
The net cash used for operations in 1998 reflects the significant losses
incurred in 1998. In addition, cash flow was negatively impacted by an increase
in accounts receivable and inventory expenditures. If the Company's liquidity
position continues to decline, the Company may need to seek additional sources
of financing, and there can be no assurance that such financing will be
available. See "--Compliance with Senior Credit Facility; Borrowing Capacity
under Senior Credit Facility" and "Item 7--Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources."

COMPLIANCE WITH SENIOR CREDIT FACILITY AND OTHER DEBT INSTRUMENTS; BORROWING
CAPACITY UNDER SENIOR CREDIT FACILITY

The Company was not in compliance with certain of the financial covenants
contained in its Senior Credit Facility as of December 31, 1998. As a result the
Lenders have the right to require repayment of all amounts outstanding under the
Senior Credit Facility.

At April 19, 1999, the Lenders had not demanded repayment of the Senior
Credit Facility. The Company is seeking from the Lenders an amendment to the
Senior Credit Facility to cure its non-compliance and amend the financial
covenants. However, no agreement to waive the 1998 financial covenants
violations or amend the future financial covenants has been reached. Under the
terms of the Senior Credit Facility, the Company is prohibited from further
borrowing on the Senior Credit Facility. Accordingly, the Company will have to
fund all operations, capital expenditures, and required debt service from
existing cash reserves and future net cash flows from operations, if any.

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Company is not in compliance as of December 31, 1998 with certain financial
covenants contained in certain master lease agreements for 96 of its long-term
care facilities in the United States and 33 of its long-term care facilities in
the United Kingdom. The Company was also in cross default under lease agreements
for 14 of its long-term care facilities in the United States. As a result, the
lessors under the master lease agreements have certain rights, including the
right to require the Company to relinquish the leased facilities. At April 19,
1999, the mortgage lender and lessors have not exercised their rights under the
respective agreements. The Company is in discussions with the mortgage lender
and the lessors under the master lease agreements to cure its non-compliance and
amend the financial covenants.

SUBSTANTIAL LEVERAGE; NEED FOR ADDITIONAL FINANCING

Sun has substantial indebtedness. As of December 31, 1998, Sun had on a
consolidated basis approximately $1.6 billion of indebtedness, including capital
lease obligations and $745.6 million of indebtedness under the Senior Credit
Facility. The Company had approximately $33.8 million of stockholders' equity at
December 31, 1998. At December 31, 1998, Sun had outstanding commitments for
construction and development costs of approximately $49.3 million in the United
States and United Kingdom. In addition, as of December 31, 1998, Sun's existing
lease agreements required aggregate annual payments for the years ending
December 31, 1998, 1999, 2000, 2001, 2002 and 2003 of $245.2 million, $241.5
million, $229.8 million, $226.4 million and $219.5 million, respectively.

The degree to which Sun is leveraged could have important consequences to
holders of Sun's common stock, including, but not limited to, the following: (i)
a substantial portion of Sun's cash flow from operations will be required to be
dedicated to debt service and will not be available for other purposes,
including acquisitions; (ii) Sun's ability to obtain additional financing in the
future could be limited; (iii) certain of Sun's borrowings are at variable rates
of interest, which could result in higher interest expense in the event of
increases in interest rates; and (iv) the indentures with respect to the
Company's 9 1/2% Senior Subordinated Notes due 2007 and 9 3/8% Senior
Subordinated Notes due 2008 and the Company's Senior Credit Facility generally
contain financial and restrictive covenants that limit the ability of Sun to,
among other things, borrow additional funds, dispose of assets or pay cash
dividends. Failure by Sun to comply with such covenants could result in an event
of default which, if not cured or waived, would have a material adverse effect
on Sun. The Company expects that it may need to raise additional equity or debt
financing in the future. There can be no assurance that Sun will be successful
in raising additional equity or debt financing on terms favorable to the
Company, if at all. Moreover, any additional equity raised could be
substantially dilutive to the holder's of the Company's Common Stock. See "Item
7-- Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."

REDUCED REVENUES RESULTING FROM PROSPECTIVE PAYMENT SYSTEM

For a description of certain risks related to PPS, see "Recent
Developments--PPS."

RISKS ASSOCIATED WITH REIMBURSEMENT PROCESS

The Company derives a substantial percentage of its total revenues from
Medicare, Medicaid and private insurance. Net revenues realizable under
third-party payor agreements are subject to change due to examination and
retroactive adjustment by payors during the settlement process. Payors may
disallow in

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whole or in part requests for reimbursement based on determinations that certain
costs are not reimbursable or reasonable or because additional supporting
documentation is necessary. The Company recognizes revenues from third-party
payors and accrues estimated settlement amounts in the period in which the
related services are provided. The Company estimates these settlement balances
by making determinations based on its prior settlement experience and its
understanding of the applicable reimbursement rules and regulations. The
majority of Medicare and Medicaid balances are settled two to three years
following the provision of services, although the Company has from time to time
experienced delays in receiving final settlement and reimbursement.

The Company has also experienced differences between the net amounts accrued
and subsequent settlements, which differences are recorded in operations at the
time of settlement. For example, in the fourth quarter of 1998, the Company
recorded negative revenue adjustments totaling approximately $34.7 million
primarily for the projected settlement of 1997 facility cost reports which were
not settled as of December 31, 1998 and the projected settlement of the 1998
cost reports based on historical information. The Company currently has a number
of outstanding cost reports, and there can be no assurance that the settlement
of these cost reports will not result in material negative revenue adjustments
to the Company. The Company's results of operations would be materially and
adversely affected if the amounts actually received from third-party payors in
any reporting period differs materially from the amounts accrued in prior
periods. See "Item 7--Management's Discussion and Analysis of Financial
Condition and Results of Operations--Effects from Changes in Reimbursement."

COLLECTABILITY OF CERTAIN ACCOUNTS RECEIVABLE

The Company's net accounts receivable increased from approximately $523.2
million at December 31, 1997 to approximately $538.3 million at December 31,
1998. The Company's allowance for doubtful accounts increased from approximately
$34.4 million at December 31, 1997 to approximately $79.0 million at December
31, 1998. The Company believes that the implementation of PPS for certain
nonaffiliated ancillary service customers has negatively affected their cash
flows affecting the collectibility of amounts due to the Company. Other
nonaffiliated ancillary service customers, in preparation for impending
transition to PPS have slowed, reduced or stopped payment for service in
anticipation of the adverse effect PPS will have on their cash flow. As a
result, accounts receivable for nonaffiliated customers has increased, and the
Company has increased its provision for doubtful accounts in the fourth quarter.
The Company's financial condition and results of operation could be materially
adversely affected by the inability to collect its accounts receivable.

RISK OF ADVERSE EFFECT OF FUTURE HEALTHCARE REFORM

In recent years, an increasing number of legislative proposals have been
introduced or proposed in Congress and in some state legislatures that would
effect major changes in the healthcare system, either nationally or at the state
level. Among the proposals that have been introduced are further changes in
reimbursement by federal and state payors such as Medicare and Medicaid and
health insurance reforms. It is not clear at this time when or whether any new
proposals will be adopted, or, if adopted, what effect, if any, such proposals
would have on Sun's business. There can be no assurance that future healthcare
legislation or other changes in the administration or interpretation of
governmental healthcare programs will not have a material adverse effect on
Sun's financial condition or results of operations.

POTENTIAL LIABILITY FOR REIMBURSEMENTS PAID TO FORMER OPERATORS OF ACQUIRED
FACILITIES

Sun's growth strategy has relied heavily on the acquisition of long-term and
subacute care facilities. Regardless of the legal form of the acquisition, the
Medicare and Medicaid programs often require that Sun assume certain obligations
relating to the reimbursement paid to the former operators of facilities
acquired by Sun. From time to time, fiscal intermediaries and Medicaid agencies
examine cost reports filed by such predecessor operators. If, as a result of any
such examination, it is concluded that overpayments to

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a predecessor operator were made, the Company, as the current operator of such
facilities, may be held financially responsible for such overpayments. At this
time the Company is unable to predict the outcome of any existing or future
examinations. See "--Difficulty of Integrating Acquired Operations" and "Item
7--Management's Discussion and Analysis of Financial Condition and Results of
Operations--Effects from Changes in Reimbursement."

POTENTIAL ADVERSE EFFECT OF CHANGE IN REVENUE SOURCES

Changes in the mix of patients among the Medicaid, Medicare and private pay
categories, and among different types of private pay sources, could
significantly affect the revenues and the profitability of Sun's operations.
There can be no assurance that Sun will continue to attract and retain private
pay patients or maintain its current payor or revenue mix. In addition, there
can be no assurance that the facilities operated by Sun, or the provision of
services and products by Sun, now or in the future, will initially meet or
continue to meet the requirements for participation in the Medicare and Medicaid
programs. A loss of Medicare or Medicaid certification or a change in Sun's
reimbursement under Medicare or Medicaid could have an adverse effect on its
financial condition and results of operations. See "--Risks Related to
Investigations and Legal Proceedings" and "--Risk of Adverse Effect of Future
Healthcare Reform."

RISKS RELATED TO INVESTIGATIONS AND LEGAL PROCEEDINGS

The Company's subsidiaries including, but not limited to, those which
provide subacute and long-term care, rehabilitation and respiratory therapy and
pharmaceutical services, are engaged in industries which are extensively
regulated. See "--Potential Adverse Impact from Extensive Regulation." As such,
in the ordinary course of business, the operations of these subsidiaries are
continuously subject to state and Federal regulatory scrutiny, supervision and
control. Such regulatory scrutiny often includes inquiries, investigations,
examinations, audits, site visits and surveys, some of which may be non-routine.
The Company's subsidiaries are currently the subject of several such
investigations. If any of the Company's subsidiaries is ever found to have
engaged in improper practices, it could be subjected to civil, administrative,
or criminal fines, penalties or restitutionary relief and reimbursement
authorities could also seek the suspension or exclusion of the subsidiary or
individuals from participation in their program. From time to time, the
existence of regulatory investigations has hindered or prevented the Company
from pursuing certain business opportunities. There can be no assurance that the
existence of any such investigations will not affect the Company's ability to
pursue future business opportunities. See "Recent Developments-- Increase in
Survey and Enforcement Activities" and "Item 7--Management's Discussion and
Analysis of Financial Condition and Results of Operations--Regulation."

For a description of certain risks related to legal proceedings, see "Item
7--Management's Discussion and Analysis of Financial Condition and Results of
Operations--Litigation."

POTENTIAL ADVERSE IMPACT FROM EXTENSIVE REGULATION

All of the facilities operated or managed by Sun are required to be licensed
in accordance with the requirements of state and local agencies having
jurisdiction over their operations. Most of Sun's facilities are also certified
as providers under the Medicaid and Medicare programs. The failure to obtain or
renew any required regulatory approvals or licenses or to comply with applicable
regulations in the future could adversely affect Sun's financial condition and
results of operations. See "--Risks Related to Investigations and Legal
Proceedings" and "Item 7--Management's Discussion and Analysis of Financial
Condition and Results of Operations--Regulation." To the extent that
Certificates of Need ("CONs") or other similar approvals are required for
expansion of Sun's operations, either through acquisitions or additions to or
provision of new services at such facilities, such expansion could be adversely
affected by the failure to obtain such CONs or approvals. There can be no
assurance that Sun's business in the future will not be materially adversely
affected by licensing and certification requirements of state and Federal
authorities.

9
<PAGE>
Medicare and Medicaid antifraud and abuse laws also prohibit certain
business practices and relationships that might affect the provision and cost of
healthcare services reimbursable under Medicare and Medicaid. Expressly
prohibited are kickbacks, bribes and rebates related to Medicare or Medicaid
referrals. Federal laws also provide civil and criminal penalties for any false
or fraudulent statements, knowingly made, in any claim for payment under a
Federal or state health care program as well as any material omissions in such
claims. In addition, certain states have adopted fraud and abuse and false
claims laws that prohibit specified business practices. Sanctions for violating
these laws include criminal penalties and civil sanctions, including fines and
possible exclusion from the Medicare and Medicaid programs. See "Recent
Developments--Increase in Survey, Certification and Enforcement Activities."

DIFFICULTY OF INTEGRATING ACQUIRED OPERATIONS

Sun's growth strategy has relied heavily on the acquisition of long-term and
subacute care facilities. Significant acquisitions since October 1997 include
Regency Health Services, Inc., RCA and Contour. Acquisitions present problems of
integrating the acquired operations with existing operations, including the loss
of key personnel and institutional memory of the acquired business, difficulty
in integrating corporate, accounting, financial reporting and management
information systems and strain on existing levels of personnel to operate such
acquired businesses. In addition, certain assumptions regarding the financial
condition of an acquired business may later prove to be incorrect. See "Item
7--Management's Discussion and Analysis of Financial Condition and Results of
Operation."

RISK OF INTERNATIONAL OPERATIONS; FOREIGN EXCHANGE RISK

Sun currently conducts business in the United Kingdom, Spain, Germany and
Australia. Foreign operations accounted for approximately 5%, 10% and 9% of
Sun's total net revenues during the years ended December 31, 1996, 1997 and
1998, respectively, and 17% of Sun's consolidated total assets as of December
31, 1998. Adverse results from Sun's international operations have and continue
to negatively affect Sun's financial condition and results of operations. The
success of Sun's operations in and expansion into international markets depends
on numerous factors, many of which are beyond its control. Such factors include,
but are not limited to, economic conditions and healthcare regulatory systems in
the foreign countries in which Sun operates. In addition, international
operations and expansion may increase Sun's exposure to certain risks inherent
in doing business outside the United States, including slower payment cycles,
unexpected changes in regulatory requirements, potentially adverse tax
consequences, currency fluctuations, restrictions on the repatriation of profits
and assets, compliance with foreign laws and standards and political risks.
Sun's financial condition and results of operations are also subject to foreign
exchange risk.

RISKS RELATED TO YEAR 2000 DATE CHANGE

For a description of certain risks related to the Year 2000 date change, see
"Item 7--Management's Discussion and Analysis of Financial Condition and Results
of Operations--Year 2000 Issue."

INCREASED LABOR COSTS AND AVAILABILITY OF PERSONNEL

In recent years Sun has experienced increases in its labor costs primarily
due to higher wages and greater benefits required to attract and retain
qualified personnel and increased staffing levels in its long-term and subacute
care facilities due to greater patient acuity. Since under PPS and fee schedules
reimbursement is no longer on a "pass-through" basis, increases in labor costs
will no longer result in increases in reimbursement rates. In addition, Sun's
ability to hire and retain qualified employees may be affected by, among other
things, the wage freeze implemented in January 1999 that is applicable to the
majority of Sun's employees and the perceived uncertainty about Sun's financial
performance. There can be no assurance that in the future Sun will be able to
continue to hire and retain a sufficient number of qualified personnel to
operate the Company effectively. See "Business--Employees."

10
<PAGE>
ANTI-TAKEOVER PROVISIONS; POSSIBLE ISSUANCE OF PREFERRED STOCK

Sun's certificate of incorporation and by-laws contain provisions that may
make it more difficult for a third party to acquire, or discourage acquisition
bids for, Sun. In addition, approximately 3.2% of the Company's common stock is
owned by a grantor stock trust (the "Grantor Trust"), which holds such shares
for issuance under the company's stock option plans and employee stock purchase
plan. Employees and nonemployee directors holding stock options and employee
stock purchase plan participants have the right to vote all of the shares held
by the Grantor Trust. The voting control of such shares of stock by employees
and management may make it more difficult for a third party to acquire (or such
ownership may discourage bids for) Sun. The provisions in the certificate of
incorporation and by-laws, together with ownership of such shares by the Grantor
Trust, could limit the price that certain investors might be willing to pay in
the future for shares of Common Stock. In addition, shares of Sun's preferred
stock may be issued in the future without further stockholder approval and upon
such terms and conditions and having such rights, voting powers, preferences and
relative, participating, optional and other special privileges as the board of
directors may determine. The rights of the holders of Common Stock will be
subject to, and may be adversely affected by, the rights of any holders of
preferred stock that may be issued in the future. The issuance of preferred
stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could have the effect of making it
more difficult for a third party to acquire, or discouraging a third party from
acquiring, a majority of the outstanding voting stock of Sun. Sun has no present
plans to issue any shares of its preferred stock. In addition, Sun has adopted a
stockholder rights plan that, along with certain provisions of Sun's certificate
of incorporation, have the effect of discouraging certain transactions involving
a change of control of Sun.

VOLATILITY OF STOCK PRICE

There has in the past been significant volatility, and more recently a
significant decline, in the market prices of securities of the Company and many
other publicly-owned long-term care companies. In particular, the market price
of Sun's common stock has in the past been subject to heightened volatility
resulting from, among other things, announcements of operating results and
uncertainties regarding certain Medicare reimbursement policies and government
investigations of Sun. Sun believes factors such as, but not limited to,
legislative and regulatory developments, continuing uncertainties regarding
certain Medicare reimbursement policies and government investigations of Sun and
quarterly variations in financial results could cause the market price of Sun's
common stock to fluctuate substantially. See "Item 5--Market for Registrant's
Common Equity and Related Stockholder Matters."

ITEM 2. PROPERTIES

Previously filed in Form 10-K.

ITEM 3. LEGAL PROCEEDINGS

See "Item 7--Management's Discussion and Analysis of Financial Condition and
Results of Operations--Litigation."

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1998.

11
<PAGE>
PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's common stock is traded on the New York Stock Exchange (the
"NYSE") under the symbol "SHG." The following table shows the high and low sales
prices for the common stock as reported by the NYSE for the periods indicated:

<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
1997
First Quarter................................................................................ $ 16.25 $ 12.75
Second Quarter............................................................................... 20.81 13.88
Third Quarter................................................................................ 23.44 19.63
Fourth Quarter............................................................................... 22.94 17.25
1998
First Quarter................................................................................ $ 20.13 $ 18.13
Second Quarter............................................................................... 19.25 14.63
Third Quarter................................................................................ 17.69 6.50
Fourth Quarter............................................................................... 7.75 4.88
</TABLE>

There were approximately 6,500 holders of record as of March 26, 1999 of the
Company's common stock.

The Company has not paid nor declared any dividends on its common stock
since its inception and anticipates that its future earnings will be retained to
finance the continuing development of its business. The payment of any future
dividends will be at the discretion of the Company's Board of Directors and will
depend upon, among other things, future earnings, the success of the Company's
business activities, regulatory and capital requirements, the general financial
condition of the Company and general business conditions. The Company is
restricted from paying dividends under the Senior Credit Facility.

12
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA

The following Selected Consolidated Financial Data for the years ended
December 31, 1998, 1997, 1996, 1995, and 1994 have been derived from the
Company's Consolidated Financial Statements. The financial data set forth below
should be read in connection with "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations" and with the Company's
Consolidated Financial Statements and related notes thereto.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
1998(1) 1997(2) 1996(3) 1995(4)(5) 1994(4)
------------ ------------ ------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Total net revenues......................... $ 3,088,460 $ 2,010,820 $ 1,316,308 $ 1,135,508 $ 673,354
Earnings before income taxes and
extraordinary loss....................... (689,842) 95,882 52,466 12,794 36,807
Earnings (losses) before extraordinary
loss..................................... (743,419) 54,729 21,536 (20,568) 19,561
Extraordinary loss......................... 10,274 19,928 -- 3,413 --
Net earnings (losses).................. $ (753,693) $ 34,801 $ 21,536 $ (23,981) $ 19,561

Net earnings (losses) per common and common
equivalent share (6):
Net earnings (losses) before
extraordinary loss:
Basic.................................. $ (14.29) $ 1.18 $ 0.46 $ (0.43) $ 0.63
Diluted................................ $ (14.29) $ 1.12 $ 0.46 $ (0.43) $ 0.61
Net earning (losses):
Basic................................ $ (14.49) $ 0.75 $ 0.46 $ (0.51) $ 0.63
Diluted.............................. $ (14.49) $ 0.74 $ 0.46 $ (0.51) $ 0.61

Weighted Average number of common and
common equivalent shares:
Basic.................................. 52,008 46,329 46,360 47,419 31,038
Diluted................................ 52,008 51,851 46,868 47,419 31,830

Working Capital (Deficit).................. $ (539,636) $ 307,025 $ 211,582 $ 237,147 $ 197,150
Total Assets............................... $ 2,468,038 2,579,236 1,229,426 1,042,503 1,054,223
Long term debt, net of current portion..... 705,653 1,488,861 458,453 348,460 398,534
Stockholder's equity....................... 33,759 617,053 572,137 569,042 550,449
</TABLE>

(1) Results for the year ended December 31, 1998, include a non-cash charge of
$397.4 million related to the Company's estimate of goodwill and other asset
impairment (see Note 6, IMPAIRMENT OF LONG-LIVED ASSETS AND ASSETS HELD FOR
SALE, in the Company's Consolidated Financial Statements), a non-cash charge
of $206.2 million due to the termination of certain facility lease
agreements, the sale of certain other facilities, and to reduce the carrying
amount of certain assets that the Company had determined are not integral to
its core business operations (see Note 6, IMPAIRMENT OF LONG-LIVED ASSETS
AND ASSETS HELD FOR SALE, in the Company's Consolidated Financial
Statements), a $22.5 million charge for legal and regulatory matters, a $4.6
million charge for restructuring cost in order to more closely align the
Company's inpatient, rehabilitation and respiratory therapy, and
pharmaceutical and medical supplies segments (see Note 5, RESTRUCTURING
COSTS, in the Company's Consolidated Financial Statements), and incurred an
extraordinary loss of $10.3 million, net of income tax benefit of $3.7
million, to permanently pay-down $300 million of the term loan portion of
the Company's senior credit facility in addition to the $3.7 million to
retire $5.0 million of the Contour convertible debentures purchased by the
Company.

13
<PAGE>
(2) Results for the year ended December 31, 1997, include a charge of $7.0
million recognized by the Company in order to reduce the carrying value of
the Canadian operations to fair value based on revised estimates of selling
value and of costs to sell. In addition, in 1997, the Company recorded an
extraordinary charge of $17.9 million, net of the related tax benefit, in
connection with the Company's purchase of Regency's 12.25% Junior
Subordinated Notes due 2003 and of Regency's 9.875% Senior Subordinated
Notes due 2002 and an extraordinary charge of $2.1 million, net of the
related tax benefit, related to the refinancing of the Company's senior
credit facility.

(3) Results for the year ended December 31, 1996, include a $24.0 million charge
recognized by the Company to settle certain of the lawsuits brought by
shareholders and, as a reduction of this settlement charge, $9.0 million,
which was received from the Company's director and officer liability
insurance carrier in connection with the settlement (see Note 16 to the
Consolidated Financial Statements). In addition, in 1996, the Company
recorded additional expenses of $4.3 million related to monitoring and
responding to the investigation by the United States Department of Health
and Human Services Office of the Inspector General ("OIG") and to responding
to the remaining shareholder litigation related to the announcement of the
OIG investigation. The charges do not contain any estimated amounts for
settlement of the OIG investigation or remaining shareholder matters.

(4) Results for the year ended December 31, 1995 and prior years represent pro
forma amount to include pro forma taxes of CareerStaff and Golden Care prior
to their conversions to be taxed as C corporations, which occurred in June
1994 and May 1995, respectively.

(5) Results for the year ended December 31, 1995, include a charge of $3.3
million in connection with the payment of an inducement fee to affect the
conversion in January 1995 of $39.4 million of the 6 1/2% Convertible
Subordinated Debentures and an extraordinary charge of $3.4 million, net of
the related income tax benefit, in connection with the tender offer of the
11 3/4 Senior Subordinated Notes. Also included in the results of operations
for the year ended December 31, 1995 is $5.8 million of transaction-related
merger costs incurred in connection with the merger of the Company with
CareerStaff (a temporary therapy staffing provider) and GoldenCare (a
respiratory therapy provider), a $59.0 million impairment loss recorded by
the Company which primarily relates to goodwill associated with six of the
forty facilities acquired in conjunction with the Mediplex acquisition in
1994, $4.0 million related to averting a strike and negotiating new
contracts for certain unionized nursing home employees in Connecticut, and a
charge of $5.5 million related to monitoring and responding to the
investigation by the OIG and legal fees resulting from the shareholder
litigation.

(6) See Note 1 (o), NET EARNINGS (LOSSES) PER SHARE, in the Company's
Consolidated Financial Statements for the year ended December 31, 1994 for
net earnings (losses) per share information.

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

OVERVIEW

Sun Healthcare Group, Inc., through its direct and indirect subsidiaries
(collectively referred to as "Sun" or the "Company"), is a leading provider of
high quality and cost efficient long-term, subacute and related specialty
healthcare services in the United States and the United Kingdom. The Company
also has operations in Spain, Germany and Australia. The Company operates
through four principal business segments:

INPATIENT SERVICES: This segment provides, among other services,
inpatient skilled nursing and custodial services as well as rehabilitative,
restorative and transitional medical services. The Company provides 24-hour
nursing care in these facilities by registered nurses, licenses practical
nurses and certified nursing assistants. At December 31, 1998, the Company
operated 397 inpatient facilities with 44,941 licensed beds compared to 321
facilities with 36,655 licensed beds at December 31, 1997.

14
<PAGE>
Included in the preceding are 41 facilities with 3,705 licensed beds which
the Company has announced its intention to divest or not renew leases on
certain facilities. During the year ended December 31, 1998, the Company
acquired on a net basis, 76 facilities with 8,286 licensed beds including 75
facilities acquired in connection with RCA. During 1997, in addition to 111
facilities with 11,346 licensed beds acquired in connection with Regency,
Sun acquired a net 50 facilities with 5,988 licensed beds. At December 31,
1996, the Company operated 160 facilities with 19,321 licensed beds.

REHABILITATION AND RESPIRATORY THERAPY SERVICES: This segment provides,
among other services, physical, occupational, speech and respiratory therapy
services to affiliated and nonaffiliated skilled nursing facilities. As of
December 31, 1998 the Company's rehabilitation and respiratory therapy
services segment provided services to 1,715 facilities in 46 states, 1,294
of which were operated by nonaffiliated parties compared to 1,565 facilities
as of December 31, 1997, 1,278 of which were nonaffiliated.

PHARMACEUTICAL AND MEDICAL SUPPLY SERVICES: This segment is comprised
of an institutional pharmaceutical subsidiary and a medical supply
subsidiary. The pharmaceutical subsidiary provides pharmaceutical products
primarily to long term and subacute care facilities for such purposes as
infusion therapy, pain management, antibiotic therapy and parenteral
nutrition as well as providing consultant pharmacist services. The medical
supply subsidiary primarily provides medical supplies to long-term care and
sub-acute care facilities. The Company's pharmaceutical subsidiary provided
pharmaceutical products and services to 930 long term and sub-acute care
facilities, including 584 nonaffiliated facilities, as of December 31, 1998
through its 34 pharmacies and two pharmaceutical billing and consulting
centers. At December 31, 1997 pharmaceutical products and services were
provided to approximately 801 facilities including 546 nonaffiliated
facilities. The Company's medical supply subsidiary provided products to
over 2,100 affiliated and nonaffiliated facilities as of December 31, 1998.

INTERNATIONAL OPERATIONS: This segment consists of long-term care
facilities in the United Kingdom, Spain and Germany as well as acute care
hospitals in Australia. This segment also provides pharmaceutical services
in the United Kingdom, Germany and Spain and medical supplies in Australia.
At December 31, 1998, the Company operated 155 inpatient facilities with
8,705 licensed beds in the United Kingdom; 10 inpatient facilities with
1,604 beds in Spain; 16 facilities with 1,135 licensed beds in Germany and
five hospitals with 309 licensed beds in Australia compared to 137
facilities with 7,837 licensed beds in the United Kingdom; eight facilities
with 1,320 licensed beds in Spain; 11 facilities with 930 licensed beds in
Germany; and six hospitals with 353 licensed beds in Australia as of
December 31, 1997. During 1998, the Company acquired or opened 18 facilities
with 868 licensed beds in the United Kingdom. During 1997, in addition to
Ashbourne, the Company acquired nine facilities in the United Kingdom,
resulting in a total increase of 476 licensed beds. Also in 1997, the
Company developed and opened nine facilities in the United Kingdom with 604
licensed beds. The Company also acquired 30% of the equity in Alpha
Healthcare Limited, an operator of ten acute care facilities in Australia in
1997.

The Company's international operations also include outpatient therapy
service operations in Canada. The Company sold certain of these operations
in 1998 and completed the sale of remaining operations in the first quarter
of 1999.

OTHER OPERATIONS

The Company's other operations include temporary therapy services,
assisted living services, home health and hospice, software development and
other ancillary services. The Company's temporary therapy service operations
provided approximately 2.4 million temporary therapy staffing hours to
nonaffiliates in 1998 compared to 2.8 million hours in 1997. The assisted
living subsidiary operated 31 assisted living facilities with 3,571 beds in
the United States as of December 31, 1998. The

15
<PAGE>
Company has announced that it is planning to divest itself of its assisted
living facilities. No agreements have been entered into for the sale of
these assets as of April 19, 1999.

On June 30, 1998, a wholly owned subsidiary of the Company merged with
Retirement Care Associates, Inc. ("RCA"), an operator of 98 skilled nursing
facilities and assisted living centers in eight states primarily in the
southeastern United States. RCA also owned approximately 65% of Contour Medical,
Inc. ("Contour"), a national provider of medical/surgical supplies. The Company
also acquired the remaining 35% of Contour on June 30, 1998. Both the RCA merger
and the Contour acquisition were accounted for as purchases.

In October 1997, the Company acquired Regency Health Services, Inc.
("Regency"), an operator of skilled nursing facilities and a diversified
provider of rehabilitation therapy, pharmacy and home health services. At the
date of acquisition, Regency operated 111 long-term care facilities (including
one managed facility) in the United States and provided rehabilitation therapy
and pharmacy services to both affiliated and nonaffiliated facilities.

In addition, in January 1997, the Company acquired the portion not
previously owned by the Company of Ashbourne PLC ("Ashbourne"), an operator of
49 nursing and residential support facilities with 3,613 licensed beds in the
United Kingdom.

The Company's earnings growth has historically resulted from the acquisition
of long-term and subacute care facilities, use of its long-term and subacute
care operations as a base for expansion of certain its ancillary services,
provision of ancillary services to nonaffiliated facilities and expansion of
ancillary services through acquisitions. Ancillary services, such as
rehabilitation and respiratory therapy services and pharmaceutical and medical
supply services, have had significantly higher operating margins than the
margins associated with the provision of routine services to patients at
long-term and subacute care facilities and accordingly have historically
provided more than half of the Company's operating profits. In addition, a
substantial portion of the Company's consolidated interest expense was
attributable to the Company's long-term and subacute services and its foreign
operations due to the capital intensive nature of these businesses and to
related acquisitions. The higher operating margins from the provision of
ancillary services have been primarily attributable to favorable reimbursement
rates under the Medicare reimbursement system. However, effective July 1, 1998,
Medicare began a four year phase in of a prospective payment system ("PPS") for
Part A patients which will provide reimbursement of all costs including
ancillary service and capital-related costs at a fixed fee. A small percentage
of the long-term and subacute care industry transitioned to PPS on July 1, 1998,
including the Company's facilities that were acquired in the RCA Acqusition. The
vast majority of the industry transitioned to PPS on January 1, 1999. The
Company's average per diem rates under PPS are less than the amounts received
under cost based reimbursement. The Company's RCA facilities results were
negatively impacted by the implementation of PPS. The implementation of PPS at
the Company's remaining facilities resulted in a significant decline in Medicare
revenues. In addition, as a result of the industry-wide reductions in Medicare
reimbursement, it is expected that the Company's nonaffiliated ancillary service
customers will significantly reduce their usage of such services. In the fourth
quarter of 1998, the Company experienced a significant and rapid decline in the
demand for its ancillary services as its nonaffiliated customers prepared for
the implementation of PPS. See "Effects from Changes in Reimbursement."

16
<PAGE>
The following table sets forth certain operating data for the Company as of
the dates indicated:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Inpatient Services:
Facilities 397 321 160
Licensed beds 44,941 36,655 19,321

Rehabilitation and Respiratory Therapy Service
Operations:
Nonaffiliated facilities served 1,294 1,278 759
Affiliated facilities served 421 287 152
--------- --------- ---------
Total 1,715 1,565 911
--------- --------- ---------
--------- --------- ---------
Pharmaceutical and Medical Supply Services:
Nonaffiliated facilities served 584 546 325
Affiliated facilities served 346 255 112
--------- --------- ---------
Total 930 801 437
--------- --------- ---------
--------- --------- ---------
International Operations:
Facilities
United Kingdom 155 137 75
Other foreign 31 25 --
--------- --------- ---------
Total 186 162 75
--------- --------- ---------
--------- --------- ---------
Licensed beds
United Kingdom 8,705 7,837 3,420
Other foreign 3,048 2,611 --
--------- --------- ---------
Total 11,753 10,448 3,420
--------- --------- ---------
--------- --------- ---------
</TABLE>

RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Inpatient Services...................................................... $ 2,045,270 $ 1,249,861 $ 833,116
Rehabilitation and Respiratory Therapy Services......................... 678,803 466,358 324,336
Pharmaceutical and Medical Supply Services.............................. 254,455 157,336 91,072
International Operations................................................ 285,267 198,155 61,337
Other Operations........................................................ 283,326 165,906 267,965
Corporate............................................................... -- -- --
Intersegment eliminations............................................... (458,661) (226,796) (261,518)
------------ ------------ ------------
Total net revenues.................................................. $ 3,088,460 $ 2,010,820 $ 1,316,308
------------ ------------ ------------
------------ ------------ ------------
</TABLE>

Inpatient facilities revenues for long-term care, subacute care and assisted
living services include revenues billed to patients for therapy and
pharmaceutical services and medical supplies provided by the Company's
affiliated operations. Revenues for rehabilitation and respiratory therapy
services provided to domestic affiliated facilities were $344.1 million, $180.3
million and $116.4 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Revenues for pharmaceutical and medical supply services provided
to domestic affiliated facilities were $78.9 million, $32.6 million and $20.7
million for the years ended December 31, 1998, 1997 and 1996, respectively.
Revenues for services provided by other non-reportable segments to affiliated
facilities were $35.6 million, $13.8 million and $124.4 million for the years
ended December 31, 1998, 1997 and 1996, respectively.

17
<PAGE>
The following table sets forth the amount and percentage of net segment
earnings (losses) for the periods presented (dollars in thousands):

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Inpatient Services......................................................... $ 26,738 $ 69,350 $ 19,794
Rehabilitation and Respiratory Therapy Services............................ 210,630 146,687 94,342
Pharmaceutical and Medical Supply Services................................. 11,072 18,558 12,362
International Operations................................................... (18,368) (7,508) 2,422
Other Operations........................................................... (9,495) 9,343 10,281
----------- ----------- -----------
Earnings (losses) before income taxes corporate allocation of interest and
management fees.......................................................... 220,577 236,430 139,201
Corporate.................................................................. (255,688) (133,548) (67,485)
Intersegment Eliminations.................................................. (7,857) -- --
----------- ----------- -----------
Net Segment Earnings (losses)............................................ $ (42,968) $ 102,882 $ 71,716
----------- ----------- -----------
----------- ----------- -----------
</TABLE>

Corporate expenses include amounts for interest and corporate general and
overhead expenses. The Company allocates these to its segments through
management fees and intercompany interest charges. Management fees are assessed
based on segment net revenues. Interest is charged based upon average net asset
balances at rates determined by management, and is intended to be consistent
with the rates incurred under the Company's Senior Credit Facility.

The following discussion of the "Year Ended December 31, 1998 compared to
the Year Ended December 31, 1997" is based on the financial information
presented in footnote 19 of the Consolidated Financial Statements--Segment
Information.

YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

INPATIENT SERVICES

Net revenues, which include revenues generated from therapy and
pharmaceutical services provided at the Inpatient Services facilities, increased
approximately $795.4 million from $1.25 billion for the year ended December 31,
1997 to $2.04 billion for the year ended December 31, 1998, a 63.6% increase.
Net revenues were negatively impacted in 1998 and 1997 by certain changes in
accounting estimates for third party settlements (See--Effects from Changes in
Reimbursement and Note 1 to the consolidated Financial Statements for
information regarding the Company's revenue recognition policy). In the fourth
quarter of 1998, the Company recorded negative revenue adjustments totaling
approximately $33.3 million primarily for the projected settlement of 1997
facility cost reports which were not final settled as of December 31, 1998 and
the projected settlement of the 1998 cost reports based on historical
information. The $33.3 million negative revenue adjustments represent
approximately 3.8% of total Medicare revenues. In the fourth quarter of 1997,
the Company recorded negative revenue adjustments totaling approximately $15
million resulting from changes in accounting estimates of amounts realizable
from third party payors.

Approximately $413.7 million of the net revenue increase is attributed to
111 leased or owned facilities acquired from Regency in October 1997,
approximately $124.9 million of the increase resulted from the acquisition of 75
facilities from RCA in June 1998 and approximately $216.8 million of the
increase resulted from an additional 61 facilities acquired or opened at various
times since December 31, 1996. The remaining net revenue increase of $40.0
million, after giving effect to a decrease in net revenues of approximately
$15.9 million relating to six facilities sold during 1998 and four facilities
sold during 1997, is primarily attributable to an increase in revenue per
patient day and an increase in occupancy levels since December 31, 1997 on a
same facility basis for the 160, net leased or owned facilities in operation for
all of 1997 and 1998. The increase in revenue per patient day was primarily a
result of payor rate increases and the expansion of the Company's subacute
services.

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<PAGE>
Operating expenses, which include rent expense of $217.8 million and $122.9
million for the year ended December 31, 1998 and 1997, respectively, increased
69.9% from $1.13 billion for the year ended December 31, 1997 to $1.92 billion
for the year ended December 31, 1998. The increase resulted primarily from the
net increase of 237 leased or owned facilities acquired at various times since
December 31, 1996. Operating expenses as a percentage of net revenues increased
from 90.7% for the year ended December 31, 1997 to 93.9% for the year ended
December 31, 1998. The increase in operating expenses as a percentage of revenue
is primarily due to decreased Medicare revenue as a result of the implementation
of PPS at the Company's RCA facilities effective July 1, 1998 and the effect of
the negative revenue adjustments discussed above for which there was not a
corresponding reduction in operating expenses. In addition, operating expenses
were negatively impacted by state-mandated changes in Regency workers'
compensation self-insurance reserves, primarily related to preacquisition
periods and increases in rent expense for therapy and computer equipment
rentals. On January 1, 1999, the Company's non-RCA facilities transitioned to
PPS. It is expected that these facilities revenues and operating margins will be
significantly and adversely affected by the rates under PPS.

Corporate general and administrative expenses, which include regional costs,
related to the supervision of operations, increased 125.2% from $15.1 million
for the year ended December 31, 1997 to $34.0 million for the year ended
December 31, 1998. As a percentage of net revenues, corporate general and
administrative expenses increased from 1.2% for the year ended December 31, 1997
to 1.7% for the year ended December 31, 1998. The increase was primarily due to
an increase in costs relating to the expansion of the Inpatient Service
segment's corporate and regional infrastructure to support newly acquired
operations including the acquisition of Regency and RCA.

Provision for losses on accounts receivable increased 214.0% from $5.0
million for the year ended December 31, 1997 to $15.7 million for the year ended
December 31, 1998. As a percentage of net revenues, provision for losses on
accounts receivable increased from 0.4% for the year ended December 31, 1997 to
0.8% for the year ended December 31, 1998. The change was primarily due to
increased aging of certain accounts receivable.

Depreciation and amortization increased 82.3% from $22.6 million for the
year ended December 31, 1997 to $41.2 million for the year ended December 31,
1998. As a percentage of net revenues, depreciation and amortization expense
increased from 1.8% for the year December 31, 1997 to 2.0% for the year ended
December 31, 1998, respectively. The increase is primarily a result of
amortization of goodwill recorded in connection with the acquisitions of Regency
in October 1997 and RCA in June 1998.

Net interest expense increased 56.1% from $4.1 million for the year ended
December 31, 1997 to $6.4 million for the year ended December 31, 1998. As a
percentage of net revenues, interest expense remained consistent at .3% for the
years ended December 31, 1997 and 1998, respectively. The increase is primarily
a result of facility debt assumed in the RCA acquisition.

REHABILITATION AND RESPIRATORY THERAPY SERVICES

Net revenues from rehabilitation and respiratory therapy services increased
45.6% from $466.4 million for the year ended December 31, 1997 to $678.8 for the
year ended December 31, 1998. Revenues from services provided to affiliated
facilities increased from $180.3 million for the year ended December 31, 1997 to
$344.1 million for the year ended December 31, 1998, an increase of 90.8%. This
increase is a result of the net 237 inpatient facilities acquired or opened at
various times since December 31, 1996. Revenues from services provided to
nonaffiliated facilities increased approximately $48.5 million, or 16.9%, from
$286.1 million for the year ended December 31, 1997 to $334.6 million for the
year ended December 31, 1998. Nonaffiliated facilities served increased 1.3%
from 1,278 in 1997 to 1,294 in 1998. In the fourth quarter of 1998, revenues
from nonaffiliated facilities decreased significantly from $93.6 million in 1997
to $63.9 million in 1998, an 31.7% decrease. The decrease is a result of the
industry's transition to PPS and the resulting decline in demand for the
Company's therapy services. This trend is expected to

19
<PAGE>
continue into 1999 for both affiliated and non-affiliated business as the
majority of the long-term care industry transitions to PPS.

In addition to the decline in demand for the Company's therapy services,
market rates for these services declined significantly in the fourth quarter of
1998 and the first quarter of 1999. This decline is attributed to downward
pricing pressure as a result of an excess supply of therapy service providers
due to the industry's restructuring in response to decreased reimbursement under
PPS (see "Effects of Changes in Reimbursement").

Operating expenses increased 40.0% from $306.2 million for the year ended
December 31, 1997 to $428.8 million for the year ended December 31, 1998. The
increase resulted primarily from the increase in the number of facilities served
from 1,565 to 1,715 for the years ended December 31, 1998 and 1997,
respectively. Operating expenses as a percentage of total segment revenue
decreased from 65.7% for the year ended December 31, 1997 to 63.2% for the year
ended December 31, 1998.

Provision for losses on accounts receivable increased 215.0% from $9.4
million for the year ended December 31, 1997 to $29.6 million for the year ended
December 31, 1998. As a percentage of net revenues, provision for losses on
accounts receivable increased from 2.0% for the year ended December 31, 1997 to
4.4% for the year ended December 31, 1998. Approximately $11.7 million of this
increase was recognized in connection with the financial deterioration of a
major customer in the fourth quarter of 1997. The remaining increase is a result
of additional reserves recorded due to the impact of PPS, which for certain
nonaffiliated customers has negatively affected their cash flows, adversely
affecting the collectibility of amounts due to the Company. Other nonaffiliated
customers, in preparation for the impending transition to PPS have slowed,
reduced or stopped payment for service in anticipation of the adverse effect PPS
will have on their cash flow.

Depreciation and amortization increased 131.0% from $4.2 million for the
year ended December 31, 1997 to $9.7 million for the year ended December 31,
1998. As a percentage of net revenues, depreciation and amortization expense
increased from 0.9% for the year December 31, 1997 to 1.4% for the year ended
December 31, 1998, respectively. The increase is primarily a result of the
expansion of the Company's respiratory therapy and therapy equipment
manufacturing businesses in 1998, as well as amortization of goodwill recorded
in connection with the acquisition of Regency's therapy subsidiary in October
1997.

PHARMACEUTICAL AND MEDICAL SUPPLY OPERATIONS

Net revenues from pharmaceutical and medical supply services increased 61.7%
from $157.3 million for the year ended December 31, 1997 to $254.5 for the year
ended December 31, 1998. Approximately $28.5 million of this increase is a
result of the company's medical supply operations acquired in connection with
the RCA and Contour mergers in June 1998. Approximately $51.9 million is a
result of the addition of 10 pharmacies and related affiliated contracts
acquired from Regency. The remaining increase is a result of four pharmacies
opened or acquired in 1998.

Operating expenses increased 65.5% from $134.2 million for the year ended
December 31, 1997 to $222.1 million for the year ended December 31, 1998.
Operating expenses as a percentage of revenue increased from 85.3% for the year
ended December 31, 1997 to 87.3% for the year ended December 31, 1998. This
increase is primarily a result of the acquisition of Contour, which has higher
operating costs than the company's pharmacy services operation. Excluding
Contour, operating expenses as a percentage of revenue remained constant at
approximately 85.2%.

Provision for losses on accounts receivable increased 827.3% from $1.1
million for the year ended December 31, 1997 to $10.2 million for the year ended
December 31, 1998. As a percentage of net revenues, provision for losses on
accounts receivable increased from 0.7% for the year ended December 31, 1997 to
4.0% for the year ended December 31, 1998. This increase is a result of the
effect PPS has had on nonaffiliated customers' cash flow (as discussed above
under Rehabilitation and Respiratory

20
<PAGE>
Therapy Services). In addition, the Company recorded additional reserves for its
Medicare Part B billing operations related to increased aging of accounts
receivable.

Depreciation and amortization increased 227.3% from $3.3 million for the
year ended December 31, 1997 to $10.8 million for the year ended December 31,
1998. As a percentage of net revenues, depreciation and amortization expense
increased from 2.1% for the year December 31, 1997 to 4.2% for the year ended
December 31, 1998, respectively. The increase is primarily a result of the
amortization of goodwill recorded in connection with the acquisition of
Regency's pharmacy operation in October 1997 and the RCA and Contour
acquisitions in June 1998.

INTERNATIONAL OPERATIONS

Revenues from international operations increased $87.1 million, or 44.0%,
from approximately $198.2 million for the year ended December 31, 1997 to $285.3
million for the year ended December 31, 1998. Approximately $43.4 million of
this increase is a result of acquisitions in late 1997 and 1998 in Germany and
Australia. An additional $44.5 million of this increase was provided by U.K.
inpatient services whose net revenues increased from $168.3 million for the year
ended December 31, 1997 to $212.8 million for the year ended December 31, 1998.
The increase in U.K. revenues is due to the addition of 18 facilities during
1998 as well as an increase in occupancy rates from 77.6% in 1997 to 80.3% in
1998.

Operating expenses, which include rent expense of $14.7 million and $31.2
million for the years ended December 31, 1997 and 1998, respectively, increased
approximately 53.3% from $163.6 million for the year ended December 31, 1997 to
$250.8 million for the year ended December 31, 1998. As a percentage of
revenues, operating expenses increased from 82.6% in 1997 to 87.9% in 1998. In
addition to increased operating costs associated with acquisitions in new
international markets, operating costs in the United Kingdom were impacted by
increased temporary staffing costs due to a nursing shortage. Increases in rent
expense are primarily a result of expansion into new international markets and
the sale-leaseback of 32 facilities completed October 1998.

Depreciation and amortization for international operations increased $3.8
million from $15.5 million for the year ended December 31, 1997 to $19.3 million
for the year ended December 31, 1998. Approximately $2.4 million of this
increase is directly attributed to acquisitions in late 1997 and 1998 in Germany
and Australia.

OTHER NONREPORTABLE SEGMENTS AND CORPORATE GENERAL AND ADMINISTRATIVE
DEPARTMENTS

Nonreportable segments include temporary therapy staffing, home health,
software development and other ancillary services. Revenues from other
nonreportable segments increased 70.6% from $165.9 million for the year ended
December 31, 1997 to $283.1 million for the year ended December 31, 1998.
Operating expenses increased 76.4% from $148.1 million for the year ended
December 31, 1997 to $261.3 for the year ended December 31, 1998. Operating
expenses as a percentage of revenues were 89.3% and 92.2% for the years ended
December 31, 1997 and 1998, respectively. Total revenues and operating expenses
for nonreportable segments represent less than 10% of the consolidated Company's
results. Growth in revenues and operating expenses relates primarily to
acquisitions in the Company's home health, disease state management, laboratory
and radiology subsidiaries. Operating results were negatively impacted by
expenses related to software development costs incurred by the Company's
subsidiary, Sun Healthcare Systems. These costs are being expensed in accordance
with Statement of Financial Accounting Standards No. 86: Accounting for Costs of
Computer Software to be Sold, Leased or Otherwise Marketed. Development of the
Company's products are not expected to reach the stage under which
capitalization is permitted until late 1999 or 2000. In addition, the Company's
temporary therapy staffing business' results were adversely affected by the long
term care industry's transition to PPS. Nonaffiliated revenues declined 73.8% in
the fourth quarter of 1998 as compared to the same period in 1997. This trend is
expected to continue in 1999.

21
<PAGE>
Corporate general and administrative costs not directly attributed to
segments increased 93.8% from $71.1 million for the year ended December 31, 1997
to $137.8 million at December 31, 1998. As a percentage of consolidated net
revenues of $3.1 billion and $2.0 billion for the years ended December 31, 1998
and 1997, respectively, corporate general and administrative expenses not
directly attributed to segments increased from 3.5% to 4.5%. This increase was
primarily due to an increase in costs relating to the expansion of the Company's
corporate infrastructure to support newly acquired domestic operations including
Regency and RCA, as well as implementation of new business strategies.

Net interest expense not directly attributed to segments increased 95.7%
from $53.8 million for the year ended December 31, 1997 to $105.3 million for
the year ended December 31, 1998. As a percentage of consolidated net revenues,
interest expense increased from 2.7% for the year ended December 31, 1997 to
3.4% for the year ended December 31, 1998. The increase was related to (i) an
increase in the Company's weighted average interest rate resulting from the
issuance of $250 million of 9 1/2% Notes in July 1997 and the Company's issuance
of $150 million of 9 3/8% Notes in May 1998, (ii) higher interest rates and
borrowing costs under the Company's Senior Credit Facility as compared to the
previous credit facility that was retired in October 1997, (iii) an increase in
borrowings under the Company's Senior Credit Facility principally related to
various acquisitions during 1997 and 1998 and (iv) offset partially by the
Company's hedging strategy (see "Liquidity and Capital Resources").

OTHER SPECIAL AND NON-RECURRING CHARGES

Impairment of Goodwill and Other Long-lived Assets

The Company periodically evaluates the carrying value of goodwill and any
other related long-lived assets in relation to the future projected cash flows
of the underlying business segment. The assets are considered to be impaired
when the expected future cash flows of the inpatient facilities or other
business segment divisions do not exceed the carrying balances of the goodwill
or other long-lived assets. Accordingly, the Company recorded a non-cash
impairment charge of $397.4 million related to the Company's estimate of
goodwill and other asset impairment. The charge included approximately $293.1
million related to 147 of its inpatient facilities segment, $41.0 million
related to its rehabilitation and respiratory therapy services segment. $36.7
million related to the certain inpatient facilities in the United Kingdom, and
$3.0 million related to two pharmacies in its pharmaceutical and medical supply
services segment and approximately $23.6 million related to other operations.

The significant write-down of goodwill resulted from the decline in the
level of Medicare reimbursement and the demand for the Company's rehabilitation
and respiratory therapy and pharmaceutical and medial supply services due to the
industry changes mandated by PPS (see "Effects of Changes to Reimbursement").
Additionally, certain of the United Kingdom facilities have not achieved
profitability targets established upon their acquisition (most of which were
acquired in conjunction with Ashbourne).

Loss on Sale of Assets

The Company recorded a non-cash charge of approximately $206.2 million due
to the termination of certain facility lease agreements, the sale of certain
other facilities, and to reduce the carrying amount of certain assets that the
Company determined were not integral to its core business operations. These non-
core assets include assisted living facilities, rehabilitation hospitals, and
other non-core operations, which are all considered assets held for sale
including approximately $11.6 million to further reduce the carrying value of
its Canadian operations.

In 1997, the Company recorded a charge totalling $7.0 million in order to
reduce the carrying value of the Canadian operations to fair value based on
revised estimates of selling value and of costs to sell.

22
<PAGE>
Legal and Regulatory Matters

The Company recorded charges for litigation and investigation costs of
approximately $22.5 million for the year ended December 31, 1998 for
professional fees and settlement costs related to certain legal and regulatory
matters. The charge includes (i) approximately $8.0 million for the settlement
of a shareholder suit related to the Company's acquisition of SunCare in 1995
(see "Litigation"); (ii) approximately $8.2 million for estimated costs to
resolve the investigation by the Connecticut Department of Social Services
("DSS") (see "Regulation"); and (iii) approximately $5.5 million provided for
certain monetary penalties (see "Regulation") and general legal costs of its
inpatient services segment.

Restructuring Costs

In response to the industry changes mandated by PPS the Company recorded a
charge of approximately $4.6 million predominately related to restructuring its
operations in order to more closely align the inpatient services, rehabilitation
and respiratory therapy services, and pharmaceutical and medical supply services
divisions. The restructuring plan includes termination of 2,700, or 6.0%, of its
inpatient facilities employees; 4,600, or 36%, of its rehabilitation and
respiratory therapy employees; and 190, or 13%, of its corporate employees.

Extraordinary Loss

In 1998, the Company recorded an extraordinary loss of $10.3 million, net of
income tax benefit of $3.7 million. Approximately $10.2 million of the gross
loss of $14.0 million relates to permanent pay-down of $300 million of the term
loan portion of the Company's credit facility. The remaining $3.7 million of the
gross loss relates to the retirement of $5.0 million of Contour convertible
debentures which were purchased by the Company.

In 1997, the Company recorded an extraordinary charge of $17.9 million net
of the related tax benefit, in connection with the Company's purchase of
Regency's 12.25% Junior Subordinated Notes due 2003 and of Regency's 9.875%
Senior Subordinated Notes due 2002 and an extraordinary charge of $2.1 million,
net of the related tax benefit, related to the refinancing of the Company's
credit facility.

CONSOLIDATED RESULTS OF OPERATIONS

Income tax expense for the year ended December 31, 1998 was $53.5 million
compared to $41.2 million for the year ended December 31, 1997. In 1998, the
Company increased its valuation allowance by $115.5 million for deferred tax
assets which may not be realized as a result of the adverse effect of the new
operating environment under PPS. Also, in 1998 the Company established a
valuation allowance of $12.5 million for U.K. deferred tax assets, which may not
be realizable. In addition, the Company's effective tax rate for 1998 was
unfavorably impacted by the significant loss incurred and the resulting
disproportionate effect of non-deductible items such as goodwill amortization.
Excluding the above increases in valuation allowances, the resulting tax benefit
is 10.8% of the consolidated net loss before income taxes and extraordinary loss
compared to an effective tax rate of 47.1% in 1997.

The net loss for the year ended December 31, 1998 was $753.7 million
compared to net earnings of $34.8 million for the year ended December 31, 1997.
The net loss before extraordinary loss for the year ended December 31, 1998 was
$743.4 million compared to net earnings of $54.7 million for the year ended
December 31, 1997. Before considering the impairment loss, loss on sale of
assets, the software development costs, legal and regulatory costs, the
restructuring costs and the extraordinary loss, the loss before income taxes for
the year ended 1998 was $59.1 million compared to earnings before income taxes
and extraordinary loss of $102.8 million in 1997. The loss in 1998 was due to
the negative revenue adjustments for changes in estimates for third party
settlements; the increased reserves for self-insured workers compensation
claims, the increased allowance for doubtful accounts and the implementation of
PPS and its resulting adverse impact on the demand for ancillary services.

23
<PAGE>
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

THIS DISCUSSION WAS PREPARED PRIOR TO THE ADOPTION OF STATEMENT OF FINANCIAL
ACCOUNTING STANDARDS NO. 131--DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND
RELATED INFORMATION ("FAS 131"). CERTAIN BUSINESSES, WHICH ARE CLASSIFIED AS
OTHER NON-REPORTABLE SEGMENTS UNDER FAS 131 WERE CLASSIFIED AS PART OF LONG-TERM
AND SUBACUTE SERVICES, THERAPY SERVICES OR PHARMACEUTICAL SERVICES FOR PURPOSES
OF THIS DISCUSSION, THE EFFECT OF WHICH IS IMMATERIAL.

Total net revenues for the year ended December 31, 1997 increased 53% from
$1,316 million for the year ended December 31, 1996 to $2,011 million.

Net revenues from long-term and subacute care services, which includes
revenues generated from therapy and pharmaceutical services provided at the
Company's facilities, increased from $826.8 million for the year ended December
31, 1996 to $1,237.7 million for the year ended December 31, 1997, a 50%
increase. Net revenues from long-term and subacute care services were negatively
impacted in 1997 and 1996 by certain changes in accounting estimates for
third-party settlements (see "Effects from Changes in Reimbursement" and Note 1
to the Consolidated Financial Statements for information regarding the Company's
revenue recognition policy). In the fourth quarter of 1997, the Company recorded
negative revenue adjustments totaling approximately $15 million resulting from
changes in accounting estimates primarily based on new information arising from
the settlement in late 1997 of substantially all of the Company's facility cost
reports for 1994 and 1995. This charge also includes an estimate for projected
settlements in 1996 based on prior years' settlements. The $15 million of
negative revenue adjustments represents approximately 2% of total Medicare
revenues recognized in the periods settled and 1996. Historically, fiscal
intermediaries have settled the Company's facility cost reports during the
latter half of the year.

In addition, the extinguishment of certain Regency debt during the fourth
quarter of 1997, resulted in an increase in certain reimbursable costs from
Medicare. As a result, the Company recognized $4.0 million of revenues from
Medicare of which $3.5 million was for long-term and subacute care services.

In the fourth quarter of 1996, the Company recorded negative revenue
adjustments totalling approximately $23.0 million resulting from changes in
accounting estimates of amounts realizable from third-party payors. These
changes in accounting estimates primarily arose out of the cost reporting
settlement process in the latter part of 1996, including the settlement of
outstanding Medicare cost reports and the results of Medicare and Medicaid cost
report audits. Approximately $19.4 million of the adjustments related to changes
in estimates out of the settlement of prior years' cost reports including $11.1
million of adjustments from the Company's Mediplex facilities.

Giving effect to the adjustments in 1997 and 1996 (discussed above), net
revenues from long-term and subacute care services increased 50% from $826.8
million for the year ended December 31, 1996 to $1,237.7 million for the year
ended December 31, 1997. Approximately $126.8 million or 31% of this increase
results from the 110 leased or owned facilities acquired from Regency and
approximately $206.4 million or 50% of this increase resulted from an additional
79 leased or owned facilities acquired or opened since December 31, 1995. The
acquisition of Regency occurred in October 1997 and net revenues include the
results of operations since the date of acquisition. The remaining net revenue
increase of $89.2 million, after giving effect to a decrease in net revenues of
approximately $11.4 million relating to three facilities sold during 1996 and
four facilities sold during 1997, is primarily attributable to an increase in
revenue per patient day on a same facility basis for the 123 leased or owned
facilities in operation for all of 1996 and 1997. The increase in revenue per
patient day was a result of payor rate increases and the expansion of the
Company's subacute services.

Net revenues from therapy services to nonaffiliated facilities increased 37%
from $220.6 million for the year ended December 31, 1996 to $301.3 million for
the year ended December 31, 1997 primarily as a result of an increase in the
number of nonaffiliated facilities served from 759 facilities at December 31,
1996 to 1,278 facilities at December 31, 1997. This increase includes 46
nonaffiliated facilities and

24
<PAGE>
approximately $10.2 million in net revenues from therapy services provided to
Retirement Care facilities primarily in the latter half of 1997.

Net revenues from foreign operations increased 225% from $61.0 million for
the year ended December 31, 1996 to $198.1 million for the year ended December
31, 1997. Approximately $111.1 million or 81% of this increase was the result of
increased net revenues from the nursing home operations in the United Kingdom.
The increase relating to the nursing home operations in the United Kingdom was
primarily the result of the Company's acquisitions of Ashbourne in January 1997
and APTA in December 1996, which when combined, added approximately $94.0
million or 85% of the increase in net revenues from the nursing home operations
in the United Kingdom during the year ended December 31, 1997. Approximately
$15.1 million or 11% of the total increase was the result of increased net
revenues from the pharmacy operations which was primarily the result of 18
pharmacies and a supply distribution center acquired or opened since December
31, 1995 in the United Kingdom. The remaining increase in net revenues is
attributable to the Company's acquisitions of nursing homes in Spain, acute care
facilities in Australia, and increased revenues from the Company's outpatient
clinics in Canada. As previously discussed, the Company has announced its
intention to sell and divest itself of its outpatient therapy service operations
in Canada.

Net revenues from temporary therapy staffing services to nonaffiliated
facilities increased 19% from $116.8 million for the year ended December 31,
1996 to $138.6 million for the year ended December 31, 1997 primarily as a
result of an increase in service hours billed to nonaffiliates from 2,402,000
hours in the year ended December 31, 1996 to 2,817,000 hours in the year ended
December 31, 1997. The increase in service hours billed was primarily
attributable to acquisitions during 1997 and 1996.

Net revenues from pharmaceutical services to nonaffiliated facilities
increased 75% from $70.7 million for the year ended December 31, 1996 to $123.4
million for the year ended December 31, 1997. Approximately $24.9 million or 47%
of the increase in net revenues was the result of the addition of 10 pharmacies
and 14 home health agencies acquired from Regency. In addition, net revenues
increased by $22.0 million primarily as a result of the increase in
nonaffiliated facilities served as a result of additional acquisitions during
1997 and 1996.

Operating expenses, which includes rent expense of $143.9 million and $91.7
million for the year ended December 31, 1997 and 1996, respectively, increased
50% from $1,107.8 million for the year ended December 31, 1996 to $1,662.8
million for the year ended December 31, 1997. The increase resulted primarily
from the net increase of 62 leased or owned facilities during various times
during the year ended December 31, 1996 and 257 leased or owned facilities
during the year ended December 31, 1997 and the growth in therapy and temporary
therapy staffing services. Operating expenses as a percentage of net revenues
decreased from 84.2% for the year ended December 31, 1996 to 82.7% for the year
ended December 31, 1997. The decrease in operating expenses as a percentage of
net revenues was primarily due to the acquisitions of Ashbourne and APTA whose
facility leases are primarily capital leases and therefore include interest and
depreciation expense instead of rent expense. The decrease is offset by lower
operating margins in the United Kingdom as occupancy rates in the United Kingdom
have been negatively impacted by an excess number of available beds in the
United Kingdom. In addition, since December 31, 1995, the Company has opened 20
long-term care facilities in the United Kingdom which has also negatively
impacted occupancy as well as operating margins.

Corporate general and administrative expenses, which include regional costs
related to the supervision of operations, increased 58% from $62.1 million for
the year ended December 31, 1996 to $98.2 million for the year ended December
31, 1997. As a percentage of net revenues, corporate general and administrative
expenses increased from 4.7% for the year ended December 31, 1996 to 4.9% for
the year ended December 31, 1997. The increase was primarily due to an increase
in costs relating to the expansion of the Company's corporate infrastructure to
support the development of the Company's foreign operations, newly acquired
domestic operations including the acquisition of Regency, and implementation of
new business strategies.

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<PAGE>
The provision for losses on accounts receivable increased 5% from $15.0
million for the year ended December 31, 1996 to $15.8 million for the year ended
December 31, 1997. As a percentage of net revenues, provision for losses on
accounts receivable decreased from 1.1% for the year ended December 31, 1996 to
0.8% for the year ended December 31, 1997. In 1996, the Company experienced
higher than expected write-offs of patient accounts receivable primarily at its
Mediplex facilities acquired in June 1994 and recorded an additional provision
for losses on accounts receivable of approximately $6.6 million. In addition,
beginning in mid 1996, the Company increased its accounts receivable reserve in
response to a slowdown in collections from nonaffiliated facilities for therapy
services due to delays in payment by the nonaffiliated facilities' Medicare
fiscal intermediaries (see "Liquidity and Capital Resources").

Depreciation and amortization increased 67% from $33.8 million for the year
ended December 31, 1996 to $56.6 million for the year ended December 31, 1997.
As a percentage of net revenues, depreciation and amortization expense increased
from 2.6% for the year ended December 31, 1996 to 2.8% for the year ended
December 31, 1997, respectively. The increase is primarily due to the assets
acquired by the Company, including goodwill, of Regency acquired during the
fourth quarter of 1997, of Ashbourne acquired during the first quarter of 1997
and of APTA acquired during the fourth quarter of 1996.

Net interest expense increased 188% from $25.9 million for the year ended
December 31, 1996 to $74.5 million for the year ended December 31, 1997. As a
percentage of net revenues, interest expense increased from 2.0% for the year
ended December 31, 1996 to 3.7% for the year ended December 31, 1997. The
increase was related to (i) an increase in borrowing costs resulting from the
Company's issuance of $250 million of 9 1/2% Senior Subordinated Notes due 2007
in July of 1997, and (ii) an increase in borrowings and borrowing costs under
the Company's credit facility associated with acquisitions during 1996 and 1997
including Regency, Ashbourne and APTA. The increase was also due to interest
expense related to capital leases assumed by the Company as part of the
Company's acquisitions of Ashbourne and APTA.

In 1997, the Company recorded a charge totaling $7.0 million in order to
reduce the carrying value of the Canadian operations to fair value based on
revised estimates of selling value and of costs to sell.

In 1996, the Company reached an agreement in principle to settle certain of
the class-action lawsuits brought by shareholders for $24.0 million and
recognized, as a reduction of the settlement cost, a $9.0 million claim from its
director and officer liability insurance carrier. Although the Company funded
the settlement payment in 1996, the Company did not receive payment from its
insurance carrier until March 1997. In addition, in 1996 the Company accrued
additional charges and expenses of $4.3 million related to monitoring and
responding to the continuing investigation by the U.S. Department of Health and
Human Services' Office of Inspector General ("OIG") and responding to the
remaining shareholder litigation filed after the announcement of the OIG
investigation. The charges do not contain any estimated amounts for settlement
of the OIG investigation or remaining shareholder litigation matters (see
"Effects from Changes in Reimbursement" and "Litigation").

The Company's effective tax rate was 40% for the year ended December 31,
1997 after excluding the loss on the sale of the Canadian operations and was 41%
for the year ended December 31, 1996 after excluding the investigation and
litigation charge. The decrease in the effective tax rate was due to a more
favorable mix of state income in the United States than in the prior year. The
effective tax rate is expected to increase during 1998 primarily due to a less
favorable mix of state income in the United States and the increased amount of
nondeductible goodwill resulting primarily from the acquisition of Regency.

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Net earnings were $34.8 million for the year ended December 31, 1997 as
compared to net earnings of $21.5 million for the year ended December 31, 1996.
Net earnings were $54.7 million for the year ended December 31, 1997 before the
extraordinary loss, as compared to net earnings of $21.5 million for the year
ended December 31, 1996. As a percentage of net revenues, net earnings before
the extraordinary loss were 2.7% for the year ended December 31, 1997 and 1.6%
for the year ended December 31, 1996. Net earnings before the extraordinary loss
and the loss on sale of the Canadian operations for the year ended December 31,
1997 were $61.7 million or 3.1% as a percentage of net revenues and net earnings
before the investigation and litigation costs for the year ended December 31,
1996 were $42.4 million, or 3.2% as a percentage of net revenues. The margin
decrease was primarily due to the increased costs and lower margins from the
Company's nursing home operations in the United Kingdom, including the borrowing
costs associated with acquisitions in the United Kingdom (discussed above).

LIQUIDITY AND CAPITAL RESOURCES

At April 19, 1999, the Lenders had not demanded repayment of the Senior
Credit Facility. The Company is seeking from the Lenders an amendment to the
Senior Credit Facility to cure its non-compliance and amend the financial
covenants. However, no agreement to waive the 1998 financial covenants
violations or amend the future financial covenants has been reached. Under the
terms of the Senior Credit Facility, the Company is prohibited from further
borrowing on the Senior Credit Facility. Accordingly, the Company will have to
fund all operations, capital expenditures, and regularly scheduled debt service
from existing cash reserves and future net cash flows from operations, if any.

The Company is also in non-compliance with the financial covenants related
to certain mortgages totaling $31.9 million at December 31, 1998 for four
long-term care facilities. As a result, the amounts outstanding are due upon
demand and have been reclassified as current liabilities. In addition, the
Company is not in compliance as of December 31, 1998 with certain financial
covenants contained in certain lease agreements for 96 of its long-term care
facilities in the United States and 33 of its long-term care facilities in the
United Kingdom. The Company was also in cross default for 14 of its long-term
care facilities in the United States. As a result, the lessors under the lease
agreements have certain rights, including the right to require the Company to
relinquish the leased facilities. As of April 19, 1999, the mortgage lender and
lessors had not exercised their rights under the respective agreements. The
Company is in discussions with the mortgage lender and the lessors under the
master lease agreements to cure its non-compliance and amend the financial
covenants.

The Company also has other debt arrangements that provide that a default on
any mortgage indenture or instrument which results in the acceleration of
repayment or default in payment of obligations from $0.1 million to in excess of
$20.0 million depending on the terms of the agreement, would allow the creditor
to demand immediate repayment. No acceleration of repayment has occurred as of
April 19, 1999; therefore, such borrowings which total $520.9 million are
classified as long-term liabilities. The specific default events which could
trigger the acceleration of payment provisions in certain debt arrangements are
detailed in Note 7 of the Company's consolidated financial statements.

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For the year ended December 31, 1998, net cash used for operations was $45.6
million compared to net cash provided by operations for the year ended December
31, 1997 of $21.7 million. The net cash used for operations in 1998 reflects the
significant losses incurred (as discussed in "Results of Operations" above). In
addition, cash flow was negatively impacted by an increase in accounts
receivable and inventory expenditures.

The Company's accounts receivable have increased since December 31, 1997.
Accounts receivable increased in part because of the growth in the Company's
inpatient, therapy and pharmaceutical services businesses since December 31,
1997. RCA and Contour represent $91.4 million of the gross increase. The
implementation of PPS for certain nonaffiliated ancillary service customers has
negatively affected their cash flows thereby adversely affecting the
collectibility of amounts due to the Company. Other nonaffiliated ancillary
service customers, in preparation for the impending transition to PPS, have
slowed, reduced or stopped payment for service in anticipation of the adverse
effect PPS would have on their cash flow. As a result, accounts receivable for
nonaffiliated customers has increased, and the Company has increased its
provision for doubtful accounts in the fourth quarter. Also, accounts receivable
for therapy services have also increased in part because the ability of
nonaffiliated facilities to provide timely payment has been impacted by their
receipt of payments from fiscal intermediaries which, in some instances, have
been delayed due, in part, to the fiscal intermediaries conducting reviews of
facilities' therapy claims.

Other significant operating uses of cash for the year ended December 31,
1998 were $143.8 million for net interest payments and $23.9 million for income
taxes.

The Company believes that its existing cash reserves ($67.8 million at April
19, 1999) and the successful execution of its operational and financial recovery
plan will provide sufficient cash for its operations, capital expenditures and
regularly scheduled debt service throughout fiscal 1999. The projected cash
balance during 1999 would not be adequate if the Company were required to repay
the balance outstanding under the Senior Credit Facility or certain Mortgage
Notes. No assurance can be given that the Company will have sufficient cash for
operations, capital expenditures and regularly scheduled debt service throughout
fiscal 1999. Further, no assurance can be given that the Company will be
successful in negotiating waivers and amendments to the Senior Credit Facility
and certain Mortgage Notes or that the Company will be able to meet any amended
financial covenants prospectively. If the Company is unable to generate
sufficient cash flow from its operations or successfully renegotiate an
amendment of the Senior Credit Facility, it would explore a variety of other
options, including but not limited to other sources of financing, additional
asset dispositions, or relief under the United States Bankruptcy code.

In response to the significant losses experienced in the fourth quarter of
1998, the Company has developed an operational and financial recovery plan that
is intended to restore the Company's profitability in the new operating
environment under PPS, although no assurance can be given that the plan will be
successful. The Company's four-part recovery plan is as follows:

--COMPANY-WIDE REDUCTIONS IN OPERATING EXPENSES. During the fourth quarter
of 1998 and the first quarter of 1999, Sun initiated company-wide reductions in
operating expenses. The Company's cost cutting initiatives together with
previous reductions achieved during 1998, are designed to reduce costs by
approximately $400 million on an annual basis. The savings are being achieved
primarily through the elimination of more than 10,000 positions in 1998 and
early 1999, and the consolidation or elimination of regional and divisional
operating units including the closing of 70 offices in 1998 and early 1999. On
January 1, 1999, management also instituted a company-wide wage freeze and a
reduction in certain personnel benefits packages.

--THE DIVESTITURE OF NON-CORE ASSETS AND THE REDUCTION OF OUTSTANDING
DEBT. The Company has targeted for sale several non-core assets to provide for
the reduction of the Company's debt.

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<PAGE>
reduced facility staffing levels within the bounds of regulatory requirements,
changed the compensation for therapists from a salaried base to hourly pay, and
cancelled approximately 75 unprofitable therapy contracts. The Company has also
reviewed its case management system to assure that the proper level of ancillary
services is provided to all patients.

--PROACTIVE GOVERNMENT RELATIONS FOCUSED ON IMPROVING MEDICARE AND MEDICAID
REIMBURSEMENT. Since the fourth quarter of 1998, the Company has been
proactively engaging state and federal government officials, and spearheading
industry-wide efforts, to achieve improved Medicare and Medicaid reimbursement
rates. In close cooperation with the New Mexico Congressional delegation, and in
several key states around the country, company officials are actively proposing
legislative and administrative solutions to the financial crisis now engulfing
the long-term care industry.

The Company incurred $160.4 million in capital expenditures during the year
ended December 31, 1998. Expenditures related primarily to the construction of a
corporate office building and to the Company's long-term care, subacute care and
assisted living facility operations including the construction of two new
facilities in the United States and three new facilities in the United Kingdom
as well as routine capital expenditures. The Company had capital expenditure
commitments as of December 31, 1998, under various contracts of $49.3 million,
including approximately $47.9 million in the United States and L0.9 million
($1.4 million as of December 31, 1998) in the United Kingdom. These include
contractual commitments to improve existing facilities and to develop, construct
and complete a corporate office building.

The Company paid approximately $60.6 million in cash for acquisitions during
the year ended December 31, 1998. These acquisitions were funded by borrowings
under the Company's Senior Credit Facility or from the proceeds of the sale
leaseback of 32 buildings in the United Kingdom.

On June 30, 1998, a wholly owned subsidiary of the Company merged with RCA,
an operator of skilled nursing facilities and assisted living centers in eight
states principally in the southeastern United States. RCA also owned
approximately 65% of Contour, a national provider of medical/surgical supplies.
Under the amended terms of the merger agreement, the Company issued
approximately 7.6 million shares of its common stock (valued at $122.0 million
based upon the average closing price of the Company's common stock for 20
business days prior to the acquisition closing date, which was $16.03) for all
outstanding common stock of RCA and certain redeemable preferred shares of RCA.
The Company also issued 298,334 shares of its Series B Convertible Preferred
Stock in exchange for the outstanding shares of RCA's Series F Preferred Stock,
which were subsequently converted into 287,892 shares of Sun common stock valued
at $2.8 million at June 30, 1998. As of December 31, 1998, all the Series B
Shares have been converted into Sun common stock. In addition, the Company
assumed approximately $170.4 million of RCA indebtedness. The merger was
accounted for as a purchase and resulted in $234.7 million of goodwill.

On June 30, 1998, the Company also acquired the remaining 35% of Contour.
The Company issued approximately 1.9 million shares of its common stock (valued
at approximately $27.6 million) for the remaining outstanding Contour common
stock. The acquisition was accounted for as a purchase and resulted in $23.4
million of additional goodwill.

In connection with the RCA Merger, the Company recorded purchase liabilities
including $24.7 million for severance and related costs and $1.4 million for
costs associated with the shutdown of certain administrative facilities.

In the fourth quarter of 1998 and the first quarter of 1999, the Company
initiated restructuring plans focused primarily on reducing the operating
expenses of its U.S. operations. Related to the restructuring plan completed in
the fourth quarter of 1998, the Company recorded a charge of $4.6 million. The
1998 restructuring plan included the elimination of 2,700, or 6% of its
inpatient service positions; 4,600, or 36%, of its rehabilitation services
positions; and 110, or 8%, of its corporate positions. The plan modified its
domestic operations to more closely align the inpatient, rehabilitation and
pharmaceutical services

29
<PAGE>
divisions. The plan also included the closing of approximately 45 divisional and
regional offices related to the aforementioned operations. As of December 31,
1998, the Company had terminated 1,440 employees and paid approximately $1.3
million and $0.1 million in termination benefits and lease termination costs,
respectively, in connection with the restructuring plan. The restructuring
charge during 1998 consisted of approximately $3.7 million related to employee
terminations and $0.9 million related to lease termination costs. As of December
31, 1998, the Company's restructuring reserve balance was approximately $3.1
million. The 1999 restructuring plan included the additional elimination of
2,900 of its rehabilitation services positions and 80 of its corporate positions
including certain executive positions. The plan also included the closing of
approximately 23 divisional and regional offices related to the aforementioned
operations. Restructuring costs for the first quarter 1999 are estimated to be
approximately $7 million and were substantially paid at the end of the quarter.

The Company also conducts business in the United Kingdom, Spain, Australia
and Germany. International operations accounted for 9% and 10% the Company's
total net revenues during the years ended December 31, 1998 and 1997
respectively, and 17% of the Company's consolidated total assets as of December
31, 1998. The Company's financial condition and results of operations are
subject to foreign exchange risk. Exceptional planned foreign currency cash flow
requirements, such as acquisitions overseas, are hedged selectively to prevent
fluctuations in the anticipated foreign currency value. Changes in the net worth
of the Company's foreign subsidiaries arising from currency fluctuations are
reflected in the accumulated other comprehensive income component of
stockholders' equity.

During the year ended December 31, 1998, the Company, through its UK
subsidiary, sold 32 of its long-term care facilities for approximately $117.5
million and leased them back under twelve-year leases.

Subsequent to December 31, 1998, the Company decided to dispose of several
non-core businesses including assisted living facilities, rehabilitation
hospitals and other non-core businesses. The Company recorded a loss of $161.6
million before unrecorded gains in the fourth quarter of 1998 to reduce the
carrying amount of these businesses identified for disposal to fair value based
on estimates of selling value and of costs to sell. The aggregate carrying
amount of these businesses is approximately $243.8 million at December 31, 1998.
The Company expects net proceeds including cash related to those operations with
unrecorded gains of $113.5 million after the reduction of related debt of
approximately $102.7 million. Under the terms of the Senior Credit Facility such
proceeds are required to be used to permanently reduce outstanding borrowings
under the Senior Credit Facility.

During 1998 certain leases were not renewed. In connection with these lease
terminations, the Company recorded a loss of $25.6 million related primarily to
the carrying amount of building improvements, equipment and goodwill related to
the facilities.

In May 1997, the Company announced its intent to sell and divest of its
outpatient rehabilitation clinics in the United States as well as Canada. The
carrying amount of the assets held for sale was $11.6 million and $22.5 million
as of December 31, 1998 and 1997, respectively. The Company completed the sales
certain of the U.S. rehabilitation clinics and a portion of the Canadian clinics
during 1998. The remaining Canadian clinics were sold during March 1999. The
Company recorded a loss of $11.4 million and $7.0 million during 1998 and 1997,
respectively, in order to reduce the carrying value of the Canadian operations
to fair value based on revised estimates of selling value less costs to sell.
The results of operations of these businesses is not material.

Under the terms of an Amended and Restated subordinated Loan Agreement (the
"Subordinated Loan"), the Company has advanced $37.4 million and has agreed to
advance up to a total of $40.0 million, plus an additional $5.0 million to cover
accrued interest due and owing to the Company and other lenders, to a developer
of assisted living facilities to cover 20% of the costs of the development,
construction and operation of assisted living facilities. Advances are subject
to certain conditions, including the approval of each project by the Company.
Advances under the Subordinated Loan are part of the assets related to the
Company's assisted living facilities which the Company intends to divest (as
discussed above).

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At December 31, 1998, the Company had on a consolidated basis, $1.6 billion
of outstanding indebtedness including capital lease obligations and $745.6
million of indebtedness under its $885.5 million Senior Credit Facility. The
Company also had $44.8 million of outstanding standby letters of credit under
its Senior Credit Facility as of December 31, 1998.

Scheduled aggregate principal payments of the Company's long-term debt for
the next five years as of December 31, 1998 assuming that debt in non-compliance
is remedied are as follows: $50.4 million in 1999, $32.3 million in 2000, $50.2
million in 2001, $48.2 million in 2002, $426.7 million in 2003 and $910.5
million thereafter. The amounts of scheduled principal and interest payments
related to the Company's long-term debt are subject to changes which may be
significant, in outstanding borrowings, interest rates and foreign currency
exchange rates.

In May 1998, the Company issued $345 million of 7% Convertible Trust Issued
Preferred Securities (the "CTIPS") and $150 million of 9 3/8% Senior
Subordinated Notes due 2008 (yield of 9.425%) (collectively the "Offerings").
Each convertible preferred security is convertible into 1.2419 shares of Sun
common stock, par value $0.01 per share, of Sun (equivalent to an initial
conversion price of $20.13 per share of Sun common stock). Of the net proceeds,
$300 million from the Offerings were used by the Company to permanently repay
certain outstanding borrowings under the term loan portion of the Senior Credit
Facility and the remainder of the net proceeds from the Offerings were used to
reduce certain outstanding borrowings under the revolving credit portion of the
Company's Senior Credit Facility. On April 14, 1999, the Company announced that
it was exercising its right to defer the dividend payment, scheduled for May 1,
1999, on the CTIPS.

On May 5, 1998, the Company entered into certain interest rate transactions
with an aggregate notional value of $850 million to minimize the risks and/or
costs associated with certain long-term debt of the Company. On April 9, 1999,
the interest rate swap transactions were terminated due to an event of default
relating to the Company's non-compliance with certain covenants contained in the
Senior Credit Facility. The termination will result in a pre-tax loss of $3.0
million in 1999. The Company does not otherwise utilize financial instruments
for trading or other speculative purposes. The interest rate swap transactions
were designated as hedges for accounting purposes. The amounts paid or received
were accrued and recognized as an adjustment to interest expense. Under the
interest rate swap transactions, the Company was a variable rate payor,
effectively converting $550 million of fixed rate debt and $300 million of
variable rate Senior Credit Facility debt, which is based on U.S. LIBOR, into
variable rate debt based on an index of foreign interest rates. See Footnote
7--Long-Term Debt.

EFFECTS FROM CHANGES IN REIMBURSEMENT

The Company derives a substantial percentage of its total revenues from
Medicare, Medicaid and private insurance. The Company's financial condition and
results of operations may be affected by the revenue reimbursement process,
which is complex and can involve lengthy delays between the recognition of
revenue and the time reimbursement amounts are settled. Net revenues realizable
under third-party payor agreements are subject to change due to examination and
retroactive adjustment by payors during the settlement process. Payors may
disallow in whole or in part requests for reimbursement based on determinations
that certain costs are not reimbursable or reasonable or because additional
supporting documentation is necessary. The Company recognizes revenues from
third-party payors and accrues estimated settlement amounts in the period in
which the related services are provided. The Company estimates these settlement
balances by making determinations based on its prior settlement experience and
its understanding of the manner in which the third-party payors will interpret
the applicable reimbursement rules and regulations. The majority of third-party
payor balances are settled two to three years following the provision of
services.

The Company has experienced differences between the net amounts accrued and
subsequent settlements, which differences are recorded in operations at the time
of settlement. For example, in the fourth

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quarter of 1998, the Company recorded negative revenue adjustments totalling
$34.7 million primarily for the projected settlement of 1997 facility cost
reports which were not settled as of December 31, 1998 and the projected
settlement of the 1998 cost reports based on historical information. Accounts
receivable have also increased in part because the ability of nonaffiliated
facilities to provide timely payments has been impacted by their receipt of
payments from fiscal intermediaries which, in some instances, have been delayed
due to the fiscal intermediaries conducting reviews of facilities' therapy
claims.

The implementation of PPS for certain nonaffiliated ancillary service
customers has negatively affected their cash flows, which has adversely affected
the collectibility of amounts due to the Company. Other non-affiliated ancillary
service customers, in preparation for the impending transition to PPS have
slowed, reduced or stopped payment for service in anticipation of the adverse
effect PPS should have on their cash flow. As a result, accounts receivable for
nonaffiliated customers has increased, and the Company has increased its
provision for doubtful accounts in the fourth quarter.

The Company's results of operations could be materially and adversely
affected if the amounts actually received from third-party payors in any
reporting period differed materially from the amounts accrued in prior periods.
The Company's financial condition and results of operations may also be affected
by the timing of reimbursement payments and rate adjustments from third-party
payors. The Company has from time to time experienced delays in receiving final
settlement and reimbursement from government agencies.

Various cost containment measures adopted by governmental and private pay
sources restrict the scope and amount of reimbursable healthcare expenses and
limit increases in reimbursement rates for medical services. Any reductions in
reimbursement levels under Medicaid, Medicare or private payor programs and any
changes in applicable government regulations or interpretations of existing
regulations could significantly affect the Company's profitability. Furthermore,
government programs are subject to statutory and regulatory changes, retroactive
rate adjustments, administrative rulings and government funding restrictions,
all of which may materially affect the rate of payment to the Company's
facilities and its therapy and pharmaceutical services businesses. There can be
no assurance that payments under governmental or private payor programs will
remain at levels comparable to present levels or will be adequate to cover the
costs of providing services to patients eligible for assistance under such
programs. Significant decreases in utilization and changes in reimbursement
could have a material adverse effect on the Company's financial condition and
results of operations, including the possible impairment of certain assets.

In the Balanced Budget Act of 1997 ("BBA"), Congress passed numerous changes
to the reimbursement policies applicable to exempt hospital services, skilled
nursing, therapy and other ancillary services. The BBA mandates the
implementation of a prospective payment system for skilled nursing facilities.
PPS became effective on July 1, 1998 for the Company's facilities that it
acquired with RCA and on January 1, 1999 for the remainder of its facilities.
Under PPS, Medicare pays skilled nursing facilities a fixed fee per patient per
day based on the acuity level of the patient to cover all post-hospital extended
care routine service costs (i.e. Medicare Part A patients), including ancillary
and capital related costs for beneficiaries receiving skilled services. Prior to
the implementation of PPS, the costs of many of such services were reimbursed on
a "pass through" basis. During the first three years of the PPS phase-in,
payments will generally be based on a blend of the facility's historical costs
based on 1995 cost data and a federally established per diem rate. Although it
is unclear what the long-term impact of PPS will be, the transition to PPS
negatively impacted the Company's earnings for the quarters ended September 30,
1998 and December 31, 1998. There can be no assurance that PPS will not have a
long-term material adverse effect on the results of operations and financial
condition of the Company.

The Company's revenues from its inpatient facilities have been significantly
affected by the federally established PPS per diem rate. The per diem rate sets
limits on the certain types of care the government will pay for per patient per
day. The Company's experience has been that the average per diem

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reimbursement rate is less than the amount the Company's inpatient facilities
received on a daily basis under cost-based reimbursement. In response, the
Company has taken various actions to reduce its costs. Moreover, since the
Company treats a greater percentage of higher acuity patients than many nursing
homes, the Company has also been adversely impacted because federal per diem
rates for higher acuity patients do not adequately compensate the Company for
the additional expenses and risks for caring for such patients. There can be no
assurance that PPS will not have a long-term material adverse effect on the
Company's financial condition and results of operations.

In addition, the implementation of PPS has resulted in a greater than
expected decline in demand for the Company's therapy and pharmaceutical
services. For instance, the nursing home industry has responded to the lower
reimbursement levels under PPS by, among other things, seeking lower acuity
residents who need less ancillary services and by providing therapy services
in-house, which has resulted in a significant decline in the demand for the
Company's therapy services. Prior to the implementation of PPS, Sun's ancillary
services, such as rehabilitation and respiratory therapy services and
pharmaceutical services, had significantly higher operating margins than the
margins associated with Sun's long-term and subacute care facilities and
accordingly such services provided most of Sun's operating profits. Although the
Company has taken and continues to take actions to reduce its costs of providing
ancillary services, there can be no assurance that the Company will be able to
maintain its prior profit margins on its ancillary services.

The Company's response to the implementation of PPS includes the
establishment of SunSolution. SunSolution provides ancillary services for a
fixed fee to nonaffiliated facilities. As of April 19, 1999, SunSolution has
secured fewer contracts with nonaffiliated facilities than projected and the
average revenue per contract was significantly less than the Company projected.
There can be no assurance that the Company will develop a market for the
SunSolution products and services. Even if there is a market for SunSolution's
services, no assurance can be given that the costs of providing the contracted
services will be less than the fixed fee received by the Company for such
services. Given the importance of the profitability of Sun's ancillary services,
there can be no assurance that PPS will not have a long-term material adverse
effect on the Company's margins and ultimately the Company's results of
operations and financial condition.

Effective January 1, 1999, for all nursing home patients not receiving
post-hospital extended care services (i.e., Medicare Part B patients), Medicare
reimbursement for ancillary services, including rehabilitation therapy, medical
supplies, pharmacy, temporary staffing for rehabilitation therapy, and other
ancillary services, will be made to the skilled nursing facility pursuant to fee
schedules published on November 2, 1998. In addition, effective January 1, 1999,
there is an annual per beneficiary cap of $1,500 on Medicare reimbursement for
outpatient physical therapy and speech therapy and an annual per beneficiary cap
of $1,500 on Medicare reimbursement for occupational therapy. Facilities will be
permitted to bill patients directly for services rendered in excess of these
caps; however, there can be no assurance that the Company will receive any
payment in excess of these caps. There can also be no assurance that such fee
schedules and caps will not have a material adverse effect on the Company.

The Company's growth strategy has relied heavily on the acquisition of
long-term and subacute care facilities. Regardless of the legal form of the
acquisition, the Medicare and Medicaid programs often require that the Company
assume certain obligations relating to the reimbursement paid to the former
operators of the facilities acquired by the Company. From time to time, fiscal
intermediaries and Medicaid agencies examine cost reports filed by such
predecessor operators. The Company is currently the subject of several such
examinations. If, as a result of any such examinations, it is concluded that
overpayments to a predecessor operator were made, the Company, as the current
operator of such facilities, may be held financially responsible for such
overpayments. At this time the Company is unable to predict the outcome of any
examinations.

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Prior to the implementation of PPS, reimbursement for therapy services was
evaluated under Medicare's reasonable cost principles. In 1995, and periodically
since then, HCFA provided information to fiscal intermediaries for use in
determining reasonable costs for occupational and speech therapy. This
information, although not intended to impose limits on such costs, suggested
that fiscal intermediaries should carefully review costs which appear to be in
excess of what a "prudent buyer" would pay for those services. While the effect
of these directives is still uncertain, they are a factor considered by such
intermediaries in evaluating the reasonableness of amounts paid by providers for
the services of the Company's rehabilitation therapy subsidiary for fiscal years
prior to the implementation of PPS. Because PPS payments and fee schedules have
become the methods of reimbursement for these services, HCFA directives and
reasonable cost guidelines discussed in this paragraph have no impact on the
Company as to services rendered after January 1, 1999. A retroactive adjustment
of Medicare reimbursement could, however, be made for some prior periods. With
respect to nonaffiliated facilities, an adjustment of reimbursement rates for
therapy services could result in indemnity claims against the Company, based on
the terms of substantially all of the Company's existing contracts with such
facilities, for payments previously made by such facilities to the Company that
are reduced by Medicare in the audit process.

For periods prior to the effective date of PPS, certain Medicare regulations
applied to transactions between related parties, such as between the Company's
subsidiaries that operate skilled nursing facilities and subsidiaries which
provide ancillary services. These regulations are relevant to the amount of
Medicare reimbursement that the Company's skilled nursing facilities are
entitled to receive for certain rehabilitation and respiratory therapy and
pharmaceutical services provided by the Company's ancillary service
subsidiaries. An exception to the related party regulations is available
provided that, among other things, a substantial part of the services of the
relevant subsidiary supplier be transacted with nonaffiliated entities. When
that exception applies, the skilled nursing facility may receive reimbursement
for services provided by the Company's ancillary service subsidiaries at the
rates applicable to services provided to nonaffiliated entities. The related
party regulations do not indicate a specific level of services that must be
provided to nonaffiliated entities in order to satisfy the "substantial part"
requirement of this exception. In instances where this issue has been litigated
by others, no consistent standard has emerged as to the appropriate threshold
necessary to satisfy the "substantial part" requirement.

The Company's net revenues from rehabilitation therapy services, including
net revenues from temporary therapy staffing services, provided to nonaffiliated
facilities represented 56%, 70% and 71% of total rehabilitation and temporary
therapy staffing services net revenues for the years ended December 31, 1998,
1997 and 1996, respectively. Respiratory therapy services provided to
nonaffiliated facilities represented 46%, 63% and 58% of total respiratory
therapy services net revenues for the years ended December 31, 1998, 1997 and
1996, respectively. Net revenues from pharmaceutical services billed to
nonaffiliated facilities represented 70%, 79% and 78% of total pharmaceutical
services revenues for the years ended December 31, 1998, 1997 and 1996,
respectively. The Company considers RCA a nonaffiliated entity for all periods
prior to its acquisition. The Company believes that it satisfies the
requirements of the exception to the regulations regarding nonaffiliated
business. Consequently, it has claimed and received reimbursement under Medicare
for rehabilitation and respiratory therapy and pharmaceutical services provided
to patients in its own facilities at fair market value, rather than at Company
cost, which would have applied if it did not satisfy the exception. If the
Company were deemed to not have satisfied these regulations, the reimbursement
that the Company receives for rehabilitation and respiratory therapy and
pharmaceutical services provided to its own facilities would be significantly
reduced, as a result of which the Company's financial condition and results of
operations would be materially and adversely affected. If, upon audit by Federal
or state reimbursement agencies, such agencies find that the exception has not
been satisfied, and if, after appeal, such findings are sustained, the Company
could be required to refund some or all of the difference between its cost of
providing these services to any entity found to be subject to the related party
regulations and the fair market value amount actually received. While the
Company believes that it has satisfied these regulations, there can be no
assurance that its position would prevail if contested by relevant reimbursement
agencies. The foregoing statements with respect to the Company's ability to

34
<PAGE>
satisfy these regulations are forward looking and could be affected by a number
of factors, including the interpretation of Medicare regulations by Federal or
state reimbursement agencies and the Company's ability to provide services to
nonaffiliated facilities. The implementation of PPS and the fee schedules has
significantly reduced the Medicare impact of the related party rule.

The office of the Inspector General of the U.S. Department of Health and
Human Services ("OIG") has begun to conduct a national medical review that will
assess the medical necessity of physical and occupational therapy services
provided to skilled nursing facility patients. The OIG has indicated the results
of the review will be used to quantify overpayments for therapy services and to
develop baseline data that can be used to assess the impact of the BBA. The
Company is unable to determine what if any impact this review might have on the
Company, including its prospective payment rates.

REGULATION

The Company's subsidiaries, including those that provide subacute and
long-term care, rehabilitation and respiratory therapy and pharmaceutical
services, are engaged in industries that are extensively regulated. As such, in
the ordinary course of business, the operations of these subsidiaries are
continuously subject to state and federal regulatory scrutiny, supervision and
control. Such regulatory scrutiny often includes inquiries, investigations,
examinations, audits, site visits and surveys, some of which may be non-routine.
The Company's subsidiaries are currently the subject of several such
investigations. In addition to being subject to the direct regulatory oversight
of state and federal regulatory agencies, these industries are frequently
subject to the regulatory supervision of fiscal intermediaries.

If a provider is ever found by a court of competent jurisdiction to have
engaged in improper practices, it could be subject to civil, administrative, or
criminal fines, penalties or restitutionary relief, and reimbursement
authorities could also seek the suspension or exclusion of the provider or
individuals from participation in their program. If a facility is decertified,
the facility will not be reimbursed by the Federal government for caring for
residents that are covered by Medicare and Medicaid, and the facility would be
forced to care for such residents without being reimbursed or to transfer such
residents. The Company currently has several facilities that are the subject of
decertification efforts by HCFA, which the Company is contesting.
Decertification could cause material adverse financial and operational effects
on individual facilities.

It is the policy of the Company to comply with all applicable laws and
regulations. However, given the extent to which the interpretation and
implementation of applicable laws and regulations vary and the lack of clear
guidance in many of the areas which are the subject of regulatory scrutiny,
there can be no assurance that the business activities of the Company's
subsidiaries will not from time to time become the subject of regulatory
scrutiny, or that such scrutiny will not result in interpretations of applicable
laws or regulations by government regulators or intermediaries which differ
materially from those taken by the Company's subsidiaries.

Pursuant to Health Insurance Portability and Accountability Act of 1996,
Congress has provided additional funding to Medicare and Medicaid enforcement
units to investigate potential cases of reimbursement abuse in the health care
services industry. The Act also sets guidelines to encourage federal, state, and
local law enforcement agencies to share general information and to coordinate
specific law enforcement activities including conducting investigations, audits,
evaluations, and inspections relating to the delivery of and payment for health
care. From time to time enforcement agencies conduct audits, inspections and
investigations with respect to the reimbursement activities of the subsidiaries
of the Company. The Company's subsidiaries are currently the subject of several
such investigations. It is the Company's practice to cooperate fully in such
matters.

35
<PAGE>
LITIGATION

In March 1999 and through April 19, 1999, several stockholders of the
Company filed class action lawsuits against the Company and three officers of
the Company in the United States District Court for the District of New Mexico.
The lawsuits allege, among other things, that the Company did not disclose
material facts concerning the impact that PPS would have on the Company's
results of operations. The lawsuits seek compensatory damages and other relief
for stockholders who purchased the Company's common stock during the
class-action period. Although the Company intends to vigorously defend itself in
this matter, there can be no assurance that the outcome of this matter will not
have a material adverse effect on the results of operations and financial
condition of the Company.

In January 1999, the state of Florida filed criminal charges in the Circuit
Court of the Eighth Judicial Circuit for Alachua County, Florida against three
subsidiaries which were acquired by the Company on June 30, 1998: RCA, Capitol
Care Management Co., Inc. and Gainesville Health Care Center, Inc. All of the
allegations of wrongdoing relate to activities prior to June 30, 1998, the date
of the RCA acquisition. Florida's allegations include violations of certain RICO
laws, abuse or neglect of elderly or disabled persons, grand theft and Medicaid
fraud at a nursing home facility in Florida. Also named as defendants were five
individuals who were involved in the operation of the facility in their
capacities as officers, directors or employees of the defendant entities. If the
defendant entities are convicted, they could be banned from participating in the
Florida Medicaid program. Although the Company's subsidiaries will defend
themselves vigorously in this matter, there can be no assurance that the outcome
of this matter will not have a material adverse effect on the results of
operations and financial condition of the Company.

The Company and certain of its subsidiaries are defendants in two QUI TAM
lawsuits brought by private citizens in the United States District Court for the
Eastern District of California alleging violations of the federal False Claims
Act. The plaintiffs allege that skilled nursing facilities operated by the
subsidiaries and others conspired over the last decade to (i) falsely certify
compliance with regulatory requirements in order to participate in the Medicare
and Medicaid programs, and (ii) falsify records to conceal failures to provide
services in accordance with such regulatory requirements. Although the Company
and its subsidiaries intend to vigorously defend themselves in these matters,
there can be no assurance that the outcome of any one of these matters will not
have a material adverse effect on the results of operations and financial
condition of the Company.

Between August 25, 1997 and October 24, 1997, 10 putative class action
lawsuits (the "Actions") were filed in the United States District Court for the
Northern District of Georgia on behalf of persons who purchased RCA Common
Stock, naming RCA and certain of its officers and directors as defendants. The
complaints have overlapping defendants and largely overlapping (although not
identical) class periods. The complaints allege violations of Federal securities
laws by the defendants for disseminating allegedly false and misleading
financial statements for RCA's fiscal year ended June 30, 1996 and its first
three quarters of fiscal year 1997, which the plaintiffs allege materially
overstated RCA's profitability. Generally, each of the Actions seeks unspecified
compensatory damages, prejudgment and postjudgment interest, attorneys' fees and
costs and other equitable and injunctive relief.

On November 25, 1997, RCA, the Company and representatives of the plaintiffs
in the Actions entered into a Memorandum of Understanding ("MOU"). Pursuant to
the MOU, the Company paid $9 million into an interest-bearing escrow account
maintained by the Company (the "Escrow Account") to settle the Actions (the
"Settlement"). RCA also agreed to assign coverage under its directors' and
officers' liability insurance policy for these specific claims to the
plaintiffs. All of the parties have signed the Settlement Agreement and it will
become final upon court approval. Upon court approval of the Settlement, all
claims by the class that were or could have been asserted by the plaintiffs
against RCA or any of the other defendants in the Actions will be settled and
released, and the Actions will be dismissed in their entirety with prejudice in
exchange for the release of all funds from the Escrow Account to the Plaintiffs.
No assurance can be given that the Settlement will become final.

36
<PAGE>
In 1997, the Company was notified by a law firm representing several
national insurance companies that these companies believed that the Company had
engaged in improper billing and other practices in connection with the Company's
delivery of therapy and related services. In response, the Company began
discussions directly with these insurers and hopes to resolve these matters
without litigation; however, the Company is unable at this time to predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.

The Company is a party to various other legal actions and administrative
proceedings and is subject to various claims arising in the ordinary course of
business. The Company does not believe that the ultimate disposition of these
other matters will have a material adverse effect on the financial position or
results of operations of the Company.

YEAR 2000 RISK

STATE OF READINESS. The Company has implemented a process to address its
Year 2000 compliance issues. The process includes (i) an inventory and
assessment of the compliance of the essential systems and equipment of the
Company and of critical suppliers, customers and other third parties, (ii) the
remediation of non-compliant systems and equipment, and (iii) contingency
planning. The Company has completed its inventory and assessment of its
information technology ("IT") systems and equipment and non-IT systems and
equipment (embedded technology) and approximately 90% of its inventory and
assessment of the systems and equipment of critical suppliers, customers and
other third parties.

With respect to the Year 2000 compliance of critical third parties, the
Company derives a substantial portion of its revenues from the Medicare and
Medicaid programs. Congress' General Accounting Office concluded in 1998 that it
is highly unlikely that all Medicare systems will be compliant on time to ensure
the delivery of uninterrupted benefits and services into the Year 2000.

The Company has completed approximately 90% of the remediation process for
critical IT and non-IT systems and equipment. The Company has also completed
approximately 80% of contingency planning in the event that essential systems
and equipment fail to be Year 2000 compliant. The Company is planning to be Year
2000 compliant for all its essential systems and equipment by the fourth quarter
of 1999, although there can be no assurance that it will achieve its objective
by such date or by January 1, 2000 or that such potential non-compliance will
not have a material adverse effect on the Company's business, financial
condition or results of operations. In addition, there can be no assurance that
all of the Company's critical suppliers, customers and other third parties will
be Year 2000 compliant by January 1, 2000, or that such potential non-compliance
will not have a material adverse effect on the Company's business financial
condition or results of operations.

COSTS. The Company currently estimates that its aggregate costs directly
related to Year 2000 compliance efforts will be approximately $12 million, of
which approximately $2.5 million has been spent through December 31, 1998. Of
these costs, the Company estimates that approximately $3 million will be spent
to repair systems and equipment and $9 million will be spent to replace systems
and equipment. The Company's Year 2000 efforts are ongoing and its overall plan
and cost estimations will continue to evolve as new information becomes
available. The Company's analysis of its Year 2000 issues is based in part on
information from third party suppliers and customers; there can be no assurance
that such information is accurate or complete.

RISKS. The failure of the Company or third parties to be fully Year 2000
compliant for essential systems and equipment by January 1, 2000 could result in
interruptions of normal business work operations. The Company's potential risks
include (i) the inability to deliver critical care, resulting in death or
personal injury of residents of the Company's facilities and in non-affiliated
facilities, (ii) the delayed receipt of reimbursement from the Federal or State
governments, private payors, or intermediaries, (iii) the failure of security
systems, elevators, heating systems or other operational systems and equipment,
resulting in death or personal injury of residents of the Company's facilities
and (iv) the inability to receive

37
<PAGE>
critical equipment and supplies from vendors. Each of these events could have a
material adverse affect on the Company's business, results of operations and
financial condition.

CONTINGENCY PLANS. The Company has completed approximately 80% of its
contingency plan for Year 2000-related issues. These plans include, but are not
limited to, identification of alternate supplies, alternate electronic processes
and alternate manual systems. The company is planning to have contingency plans
completed for essential systems and equipment by July 1, 1999; however, there
can be no assurance that it will meet this objective by such date or by January
1, 2000.

FORWARD-LOOKING STATEMENTS. The Year 2000 disclosure set forth above
contains forward-looking statements. Specifically, such statements are contained
in sentences including the words "plans," "expects" or "anticipates." Such
forward-looking statements are subject to inherent risks and uncertainties that
may cause actual results to differ materially from those contemplated by the
forward-looking statements. Factors that may cause actual results to differ
materially from those contemplated by the forward-looking statements include
availability and cost of personnel trained in this area, and the failure of
third parties to (i) respond to the Company's inquiries as to whether the
systems and equipment supplied to the Company are compliant and (ii) adequately
remediate Year 2000 issues. The Company could experience material adverse
affects to its business, results of operations, and financial condition if it is
unable to identify and remediate all non-compliant essential systems and
equipment on the time schedule currently planned.

YEAR 2000 INFORMATION AND READINESS DISCLOSURE ACT. The Year 2000
disclosure set forth above is intended to be a "year 2000 statement" as such
term is defined in the Year 2000 Information and Readiness Disclosure Act of
1998 (the "Year 2000 Act") and, to the extent such disclosure relates to year
2000 processing of the Company or to products or services offered by the
Company, is also intended to be a "Year 2000 readiness disclosure" as such term
is defined in the Year 2000 Act.

EFFECTS OF INFLATION

Healthcare costs have been rising and are expected to continue to rise at a
rate higher than that anticipated for consumer goods as a whole. The Company's
operations could be adversely affected if it experiences significant delays in
receiving reimbursement rate increases from Medicaid sand Medicare sources for
its labor and other costs.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Information with respect to Item 8 is contained in the Company's
consolidated financial statements and financial statement schedules and are set
forth herein beginning on Page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

38
<PAGE>
PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The directors and executive officers of Sun as of March 31, 1999 were:

<TABLE>
<CAPTION>
NAME POSITION WITH SUN
- --------------------------------------- ------------------------------------------------------------------------
<S> <C>
Andrew L. Turner Chairman of the Board of Directors and Chief Executive Officer
Mark G. Wimer President, Chief Operating Officer and Director
Robert D. Woltil Chief Financial Officer and Director
Warren C. Schelling President and Chief Operating Officer of Sun Healthcare Group
International
Julie Collins Chief Administrative Officer
Robert F. Murphy General Counsel and Secretary
Andrew P. Masetti Vice President--Finance
Warren H. McInteer Chief Financial Officer of Sun Healthcare Group International
Matthew G. Patrick Vice President and Treasurer
William C. Warrick Vice President--Corporate Controller
William R. Anixter Director
John E. Bingaman Director
Zev Karkomi Director
Martin G. Mand Director
Lois E. Silverman Director
James R. Tolbert, III Director
R. James Woolsey Director
</TABLE>

Set forth below are the names of the executive officers and directors of Sun
and their ages as of March 31, 1999. The Board of Directors is divided into
three classes elected for staggered terms. Each director holds office until the
next annual meeting of stockholders at which the class of directors of which he
or she is a member is elected or until his/her successor has been elected and
qualified. The terms of Messrs. Karkomi and Wimer and Ms. Silverman expire in
1999, the terms of Messrs. Turner, Anixter and Woltil expire in 2000 and the
terms of Messrs. Bingaman, Mand, Tolbert and Woolsey expire in 2001. The
executive officers of Sun are chosen annually to serve until the first meeting
of the Board of Directors following the next annual meeting of stockholders and
until their successors are elected and have qualified, or until death,
resignation or removal, whichever is sooner.

Andrew L. Turner, age 52, has been the Chairman of the Board of Directors
and Chief Executive Officer of the Company since its formation and served as
President of the Company from the Company's formation until September 1997. Mr.
Turner is also the founder of the Company and has overseen the development of
the Company's business since its inception in 1989. Mr. Turner was also a
founder and previously served as Chief Operating Officer of Horizon Healthcare
Corporation, a healthcare services provider, from 1986 to 1989. Prior to 1986,
Mr. Turner served as a Senior Vice President of Operations of The Hillhaven
Corporation ("Hillhaven"). Mr. Turner has over 20 years of experience in the
long-term care industry. Mr. Turner is also a member of the Board of Directors
of Watson Pharmaceuticals, Inc., a pharmaceutical products company, and of The
Sports Club Company, Inc., an operator of sports and fitness clubs.

Mark G. Wimer, age 45, has been a director of the Company since 1993 and the
President and Chief Operating Officer of the Company since September 1997. Mr.
Wimer had previously served as Senior Vice President for Inpatient Services from
1996 until September 1997, and as the President of SunRise Healthcare
Corporation ("SunRise"), the Company's subsidiary responsible for operations of
the Company's long-term care facilities, from 1993 until 1995. From 1988 to
1993, Mr. Wimer was President and Chief Executive Officer of Franciscan
Eldercare Corporation, a non-profit organization that develops and

39
<PAGE>
manages long-term care facilities. From 1984 through 1988, Mr. Wimer was
Regional Vice President of Operations for Hillhaven and had responsibility for
management of long-term care facilities for Hillhaven in Washington, Oregon,
Idaho and Montana.

Robert D. Woltil, age 44, has been a director of the Company since 1996 and
the Chief Financial Officer of the Company since 1996. From 1982 to 1996, Mr.
Woltil served in various capacities for Beverly Enterprises, Inc. ("Beverly"), a
healthcare services provider. From 1995 until 1996, Mr. Woltil was President and
Chief Executive Officer of Pharmacy Corporation of America, a subsidiary of
Beverly. From 1992 to 1995, he was the Chief Financial Officer of Beverly, and
from 1990 to 1992, Mr. Woltil was the Vice President--Financial Planning and
Control for Beverly. Mr. Woltil is also a certified public accountant.

Warren C. Schelling, age 45, has been President and Chief Operating Officer
of Sun Healthcare Group International since February 1999. Previously, Mr.
Schelling was the Senior Vice President for Pharmaceuticals of the Company from
1996 to February 1999, a director of the Company from 1996 to 1998 and President
of SunScript from 1994 to 1995. Prior to joining the Company, Mr. Schelling was
the President and Chief Operating Officer of HPI Health Care Services, Inc., a
subsidiary of Diagnostek, Inc., which provides pharmacy management services to
hospitals, HMOs, long-term care facilities and health systems, from 1993 to July
1994. From January 1994 to July 1994, Mr. Schelling also served as the Executive
Vice President/Pharmacy Services Officer at Diagnostek, Inc. From 1985 to 1993,
Mr. Schelling was a manager in HPI Health Care Services, Inc.

Julie Collins, age 51, has been Chief Administrative Officer of the Company
since February 1999. From 1996 to February 1999 she was the Company's Senior
Vice President--Administrative Services and from 1994 to 1995, she was the
Company's Vice President Human Resources. Prior to joining the Company, Ms.
Collins was the Vice President of Human Resources and Support Services for St.
Joseph Health System in Atlanta, Georgia from 1993 to 1994. From 1991 to 1993,
Ms. Collins was the Vice President of Human Resources of SunRise. From 1990 to
1991, Ms. Collins was Director of Human Resources for Shepherd Spinal Center in
Atlanta, Georgia.

Robert F. Murphy, age 45, has been General Counsel of the Company since 1995
and Secretary of the Company since 1996. From 1986 to 1995 Mr. Murphy served in
several capacities as an officer and legal counsel to FHP International
Corporation, most recently as Vice President and Associate General Counsel.
Prior to 1986, Mr. Murphy was in private practice for several years.

Andrew P. Masetti, age 41, has been Vice-President--Finance of the Company
since October 1997. From June 1997 to October 1997, Mr. Masetti was Vice
President and Controller of Rehab Services of Sun. Prior to joining Sun, Mr.
Masetti was Divisional Chief Financial Officer of Harte-Hanks from 1996 to 1997,
Chief Financial Officer of Vista Healthcare from 1995 to 1996, Chief Financial
Officer of Diagnostek from 1994 to 1995 and he held various financial management
positions with Martin Marietta/General Electric from 1979 to 1994.

Warren H. McInteer, age 39, has been Chief Financial Officer of Sun
Healthcare Group International since February 1999. Mr. McInteer was Vice
President of Mergers & Acquisitions from 1995 to February 1999 and Treasurer of
the Company from 1996 to 1998. Prior to joining the Company, Mr. McInteer was
the Vice President of Financial Planning for Continental Medical Systems
("Continental") in Mechanicsburg, Pennsylvania, from 1993 to 1995 and a
management consultant for Price Waterhouse from 1985 to 1993.

Matthew G. Patrick, age 39, has been Vice President and Treasurer of the
Company since 1998. From 1993 to 1998, Mr. Patrick was Vice President of the
Dallas Agency of The Sanwa Bank, Ltd. From 1992 to 1993, Mr. Patrick served as
financial consultant for Merrill, Lynch, Pierce, Fenner and Smith, Inc.'s
Private Client Group in Dallas and from 1985 to 1990 he held various financial
positions in the International Division of National Westminster Bank, PLC.

40
<PAGE>
William C. Warrick, age 36, has been Vice President, Corporate Controller of
the Company since 1994. From 1991 to 1994, Mr. Warrick directed financial
reporting for Continental. From 1990 to 1991, Mr. Warrick held a similar
position with McCrory Stores, a retail chain store company. Prior to 1990, Mr.
Warrick was an accountant with KPMG Peat Marwick. Mr. Warrick is a certified
public accountant.

William R. Anixter, age 75, became a director of the Company in April 1998.
Mr. Anixter has been the President of Chama Resources, Inc., a privately held
real estate management company, since 1990. He was co-founder and vice chairman
of Anixter Bros., Inc., a publicly owned international distributor of wire,
cable, fiber optics and related networking products, which was sold to an
investor group in 1986. Mr. Anixter also serves on the boards of Anicom, Inc., a
publicly owned distributor of communications-related equipment, the United World
College and the Boys Club of Albuquerque.

John E. Bingaman, age 52, became a director of the Company in 1993. Mr.
Bingaman also served as a consultant to the Company from 1994 to 1996. Since
1993, Mr. Bingaman has been Vice President of BKS Properties. From 1991 to 1993,
Mr. Bingaman was the President of Four Seasons Healthcare Management, Inc.,
which was the Company's subsidiary that managed certain long-term care
facilities through management contracts. Between 1984 and July 1993, Mr.
Bingaman was Chief Executive Officer of Honorcare Corporation ("Honorcare"), a
provider of long-term care services, responsible for the overall management and
strategic planning of Honorcare. Mr. Bingaman has over 25 years of experience in
the long-term care industry.

Zev Karkomi, age 75, became a director of the Company in 1993. Mr. Karkomi
has over 25 years of experience in the real estate business, with a primary
emphasis on properties owned and leased to long-term healthcare operators. He
has served as President of Karell Capital Ventures, Inc., a corporation involved
in the acquisition, sale, leasing and management of long-term care facilities,
since 1980. Mr. Karkomi also serves as the President of Zevco Enterprises, Inc.
and Executive Vice President and Chairman of the Board of Progressive Health
Group, Inc., real estate investment companies.

Martin G. Mand, age 62, became a director of the Company in 1996. Since
1995, Mr. Mand has been Chairman, President and Chief Executive Officer of Mand
Associates, Limited, a financial consulting, speaking and writing firm. Mr. Mand
was previously Executive Vice President and Chief Financial Officer of Northern
Telecom, Ltd., a global manufacturer of telecommunications equipment, from 1990
to 1994. Mr. Mand also previously served as Vice President and Treasurer of E.I.
du Pont de Nemours & Co., a chemical, allied products and energy company. Mr.
Mand also serves on the Board of Directors of the Fuji Bank and Trust Company
and CAI Wireless Systems, Inc.

Lois E. Silverman, age 58, became a director of the Company in 1995. Ms.
Silverman is a director of CONCENTRA Managed Care, Inc., a publicly owned
provider of services to reduce the costs of workers' compensation, automobile,
disability and health insurance claims. Ms. Silverman was a co-founder, served
as the Chairman of the Board of CRA Managed Care, Inc. from 1994 to September
1997 and as its Chief Executive Officer from 1988 to 1995. Ms. Silverman is the
President of the Commonwealth Institute, a nonprofit organization she
established in 1997 for the advancement of women entrepreneurs. Ms. Silverman is
also a director of CareGroup and Immunetics, a member of the Dean's Council of
the Harvard School of Public Health, an overseer of Tufts University Medical
School and a Trustee at Simmous College.

James R. Tolbert, III, age 63, became a director of the Company in 1995 and
was appointed Lead Independent Director of the Board of Directors in 1998. Mr.
Tolbert has served as the Chairman, President, Chief Executive Officer and
Treasurer of First Oklahoma Corporation, a holding company, since 1986. Mr.
Tolbert has over 15 years of experience in the nursing home industry. In
addition, Mr. Tolbert is a member of the Board of Directors of Bonray Drilling
Corporation, a corporation engaged in domestic onshore contract drilling of oil
and gas wells.

41
<PAGE>
R. James Woolsey, age 57, became a director of the Company in 1995. Mr.
Woolsey has been a partner in the law firm of Shea & Gardner since 1995, where
he previously had been a partner from 1980 to 1989 and from 1991 to 1993. From
1993 to 1995, Mr. Woolsey served as the Director of Central Intelligence for the
U.S. government. From 1989 to 1991, Mr. Woolsey was the Ambassador and U.S.
Representative to the Negotiation on Conventional Armed Forces in Europe.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Exchange Act and the rules promulgated thereunder
require the Company's directors and executive officers and persons who own more
than ten percent of the Company's Common Stock to report their ownership and
changes in their ownership of Common Stock to the Securities and Exchange
Commission (the "Commission") and the New York Stock Exchange. Copies of the
reports must also be furnished to the Company. Specific due dates for the
reports have been established by the Commission and the Company is required to
report in this Proxy Statement any failure of its directors, executive officers
and more than ten percent stockholders to file by these dates.

Based solely on a review of the copies of such forms received by it, or
written representations from certain reporting persons, the Company believes
that during 1998 all Section 16(a) filing requirements applicable to its
directors, executive officers and greater than ten percent beneficial owners
were met with the exception of Zev Karkomi, who reported one transaction
reportable on Form 4 one week late due to an oversight.

ITEM 11. EXECUTIVE COMPENSATION

Previously filed in Form 10-K.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Previously filed in Form 10-K.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Previously filed in Form 10-K.

42
<PAGE>
PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) Financial Statements and Financial Statement Schedules

(i) Financial Statements:

Report of Independent Public Accountants

Consolidated Balance Sheets for the years ended December 31, 1998 and
1997

Consolidated Statements of Earnings (Loss) for the years ended
December 31, 1998, 1997 and 1996

Notes to Consolidated Financial Statements

(ii) Financial Statement Schedules:

Report of Independent Public Accountants

Schedule II Valuation and Qualifying Accounts for the years ended

December 31, 1998, 1997 and 1996

(All other financial statement schedules required by Rule 5-04 of Regulation
S-X are not applicable or the required information is included in the audited
financial statements.)

(b) Reports on Form 8-K

None.

<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- --------------- -------------------------------------------------------------------------------------------------
<S> <C>

2.1(16) Agreement and Plan of Merger and Reorganization, dated as of February 17, 1997 among Sun, Peach
Acquisition Corporation and Retirement Care Associates, Inc.

2.2(16) Agreement and Plan of Merger and Reorganization, dated as of February 17, 1997 among Sun,
Nectarine Acquisition Corporation and Contour Medical, Inc.

2.3(21) Amendment No. 1 to the Agreement and Plan of Merger and Reorganization dated as of February
17,1997 among Sun, Retirement Care Associates, Inc. and Peach Acquisition Corporation dated May
27, 1997

2.4(22) Amendment No. 2 to the Agreement and Plan of Merger and Reorganization dated as of February
17,1997 among Sun, Retirement Care Associates, Inc. and Peach Acquisition Corporation dated
August 21, 1997

2.5(22) Amendment No. 1 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Contour Medical, Inc. and Nectarine Acquisition Corporation dated August 21, 1997

2.6(23) Amendment No. 3 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Retirement Care Associates, Inc. and Peach Acquisition Corporation dated November
25, 1997

2.7(23) Amendment No. 2 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Contour Medical, Inc. and Nectarine Acquisition Corporation dated November 25,
1997
</TABLE>

43
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- --------------- -------------------------------------------------------------------------------------------------
<S> <C>
2.8(20) Agreement and Plan of Merger, dated as of July 26, 1997, among Sun, Sunreg Acquisition Corp. and
Regency Health Services, Inc.

2.9(28) Amendment No. 4 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Retirement Care Associates, Inc. and Peach Acquisition Corporation, dated April
3, 1998.

2.10(28) Amendment No. 3 to the Agreement and Plan of Merger and Reorganization dated as of February 17,
1997 among Sun, Contour Medical, Inc. and Nectarine Acquisition Corporation dated April 3, 1998.

3.1(26) Certificate of Incorporation of Sun, as amended

3.2(1)(8) Bylaws of Sun, as amended

4.1(2) Fiscal Agency Agreement dated as of March 1, 1994 between Sun and NationsBank of Texas, N.A., as
Fiscal Agent

4.2(10) Form of Rights Agreement, dated as of June 2, 1995, between Sun and Boatmen's Trust Company,
which includes the form of Certificate of Designations for the Series A Preferred Stock as
Exhibit A, the form of Right Certificate as Exhibit B and the form of Summary of Preferred Stock
Purchase Rights as Exhibit C

4.3(11) First Amendment to Rights Agreement, dated as of August 11, 1995, amending the Rights Agreement,
dated as of June 2, 1995, between Sun and Boatmen's Trust Company

4.4* Removal of Rights Agent, Appointment and Acceptance of Successor Rights Agent and Amendment No. 2
to Rights Agreement among Sun, ChaseMellon Shareholder Services, LLC and American Stock Transfer
& Trust Company

4.5(26) Certificate of Designations of Series A Preferred Stock of the Company

4.6(25) Amended and Restated Declaration of Trust of Sun Financing I among the Company, as sponsor,
Robert F. Murphy, Robert D. Woltil and William Warrick, as trustees, the Bank of New York
(Delaware), as trustee, and the Bank of New York, dated as of May 4, 1998

4.7(25) Preferred Securities Guarantee among the Company and the Bank of New York, as trustee, dated as
of May 4, 1998

4.8(25) Registration Rights Agreement among the Company, certain guarantors and Bear, Stearns & Co.,
Inc., Donaldson, Lufkin & Jenrette Securities Corporation, J.P. Morgan Securities, Inc.,
NationsBanc Montgomery Securities LLC and Schroder & Co., Inc., dated as of May 4, 1998 (7%
Convertible Trust Issued Preferred Securities)

4.9(25) Registration Rights Agreement among Sun Financing I, the Company and Bear, Stearns & Co., Inc.,
Donaldson, Lufkin & Jenrette Securities Corporation, J.P. Morgan Securities, Inc., NationsBanc
Montgomery Securities LLC and Schroder & Co., Inc., dated as of May 4, 1998 (9 3/8% Senior
Subordinated Debentures due 2008)

10.1(3) Lease Agreement dated as of August 31, 1986, by and between Karan Associates (Lessee) and
Campbell Care of Wylie, Inc., Assignment of Lease dated November 20, 1989 by and between Campbell
Care of Wylie, Inc. and Honorcare Corporation (Lessee), with First Lease Addendum dated August
31, 1986, Second Addendum dated January 9, 1987, Third Addendum dated November 30, 1989 and
Fourth Addendum dated July 12, 1993, and Assignment Agreement dated as of July 13, 1993, by and
</TABLE>

44
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- --------------- -------------------------------------------------------------------------------------------------
between Honorcare Corporation (Assignor) and Sun Healthcare Corporation (Assignee) (Hillcrest
Manor Nursing Center)
<S> <C>

10.2(13) Lease Agreement for West Magic Care Center dated as of August 1, 1987, between Skyview Associates
(Lessor) and Don Bybee and A. Keith Holloway (Lessee)

10.3(1) Lease Agreement for East Mesa Care Center dated as of September 30, 1990, between East Mesa
Associates Limited Partnership (Lessor) and SunRise (Lessee)

10.4(1) Assignment and Assumption of Lease with Consent of Lessor for Torrington Extend-A-Care Center
dated as of November 1, 1990, between Beverly Enterprises Connecticut, Inc. (Assignor/Lessee),
Turner Enterprises, Inc. (Assignee), Andrew L. Turner and Nora Turner (Guarantors), Harvey J.
Angell and Zev Karkomi (Special Guarantors) and Beverly Investment Properties, Inc. (Lessor)
(Lease attached)

10.5(1) Lease Agreement for Mercer Island Care Center dated as of July, 1991, among Mercer View
Convalescent Center, Tenants-in-Common (Lessor), SunRise (Lessee) and Andrew L. Turner and Nora
Turner, husband and wife (Guarantor)

10.6(1) Lease Agreement for Bayside Health and Rehabilitation Center dated as of July 26, 1991, between
Bellingham Associates Limited Partnership (Lessor) and SunRise (Lessee)

10.7(1) Lease Agreement for Menlo Park Healthcare Center dated as of November 1, 1991, between Oregon
Associates Limited Partnership (Lessor) and SunRise (Lessee)

10.8(1) Sublease Agreement for Hillside Living Center d/b/a Hillside Healthcare Center dated as of March
1, 1992, between Elite Care Corporation (Sublessor) and Turner Enterprises, Inc. (Sublessee)
(Lease attached as Exhibit)

10.9(1) Sublease Agreement for Crown Manor Living Center d/b/a Crown Manor Healthcare Center dated as of
March 1, 1992, between Elite Care Corporation (Sublessor) and Turner Enterprises, Inc.
(Sublessee) (Lease attached as Exhibit)

10.10(1) Sublease Agreement for Colonial Manor Living Center d/b/a Colonial Manor Healthcare Center dated
as of March 1, 1992, between Elite Care Corporation (Sublessor) and Turner Enterprises, Inc.
(Sublessee) (Lease attached as Exhibit)

10.11(1) Sublease Agreement for Douglas Living Center d/b/a Douglas Healthcare Center dated as of March 1,
1992, between Elite Care Corporation (Sublessor) and Turner Enterprises, Inc. (Sublessee) (Lease
attached as Exhibit)

10.12(1) Lease Agreement for Columbia View Nursing Home dated as of June 30, 1992, between Columbia
Associates Limited Partnership (Lessor) and Turner Enterprises, Inc. (Lessee)

10.13(1) Lease Agreement for Adams House Healthcare Center dated as of October 1, 1992, between Adams
Connecticut Associates Limited Partnership (Lessor) and Turner Enterprises, Inc. (Lessee)

10.14(1) Lease Agreement for San Juan Care Center and Burton Care Center dated as of October 31, 1992, by
and between Zev Karkomi and Jerold Ruskin (collectively, the Lessors) and SunRise (Lessee)

10.15(3) Lease Agreement dated as of July 13, 1993, by and between Angelina Associates (Lessor) and
Honorcare Corporation (Lessee), with Assignment Agreement dated as of
</TABLE>

45
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- --------------- -------------------------------------------------------------------------------------------------
July 13, 1993 by and between Honorcare Corporation (Assignor) and Sun Healthcare Corporation
(Assignee) (Angelina Facility)
<S> <C>

10.16(3) Lease Agreement dated as of July 13, 1993, by and between July Associates IV (Lessor) and
Honorcare Corporation (Lessee), with Assignment Agreement dated as of July 13, 1993, by and
between Honorcare Corporation (Assignor) and Sun Healthcare Corporation (Assignee) (Park Plaza)

10.17(3) Lease Agreement dated as of July 13, 1993, by and between Angelina Associates (Lessor) and
Honorcare Corporation (Lessee), with Assignment Agreement dated as of July 13, 1993, by and
between Honorcare Corporation (Assignor) and Sun Healthcare Corporation (Assignee) (Wells)

10.18(3) Lease Agreement dated as of July 13, 1993, by and between Angelina Associates (Lessor) and
Honorcare Corporation (Lessee), with Assignment Agreement dated as of July 13, 1993, by and
between Honorcare Corporation (Assignor) and Sun Healthcare Corporation (Assignee) (Pineywood)

10.19(3) Lease Agreement dated as of July 13, 1993, by and between Golden Age Associates (Lessor) and
Honorcare Corporation (Lessee) (Golden Age)

10.20(3) Lease Agreement dated as of July 13, 1993, by and between July Associates III (Lessor) and
Honorcare Corporation (Lessee) (High Plains)

10.21(7) Lease Agreement dated as of July 30, 1993 between Zev Karkomi, Thunderbird Associated Limited
Partnership and SunRise Healthcare Corporation

10.22(7) Lease Agreement dated as of September 22, 1993, as amended, between Carlinville Associates and
SunRise Healthcare Corporation

10.23(4) Lease Agreement dated October 1993, by and between Salem Associates, Ltd. (Lessor) and SunRise
(Lessee) (Doctors Nursing Home)

10.24(4) Lease Agreement dated as of December 6, 1993, by and between Massachusetts Nursing Homes Limited
Partnership (Lessor) and SunRise (Lessee)

10.25(3) Lease Assignment and Transfer of Operations Agreement dated as of December 30, 1993, by and
between HEA of New Mexico, Inc. and SunRise (Lease attached) (Country Life Manor)

10.26(3) Lease Agreement dated as of January 1, 1994, by and between October Associates (Lessor) and
SunRise (Lessee) (Stanton Nursing Home)

10.27(3) Lease Agreement dated as of January 1, 1994, by and between Whitewright Associates (Lessor) and
SunRise (Lessee) (Campbell Care of Whitewright)

10.28(3) Lease Agreement dated as of January 1, 1994, by and between October Associates (Lessor) and
SunRise (Lessee) (Valley Mills Care Center)

10.29(3) Lease Agreement dated as of January 1, 1994, by and between October Associates (Lessor) and
SunRise (Lessee) (Moody Care Center)

10.30(6) Lease Agreement dated as of April 26, 1994, by and between Sumner Nursing Home, L.L.C. and
SunRise

10.31(5) Lease Agreement by and between Bellingham II Associates Limited Partnership and SunRise
Healthcare Corporation, dated May 31, 1994
</TABLE>

46
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- --------------- -------------------------------------------------------------------------------------------------
<S> <C>
10.32(12) Lease Agreement for Wheeler Care Center, dated as of July 24, 1995, by and between Wheeler
Healthcare Associates, L.L.C., a Texas limited liability company (Lessor) and SunRise Healthcare
Corporation (Lessee).

10.33(12) Agreement with Respect to and Second Amendment of Lease Agreement, dated as of September 1, 1995,
by and between Massachusetts Nursing Homes Limited Partnership (Lessor) and SunRise Healthcare
Corporation (Lessee).

10.34(12) Third Amendment of Lease Agreement, dated as of September 1, 1995, by and between Massachusetts
Nursing Homes Limited Partnership (Lessor) and SunRise Healthcare Corporation (Lessee).

10.35(12) Lease Agreement for Clifton Care Center, dated as of September 13, 1995, between Missouri
Associates (Lessor) and SunRise Healthcare Corporation (Lessee).

10.36(17) Lease Agreement for Heritage Heights dated as of March 1, 1996, by and between Tor Associates
(Lessor) and SunRise Healthcare Corporation (Lessee).

10.37(15) Second Amendment to Lease, dated as of June 1, 1996, by and between East Mesa Associates Limited
Partnership (Lesser) and SunRise Healthcare Corporation (Lessee).

10.38(14) Lease Agreement dated July 1, 1996 between Oak/Jones, Inc. and SunRise Healthcare Corporation for
Oaks Health & Rehabilitation Center.

10.39(14) Lease Agreement dated July 1, 1996 between Oak/Jones, Inc. and SunRise Healthcare Corporation for
Jones Health & Rehabilitation Center.

10.40(15) Sub-Sublease Agreement, dated as of August 22, 1996, by and between Yuba Nursing Homes, Inc.
(Lessor) and SunRise Healthcare Corporation (Lessee).

10.41(17) Lease Agreement for Casa del Sol Nursing Home dated as of November 26, 1996, by and between Raton
Property Limited Company (Lessor) and SunRise Healthcare Corporation (Lessee).

10.42(17) Lease Agreement for Blue Mountain Convalescent Center dated as of November 30, 1996, by and
between Washington Associates (Lessor) and SunRise Healthcare Corporation (Lessee).

10.43(17) Lease Agreement for Payette Lakes Care Center dated as of November 30, 1996, by and between Idaho
Associates L.L.C. (Lessor) and SunRise Healthcare Corporation (Lessee).

10.44(17) Lease Agreement for Valley Rehabilitation and Living Center dated as of November 30, 1996, by and
between Idaho Associates L.L.C. (Lessor) and SunRise Healthcare Corporation (Lessee).

10.45(17) Unconditional Guaranty of Lease dated as of November 30, 1996 given by Sun Healthcare Group, Inc.
(Guarantor) to Idaho Associates, L.L.C. (Lessor) relating to Magic Valley Manor.

10.46(17) Unconditional Guaranty of Lease dated as of November 30, 1996 given by Sun Healthcare Group, Inc.
(Guarantor) to Idaho Associates, L.L.C. (Lessor) relating to Valley Rehabilitation and Living
Center.

10.47(3) Form of Management Agreement between GF/Massachusetts, Inc. and SunRise
</TABLE>

47
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- --------------- -------------------------------------------------------------------------------------------------
<S> <C>
10.48(5) Amendment and Restatement of Loan Agreement [Brookline] by and between Mediplex of Massachusetts,
Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994

10.49(5) Amendment and Restatement of Loan Agreement [Columbus] by and between Mediplex Rehabilitation of
Massachusetts, Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994

10.50(5) Loan Agreement [Denver] by and between Mediplex of Colorado, Inc. and Valley View Psychiatric
Services, Inc. and Meditrust Mortgage Investments, Inc., dated June 23, 1994

10.51(13) Omnibus Amendment to Loan Agreements, dated as of March 28, 1996, by and between certain
subsidiaries of The Mediplex Group, Inc. and certain subsidiaries of Sun

10.52(19) Credit Agreement among Sun, certain lenders, certain co-agents, and NationsBank of Texas, N.A.,
as Administrative Lender, dated October 8, 1997

10.53(19) Form of First Amendment to Credit Agreement dated October 8, 1997 among Sun, certain lenders,
certain co-agents, and NationsBank of Texas, N.A., as Administrative Lender, to be dated as of
November 12, 1997

10.54(9) First Amendment to Sun 1992 Director Stock Option Plan

10.55(1) Sun 1993 Combined Incentive and Nonqualified Stock Option Plan

10.56(1) Sun 1993 Directors Stock Option Plan

10.57(9) Amendments to Sun 1993 Combined Incentive and Nonqualified Stock Option Plan

10.58(13) Sun 1995 Non-Employee Directors' Stock Option Plan

10.59(13) Sun Employee Stock Purchase Plan

10.60(13) 1996 Combined Incentive and Nonqualified Stock Option Plan

10.61(1) Tax Indemnity Agreement between Sun, SunDance Rehabilitation Corporation, Turner Enterprises,
Inc. and Andrew L. Turner and Nora L. Turner

10.62(1) Form of Indemnity Agreement between Sun and each of Sun's Directors before July 3, 1996

10.63(25) Form of Indemnity Agreement between Sun and each of Sun's Directors from and after July 3, 1996

10.64(1) Agreement as of May 5, 1993, between SunDance Rehabilitation Corporation and Andrew L. Turner

10.65(17) Form of Severance Agreement entered into between Sun and its President, Chief Financial Officer
and Senior Vice Presidents

10.66(18) Sun 1997 Non-Employee Directors' Stock Plan

10.67(18) Sun 1997 Stock Incentive Plan

10.68(18) Lease Agreement for Casa Loma Convalescent Center dated as of February 24, 1997 by and between
Idaho Associates, LLC (Lessor) and SunRise Healthcare Corporation (Lessee)
</TABLE>

48
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
- --------------- -------------------------------------------------------------------------------------------------
<S> <C>
10.69(19) Lease Agreement for Evergreen Nursing and Convalescent Centre dated as of June 5, 1997, between
Effingham Associates, L.L.C. (Lessor) and SunRise Healthcare Corporation (Lessee)

10.70(25) Second Amendment to Credit Agreement dated October 8, 1997 among the Company, certain lenders,
certain co-agents, and NationsBank of Texas, N.A., as Administrative Lender, dated as of March
27, 1998

10.71(27) Fourth Amendment to Credit Agreement dated October 8, 1997 among the Company, certain lenders,
certain co-agents, and NationsBank of Texas, N.A., as Administrative Lender, dated as of October
30, 1998

10.72(27) Employment Agreement dated June 2, 1998 between Andrew L. Turner and the Company.

10.73(24) Indenture dated July 8, 1997 by and between Sun, the Guarantors named therein, and First Trust
National Association (9 1/2% Senior Subordinated Notes due 2007)

10.74(5) Amended and Restated Indenture, dated October 1, 1994, among Sun, The Mediplex Group, Inc. and
Fleet Bank of Massachusetts, N.A. as Trustee (6% Convertible Subordinated Debentures due 2004)

10.75(5) Amended and Restated First Supplemental Indenture to Amended and Restated Indenture, dated
October 1, 1994, among Sun, The Mediplex Group, Inc. and Fleet Bank of Massachusetts, N.A. as
Trustee (6 1/2% Convertible Subordinated Debentures due 2003)

10.76(25) Indenture dated May 4, 1998 among the Company, the Bank of New York, as trustee (7% Convertible
Junior Subordinated Debentures due 2028)

10.77(25) Indenture dated May 4, 1998 among the Company, U.S. Bank Trust National Association, as trustee,
and certain guarantors (9 3/8% Senior Subordinated Notes due 2008)

21* Subsidiaries of the Registrant

23** Consent of Arthur Andersen LLP

27** Financial Data Schedule
</TABLE>

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

* Previously filed.

** Filed herewith.

(1) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-62670) on Form S-1.

(2) Incorporated by reference from exhibits to the Company's Form 8-K dated
March 11, 1994.

(3) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1993.

(4) Incorporated by reference from exhibits to the Company's Form 10-Q/A-1 for
the quarter ended September 30, 1993.

(5) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended September 30, 1994.

49
<PAGE>
(6) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-77522) on Form S-1.

(7) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-77272) on Form S-4.

(8) Incorporated by reference from exhibits to the Company's Registration
Statement (No. 33-77870) on Form S-1.

(9) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994.

(10) Incorporated by reference from exhibits to the Company's Form 8-A filed
June 6, 1995.

(11) Incorporated by reference from exhibits to the Company's Form 8-A/A-1 filed
August 17, 1995.

(12) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1995.

(13) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended March 31, 1996.

(14) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended June 30, 1996.

(15) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended September 30, 1996.

(16) Incorporated by reference from exhibits to the Company's Form 8-K dated
February 17, 1997.

(17) Incorporated by reference from exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1996.

(18) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended March 31, 1997.

(19) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended September 30, 1997

(20) Incorporated by reference from exhibits to the Company's Form 8-K dated
October 8, 1997.

(21) Incorporated by reference from exhibits to the Company's Form 8-K dated May
27, 1997.

(22) Incorporated by reference from exhibits to the Company's Form 8-K dated
August 21, 1997.

(23) Incorporated by reference from exhibits to the Company's Form 8-K dated
November 25, 1997.

(24) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended June 30, 1997.

(25) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended March 31, 1998.

(26) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended June 30, 1998.

(27) Incorporated by reference from exhibits to the Company's Form 10-Q for the
quarter ended September 30, 1998.

(28) Incorporated by reference from exhibits to the Company's Form 8-K dated
April 3, 1998.

50
<PAGE>
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.

SUN HEALTHCARE GROUP, INC.

By: /s/ Robert D. Woltil
--------------------------------------
Robert D. Woltil

CHIEF FINANCIAL OFFICER

51
<PAGE>
SUN HEALTHCARE GROUP
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Report of Independent Public Accountants................................................................... F-2

Consolidated balance sheets as of December 31, 1998 and 1997............................................... F-3

Consolidated statements of earnings (losses) for the years ended December 31, 1998, 1997 and 1996.......... F-4

Consolidated statements of stockholders' equity for the years ended December 31, 1998, 1997 and 1996....... F-5

Consolidated statements of cash flows for the years ended December 31, 1998, 1997 and 1996................. F-6

Notes to Consolidated Financial Statements................................................................. F-7
</TABLE>

F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

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

We have audited the accompanying consolidated balance sheets of Sun
Healthcare Group, Inc. (a Delaware corporation) and subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of earnings (losses),
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Sun Healthcare Group, Inc.
and subsidiaries as of December 31, 1998 and 1997, and the results of its
operations and its cash flows for the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company incurred net losses for the year ended
December 31, 1998 of $753.7 million and was not in compliance with certain
financial covenants of the Senior Credit Facility ($745.6 million at December
31, 1998) and certain Mortgage Notes ($31.9 million at December 31, 1998).
Further, the Company does not expect to be in compliance with the financial
covenants of the Senior Credit Facility and certain Mortgage Notes during 1999
and their remaining terms. Accordingly, the Company has classified the Senior
Credit Facility and certain Mortgage Notes as current liabilities in the
accompanying balance sheet as of December 31, 1998. The Company is also in
non-compliance with certain financial covenants contained in certain master
lease agreements for 129 of its long-term care facilities, which gives the
lessors the right to require the Company to relinquish the leased facilities.
Certain of the Company's other debt agreements also contain provisions that
provide that such debt would become due on demand if there is an acceleration of
payment of debt obligations, including the Senior Credit Facility or certain
Mortgage Notes. Such debt agreement provisions are explained in Note 7 to the
financial statements.

The Company has determined that no further amounts may be borrowed under the
Senior Credit Facility or any other existing credit agreements. Because the
Company is in non-compliance with the terms of the Senior Credit Facility and
certain Mortgage Notes, the creditors may demand immediate repayment.
Accordingly, if the Company is required to repay the amounts outstanding under
the Senior Credit Facility and certain Mortgage Notes or is unable to fund all
operations, capital expenditures and regularly scheduled debt service from
existing cash reserves and net cash flows from operations, if any, it will
explore a variety of options, including seeking relief under the United States
Bankruptcy Code.

These factors raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to this matter are
also described in Note 2. The financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts (including property and equipment of $601.3 million and goodwill of
$795.9 million) or the amount and classification of liabilities that might
result should the Company be unable to continue as a going concern.

Albuquerque, New Mexico /s/ Arthur Andersen LLP

April 19, 1999 ARTHUR ANDERSEN LLP

F-2
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 1998 AND 1997
(IN THOUSANDS EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................................... $ 27,504 $ 21,020
Accounts receivable, net of allowance for doubtful accounts of $79,015 and $34,433 at December 31,
1998 and 1997, respectively....................................................................... 538,329 523,161
Other receivables................................................................................... 48,073 33,550
Inventory, net...................................................................................... 48,862 28,219
Prepaids and other assets........................................................................... 13,091 10,221
Income tax receivable............................................................................... 15,874 --
Deferred tax assets................................................................................. -- 16,546
--------- ---------
Total current assets.............................................................................. 691,733 632,717
--------- ---------
Property and equipment, net........................................................................... 601,270 631,102
Goodwill, net......................................................................................... 795,945 1,030,893
Notes receivable...................................................................................... 32,334 91,062
Assets held for sale.................................................................................. 192,447 --
Other assets, net..................................................................................... 148,309 171,898
Deferred tax assets................................................................................... 6,000 21,564
--------- ---------
Total assets...................................................................................... $2,468,038 $2,579,236
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt................................................................... $ 812,621 $ 56,817
Current portion of obligations under capital leases................................................. 3,703 2,054
Accounts payable.................................................................................... 94,143 61,873
Accrued compensation and benefits................................................................... 102,091 78,960
Accrued interest.................................................................................... 26,095 20,451
Accrued self-insurance obligations.................................................................. 54,865 34,354
Other accrued liabilities........................................................................... 137,851 71,183
--------- ---------
Total current liabilities......................................................................... 1,231,369 325,692
--------- ---------
Long-term debt, net of current portion................................................................ 705,653 1,488,861
Obligations under capital leases, net of current portion.............................................. 103,679 79,110
Other long-term liabilities........................................................................... 41,061 42,428
Deferred income taxes................................................................................. -- 9,807
--------- ---------
Total liabilities................................................................................. 2,081,762 1,945,898
--------- ---------
Commitments and contingencies.........................................................................
Minority interest..................................................................................... 7,517 16,285
Company-obligated mandatorily redeemable convertible preferred securities of a subsidiary trust
holding solely 7% convertible junior subordinated debentures of the Company......................... 345,000 --

Stockholders' equity
Preferred stock of $.01 par value, authorized 5,000,000 shares, none issued......................... -- --
Common stock of $.01 par value, authorized 155,000,000 shares, 61,930,159 and 51,697,914 shares
issued and outstanding at December 31, 1998 and 1997, respectively................................ 619 517
Additional paid-in capital.......................................................................... 774,860 639,637
Retained earnings................................................................................... (696,049) 57,114
Accumulated other comprehensive income.............................................................. 2,902 1,766
--------- ---------
82,332 699,034
--------- ---------
Less:
Unearned compensation............................................................................. 8,552 14,203
Common stock held in treasury, at cost, 2,124,868 and 2,053,207 shares as of December 31, 1998 and
1997, respectively............................................................................... 26,967 25,574
Grantor stock trust, at market, 1,989,132 and 2,178,315 shares at December 31, 1998 and 1997,
respectively..................................................................................... 13,054 42,204
--------- ---------
Total stockholders' equity.......................................................................... 33,759 617,053
--------- ---------
Total liabilities and stockholders' equity.......................................................... $2,468,038 $2,579,236
--------- ---------
--------- ---------
</TABLE>

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

F-3
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES)

FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Total net revenues.................................................................. $ 3,088,460 $ 2,010,820 $ 1,316,308
------------ ------------ ------------
Costs and expenses:
Operating......................................................................... 2,629,485 1,662,818 1,107,821
Corporate general and administrative.............................................. 180,934 98,169 62,085
Provision for losses on accounts receivable....................................... 83,083 15,839 14,970
Depreciation and amortization..................................................... 102,515 56,630 33,817
Interest, net..................................................................... 135,411 74,482 25,899
Impairment loss................................................................... 397,492 -- --
Loss on sale of assets............................................................ 206,205 7,000 --
Legal and regulatory matters...................................................... 22,456 -- 19,250
Restructuring costs............................................................... 4,558 -- --
------------ ------------ ------------
Total costs and expenses........................................................ 3,762,139 1,914,938 1,263,842
------------ ------------ ------------
Dividends on convertible preferred securities of subsidiary......................... 16,163 -- --
------------ ------------ ------------
Earnings (losses) before income taxes and extraordinary loss........................ (689,842) 95,882 52,466
Income taxes........................................................................ 53,577 41,153 30,930
------------ ------------ ------------
Net earnings (losses) before extraordinary loss................................... (743,419) 54,729 21,536

Extraordinary loss from early extinguishment of debt, net of income tax benefit of
$3,700 and $9,815 in 1998 and 1997, respectively.................................. 10,274 19,928 --
------------ ------------ ------------
Net earnings (losses)............................................................. $ (753,693) $ 34,801 $ 21,536
------------ ------------ ------------
------------ ------------ ------------
Net earnings (losses) per common and common equivalent share:
Earnings (losses) before extraordinary loss
Basic............................................................................. $ (14.29) $ 1.18 $ 0.46
------------ ------------ ------------
------------ ------------ ------------
Diluted........................................................................... $ (14.29) $ 1.12 $ 0.46
------------ ------------ ------------
------------ ------------ ------------
Net earnings (losses)
Basic............................................................................. $ (14.49) $ 0.75 $ 0.46
------------ ------------ ------------
------------ ------------ ------------
Diluted........................................................................... $ (14.49) $ 0.74 $ 0.46
------------ ------------ ------------
------------ ------------ ------------
Weighted average number of common and common equivalent shares outstanding
Basic............................................................................. 52,008 46,329 46,360
------------ ------------ ------------
------------ ------------ ------------
Diluted........................................................................... 52,008 51,851 46,868
------------ ------------ ------------
------------ ------------ ------------
</TABLE>

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

F-4
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
---------------------- -----------
SHARES AMOUNT SHARES
----------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
COMMON STOCK
Issued and outstanding at beginning of year............................................... 51,698 $ 517 51,143
Issuance of common stock for employee benefits............................................ 37 -- 487
Conversion of 6 1/2% Convertible Subordinated Debentures due 2003......................... 2 -- 68
Issuance of common stock in connection with establishment of the Grantor Stock Trust...... -- -- --
Common stock issued in connection with acquisitions....................................... 9,981 100 --
Common stock issued in connection with immaterial poolings................................ 212 2 --
----------- --------- -----------
Issued and outstanding at end of year..................................................... 61,930 619 51,698
----------- --------- -----------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year.............................................................. 639,637
Issuance of common stock for employee benefits............................................ 522
Tax benefit of stock options exercised.................................................... 57
Conversion of 6 1/2% Convertible Subordinated Debentures due 2003......................... 33
Consideration recorded for the fair value of warrants issued in connection with
acquisitions............................................................................ 121
Adjustment to market value of common stock held by the Grantor Stock Trust................ (26,895)
Issuance of common stock in connection with the establishment of the Grantor Stock Trust.. --
Common stock issued in connection with acquisitions....................................... 161,376
Common stock issued in connection with immaterial poolings................................ 9
----------- --------- -----------
Additional paid-in capital at end of year................................................. 774,860
----------- --------- -----------
RETAINED EARNINGS
Balance at beginning of year.............................................................. 57,114
Net earnings (losses)..................................................................... (753,693)
Common stock issued in connection with immaterial poolings................................ 530
----------- --------- -----------
Retained earnings at end of year.......................................................... (696,049)
----------- --------- -----------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of year.............................................................. 1,766
Foreign currency translation adjustment, net of tax....................................... 1,136
----------- --------- -----------
Accumulated other comprehensive income at end of year..................................... 2,902
----------- --------- -----------
Total..................................................................................... 61,930 82,332 51,698
----------- --------- -----------
UNEARNED COMPENSATION
Balance at beginning of year.............................................................. (14,203)
Issuance of shares of restricted common stock............................................. (564)
Amortization of stock issued under restricted stock option plan........................... 6,215
----------- --------- -----------
Unearned compensation at end of year...................................................... (8,552)
----------- --------- -----------
COMMON STOCK IN TREASURY
Balance at beginning of year.............................................................. (25,574)
Acquired at cost.......................................................................... (1,393)
----------- --------- -----------
Common stock in treasury at end of year................................................... (26,967)
----------- --------- -----------
GRANTOR STOCK TRUST
Balance at beginning of year.............................................................. (42,204)
Issuance of common stock in connection with establishment of the Grantor Stock Trust...... --
Issuance of common stock from the Grantor Stock Trust..................................... 1,692
Issuance of shares of restricted common stock............................................. 563
Adjustment to market value of common stock held by the Grantor Stock Trust................ 26,895
----------- --------- -----------
Grantor stock trust at end of year........................................................ (13,054)
----------- --------- -----------
Total stockholders' equity................................................................ 61,930 $ 33,759 51,698
----------- --------- -----------
----------- --------- -----------

<CAPTION>
1996
----------------------

AMOUNT SHARES AMOUNT

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

<S> <C> <C> <C>
COMMON STOCK
Issued and outstanding at beginning of year............................................... $ 511 47,916 $ 479

Issuance of common stock for employee benefits............................................ 5 106 1

Conversion of 6 1/2% Convertible Subordinated Debentures due 2003......................... 1 -- --

Issuance of common stock in connection with establishment of the Grantor Stock Trust...... -- 3,050 30

Common stock issued in connection with acquisitions....................................... -- 71 1

Common stock issued in connection with immaterial poolings................................ -- -- --

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

Issued and outstanding at end of year..................................................... 517 51,143 511

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

ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year.............................................................. 611,434 568,054

Issuance of common stock for employee benefits............................................ 5,518 1,206

Tax benefit of stock options exercised.................................................... 1,741 99

Conversion of 6 1/2% Convertible Subordinated Debentures due 2003......................... 1,109 --

Consideration recorded for the fair value of warrants issued in connection with
acquisitions............................................................................ 191 --

Adjustment to market value of common stock held by the Grantor Stock Trust................ 19,644 3,445

Issuance of common stock in connection with the establishment of the Grantor Stock Trust.. -- 37,670

Common stock issued in connection with acquisitions....................................... -- 960

Common stock issued in connection with immaterial poolings................................ -- --

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

Additional paid-in capital at end of year................................................. 639,637 611,434

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

RETAINED EARNINGS
Balance at beginning of year.............................................................. 22,313 777

Net earnings (losses)..................................................................... 34,801 21,536

Common stock issued in connection with immaterial poolings................................ -- --

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

Retained earnings at end of year.......................................................... 57,114 22,313

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

ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of year.............................................................. 3,718 (268)

Foreign currency translation adjustment, net of tax....................................... (1,952) 3,986

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

Accumulated other comprehensive income at end of year..................................... 1,766 3,718

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

Total..................................................................................... 699,034 51,143 637,976

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

UNEARNED COMPENSATION
Balance at beginning of year.............................................................. -- --

Issuance of shares of restricted common stock............................................. (17,458) --

Amortization of stock issued under restricted stock option plan........................... 3,255 --

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

Unearned compensation at end of year...................................................... (14,203) --

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

COMMON STOCK IN TREASURY
Balance at beginning of year.............................................................. (25,069) --

Acquired at cost.......................................................................... (505) (25,069)

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

Common stock in treasury at end of year................................................... (25,574) (25,069)

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

GRANTOR STOCK TRUST
Balance at beginning of year.............................................................. (40,770) --

Issuance of common stock in connection with establishment of the Grantor Stock Trust...... -- (37,700)

Issuance of common stock from the Grantor Stock Trust..................................... 752 375

Issuance of shares of restricted common stock............................................. 17,458 --

Adjustment to market value of common stock held by the Grantor Stock Trust................ (19,644) (3,445)

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

Grantor stock trust at end of year........................................................ (42,204) (40,770)

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

Total stockholders' equity................................................................ $ 617,053 51,143 $ 572,137

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

</TABLE>

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

F-5
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

(IN THOUSANDS)

<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (losses)............................................................... $ (753,693) $ 34,801 $ 21,536
Adjustments to reconcile net earnings (losses) to net cash (used for) provided by
operating activities--
Extraordinary loss................................................................ 10,274 29,743 --
Loss on sale of assets............................................................ 206,205 7,000 --
Impairment loss................................................................... 397,492 -- --
Litigation settlement............................................................. -- -- (4,750)
Depreciation and amortization..................................................... 102,515 56,630 33,817
Provision for losses on accounts receivable....................................... 83,083 15,839 14,970
Other, net........................................................................ 9,068 3,312 (2,032)
Changes in operating assets and liabilities:
Accounts receivable............................................................. (61,679) (164,966) (57,059)
Other current assets............................................................ (19,557) (6,323) (6,696)
Other current liabilities....................................................... (41,530) 24,228 3,262
Income taxes payable............................................................ 22,242 21,469 23,764
----------- ------------ -----------
Net cash (used for) provided by operating activities............................ (45,580) 21,733 26,812
----------- ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net........................................................... (160,416) (103,162) (76,223)
Acquisitions, net of cash acquired.................................................. (60,641) (564,134) (75,579)
Purchase of minority interest in OmniCell Technologies, Inc......................... -- -- (25,332)
Net proceeds from sale of SunSurgery Corporation.................................... -- -- 24,828
Expenditures from operations and sale of assets held for sale....................... -- -- (3,810)
Proceeds from sale and leaseback of property and equipment.......................... 134,375 80,457 34,603
Increase in long-term note receivables.............................................. (5,977) (57,431) (8,665)
Decrease (increase) in other assets................................................. 6,794 (35,851) (12,011)
----------- ------------ -----------
Net cash used for investing activities.......................................... (85,865) (680,121) (142,189)
----------- ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings........................................................... 248,818 1,837,062 137,155
Long-term debt repayments........................................................... (438,607) (966,024) (4,273)
Repurchase of 12.25% Junior Subordinated Notes and 9.875% Senior Subordinated
Notes............................................................................. -- (182,070) --
Net proceeds from issuance of convertible trust issued preferred securities of
subsidiary........................................................................ 334,044 -- --
Net proceeds from issuance of common stock.......................................... 2,337 6,275 1,582
Purchases of treasury stock......................................................... (1,393) (505) (25,069)
Other financing activities.......................................................... (8,151) (33,411) (1,776)
----------- ------------ -----------
Net cash provided by financing activities....................................... 137,048 661,327 107,619
----------- ------------ -----------
Effect of exchange rate on cash and cash equivalents.................................. 881 3,201 (464)
----------- ------------ -----------
Net increase (decrease) in cash and cash equivalents.................................. 6,484 6,140 (8,222)
Cash and cash equivalents at beginning of year........................................ 21,020 14,880 23,102
----------- ------------ -----------
Cash and cash equivalents at end of year.............................................. $ 27,504 $ 21,020 $ 14,880
----------- ------------ -----------
----------- ------------ -----------
</TABLE>

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

F-6
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1998

(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES

(a) NATURE OF BUSINESS

Sun Healthcare Group, Inc., a Delaware corporation, through its direct and
indirect subsidiaries (hereinafter collectively referred to as "Sun" or the
"Company"), is a provider of long-term, subacute and related specialty
healthcare services, including rehabilitation and respiratory therapy services
and pharmaceutical and medical supply services. Long-term and subacute care and
outpatient therapy services are provided through Company-operated facilities.
Therapy services and pharmaceutical and medical supply services are provided
both in Company-operated and in other nonaffiliated facilities located in the
United States. The Company also provides long-term care services in the United
Kingdom, Spain and Germany, acute care services in Australia and pharmaceutical
services in the United Kingdom and Spain.

(b) PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and its greater than 50% owned subsidiaries. Investments in affiliates, in which
the Company owns 20% to 50%, are carried on the equity method. Investments in
companies owned less than 20% are carried at cost. All significant intercompany
accounts and transactions have been eliminated in consolidation.

The Company considers all highly liquid, unrestricted investments with
original maturities of three months or less to be cash equivalents. Cash
equivalents are stated at cost.

(d) NET REVENUES

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

The Company has submitted to the Health Care Financing Administration
("HCFA") various requests for exceptions to the Medicare established routine
cost limitations for reimbursement ("RCLs"). These exceptions are permitted
under the Medicare regulations to allow providers to be reimbursed for the cost
of treating higher acuity patients. Included in net revenues are amounts related
to exceptions to the RCLs of $30.9 million, $16.6 million and $12.3 million for
the years ended December 31, 1998, 1997 and 1996, respectively. These amounts
are net of adjustments to record management's estimate, based on its prior
experience with the Medicare program's regulations and the Company's records of
service provided, of amounts that will ultimately be approved by HCFA. Accounts
receivable include requests for exceptions to the RCLs of $41.0 million, and
$28.8 million at December 31, 1998 and 1997, respectively. Amounts realizable
are subject to final settlement of the respective cost reports. Differences
between the net

F-7
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(CONTINUED)
amounts accrued and subsequent settlements or estimates of expected settlements
are recorded in operations at the time of settlement.

(e) ACCOUNTS RECEIVABLE

The Company's accounts receivable relate to services provided by its various
operating divisions to a variety of payors and customers. The primary payors for
services provided in long-term and subacute care facilities that the Company
operates in the United States are the Medicare program and the various Medicaid
programs. The rehabilitation and respiratory therapy service operations in the
United States provides services to patients in unaffiliated long-term,
rehabilitation and acute care facilities. The billings for those services are
submitted to the unaffiliated facilities. Many of the unaffiliated long-term
care facilities receive a large majority of their revenues from the Medicare
program and the state Medicaid programs. Because of the significant reduction in
average payments per patient day caused by Medicare's newly enacted Prospective
Payment System ("PPS"), the Company believes that it is reasonably possible that
its estimate of uncollectible accounts receivable from unaffiliated long-term
care facilities may increase over time.

Management does not believe that there are any credit risks associated with
receivables from governmental agencies. In certain instances, the collection of
amounts from healthcare providers for therapy services has slowed because
payment is primarily dependent upon such facilities' receipt of payment from
fiscal intermediaries. In addition, fiscal intermediaries of long-term care
facilities acquired by the Company are changed to the Company's fiscal
intermediary, resulting in temporary delays in timing of third-party payments.

(f) PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Major renewals or improvements
are capitalized, whereas ordinary maintenance and repairs are expensed as
incurred. Depreciation and amortization is computed using the straight-line
method over the estimated useful lives of the assets as follows: buildings and
improvements 5 to 40 years; leasehold improvements--the shorter of the estimated
useful lives of the assets or the life of the lease; equipment 3 to 20 years.

The Company capitalizes certain costs associated with developing and
acquiring healthcare facilities and related outpatient programs. Capitalized
costs include site investigation, negotiation, development, acquisition and
preconstruction costs; indirect and general expenses related to such activities
are expensed as incurred. Preconstruction costs include the direct costs of
securing control of the development site, obtaining the requisite certificate of
need and other approvals, as well as the direct costs of preparing for actual
development and construction. The capitalized costs are transferred to
construction in progress and depreciable asset categories as construction is
begun and completed, respectively. The Company capitalizes interest directly
related to the development and construction of new facilities as a cost of the
related asset.

F-8
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(CONTINUED)
(g) GOODWILL

The excess of the purchase price over the fair value of the net assets of
the businesses acquired by the Company is amortized using the straight-line
method over periods ranging from 20 to 40 years. Accumulated amortization of
such costs was $82.4 million and $47.9 million as of December 31, 1998 and 1997
respectively.

(h) IMPAIRMENT OF LONG-LIVED ASSETS

The Company periodically evaluates the carrying value of goodwill along with
any other related long-lived assets in relation to the future undiscounted cash
flows of the underlying businesses to assess recoverability in accordance with
Statement of Financial Accounting Standards No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
("SFAS 121"). Under SFAS 121, an impairment loss is recognized if the sum of the
expected cash flows is less than the carrying amount of the goodwill and other
assets being evaluated. The difference between the carrying amount of the
goodwill and other assets being evaluated and the estimated fair market value of
the assets represents the impairment loss. The Company determines estimated fair
value for the long-lived assets based on anticipated future cash flows
discounted at rates commensurate with the risks involved.

(i) OTHER ASSETS

Costs incurred in obtaining debt financing are amortized as interest expense
over the terms of the related indebtedness. The accumulated amortization of
capitalized debt financing costs was $4.4 million and $1.0 million as of
December 31, 1998 and 1997, respectively. The Company amortizes preopening costs
(start-up costs related to new facilities, specialty units within a facility,
new rehabilitation regions and pharmacies) over a period ranging from one year
(for costs not reimbursed by third-party payors) to five years (for costs
reimbursed by third-party payors, including the Medicare and Medicaid programs).

(j) ACCRUED SELF-INSURANCE OBLIGATIONS

It is the policy of the Company to self-insure for certain insurable risks
including general and professional liability, workers' compensation, and
employee health benefits through the use of self-insurance or retrospective and
high deductible insurance policies and other hybrid policies which vary by the
states in which the Company operates. Provisions for estimated settlements,
including incurred but not reported losses, are provided in the period of the
related coverage. These provisions are based on internal evaluations of the
merits of individual claims and the reserves assigned by the Company's
independent insurance carriers. The methods of making such estimates and
establishing the resulting accrued liabilities are reviewed frequently, and any
adjustments resulting therefrom are reflected in current earnings. During 1998
the Company increased the accrued self-insurance obligations by $10.0 million
primarily related to unfavorable loss development experience for incidents prior
to 1998. Claims are paid over varying periods, which generally range from one to
five years. Accrued liabilities for future claims are not discounted.

F-9
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(CONTINUED)
(k) SOFTWARE DEVELOPMENT COSTS

The Company, through a subsidiary, is internally developing software that it
plans to use in its operations and to market to unaffiliated long-term care
providers. All costs incurred related to the development of the software have
been expensed. Once the Company concludes that technological feasibility is
established, all subsequent development costs will be capitalized and reported
at the lower of unamortized cost or net realizable value. Software development
costs are included in operating expenses in the accompanying consolidated
statement of earnings (losses).

(l) INCOME TAXES

Income tax expense is based on reported earnings before income taxes.
Deferred income taxes reflect the impact of temporary differences between the
amount of assets and liabilities recognized for financial reporting purposes and
such amounts recognized for tax purposes. A valuation allowance is recognized if
it is anticipated that some or all of a deferred tax asset may not be realized.

(m) FOREIGN CURRENCY TRANSLATION ADJUSTMENT

The financial position and results of operations of the Company's foreign
subsidiaries are measured using local currency as the functional currency.
Assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each year end. Statement of earnings (losses) accounts are
translated at the average rate of exchange prevailing during the year.
Translation adjustments arising from differences in exchange rates from period
to period are included in accumulated other comprehensive income.

(n) STOCK-BASED COMPENSATION

The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Accordingly,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of the grant over the
amount an employee must pay to acquire the stock. Statement of Financial
Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS
123") was issued in 1995 and the Company has adopted the disclosure requirements
of SFAS 123 (see Note 13).

(o) NET EARNINGS (LOSSES) PER SHARE

Basic net earnings (losses) per share is based upon the weighted average
number of common shares outstanding during the period.

Diluted net earnings per share in periods of earnings is based upon the
weighted average number of common shares outstanding during the period plus the
number of incremental shares of common stock contingently issuable upon exercise
of stock options and, if dilutive, including the assumption that the Company's
convertible securities were converted as of the beginning of the period. Net
earnings, if conversion of the securities is assumed, is adjusted for the
interest on the debentures, 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 earnings (losses) per share is based upon the weighted average number of
common shares outstanding during the period.

F-10
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(CONTINUED)
The Company's convertible securities are described in Note 7. These securities
were not dilutive for the year ended December 31, 1998, but may be dilutive in
future periods. See Note 14 for calculation of earnings per share data for the
years ended December 31, 1998, 1997 and 1996.

The Company adopted Statement of Financial Accounting Standards No. 128
"Earnings per Share" ("SFAS 128") in 1997. All prior period earnings per common
share data have been restated to conform to the provisions of this statement.

(p) ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS

In the first quarter of 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
Comprehensive income is defined as the change in equity of a business during a
period of transactions and other events and circumstances from non-owner
sources. Under SFAS 130, the term "comprehensive income" is used to describe the
total of net earnings plus other comprehensive income, which, for the Company,
includes foreign currency translation adjustments. The Company has presented
comprehensive income in the consolidated statements of stockholders' equity.

In 1998, the Company adopted SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards
for the method that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers.

(q) NEWLY ISSUED ACCOUNTING PRONOUNCEMENTS

In 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-up
Activities". This statement requires costs of start-up activities and
organization costs to be expensed as incurred. The statement is effective for
financial statements for fiscal years beginning after December 15, 1998. In the
first quarter of 1999, the Company will adopt the provisions of SOP 98-5 which
will result in a cumulative effect of an accounting change pretax charge of
approximately $13.2 million.

In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities." Under SFAS 133,
which will be effective January 1, 2000, all derivatives are required to be
recognized on the balance sheet at fair value. Gains or losses from changes in
fair value would be recognized in earnings in the period of change unless the
derivative is designated as a hedging instrument. The Company is studying the
impact of the new standard and is unable to predict at this time the impact on
its consolidated financial statements.

(r) FINANCIAL STATEMENT PREPARATION AND PRESENTATION

The preparation of financial statements in conformity with generally
accepted accounting principles 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

F-11
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(1) SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES
(CONTINUED)
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.

Certain amounts in the 1997 and 1996 consolidated financial statements and
notes have been reclassified to conform to the 1998 presentation.

(2) NON-COMPLIANCE WITH SENIOR CREDIT FACILITY'S FINANCIAL COVENANTS AND
LIQUIDITY

The Company has incurred net losses of $753.7 million in 1998 and is in
non-compliance with certain financial covenants contained in the Senior Credit
Facility and certain Mortgage Notes as of December 31, 1998 (see Note 7). In
addition, no further amounts can be borrowed under the Senior Credit Facility.
The 1998 losses primarily occurred in the fourth quarter of 1998 and are
principally related to the write-down of long-lived assets (see Note 6),
write-down of assets held for sale (see Note 6) and the increase of the
valuation allowance on deferred tax assets (see Note 9). In the fourth quarter
of 1998, the Company experienced a loss from operations after excluding the
charges described above.

Management believes that the primary cause of the 1998 loss is the skilled
nursing industry's transition to Medicare's Prospective Payment System ("PPS").
Under PPS, Medicare pays a fixed fee per patient day based on the acuity level
of the patient to cover all post-hospital extended care routine service costs
(i.e. Medicare Part A patients). For all Medicare patients not receiving
post-hospital extended care services (i.e. Medicare Part B patients),
reimbursement for ancillary services, including rehabilitation services, are
made under fee schedules and are limited to certain per beneficiary caps. Prior
to PPS, Medicare reimbursement was made primarily based on the provider's cost
of services rendered with less extensive limitation. In the fourth quarter of
1998, a significant number of the ancillary divisions' customers reduced their
use of the Company's services in transitioning to PPS or in preparation for
their transition to PPS. The reduction in demand for ancillary services which
the Company actually experienced was greater than the reduction anticipated by
the Company. The adverse trend continued in the first quarter of 1999.

As of December 31, 1998, the Company did not meet the following financial
covenants contained in the Senior Credit Facility described below:

<TABLE>
<CAPTION>
DESCRIPTION COVENANT
- ---------------------------------------------------------------------------- ----------------
<S> <C>
Fixed Charge Coverage Ratio................................................. > 1.50 to 1
Leverage Ratio.............................................................. < 6.00 to 1
Minimum Net Worth........................................................... $672.1 million
Senior Debt to EBITDAR Ratio................................................ < 5.50 to 1
</TABLE>

The Company has held preliminary discussions with the Senior Credit Facility
Lenders ("Lenders") to obtain a waiver of the non-compliance with the financial
covenants at December 31, 1998. Further, the Company does not expect to be in
compliance with the financial covenants of the Senior Credit Facility during
1999 and its remaining term. The Company is attempting to negotiate an amendment
to the Senior Credit Facility's financial covenants so that the financial
covenants will be consistent with the Company's revised business plan. However,
as of April 19, 1999, no agreement to waive the non-compliance with the 1998
financial covenants or to amend the financial covenants had been reached.

F-12
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(2) NON-COMPLIANCE WITH SENIOR CREDIT FACILITY'S FINANCIAL COVENANTS AND
LIQUIDITY (CONTINUED)
Because the Company is in non-compliance with certain financial covenants
under the terms of the Senior Credit Facility, the Lenders could require
immediate repayment of all amounts outstanding under the Senior Credit Facility.
As a result, as of December 31, 1998, the Company has classified all borrowings
under the Senior Credit Facility as current liabilities in the accompanying
consolidated balance sheet. The Company does not have sufficient cash reserves
to repay all amounts outstanding under the Senior Credit Facility. No further
amounts may be borrowed under the Senior Credit Facility. Accordingly, the
Company will have to fund all operations, capital expenditures and regularly
scheduled debt service from existing cash reserves and future net cash flows
from operations, if any.

The Company is in default of certain Mortgage Notes amounting to $31.9
million at December 31, 1998, because the Company did not meet its debt service
coverage requirement of at least 1.25 to 1. The Company is attempting to obtain
a waiver of the non-compliance with the financial covenant and to amend certain
Mortgage Notes' financial covenants so that the financial covenants will be
consistent with the Company's revised business plan. However, as of April 19,
1999, no agreement to waive the non-compliance with the 1998 financial covenant
or to amend the financial covenants has been reached. Because the Company is in
non-compliance with the terms of certain Mortgage Notes, the creditor could
demand immediate repayment of all amounts due under the mortgages and foreclose
on four facilities. Such amounts are classified as current liabilities as of
December 31, 1998.

If the Company is required to repay the amounts outstanding under the Senior
Credit Facility and certain Mortgage Notes, or is unable to fund all operations,
capital expenditures and regularly scheduled debt service, it will explore a
variety of options, including seeking relief under the United States Bankruptcy
Code.

The Company also has other debt arrangements that provide that a default on
any mortgage indenture or instrument which results in the acceleration of
repayment or default in payment of obligations from $0.1 million to in excess of
$20.0 million depending on the terms of the agreement, would allow the creditor
to demand immediate repayment. No acceleration of repayment has occurred and
therefore such borrowings which total $520.9 million are classified as long-term
liabilities as of December 31, 1998. The specific default events which could
trigger the acceleration of payment provisions in certain debt arrangements are
explained in Note 7 to these financial statements.

As of December 31, 1998, the Company was in non-compliance with certain
financial covenants contained in certain master lease agreements for 96 of its
long-term care facilities in the United States and 33 of its long-term care
facilities in the United Kingdom. The Company was also in cross default for 14
of its long-term care facilities in the United States. As a result, the lessors
under the master lease agreements have certain rights, including the right to
require that the Company relinquish the leased facilities. As of April 19, 1999,
the lessors had not exercised their rights under their respective agreements,
although there can be no assurance that the lessors will not do so in the
future. The aggregate net book value of properties subject to potential eviction
amounted to $54.8 million at December 31, 1998. The Company has a substantial
number of other leases which may contain similar default or cross default
provisions.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The matters discussed above raise
substantial doubt about the Company's ability to continue as a going concern.
The financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts (including property
and equipment of

F-13
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(2) NON-COMPLIANCE WITH SENIOR CREDIT FACILITY'S FINANCIAL COVENANTS AND
LIQUIDITY (CONTINUED)
$601.3 million and goodwill of $795.9 million) or the amount and classification
of liabilities that might result should the Company be unable to continue as a
going concern.

In response to the significant losses experienced in the fourth quarter of
1998, the Company has developed an operational and financial recovery plan that
is intended to restore the Company's profitability in the new operating
environment under PPS. The Company's four-part recovery plan is as follows:

--COMPANY-WIDE REDUCTIONS IN OPERATING EXPENSES. During the fourth quarter
of 1998 and the first quarter of 1999, Sun initiated company-wide reductions in
operating expenses. The operating expense reductions are being achieved
primarily through the elimination of personnel and the consolidation or
elimination of regional and divisional operating units. On January 1, 1999,
management also instituted a company-wide wage freeze and a reduction in certain
personnel benefits packages.

--THE DIVESTITURE OF NON-CORE ASSETS AND THE REDUCTION OF OUTSTANDING
DEBT. The Company has targeted for sale several non-core assets to provide for
the reduction of the Company's debt (see Note 6).

--NEW OPERATING STRATEGIES AND EFFICIENCIES FOR THE DELIVERY OF INPATIENT
AND THERAPY SERVICES. In response to the impact of PPS and the significant
decline in the demand for therapy services, the Company has reduced facility
staffing levels within the bounds of regulatory requirements, changed the
compensation for therapists from a salaried base to hourly pay, and cancelled
approximately 75 unprofitable therapy contracts. The Company has also reviewed
its case management system to assure that the proper level of ancillary services
is provided to all patients.

--PROACTIVE GOVERNMENT RELATIONS FOCUSED ON IMPROVING MEDICARE AND MEDICAID
REIMBURSEMENT. Since the fourth quarter of 1998, the Company has proactively
engaged state and Federal government officials, and is spearheading
industry-wide efforts, to achieve improved Medicare and Medicaid reimbursement
rates. In close cooperation with the New Mexico Congressional delegation, and in
several key states around the country, Company officials are actively proposing
legislative and administrative solutions to the financial crisis now engulfing
the long-term care industry.

The Company believes that its existing cash reserves and the successful
execution of its operational and financial recovery plan should provide
sufficient cash for its operations, capital expenditures and regularly scheduled
debt service throughout fiscal 1999. The projected cash balance during 1999
would not be adequate if the Company were required to repay the balance
outstanding under the Senior Credit Facility or certain Mortgage Notes. No
assurance can be given that management's actions, individually or collectively,
will be adequate to provide sufficient cash for operations, capital expenditures
and regularly scheduled debt service. Further, no assurance can be given that
the Company will be successful in negotiating waivers and amendments to the
Senior Credit Facility and certain Mortgage Notes or that the Company will be
able to meet any amended financial covenants prospectively.

(3) ACQUISITIONS

On June 30, 1998, the Company acquired Retirement Care Associates, Inc.
("RCA") and approximately 35% of the common stock of Contour Medical, Inc.
("Contour"), collectively referred to as the RCA Acquisition. RCA was an
operator of skilled nursing facilities and assisted living centers in eight
states, primarily in the southeastern United States. Contour was a national
provider of medical and surgical supplies. RCA owned approximately 65% of
Contour prior to the RCA Acquisition. The Company

F-14
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(3) ACQUISITIONS (CONTINUED)
issued approximately 7.6 million shares of its common stock valued at $122.0
million (based upon the average closing price of the Company's common stock for
20 business days prior to the acquisition closing date) for all outstanding
common stock and certain redeemable preferred shares of RCA. In addition, the
Company issued approximately 1.9 million shares of its common stock valued at
$27.6 million for the minority interest in Contour's common stock. The Company
also issued 298,334 shares of its Series B Convertible preferred stock, which
were subsequently converted into 287,892 shares of Sun common stock, in exchange
for the outstanding shares of RCA's Series F preferred stock. The Company
assumed approximately $170.4 million of RCA indebtedness.

At June 30, 1998, the Company accounted for the RCA Acquisition as a pooling
of interests. On April 5, 1999, the Company determined that the RCA Acquisition
should be accounted for as a purchase. The basis for the determination was the
Company's recent decision to dispose of several non-core businesses.
Accordingly, the RCA Acquisition was accounted for as a purchase and resulted in
$234.7 million of goodwill. The results of operations of RCA and Contour have
been included in the consolidated statements of earnings (losses) from the
acquisition date. In connection with the purchase, the Company recorded purchase
liabilities including approximately $2.5 million for severance and related costs
and $1.4 million for costs associated with the shut down of certain
administrative facilities. The allocation of the RCA Acquisition purchase price
is preliminary and will be finalized upon the completion of long-lived asset
valuations. In addition, the Company is still evaluating certain obligations of
RCA prior to the acquisition and further adjustments to the preliminary purchase
price allocation may result.

In October 1997, the Company acquired the capital stock of Regency Health
Services, Inc. ("Regency"), an operator of skilled nursing facilities and a
provider of related specialty healthcare services, including rehabilitation
therapy, pharmacy and home health services in the United States (the "Regency
Acquisition"). The Regency Acquisition was accounted for as a purchase and the
operating results of Regency have been included in the consolidated statements
of earnings (losses) from the date of acquisition. Total consideration for the
shares acquired was approximately $367.2 million. The total fair value of
Regency's assets acquired, including goodwill of approximately $412.2 million,
was approximately $736.6 million, and liabilities assumed totaled approximately
$354.7 million. In connection with the purchase, the Company recorded purchase
liabilities including approximately $11.2 million for severance and related
costs and $2.0 million for costs associated with the shut down of certain
acquired pharmacies and home health service agencies that have been consolidated
with the Company's existing facilities.

On October 9, 1997, the Company completed a tender offer for 100%, or $50.0
million, of Regency's 12.25% Junior Subordinated Notes due 2003 for
approximately $60.1 million plus accrued interest, and $109.6 million of the
$110.0 million of Regency's 9.875% Senior Subordinated Notes due 2002 for
approximately $122.0 million plus accrued interest. As a result of the
repurchase of this debt, the Company recorded an extraordinary loss of $17.9
million, net of the related tax benefit, in the fourth quarter of 1997. The
Company repaid Regency's revolving credit facility of approximately $39.0
million. The extinguishment of certain Regency debt during the fourth quarter of
1997 resulted in an increase in certain reimbursable costs from Medicare. As a
result, the Company recognized $4.0 million of revenues from Medicare during
1997.

The tender offer for Regency's debt, described above, was financed by
borrowings under the Company's Senior Credit Facility and approximately $83.6
million of net proceeds received from the sale and leaseback of 30 facilities
owned by Regency prior to its acquisition by the Company.

F-15
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(3) ACQUISITIONS (CONTINUED)
The following unaudited proforma results assumes that the RCA Acquisition
and the Regency Acquisition occurred as of January 1, 1997 and include their
results of operations for the years ended December 31, 1998 and 1997 (in
thousands, except per share data):

<TABLE>
<CAPTION>
1997
1998 ------------
------------ UNAUDITED
UNAUDITED
<S> <C> <C>
Net revenues...................................................... $ 3,226,853 $ 2,761,531
Net (losses) before extraordinary items........................... (777,332) (27,232)
Net (losses)...................................................... (787,605) (47,325)

Per Share Data:
Net (losses) per share before extraordinary items................. $ (14.95) $ (0.51)

Net (losses) per share............................................ $ (15.14) $ (0.88)
</TABLE>

In addition, during 1998, the Company acquired from various third parties
the net ownership of, leasehold rights to, or the management contracts of, two
long-term care facilities in the United States and 15 long-term care facilities
in the United Kingdom. Also, during the year ended December 31, 1998, the
Company acquired nine pharmacies in the United States.

On January 30, 1997, the Company acquired all of the capital stock not
previously owned by the Company of Ashbourne PLC ("Ashbourne") which as of the
date of acquisition provided healthcare services to patients through 49 nursing
facilities in the United Kingdom. Pursuant to the acquisition, the Company paid
approximately L67.3 million ($110.1 million as of the respective dates of
payment) for the portion of Ashbourne totaling 70.8% not previously owned by the
Company. The Company had previously acquired a 9% minority interest for $10.2
million in 1996 and a 20% minority interest for $25.9 million in 1995. The
acquisition was accounted for as a purchase and Ashbourne's results of
operations have been included in the Company's financial statements from the
date of acquisition. The total fair value of 100% of Ashbourne's assets
acquired, including goodwill of approximately $61.3 million, was approximately
$300.0 million and liabilities assumed totaled approximately $147.7 million.

In July 1997, the Company acquired a majority interest in Eurosar, S.A.
("Eurosar"), a privately owned operator of eight nursing homes in Spain. In
August 1997, the Company acquired 38% of the equity of Alpha Healthcare Limited,
a publicly held acute care provider in Australia. In addition, in November 1997,
Sun acquired from Moran Healthcare Group Pty Ltd. ("Moran") a majority interest
in six hospitals in Australia. In December 1997, the Company acquired a majority
interest in Heim-Plan Unternehmensgruppe ("Heim-Plan"), an operator of 11
nursing homes in Germany.

In December 1996, the Company acquired all of the capital stock of APTA
Healthcare PLC ("APTA"), which provided healthcare services to patients through
32 nursing facilities in the United Kingdom. The Company paid cash totaling
approximately L11.3 million ($19.3 million as of the respective dates of
payment) to former stockholders of APTA and issued notes with a maturity not to
exceed five years, totaling approximately L2.5 million ($4.0 million) to the
remaining stockholders of APTA who elected not to receive cash as consideration.
The fair market value of assets acquired, including goodwill of $17.9 million,
was $72.7 million and liabilities assumed totaled $49.2 million. Also in 1996,
the Company purchased a 9.9% investment in OmniCell Technologies, Inc.
("OmniCell") for $25.3 million.

F-16
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(3) ACQUISITIONS (CONTINUED)
The effects of the Company's acquisitions during 1998 and 1997, excluding
the RCA Acquisition and the Regency Acquisition, individually and in the
aggregate, are immaterial to the results of the Company and, therefore, pro
forma information is not provided.

(4) PROPERTY AND EQUIPMENT

Property and equipment consists of the following as of December 31 (in
thousands):

<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Land.................................................................. $ 44,524 $ 56,998
Buildings and improvements............................................ 263,145 302,814
Leasehold improvements................................................ 68,037 64,826
Equipment............................................................. 126,358 136,428
Construction in progress.............................................. 30,449 45,314
Assets held under capital leases...................................... 109,207 79,227
---------- ----------
Total............................................................. 641,720 685,607
Less accumulated depreciation......................................... (29,130) (49,297)
Less accumulated amortization on assets held under capital leases..... (11,320) (5,208)
---------- ----------
Property and equipment, net....................................... $ 601,270 $ 631,102
---------- ----------
---------- ----------
</TABLE>

Amortization of assets held under capital lease agreements of $6.1 million
in 1998 and $4.4 million in 1997 is recorded in depreciation and amortization
expense.

During 1998, the Company sold seven of its long-term care facilities in the
United Kingdom and land for approximately $117.9 million in cash. Five of the
long-term care facilities were leased back to the Company under operating leases
with lease terms ranging from 11 to 20 years.

In 1997, the Company sold five of its long-term and subacute care facilities
in the United States for approximately $31.2 million in cash and approximately
$5.6 million in assumption of debt and leased them back under fourteen year
leases. Also in 1997, the Company sold 27 of its long-term care facilities in
the United Kingdom for approximately $49.3 million and leased them back under
twelve-year leases.

During 1996, the Company sold three of its long-term and subacute care
facilities for $11.9 million including the assumption of debt totaling $3.2
million and leased them back under fifteen year leases. Also during 1996, the
Company sold ten of its long-term care facilities in the United Kingdom for
$25.8 million and leased them back under twelve year leases.

F-17
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(5) RESTRUCTURING COSTS

In the fourth quarter of 1998, the Company initiated a restructuring plan
focused primarily on reducing the operating expenses of its United States
operations. Related to the restructuring plan, the Company recorded a 1998
fourth quarter charge of approximately $4.6 million. The restructuring plan
includes the termination of 2,700, or 6% of its inpatient service employees;
4,600, or 36%, of its rehabilitation and respiratory therapy services employees;
and 190, or 13%, of its corporate employees including certain executive
positions. The restructuring plan also included the closure of approximately 70
divisional and regional offices related to the aforementioned operations. As of
December 31, 1998, the Company had terminated 1,440 employees, and paid
approximately $1.3 million and $0.1 million in termination benefits and lease
termination costs, respectively, under the restructuring plan. The restructuring
costs during 1998 consists of appproximately $3.7 million related to employee
terminations and approximately $0.9 million related to lease termination costs.
As of December 31, 1998, the Company's restructuring costs reserve balance was
approximately $3.1 million.

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

(a) IMPAIRMENT OF LONG-LIVED ASSETS

SFAS 121 requires impairment losses to be recognized for long-lived assets
used in operations when indications of impairment are present and the estimate
of undiscounted future cash flows is not sufficient to recover asset carrying
amounts. SFAS 121 also requires that long-lived assets held for disposal be
carried at the lower of carrying value or fair value less costs of disposal,
once management has committed to a plan of disposal.

The Balanced Budget Act of 1997 established, among other things, a new
Medicare PPS for skilled nursing facilities. PPS became effective for the
Company's facilities acquired from RCA on July 1, 1998, and for the Company's
remaining facilities on January 1, 1999. The Company's revenues from its
Inpatient Services Division, Rehabilitation and Respiratory Therapy Services
Division and Pharmaceutical and Medical Supply Services Division will be
adversely impacted by the amount of the Federally established reimbursement
rates. In addition, the implementation of PPS has resulted in a greater than
expected decline in the demand for the Company's therapy services and
pharmaceutical services. In the fourth quarter of 1998, management determined
that these reductions are expected to have a material adverse impact on net
revenues in 1999 and the decline is other than temporary. This served as an
indication to management that the carrying values of assets of its Inpatient
Services Division, Rehabilitation and Respiratory Therapy Services Division and
its Pharmaceutical and Medical Supply Services Division, may be impaired.

In accordance with SFAS 121, management estimated the undiscounted net cash
flows for each of its facilities and its ancillary services lines of business
and compared the sum of those undiscounted net cash flows to the Company's
investment in that facility or business unit. If the sum of the estimated future
undiscounted net cash flows was less than the Company's investment, the Company
reduced the carrying value of the underlying assets to their estimated fair
values.

The Inpatient Services Division, which operates long-term care facilities,
recognized an impairment related to 147 of the 397 facilities it owns or
operates in the United States. The impairment was caused primarily by the
decrease in projected Medicare reimbursement under PPS.

F-18
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(6) IMPAIRMENT OF LONG-LIVED ASSETS AND ASSETS HELD FOR SALE (CONTINUED)
The Rehabilitation and Respiratory Therapy Services Division's write-down
was caused by the projected decrease in demand and market rates for contract
therapy services as unaffiliated long-term care facility operators shift to
on-staff therapists to reduce costs in response to PPS.

The Pharmaceutical and Medical Supply Services Division, which distributes
pharmaceuticals, nutrition products and medical supplies to long-term care
facilities, recorded a write-down at two of its 37 pharmacies due to the reduced
demand for certain products.

Certain of the United Kingdom facilities have not achieved the operating
profitability targets established when they were acquired; most were acquired
from Ashbourne in January 1997. The Company recognized an impairment related to
55 of the 186 facilities owned and operated in the United Kingdom.

The following is a summary of the impairment loss by division for the year
ended December 31, 1998 (in thousands):

<TABLE>
<CAPTION>
PROPERTY
AND OTHER
GOODWILL EQUIPMENT ASSETS TOTAL
---------- ----------- --------- ----------
<S> <C> <C> <C> <C>
Inpatient Services............................ $ 223,241 $ 55,736 $ 14,168 $ 293,145
Rehabilitation and Respiratory Therapy........ 36,734 60 4,216 41,010
Pharmaceuticals and Medical Supply Services... 2,784 233 31 3,048
International Operations...................... 26,520 10,151 -- 36,671
Other Operations.............................. 23,590 28 -- 23,618
---------- ----------- --------- ----------
$ 312,869 $ 66,208 $ 18,415 $ 397,492
---------- ----------- --------- ----------
---------- ----------- --------- ----------
</TABLE>

(b) ASSETS HELD FOR SALE

Subsequent to December 31, 1998, the Company decided to dispose of several
non-core businesses, including assisted living facilites, rehabilitation
hospitals and other in-patient facilities and other non-core businesses. The
Company recorded a loss of $161.6 million in the fourth quarter of 1998 to
reduce the carrying amount of the non-core businesses identified for disposal to
fair value based on estimates of selling value less costs to sell. The following
is a summary of the carrying amounts and loss related to the non-core businesses
to be disposed of as of December 31, 1998 (in thousands):

<TABLE>
<CAPTION>
CARRYING
AMOUNT LOSS
---------- ----------
<S> <C> <C>
Assisted living facilities............................................ $ 117,298 $ 97,298
Rehabilitation hospitals and other inpatient facilities............... 98,911 62,911
Other non-core businesses............................................. 27,621 1,419
---------- ----------
Total............................................................... $ 243,830 $ 161,628
---------- ----------
---------- ----------
</TABLE>

Management expects to complete the sales of these businesses during 1999.

F-19
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(6) IMPAIRMENT OF LONG-LIVED ASSETS AND ASSETS HELD FOR SALE (CONTINUED)
During 1998, certain leases were not renewed. In connection with these lease
terminations, the Company recorded a loss of $25.6 million related primarily to
the carrying amount of building improvements, equipment and goodwill related to
the facilities. The results of operations of these facilities is not material.

In May 1997, the Company announced its intent to sell and divest of its
outpatient rehabilitation clinics in the United States, as well as Canada. The
carrying amount of the assets held for sale was $11.6 million and $22.5 million
as of December 31, 1998 and 1997, respectively. The Company completed the sales
of the United States rehabilitation clinics and a portion of the Canadian
clinics during 1998. The remaining Canadian clinics were sold in March 1999. The
Company recorded a loss of $11.4 million and $7.0 million during 1998 and 1997,
respectively, in order to reduce the carrying value of the Canadian operations
to fair value based on revised estimates of selling value less costs to sell.
The results of operations of these businesses is not material.

In the second quarter of 1998, the Company recognized a $5.4 million loss in
connection with the anticipated sale of five nursing homes, and for certain
adjustments paid to the purchaser of three nursing homes sold in 1996. The
Company expects to complete the sale of those five nursing homes in 1999.

In the third quarter of 1998, the Company contributed assets from its
Rehabilitation and Respiratory Therapy Services Division in exchange for an
equity interest in a provider of physician services to long term care
facilities. The Company recognized a $2.2 million loss on the disposal. The
Company accounts for equity interest using the cost method.

F-20
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(7) LONG-TERM DEBT

Long-term debt consists of the following as of December 31 (dollars in
thousands):

<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Revolving Credit Facility (see below)................................................. $ 360,100 $ 275,075
Credit Facility Term Loans (see below)................................................ 385,473 700,000
RCA Line of Credit (see below)........................................................ 15,000 --
Senior Subordinated Notes due 2008.................................................... 150,000 --
Senior Subordinated Notes due 2007.................................................... 250,000 250,000
Convertible Subordinated Debentures due 2004, interest at 6% per annum................ 83,300 83,300
Convertible Subordinated Debentures due 2003, interest at 6 1/2% per annum, includes
unamortized premium of $1,899 and $2,314 as of December 31, 1998 and 1997,
respectively........................................................................ 22,564 23,029
Senior Subordinated Notes due 2002, interest at 11 3/4% per annum, includes
unamortized premium of $96 and $122 as of December 31, 1998 and 1997,
respectively........................................................................ 6,257 6,283
Mortgage notes payable due at various dates through 2005, interest at rates from 8.5%
to 11.0%, collateralized by various facilities...................................... 40,041 42,756
Mortgage notes payable in Spanish pesetas and due at various dates through 2017,
interest at rates from 5.6% to 13.3%, collateralized by various facilities in
Spain............................................................................... 16,268 13,498
Mortgage notes payable in pound sterling and due at various dates in 2015 and 2016,
interest at rates from 9.5% to 11.5% per annum, collateralized by various facilities
in the United Kingdom............................................................... 5,227 8,904
Mortgage notes payable in German marks and due at various dates through 2022, interest
at rates from 6.3% to 6.8%, collateralized by various facilities in Germany......... 8,148 7,778
Revolving lines of credit with a bank due at various dates through 2001, payable in
pound sterling, interest rates of 7.4% and variable rates from 1.0% to 1.8% over the
FHBR rate ("Finance House Base Rate"), collateralized by the assets of various
facilities.......................................................................... 4,899 90,473
Industrial Revenue Bonds.............................................................. 83,919 2,529
Other long-term debt.................................................................. 87,078 42,053
------------ ------------
Total long-term debt.................................................................. 1,518,274 1,545,678
Less amounts due within one year...................................................... (50,378) (56,817)
Less amounts in non-compliance classified as current.................................. (762,243) --
------------ ------------
Long-term debt, net of current portion................................................ $ 705,653 $ 1,488,861
------------ ------------
------------ ------------
</TABLE>

F-21
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(7) LONG-TERM DEBT (CONTINUED)
Annual scheduled maturities for the next five years as of December 31, 1998
assuming that debt in non-compliance is remedied are as follows (in thousands):

<TABLE>
<S> <C>
1999.................................... $ 50,378
2000.................................... 32,312
2001.................................... 50,156
2002.................................... 48,223
2003.................................... 426,663
Thereafter.............................. 910,542
----------
$1,518,274
----------
----------
</TABLE>

In October 1997, the Company entered into a credit agreement with certain
lenders, certain co-agents, and NationsBank of Texas, N.A. as administrative
lender to replace the Company's prior revolving credit facility. On October 30,
1998, the Company entered into a fourth amendment to the credit agreement (the
"Senior Credit Facility"). The Senior Credit Facility initially provided for
borrowings by the Company of up to $1.2 billion consisting of $500 million in a
revolving credit facility which borrowings bear interest at the prevailing prime
rate plus 0% to 1% or the LIBOR rate plus 0.75% to 2.50%, and $700 million in
term loans which bear interest at the prevailing prime rate plus 0% to 1.5% or
the LIBOR rate plus 0.75% to 3.0%. LIBOR was 5.06% as of December 31, 1998. In
May 1998, the Company permanently reduced the Senior Credit Facility Term Loans
by $300.0 million with a portion of the net proceeds from the offerings of the
7% Convertible Trust Issued Preferred Securities (see Note 12) and the 9 3/8%
Notes. As a result of the paydown, the Company recorded an extraordinary loss of
$6.4 million, net of income tax benefit of $3.7 million. The revolving credit
facility matures in November 2003 and the term loans began amortization in March
1998 and will mature in November 2005. The Senior Credit Facility, among other
restrictions; (i) requires the Company to maintain certain financial ratios;
(ii) restricts the Company's ability to incur debt and liens, make investments,
liquidate or dispose of assets, merge with another corporation, create or
acquire subsidiaries, and make acquisitions; and (iii) prohibits the payment of
dividends, the acquisition of treasury stock and the prepayment or modification
of certain debts of the Company. At December 31, 1998, the Company did not meet
the following financial covenants contained in its Senior Credit Facility
described below:

<TABLE>
<CAPTION>
DESCRIPTION COVENANT
- -------------------------------------------------------------------------- ------------------
<S> <C>
greater than 1.50
Fixed Charge Coverage Ratio............................................... to 1
less than 6.00 to
Leverage Ratio............................................................ 1
Minimum Net Worth......................................................... $672.1 million
less than 5.50 to
Senior Debt to EBITDAR Ratio.............................................. 1
</TABLE>

The Company has held preliminary discussions with its Lenders to obtain a
waiver of the non-compliance with the financial covenants as of December 31,
1998. Further, the Company does not expect to be in compliance with the
financial covenants of the Senior Credit Facility during 1999 and its remaining
term. The Company is attempting to negotiate an amendment of the Senior Credit
Facility to modify the

F-22
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(7) LONG-TERM DEBT (CONTINUED)
financial covenants so that the financial covenants will be consistent with the
Company's revised business plan. However, as of April 19, 1999, no agreement to
waive the 1998 non-compliance with the financial covenants or to amend the
future financial covenants had been reached. This represents an Event of Default
under the Senior Credit Facility.

An Event of Default under the Senior Credit Facility allows the Lenders to
require repayment of all amounts outstanding under the Senior Credit Facility.
As a result, as of December 31, 1998, the Company has classified all borrowings
under the Senior Credit Facility as current liabilities in the accompanying
consolidated balance sheet as of December 31, 1998. The Company does not have
sufficient cash reserves to repay all amounts outstanding under the Senior
Credit Facility. If such repayment is required by the Lenders, the Company will
explore a variety of options, including seeking relief under the United States
Bankruptcy Code.

No further amounts may be borrowed under the Senior Credit Facility. The
Senior Credit Facility is collateralized by a pledge of the stock of the
majority of the Company's subsidiaries. The Company had borrowings of $360.1
million outstanding under the revolving credit facility, $385.5 million
outstanding in term loans, and $44.8 million of outstanding standby letters of
credit under the Senior Credit Facility as of December 31, 1998.

Prior to the RCA Acquisition, RCA entered into a Revolving Line of Credit
Agreement ("RCA Line of Credit") with Healthcare Financial Partners ("HCFP")
that provides for borrowings by RCA of up to $15.0 million, which bears interest
at the prevailing prime rate plus 1% to 2% (9.75% at December 31, 1998) and
matures in 2001. The RCA Line of Credit is secured by certain accounts
receivable and is guaranteed by certain subsidiaries of the Company. The Company
had borrowings of $15.0 million outstanding under the RCA Line of Credit as of
December 31, 1998.

In May 1998, the Company issued $150 million aggregate principal amount of
9 3/8% Senior Subordinated Notes due 2008 (the "9 3/8 Notes"). The 9 3/8 Notes,
which are subject to customary terms and covenants, are redeemable by the
Company at a premium after May 1, 2003. The 9 3/8% Notes are senior
subordinated, unsecured general obligations of the Company, and they are
guaranteed by all existing and future material domestic subsidiaries of the
Company.

In July 1997, the Company issued $250 million aggregate principal amount of
9 1/2% Senior Subordinated Notes due 2007 (the "9 1/2% Notes"). The 9 1/2%
Notes, which are subject to customary terms and covenants, are redeemable by the
Company at a premium, in whole or in part, after July 1, 2002. The 9 1/2% Notes
are senior subordinated, unsecured general obligations of the Company, and they
are guaranteed by all existing and future material domestic subsidiaries of the
Company.

In 1994 the Company issued $83.3 million aggregate principal amount of 6%
Convertible Subordinated Debentures due 2004 which are convertible into shares
of the Company's common stock at a conversion price of $21.84, or 3,814,102
shares of the Company's common stock.

Holders of the 6 1/2% Convertible Subordinated Debentures due 2003 (the
"6 1/2% Debentures") are entitled under the indenture to receive the Mediplex
acquisition consideration in respect of each share of Mediplex common stock into
which the 6 1/2% Debentures would have been convertible at the time of the
acquisition of Mediplex. The Company has agreed to be a co-obligor of the 6 1/2%
Debentures. In January 1995, $39.4 million of the 6 1/2% Debentures were
converted. Pursuant to the conversion terms

F-23
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(7) LONG-TERM DEBT (CONTINUED)
under the indenture, the Company paid $13.6 million and issued 1,582,905 shares
of the Company's common stock to the converting holder. In addition, the Company
paid accrued interest plus a conversion fee of $3.3 million to the converting
holder, which was expensed in the first quarter of 1995, to induce conversion.
Conversion of the remaining $20.7 million of outstanding 6 1/2% Debentures would
require the issuance of an additional 831,197 shares of the Company's common
stock and a payment of $7.1 million in cash pursuant to the conversion terms
under the indenture relating to the 6 1/2% Debentures.

The RCA Line of Credit, the 9 3/8% Notes, the 9 1/2% Notes, the 6% and
6 1/2% Convertible Subordinated Debentures all contain cross default provisions
that would cause the Company to be in default on their respective covenants if
the Company is in default under any mortgage, indenture, or instrument resulting
in the acceleration of repayment or default in payment of from $0.1 million to
in excess of $20.0 million depending on the terms of the agreement. Such event
of default would allow the creditor to demand immediate repayment, and
therefore, require the debt to be classified as a current liability. No
acceleration of repayment had occurred as of April 19, 1999, and therefore such
borrowings are classified as long-term debt in the accompanying consolidated
balance sheet as of December 31, 1998.

The Company has $31.9 million of mortgages with Meditrust (certain Mortgage
Notes) as of December 31, 1998 that contain less restrictive covenants than the
Senior Credit Facility and include cross default provisions with all other
mortgages and leases also financed by Meditrust. The Meditrust mortgages are in
non-compliance as of December 31, 1998 because the Company did not meet the
fixed charge ratio of at least 1.25 to 1. The Company is attempting to negotiate
an amendment to the mortgages' financial covenants so that the financial
covenants will be consistent with the Company's revised busniness plan. As of
April 19, 1999, no agreement to waive the non-compliance with the 1998 financial
covenant or to amend the future financial covenant had been reached. Because the
Company is in non-compliance with the terms of the mortgages, Meditrust may
declare an event of default. If an event of default were declared, Meditrust
could demand immediate repayment of all amounts due under the mortgages and
foreclose on four facilities. The amounts owed under the mortgages are
classified as a current liability as of December 31, 1998. The Company also has
36 facility leases with Meditrust which are in default due to cross default
provisions with the Meditrust mortgages and leases.

The Company also is the obligor on an outstanding letter of credit with a
bank of $3.7 million as of December 31, 1998 to guarantee outstanding debt
obligations for a partnership through which the Company acquired a 50% interest.
The partnership owns a long-term care facility which is leased to a third-party
operator.

In May 1998, the Company entered into certain interest rate swap
transactions with an aggregate notional value of $850.0 million to minimize the
risks and/or costs associated with certain long-term debt of the Company. The
Company does not otherwise utilize financial instruments for trading or other
speculative purposes. The interest rate swap transactions were designated as
hedges for accounting purposes. The amounts to be paid or received were accrued
and recognized as an adjustment to interest expense.

On April 9, 1999, the interest rate swap transactions were terminated due to
an event of default relating to the Company's non-compliance with certain
covenants contained in the Senior Credit Facility. The termination will result
in a $3 million pre-tax charge in 1999.

F-24
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(7) LONG-TERM DEBT (CONTINUED)
Under the interest rate swap transactions, the Company was a variable rate
payor, effectively converting $550.0 million of fixed rate debt and $300.0
million of variable rate Senior Credit Facility debt, which was based on U.S.
LIBOR, into variable rate debt based on an index of foreign interest rates. The
index of foreign interest rates was based on an equally weighted average of the
LIBOR interest rates of Germany and Switzerland and the Bank Bill rate of
Australia. All payments were denominated in U.S. dollars. Each interest rate
swap included cap protection limiting the Company's exposure to interest rate
fluctuations. The following summarizes the terms of the various interest rate
swap transactions as of December 31, 1998 based on each transaction's respective
interest rate reset dates.

<TABLE>
<CAPTION>
INTEREST RATE
NOTIONAL MATURITY ------------------ MAXIMUM INTEREST
AMOUNT DATE RECEIVE PAY(1) RATE PAID AND PERIOD
- ------------------------- -------- ---------- ----- ------------------------
<S> <C> <C> <C> <C> <C>
$300,000,000.............. 5/2003 5.46%(2) 5.38% 7.0% (5/2003)

$300,000,000.............. 5/2008 7.00%(3) 6.14% 7.0% (5/1998-5/2001)
8.5% (5/2001-5/2008)

$250,000,000.............. 7/2002 9.50%(3) 8.92% 9.5% (5/1998-4/2000)
10.5% (4/2000-7/2002)
</TABLE>

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

(1) An index of foreign interest rates, reset quarterly (see above description).

(2) U.S. LIBOR, reset quarterly.

(3) Fixed.

(8) COMMITMENTS AND CONTINGENCIES

(a) LEASE COMMITMENTS

The Company has various noncancelable operating leases for facilities with
initial lease terms generally ranging from 5 to 23 years and renewal options of
5 to 40 years. Certain of the lease agreements provide for payment escalations
coincident with increases in certain economic indices.

F-25
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
Future minimum lease payments under noncancelable leases as of December 31,
1998 are as follows (in thousands):

<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
----------- ------------
<S> <C> <C>
1999............................................................... $ 13,146 $ 245,180
2000............................................................... 11,544 241,489
2001............................................................... 11,234 229,814
2002............................................................... 9,873 226,377
2003............................................................... 9,287 219,471
Thereafter......................................................... 264,207 1,100,678
----------- ------------

Total minimum lease payments....................................... 319,291 $ 2,263,009
------------
------------
Less amount representing interest.................................. (211,909)
-----------

Present value of net minimum lease payments under capital leases... $ 107,382
-----------
-----------
</TABLE>

Rent expense under operating leases totaled $251.3 million, $143.9 million,
and $91.7 million in 1998, 1997 and 1996, respectively.

As of December 31, 1998, the Company leases or subleases 68 facilities from
affiliates of two directors of the Company which are included in the information
above. The aggregate lease expense for these facilities was approximately $21.0
million, $20.2 million, and $16.7 million in 1998, 1997 and 1996, respectively.
Future minimum lease commitments related to these facilities total approximately
$129.3 million at December 31, 1998. The Company's management believes the terms
of all of the foregoing leases are as favorable to the Company as those that
could have been obtained from nonrelated parties.

(b) CONSTRUCTION COMMITMENTS

The Company had capital commitments, as of December 31, 1998, under various
contracts, including approximately $47.9 million in the United States and L0.9
million ($1.4 million as of December 31, 1998) in the United Kingdom. These
include contractual commitments to improve existing facilities and to develop,
construct and complete a corporate office building and a long-term care facility
in the United States and two long-term care facilities in the United Kingdom.

F-26
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
(c) FINANCING COMMITMENTS

The Company has advanced $37.4 million and has agreed to advance up to a
total of $40.0 million, plus an additional $5.0 million to cover accrued
interest due and owing to the Company and other lenders, to a developer of
assisted living facilities to cover 20% of the costs of the development,
construction and operation of assisted living facilities. Advances under this
arrangement are part of the Company's assisted living facilities investment that
is classified as Assets Held for Sale (see Note 6 above).

(d) LITIGATION

The Company is a party to various legal actions and administrative
proceedings and subject to various claims arising in the ordinary course of
business (see Note 16).

(9) INCOME TAXES

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

<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Current:
Federal.................................................... $ 10,009 $ 18,441 $ 11,930
State...................................................... 6,470 5,918 4,835
Foreign.................................................... (323) -- 860
--------- --------- ---------
16,156 24,359 17,625
--------- --------- ---------

Deferred:
Federal.................................................... 19,653 15,464 10,527
State...................................................... 19,926 3,190 2,268
Foreign.................................................... (2,158) (1,860) 510
--------- --------- ---------
37,421 16,794 13,305
--------- --------- ---------
Total...................................................... $ 53,577 $ 41,153 $ 30,930
--------- --------- ---------
--------- --------- ---------
</TABLE>

Actual tax expense differs from the "expected" tax expense on earnings
(losses) before extraordinary loss, computed by applying the U.S. Federal
corporate income tax rate of 35% to earnings (losses) before

F-27
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(9) INCOME TAXES (CONTINUED)
income taxes and extraordinary loss of the Company as follows for the year ended
December 31 (in thousands):

<TABLE>
<CAPTION>
1998 1997 1996
----------- --------- ---------
<S> <C> <C> <C>
Computed "expected" tax (benefit) expense.................. $ (241,445) $ 33,559 $ 18,363
Adjustments in income taxes resulting from:
Amortization of goodwill................................. 9,439 3,765 3,045
Impairment loss.......................................... 89,333 -- --
Increase in valuation allowance.......................... 115,478 2,450 7,615
Loss on sale of subsidiary stock......................... 4,340 -- (2,458)
Legal and regulatory matters............................. 5,847 -- --
Loss on planned asset dispositions....................... 59,714 -- --
State income tax expense, net of Federal income tax
benefit................................................ 4,044 3,041 4,617
Other.................................................... 6,827 (1,662) (252)
----------- --------- ---------
$ 53,577 $ 41,153 $ 30,930
----------- --------- ---------
----------- --------- ---------
</TABLE>

F-28
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

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

<TABLE>
<CAPTION>
1998 1997
----------- ---------
<S> <C> <C>
Deferred tax assets:
Accounts and notes receivable....................................... $ 18,644 $ --
Accrued liabilities................................................. 42,015 22,057
Property and equipment.............................................. 26,445 --
Intangible assets................................................... 39,945 18,175
Carryforward of deductions limited by Internal Revenue Code Section
382............................................................... 6,250 6,250
Write-down of assets held for sale and reserve for estimated costs
of disposal and future operating losses........................... 13,862 6,513
Deferred income..................................................... 1,565 2,840
Shareholder settlement.............................................. 1,980 1,051
Alternative minimum tax credit...................................... 4,411 3,453
Jobs and other credit carryforwards................................. 5,454 3,477
Capital loss carryforwards.......................................... 4,023 4,023
Federal net operating loss carryforwards............................ 2,202 --
State net operating loss carryforwards.............................. 10,256 7,313
United Kingdom trading loss carryforwards........................... 13,371 7,895
United Kingdom capital loss carryforwards........................... 5,013 --
Other............................................................... 1,844 2,676
----------- ---------
197,280 85,723
----------- ---------

Less valuation allowance:
Federal............................................................. (140,680) (31,195)
State............................................................... (27,616) (5,115)
United Kingdom...................................................... (12,865) --
----------- ---------
(181,161) (36,310)
----------- ---------
Total deferred tax assets............................................. 16,119 49,413
----------- ---------

Deferred tax liabilities:
Property and equipment attributable to United Kingdom operations.... (3,529) (15,234)
Property and equipment attributable to United States operations..... -- (989)
Accounts receivable................................................. -- (1,527)
Partnership investments............................................. (2,701) (522)
Changes in certain subsidiaries' methods of accounting for income
taxes from cash to accrual basis.................................. (1,899) (370)
Other............................................................... (1,990) (2,468)
----------- ---------
(10,119) (21,110)
----------- ---------
Deferred tax asset, net............................................... $ 6,000 $ 28,303
----------- ---------
----------- ---------
</TABLE>

The Company and a subsidiary have Federal net operating loss ("NOL")
carryforwards of $6.3 million with expiration dates from 2004 through 2011.
Various subsidiaries have state NOL carryforwards totaling

F-29
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(9) INCOME TAXES (CONTINUED)
$185.4 million with expiration dates through the year 2012. In addition, the
Company has capital loss carryforwards of approximately $11.5 million, of which
$4.5 million will expire in 2001 and $7.0 million will expire in 2004. United
Kingdom trading loss carryforwards of $44.6 million and the alternative minimum
tax credit carryforwards of $4.4 million have no expiration dates. The $5.3
million of jobs tax credit carryforwards will expire in years 1999 through 2018.
Because the realizability of the NOL, tax credit and capital loss carryforwards
is uncertain, a valuation allowance has been established against them.

In 1998, the Company increased the valuation allowance by $115.5 million to
reserve for deferred tax assets which may not be realized as a result of the new
operating environment under PPS. Also in 1998, the Company established a
valuation allowance of $12.5 million for United Kingdom deferred tax assets
which may not be realizable. In connection with the deferred tax assets acquired
in the acquisition of Mediplex, the Company recorded an $18.0 million valuation
allowance. The Company recorded a $5.7 and $5.2 million valuation allowance in
1998 and 1997, respectively, related to the deferred tax assets acquired in the
acquisition of Regency, and a $11.2 million valuation allowance in 1998 related
to the deferred tax assets acquired in the RCA Acquisition. Tax benefits
recognized in future periods attributable to the portions of the valuation
allowance established in connection with purchase accounting for acquisitions
(totaling $50.3 million) will be allocated to reduce goodwill recorded in
connection with these acquisitions.

The $2.5 million increase in the valuation allowance in 1997 relates to the
realizability of capital loss carryforwards.

(10) SUPPLEMENTARY INFORMATION RELATING TO STATEMENTS OF CASH FLOWS

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

<TABLE>
<CAPTION>
1998 1997 1996
---------- --------- ---------
<S> <C> <C> <C>
Cash paid during the year ended December 31 for:
Interest, net of $1,792, $2,023 and $2,472 capitalized
during 1998, 1997 and 1996, respectively................ $ 143,850 $ 68,614 $ 26,821
Income taxes.............................................. 23,869 8,553 7,608
</TABLE>

The Company's acquisitions during 1998, 1997 and 1996 involved the following
for the year ended December 31 (in thousands):

<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ ----------
<S> <C> <C> <C>
Fair value of assets acquired.......................... $ 578,333 $ 1,159,012 $ 145,652
Liabilities assumed.................................... (356,268) (613,988) (55,741)
Cash payments or payables to former APTA
shareholders......................................... -- 19,300 (23,545)
Fair value of stock and warrants issued................ (161,424) (190) (961)
----------- ------------ ----------
Cash payments made, net of cash received from others... $ 60,641 $ 564,134 $ 65,405
----------- ------------ ----------
----------- ------------ ----------
</TABLE>

F-30
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(11) FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of the Company's financial instruments as of
December 31 are as follows (in thousands):

<TABLE>
<CAPTION>
1998 1997
-------------------------- --------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Cash and cash equivalents................................ $ 27,504 $ 27,504 $ 21,020 $ 21,020
Long-term debt including current portion:
Practicable to estimate fair value..................... 1,251,437 1,088,178 1,626,842 1,640,814
Not practicable to estimate fair value................. 265,248 -- -- --
Convertible Trust Issued Preferred Securities............ 345,000 144,900 -- --
</TABLE>

The cash and cash equivalents carrying amount approximates fair value
because of the short maturity of these instruments. The fair value of the
Company's long-term debt was estimated based on quoted market prices and
information received from an international investment banking firm that is
experienced with such securities. The fair value of the Convertible Trust Issued
Preferred Securities were estimated based on information received from an
international investment banking firm that is experienced with such securities.

(12) CONVERTIBLE TRUST ISSUED PREFERRED SECURITIES

In May 1998, a statutory business trust, all of whose common securities are
owned by the Company, issued $345.0 million of 7% convertible trust issued
preferred securities due 2028 (the "CTIPS") with a liquidation amount of $25 per
CTIP. Each CTIP is convertible into 1.2419 shares of the Company's common stock
(equivalent to a conversion price of $20.13 per share). The CTIPS holders are
entitled to receive cumulative cash distributions at an annual rate of 7%,
payable quarterly. Payment of the cash distributions and principal are
irrevocably guaranteed by the Company. Sun may defer cash distribution for up to
20 consecutive quarters. If cash distributions are deferred, distribution on the
CTIPS will continue to accrue interest at the annual rate of 7%. The obligations
of Sun are subordinate and junior in right of payment to all other liabilities
of Sun and PARI PASSU with the most senior preferred stock issued by Sun. The
Company may redeem the CTIPS at any time after May 3, 2001 at their principal
amount multiplied by 1.04 if redeemed before May 3, 2002; 1.03 if redeemed
before May 3, 2003; 1.02 if redeemed before May 3, 2004; 1.01 if redeemed before
May 3, 2005; and 1.00 if redeemed after May 3, 2005. In general, the holders of
the CTIPS have no voting rights.

On April 14, 1999, Sun announced that it will exercise its right to defer
the cash distribution payable on May 1, 1999.

(13) CAPITAL STOCK

(a) COMMON STOCK REPURCHASE

In 1998 and 1997, the Company repurchased 71,661 and 23,091 shares of its
outstanding common stock at a cost of $1.4 million and $0.5 million,
respectively. In the first quarter of 1996, the Company

F-30
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(13) CAPITAL STOCK (CONTINUED)
repurchased 2,030,116 shares of its outstanding common stock at a cost,
including commissions, of $25.1 million.

(b) STOCK OPTION PLANS

STOCK INCENTIVE PLANS

The Company has stock incentive plans for certain employees, officers, and
consultants of the Company. Awards made under the plans may be in the form of
stock options, stock appreciation rights, stock awards, performance share awards
or other stock-based awards. The Board of Directors or a committee appointed by
the Board of Directors determines the vesting schedule and the option price,
which is generally not to be less than the fair market value per share of the
Company's common stock at the date of grant. Options granted prior to March 1996
generally vest at the end of three years and expire ten years from the date of
grant. Options granted during and after March 1996 generally vest ratably over
three years and expire ten years from the date of grant. As of December 31,
1998, options for 4,253,369 shares were outstanding, options for 1,901,749
shares were vested and 2,615,082 shares were available for future grants under
the stock incentive plans for officers, certain employees and consultants.
Exercise prices of outstanding options to purchase shares of the Company's
common stock range from $5.25 to $24.00.

In 1998, the Company awarded 14,000 shares of restricted stock to three
executives. Such shares generally vest over a four year period. In 1998, 5,066
of these shares vested.

In 1997, the Company awarded 783,000 shares of restricted stock to ten
executives. The related compensation expense is recognized ratably over the
vesting periods of four to five years. As of December 31, 1998, 263,000 of these
restricted shares have vested.

In connection with the RCA Acquisition, the Company issued options to
purchase 722,666 shares of its common stock in exchange for outstanding RCA and
Contour stock options. Exercise prices for these stock options range from $13.21
to $31.59 per share. As of December 31, 1998, options for 349,852 shares were
outstanding and vested.

On April 13, 1999, the Board of Directors approved a plan to offer holders
of certain employee stock options the right to exchange outstanding stock
options for new stock options. The new stock options will allow the holders to
receive fewer shares of the Company's common stock, but the exercise price for
these new stock options will be lower than the exercise price for the
outstanding stock options. Stock option holder eligible for this exchange may
elect to accept the offer until April 30, 1999. These new stock options will be
subject to a three year vesting schedule and will be accounted for as variable
options.

DIRECTOR STOCK INCENTIVE PLANS

The Company has stock incentive plans for nonemployee directors, which
provide for grants of nonqualified options, stock appreciation rights, stock
awards, performance share awards or other stock-based awards. Beginning in 1997,
all nonemployee directors receive an annual grant of options for 4,000 shares at
a price not less than fair market value of the Company's common stock at the
date of grant and an annual grant of 2,000 restricted stock awards. All awards
vest ratably over three years and stock option awards expire ten years after the
date of grant. Exercise prices of outstanding options to purchase shares of

F-31
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(13) CAPITAL STOCK (CONTINUED)
common stock range from $9.50 to $21.88. Nonemployee directors have the option
of electing to receive a portion of their annual board compensation in the form
of restricted stock awards which vest in quarterly increments over one year.
During the years ended December 31, 1998 and 1997, the Company awarded an
aggregate of 21,222 and 15,080 shares of restricted stock, respectively, to
nonemployee directors which will be expensed over the vesting period. As of
December 31, 1998, 8,138 of the restricted shares are vested and the remainder
vest ratably over one to three years. As of December 31, 1998, options for
144,500 shares were outstanding, options for 82,254 shares have vested and
342,000 shares were available for future grant under the stock incentive plans
for nonemployee directors.

The following is a summary of the status of the Company's Stock Incentive
Plans, the Director Stock Incentive Plans and assumed option plans from
acquisitions as of December 31, 1998, 1997 and 1996, and changes during the
years ending on those dates (shares in thousands):

<TABLE>
<CAPTION>
1998 1997 1996
-------------------------- ---------------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- -------------- ----------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
year........................ 3,339 $ 16.90 3,348 $ 15.91 3,648 $ 16.12
Granted
Price equals fair value..... 2,781 15.54 814 18.06 441 13.74
Price is less than fair
value..................... -- -- -- -- 15 11.00
Exercised..................... (37) 13.96 (487) 11.25 (106) 11.09
Cancelled..................... (1,335) 14.44 (336) 17.28 (650) 16.54
----- -----
Outstanding at year-end....... 4,748 16.75 3,339 16.90 3,348 15.91
--------- ----- -----
--------- ----- -----

Options exercisable at
year-end.................... 2,334 17.17 1,210 17.25 796 11.53
--------- ----- -----
--------- ----- -----

Options available for future
grant....................... 3,950 3,022
----- -----
----- -----

Weighted average fair value of
options granted during the
year........................ $ 8.02 $ 5.89 $ 5.41
--------- ----- -----
--------- ----- -----
</TABLE>

The fair value of each option granted in 1998, 1997 and 1996 is estimated at
the date of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions:

<TABLE>
<CAPTION>
1998 1997 1996
--------- ----- -----
<S> <C> <C> <C>
Expected Life (in years)...... 4 4 4
Risk-free Interest Rate....... 5.50% 6.26% 5.37%
Expected Volatility........... 66% 42% 41%
Dividend Yield................ -- -- --
</TABLE>

Had compensation cost for the Company's 1998, 1997 and 1996 option grants
been determined consistent with SFAS 123 (see Note 1(n)) which establishes fair
value as the measurement basis for stock-

F-32
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(13) CAPITAL STOCK (CONTINUED)
based awards, the Company's net earnings (losses) and net earnings (losses) per
share for 1998, 1997 and 1996 would approximate the pro forma amounts below (in
thousands, except per share data):

<TABLE>
<CAPTION>
1998 1997 1996
------------------------ ------------------------ ------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net earnings (losses)........................ $(753,693) $ (759,169) $ 34,801 $ 32,804 $ 21,536 $ 19,548
Net earnings (losses) per share
Basic...................................... $ (14.49) $ (14.60) $ 0.75 $ 0.71 $ 0.46 $ 0.42
Diluted.................................... $ (14.49) $ (14.60) $ 0.74 $ 0.70 $ 0.46 $ 0.42
</TABLE>

The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. SFAS 123 does not apply to options granted prior
to 1995, and additional option grants in future years are anticipated.

The following table summarizes information about stock options outstanding
as of December 31, 1998 (shares in thousands):

<TABLE>
<CAPTION>
OPTIONS EXERCISABLE
OPTIONS OUTSTANDING ----------------------------
------------------------------------------------ WEIGHTED
WEIGHTED AVERAGE WEIGHTED AVERAGE
NUMBER REMAINING AVERAGE NUMBER EXERCISE
RANGE OF EXERCISE PRICE OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE OUTSTANDING PRICE
- -------------------------------------- ----------- ------------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
$ 5.25 - $9.50........................ 480 7.94 $ 7.75 281 $ 9.48
11.00 - 15.84....................... 878 6.22 13.46 538 12.92
16.07 - 19.44....................... 2,510 7.77 17.80 867 18.37
20.00 - 31.59....................... 880 6.91 21.95 651 22.41
----------- -----
4,748 7.34 $ 16.75 2,337 $ 17.17
----------- -----
----------- -----
</TABLE>

In connection with the RCA Acquisition, the Company issued warrants to
purchase 451,685 shares of the Company's common stock at prices ranging from
$1.99 to $11.89 per share in exchange for outstanding warrants of RCA and
Contour.

(d) GRANTOR STOCK TRUST

In the first quarter of 1996, the Company sold 3,050,000 newly issued shares
of the Company's common stock to a newly established Grantor Stock Trust
("Trust") for approximately $37.7 million. The Trust was created to fund future
obligations under certain of the Company's benefit plans, including, but not
limited to, stock option plans, a stock purchase plan, health insurance plans
and employee compensation. The sale of the shares to the Trust was recorded as
an increase in stockholders' equity with a corresponding reduction for the value
of the shares held by the Trust. As stock is released from the Trust to satisfy
certain employee compensation and benefit plans, the number and the related fair
value of shares held by the Trust is reduced and stockholders' equity increases
correspondingly. As of December 31, 1998, the Trust held 1,989,132 shares of the
Company's common stock.

F-33
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(13) CAPITAL STOCK (CONTINUED)
The Trust delivered to the Company a promissory note for approximately $37.7
million. The cash portion of the purchase price of approximately $31,000
represents the par value of the shares of the Company's common stock sold to the
Trust. Amounts owed by the Trust will be repaid periodically with cash received
from the Company or will be forgiven by the Company thereby enabling the release
of shares from the Trust to satisfy the Company's obligations for certain
employee compensation and benefit plans.

(14) EARNINGS PER SHARE

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

<TABLE>
<CAPTION>
1998 1997 1996
----------- ---------- ---------
<S> <C> <C> <C>
BASIC:
Net earnings (losses) before extraordinary loss............................... $ (743,419) $ 54,729 $ 21,536
Net earnings (losses)......................................................... (753,693) 34,801 21,536
Weighted average shares outstanding........................................... 52,008 46,329 46,360
Earnings (losses) per share:
Net earnings (losses) before extraordinary loss............................. $ (14.29) $ 1.18 $ 0.46
Net earnings (losses)....................................................... $ (14.49) $ 0.75 $ 0.46

DILUTED:
Net earnings (losses) before extraordinary loss used in basic calculation..... $ (743,419) $ 54,729 $ 21,536
Income impact of assumed conversions.......................................... -- 3,410 --
----------- ---------- ---------
Adjusted net earnings (losses) before extraordinary loss...................... (743,419) 58,139 21,536
Extraordinary loss............................................................ (10,274) (19,928) --
----------- ---------- ---------
Net earnings (losses)......................................................... $ (753,693) $ 38,211 $ 21,536
----------- ---------- ---------
----------- ---------- ---------

Weighted average shares used in basic calculation............................. 52,008 46,329 46,360
Effect of dilutive securities:
Stock options and warrants.................................................. -- 832 508
Assumed conversion of convertible debt...................................... -- 4,690 --
----------- ---------- ---------

Weighted average common and common equivalent shares outstanding.............. 52,008 51,851 46,868
----------- ---------- ---------
----------- ---------- ---------

Earnings (losses) per share:
Net earnings (losses) before extraordinary loss............................. $ (14.29) $ 1.12 $ 0.46
Net earnings (losses)....................................................... $ (14.49) $ 0.74 $ 0.46
</TABLE>

(15) PREFERRED STOCK PURCHASE RIGHTS

On June 2, 1995, the Board of Directors declared a dividend of one preferred
stock purchase right ("Right") for each outstanding share of common stock of the
Company for stockholders of record on June 15, 1995 and for all future issuances
of common stock. The Rights are currently not exercisable or

F-34
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(15) PREFERRED STOCK PURCHASE RIGHTS (CONTINUED)
transferable apart from the common stock and have no voting rights. Each Right
entitles the registered holder to purchase from the Company one one-hundredth of
a share of Series A Preferred Stock, par value $0.01 per share. The Rights
become exercisable ten business days following the date a person or group of
affiliated persons acquires 15% or more of the Company's common stock, or
announces a tender or exchange offer which would result in the beneficial
ownership by a person or group of affiliated persons of 15% or more of the
outstanding Company's common stock. The Rights also become exercisable if any
person, who is the beneficial owner of 15% or more of the Company's common stock
as of the date of record, acquires an additional 1% or more of the outstanding
Company's common stock. The Rights may be redeemed by the Company at a price of
$.001 per Right before their expiration on June 2, 2005.

In the event that the Company is acquired in a merger or other business
combination or certain other events occur, provision shall be made so that each
holder of a Right, excluding the Rights beneficially owned by the acquiring
persons, shall have the right to receive, upon exercise thereof at the then
current exercise price, that number of shares of common stock of the surviving
company which at the time of such transaction will have a market value of two
times the exercise price of the Right.

(16) OTHER EVENTS

(a) GOVERNMENT INVESTIGATIONS

In January 1995, the Company learned that it was the subject of a pending
Federal investigation (the "Federal Investigation"). The investigating agencies
were the United States Department of Health and Human Services' Office of
Inspector General ("OIG") and the United States Department of Justice. Although
the government never specified the full scope of the investigation, it focused
principally on whether the Company's rehabilitation therapy subsidiary provided
and/or billed for unnecessary or unordered therapy services to residents of
skilled nursing facilities; and whether the Company's long-term care subsidiary
properly disclosed its relationship with the Company's rehabilitation therapy
subsidiary and properly sought reimbursement for services provided by that
subsidiary.

In July 1997, the Criminal Division of the U.S. Department of Justice
informed the Company that it had completed its investigation of the Company, and
that it would not initiate any actions against the Company or any individuals.
In the summer of 1998, the OIG informed the Company that it had no present
intention of initiating any civil or administrative actions against the Company
or any individuals or seeking monetary damages or other relief with respect to
the issues in the Federal Investigation, and the Civil Division of the
Department of Justice similarly informed the Company that it has determined not
to proceed any further at that time with the Federal Investigation. No assurance
can be given that the government will not proceed with any investigation at a
later time or initiate additional investigations based on the same or other
legal or regulatory concerns.

In 1996, the Connecticut Attorney General's office and the Connecticut
Department of Social Services ("DSS") began an investigation and initiated a
hearing in order to determine whether the Company's long-term care subsidiary
submitted false and misleading fiscal information on its 1993 and 1994 Medicaid
cost reports. In 1997, the investigation was expanded to cover information for
the 1995 cost year as well as cost reporting periods prior to 1993. In February
1999, the Company and the DSS reached a settlement of the investigation pursuant
to which the Company paid the DSS $1.4 million and agreed to forego appealing
cetain outstanding claims.

F-35
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(16) OTHER EVENTS (CONTINUED)
(b) LITIGATION

In January 1999, the state of Florida filed criminal charges in the Circuit
Court of the Eighth Judicial Circuit for Alachua County, Florida against three
subsidiaries which were acquired by the Company on June 30, 1998: RCA, Capitol
Care Management Co., Inc and Gainesville Health Care Center, Inc. All of the
allegations of wrongdoing relate to activities prior to June 30, 1998, the date
of the RCA Acquisition. Florida's allegations include violations of certain RICO
laws, abuse or neglect of elderly or disabled persons, grand theft and Medicaid
fraud at a nursing home facility in Florida. Also named as defendants were five
individuals who were involved in the operation of the facility in their
capacities as officers, directors or employees of the defendant entities. If the
defendant entities are convicted, they could be banned from participating in the
Florida Medicaid program. Although the Company and its subsidiaries intend to
vigorously defend themselves in this matter, there can be no assurance that the
outcome of this matter will not have a material adverse effect on the results of
operations and financial condition of the Company.

Between August 25, 1997 and October 24, 1997, ten putative class action
lawsuits (the "Actions") were filed in the United States District Court for the
Northern District of Georgia on behalf of persons who purchased RCA Common
Stock, naming RCA and certain of its officers and directors as defendants. The
complaints have overlapping defendants and largely overlapping (although not
identical) class periods. The complaints allege violations of Federal securities
laws by the defendants for disseminating allegedly false and misleading
financial statements for RCA's fiscal year ended June 30, 1996 and its first
three quarters of fiscal year 1997, which the plaintiffs allege materially
overstated RCA's profitability. Generally, each of the Actions seeks unspecified
compensatory damages, pre-judgement and post judgement interest, attorneys' fees
and costs and other equitable and injunctive relief.

On November 25, 1997, RCA, the Company and representatives of the plaintiffs
in the Actions entered into a Memorandum of Understanding ("MOU"). Pursuant to
the MOU, the Company paid $9.0 million into an interest-bearing escrow account
maintained by the Company (the "Escrow Account") to settle the Actions (the
"Settlement"). All of the parties have signed the Settlement Agreement and it
will become final upon court approval. Upon court approval of the Settlement,
all claims by the class that were or could have been asserted by the plaintiffs
against RCA or any of the other defendants in the Actions will be settled and
released, and the Actions will be dismissed in their entirety with prejudice in
exchange for the release of all funds from the Escrow Account to the Plaintiffs.
No assurance can be given that the Settlement will become final.

F-36
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(16) OTHER EVENTS (CONTINUED)
Federal False Claims Act. The plaintiffs allege that skilled nursing facilities
operated by the subsidiaries and others conspired over the last decade to (i)
falsely certify compliance with regulatory requirements in order to participate
in the Medicare and Medicaid programs, and (ii) falsify records to conceal
failures to provide services in accordance with such regulatory requirements.
Although the Company and its subsidiaries intend to vigorously defend themselves
in these matters, there can be no assurance that the outcome of any one of these
matters will not have a material adverse effect on the results of operations and
financial condition of the Company.

In 1996, the Company reached an agreement in principle to settle certain
class-action lawsuits brought by shareholders for $24.0 million and recognized,
as a reduction of the settlement cost, a $9.0 million claim from its director
and officer liability insurance carrier for its claim submitted in connection
with the settlement. In addition, in 1996 the Company recorded additional
charges and expenses of $4.3 million related to monitoring and responding to the
continuing investigation by the OIG and responding to the remaining shareholder
litigation filed after the announcement of the OIG investigation.

From time to time, fiscal intermediaries and Medicaid agencies examine cost
reports filed by predecessor operators of the Company's skilled nursing
facilities. If, as a result of any such examination, it is concluded that
overpayments to a predecessor operator were made, the Company, as the current
operator of such facilities, may be held financially responsible for such
overpayments. At this time the Company is unable to predict the outcome of any
existing or future examinations.

The Company was notified in 1997 by a law firm representing several national
insurance companies that these companies believed that the Company had engaged
in improper billing and other practices in connection with the Company's
delivery of therapy and related services. In response, the Company began
discussions directly with these insurers and hopes to resolve these matters
without litigation; however, the Company is unable at this time to predict
whether it will be able to do so, what the eventual outcome may be or the extent
of its liability, if any, to these insurers.

(d) LEGISLATION, REGULATIONS AND MARKET CONDITIONS

The Company is subject to extensive Federal, state and local government
regulation relating to licensure, conduct of operations, ownership of
facilities, expansion of facilities and services and reimbursement for services.
As such, in the ordinary course of business, the Company's operations are
continuously subject to state and Federal regulatory scrutiny, supervision and
control. Such regulatory scrutiny often includes inquiries, investigations,
examinations, audits, site visits and surveys, some of which may be non-routine.
The Company believes that it is in substantial compliance with the applicable
laws and regulations. However, if the Company is ever found to have engaged in
improper practices, it could be subjected to civil, administrative or criminal
fines, penalties or restitutionary relief.

F-37
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(17) SUMMARIZED FINANCIAL INFORMATION

The Company acquired Mediplex on June 23, 1994 and became a co-obligor with
Mediplex with respect to the 6 1/2% Debentures and the 11 3/4% Debentures
subsequent to the acquisition. Summarized financial information of Mediplex is
provided below (in thousands):

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------
1998 1997
-------- --------
<S> <C> <C>
Current assets................ $113,585 $108,232
Noncurrent assets............. 225,586 391,048
Current liabilities........... 13,165 26,016
Noncurrent liabilities........ 69,454 72,373
Due to parent................. 206,161 165,207
</TABLE>

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
----------- ---------- ----------
<S> <C> <C> <C>
Net revenues......................................... $ 581,288 $ 507,750 $ 457,748
----------- ---------- ----------
Costs and expenses................................... 546,833 486,541 438,799
Impairment loss...................................... 147,990 -- --
----------- ---------- ----------
Earnings (losses) before intercompany charges and
income taxes....................................... (113,535) 21,209 18,949
Intercompany charges (1)............................. 75,376 78,957 50,133
----------- ---------- ----------
Earnings (losses) before income taxes................ (188,911) (57,748) (31,184)
Income tax benefit................................... (3,619) (18,326) (9,757)
----------- ---------- ----------
Net losses........................................... $ (185,292) $ (39,422) $ (21,427)
----------- ---------- ----------
----------- ---------- ----------
</TABLE>

(1) Through various intercompany agreements entered into by Sun and Mediplex,
Sun provides management services, licenses the use of its trademarks and
acts on behalf of Mediplex to make financing available for its operations.
Sun charged Mediplex for management services totaling $23.0 million, $32.3
million and $29.0 million for the years ended December 31, 1998, 1997 and
1996, respectively. Royalty fees charged to Mediplex for the years ended
December 31, 1998, 1997 and 1996, for the use of Sun trademarks were $10.8
million, $7.4 million and $6.7 million, respectively. Intercompany interest
charged to Mediplex for the years ended December 31, 1998, 1997 and 1996,
for advances from Sun was $41.6 million, $39.3 million and $14.4 million,
respectively.

(18) QUARTERLY FINANCIAL DATA (UNAUDITED)

The following table reflects restated unaudited quarterly financial data for
fiscal 1998. As announced on April 5, 1999, the Company determined that its
acquisition of RCA should be accounted for as a purchase and not a pooling of
interests, as previously reported. The basis for the determination was the
Company's recent decision to dispose of general non-core businesses. In
addition, the Company determined that certain fourth quarter charges should have
been recorded in previous 1998 quarters. As a result, the Company has restated
its previously reported financial results for the second and third quarters

F-38
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(18) QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
of the fiscal year ended December 31, 1998. The Company's unaudited restated
consolidated quarterly financial data follows (in thousands, except per share
data) (1):

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------
FOURTH
FIRST SECOND THIRD QUARTER
QUARTER QUARTER QUARTER (4)
-------- -------- -------- ---------
<S> <C> <C> <C> <C>
Total net revenues, as
reported.................... $741,490 $753,269(2) $826,656 $ 780,170
Adjustment.................. -- (877) (12,248) --
-------- -------- -------- ---------
Total net revenues, as
adjusted.................... $741,490 $752,392 $814,408 $ 780,170
-------- -------- -------- ---------
-------- -------- -------- ---------
Earnings before income taxes
and extraordinary loss, as
reported.................... $ 31,977 $ 11,858(2) $ 20,351 $(720,976)
Revenue adjustments......... -- 877 12,248 --
Expense adjustments:
Operating expenses........ -- 3,588 802 --
Corporate general and
administrative
expenses................ -- 590 1,295 --
Provision for losses on
accounts receivable..... -- 4,810 3,827 --
Loss on sale of assets.... -- -- 2,185 --
Legal and regulatory
matters................. -- 425 938 --
RCA goodwill
amortization............ -- -- 1,467 --
-------- -------- -------- ---------
Total expense
adjustments........... -- 9,413 10,514 --
Earnings (losses) before
income taxes and
extraordinary losses, as
adjusted.................... $ 31,977 $ 1,568 $ (2,411) $(720,976)
-------- -------- -------- ---------
-------- -------- -------- ---------
Net earnings (losses) before
extraordinary loss, as
reported.................... $ 18,387 $ 8,534(2) $ 11,496 $(761,529)
Total revenue adjustments... -- (877) (12,248) --
Total expense adjustments... -- (9,413) (10,514) --
Total tax adjustments....... -- 2,509 10,236 --
-------- -------- -------- ---------
Net earnings (losses) before
extraordinary loss, as
adjusted.................... $ 18,387 $ 753 $ (1,030) $(761,529)
-------- -------- -------- ---------
-------- -------- -------- ---------
Extraordinary loss, as
reported.................... $ -- $ 10,120(3) $ -- $ 154
Net earnings (losses), as
reported.................... 18,387 (1,586)(2) 11,496 (761,683)
Total revenue adjustments... -- (877) (12,248) --
Total expense adjustments... -- (9,413) (10,514) --
Total tax adjustments....... -- 2,509 10,236 --
-------- -------- -------- ---------
Net earnings (losses) as
adjusted.................... $ 18,387 $ (9,367) $ (1,030) $(761,683)
-------- -------- -------- ---------
-------- -------- -------- ---------
Per share data, as adjusted
Net earnings (losses) before
extraordinary loss(1):
Basic....................... $ 0.39 $ 0.02 $ (0.02) $ (13.34)
-------- -------- -------- ---------
-------- -------- -------- ---------
Diluted..................... $ 0.37 $ 0.02 $ (0.02) $ (13.34)
-------- -------- -------- ---------
-------- -------- -------- ---------
Net earnings (losses)(1):
Basic....................... $ 0.39 $ (0.20) $ (0.02) $ (13.34)
-------- -------- -------- ---------
-------- -------- -------- ---------
Diluted..................... $ 0.37 $ (0.20) $ (0.02) $ (13.34)
-------- -------- -------- ---------
-------- -------- -------- ---------
</TABLE>

F-39
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(18) QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
-----------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER (5)
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Total net revenues.............................................. $ 398,636 $ 447,545 $ 486,172 $ 678,466
Earnings before income taxes and extraordinary loss............. 26,127 29,214 31,836 8,704
Net earnings before extraordinary loss.......................... 15,937 17,821 19,420 1,551
Extraordinary loss.............................................. -- -- -- 19,928
---------- ---------- ---------- -----------
Net earnings (losses)........................................... $ 15,937 $ 17,821 $ 19,420 $ (18,377)
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------

Net earnings (losses) per common and common equivalent share:

Net earnings before extraordinary loss (1):
Basic......................................................... $ 0.35 $ 0.39 $ 0.42 $ 0.03
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
Diluted....................................................... $ 0.33 $ 0.36 $ 0.39 $ 0.03
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------

Net earnings (losses)(1):
Basic......................................................... $ 0.35 $ 0.39 $ 0.42 $ (0.39)
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
Diluted....................................................... $ 0.33 $ 0.36 $ 0.39 $ (0.39)
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
</TABLE>

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

(1) Earnings per share are computed independently for each of the quarters
presented and therefore may not sum to the totals for the year (see Note
1(o)).

(2) "As reported" for the three months ended June 30, 1998 excludes the
operations of RCA which were acquired on June 30, 1998 in a business
combination accounted for as a purchase.

(3) In the second quarter of 1998, the Company recorded an extraordinary loss of
$10.1 million, net of income tax benefit of $3.7 million, in relation to the
permanent paydown of $300.0 million of the term loan portion of the credit
facility and $3.7 million related to the retirement of $5.0 million of
Contour convertible debentures purchased by the Company.

(4) The fourth quarter of 1998 includes a SFAS 121 impairment charge of $397.5
million, a charge of $196.2 million in connection with the disposition of
certain assets and termination of certain long-term leases, an income tax
expense charge of $115.5 million related to an increase in the valuation
allowance for certain expected future income tax deductions or loss
carryforwards which may not be realized, and a charge of $7.3 million
related to software development costs. Additionally, restructuring charges
totaling $4.6 million were recorded in the fourth quarter of 1998.

(5) The fourth quarter of 1997 includes a charge of $7.0 million recognized by
the Company in order to reduce the carrying value of the Canadian operations
to fair value based on revised estimates of selling value and of costs to
sell. In addition, in 1997, the Company recorded an extraordinary charge of
$17.9 million, net of the related tax benefit, in connection with the
Company's purchase of Regency's 12.25% Junior Subordinated Notes due 2003
and of Regency's 9.875% Senior Subordinated Notes due 2002 and an
extraordinary loss of $2.1 million, net of the related tax benefit, related
to the refinancing of the Company's credit facility.

F-40
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(19) SEGMENT INFORMATION

The Company adopted SFAS 131 in 1998, which changes the way the Company
reports information from its operating segments. Segment information from 1997
and 1996 has been reclassified from the prior year's presentation to conform to
the 1998 presentation. Previously the Company identified segments based on
geographic location.

The Company operates predominantly in the long-term care segment of the
healthcare industry. The Company is a provider of long-term, sub-acute and
related ancillary care services to nursing home patients. In addition to
services provided in the United States, the Company provides services in the
United Kingdom, Spain, Germany and Australia.

The following summarizes the services provided by the Company's reportable
and other segments:

INPATIENT SERVICES: This segment provides, among other services, inpatient
skilled nursing and custodial services, as well as rehabilitative, restorative
and transitional medical services. The Company provides 24-hour nursing care in
these facilities by registered nurses, licensed practical nurses and certified
nursing aids.

PHARMACEUTICAL AND MEDICAL SUPPLY SERVICES: This segment is comprised of an
institutional pharmaceutical company and a medical supply company. The
pharmaceutical company provides pharmaceutical products primarily to affiliated
and nonaffiliated long-term and sub-acute care facilities for such purposes as
infusion therapy, pain management, antibiotic therapy and parenteral nutrition
as well as providing consultant pharmacist services. The medical supply company
provides medical supplies primarily to long-term care and sub-acute care
facilities.

INTERNATIONAL OPERATIONS: This segment consists of long-term care
facilities in the United Kingdom, Spain, Australia and Germany as well as acute
care hospitals in Australia. This segment also provides pharmaceutical services
in the United Kingdom, Germany and Spain and medical supplies in Australia.
International operations also include outpatient therapy service operations in
Canada. The Company sold certain of these operations in 1998 and completed the
sale of the remaining operations in the first quarter of 1999.

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

The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company primarily evaluates
segment performance based on profit or loss from operations after allocated
expenses and before income taxes and extraordinary items. Gains or losses on
sales of assets and certain items including impairment of assets recorded in
connection with SFAS 121, legal and regulatory matters, restructuring costs,
etc. are not considered in the evaluation of segment performance. Allocated
expenses include intercompany charges assessed to segments for management
services and asset use based on segment operating results and average asset
balances, respectively. The Company accounts for intersegment sales and
provision of services at market prices.

F-41
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(19) SEGMENT INFORMATION (CONTINUED)
Corporate assets primarily consist of cash and cash equivalents, receivables
from subsidiary segments, deferred tax assets, notes receivable, property, plant
and equipment, unallocated intangible assets and goodwill.

Although corporate assets include unallocated intangible assets, the
amortization of these items is reflected in the results of operations of the
associated segment.

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

The following tables summarize, for the periods indicated, operating results
and other financial information, by business segment (in thousands):
<TABLE>
<CAPTION>
REHABILITATION
AND PHARMACEUTICAL
RESPIRATORY AND MEDICAL
INPATIENT THERAPY SUPPLY INTERNATIONAL OTHER INTERSEGMENT
SERVICES SERVICES SERVICES OPERATIONS OPERATIONS CORPORATE ELIMINATIONS
----------- ------------- -------------- ------------ ----------- ----------- ------------

<S> <C> <C> <C> <C> <C> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1998

Total Net Revenues............ $ 2,045,270 $ 678,803 $ 254,455 $ 285,267 $ 283,326 $ -- $ (458,661)
Operating expenses, corporate
general and administrative
expenses, and provision for
losses on accounts
receivable.................. 1,970,887 458,464 232,219 264,927 280,000 137,809 (450,804)
Depreciation and
amortization................ 41,223 9,727 10,755 19,296 8,968 12,546 --
Interest, net................. 6,422 (18) 409 19,412 3,853 105,333 --
----------- ------------- -------------- ------------ ----------- ----------- ------------
Earnings (losses) before
corporate allocations....... 26,738 210,630 11,072 (18,368) (9,495) (255,688) (7,857)
Corporate interest
allocation.................. 49,683 16,300 10,653 22,844 8,992 (108,472) --
Corporate management fees..... 86,777 34,486 10,148 2,694 (718) (125,530) (7,857)
----------- ------------- -------------- ------------ ----------- ----------- ------------
Net segment earnings
(losses).................... $ (109,722) $ 159,844 $ (9,729) $ (43,906) $ (17,769) $ (21,686) $ --
----------- ------------- -------------- ------------ ----------- ----------- ------------
----------- ------------- -------------- ------------ ----------- ----------- ------------

Intersegment revenues......... $ -- $ 344,118 $ 78,954 $ -- $ 35,589 $ -- $ (458,661)
Identifiable segment assets... $ 661,349 $ 203,365 $ 141,664 $ 419,660 $ 230,969 $ 1,427,243 $ (616,212)
Segment capital expenditures,
net......................... $ 68,145 $ 5,393 $ 19,307 $ 4,755 $ 27,580 $ 40,257 $ (5,021)

CONSOLIDATED
------------
<S> <C>
FOR THE YEAR ENDED DECEMBER 31
Total Net Revenues............ $3,088,460
Operating expenses, corporate
general and administrative
expenses, and provision for
losses on accounts
receivable.................. 2,893,502
Depreciation and
amortization................ 102,515
Interest, net................. 135,411
------------
Earnings (losses) before
corporate allocations....... (42,968)
Corporate interest
allocation.................. --
Corporate management fees..... --
------------
Net segment earnings
(losses).................... $ (42,968)
------------
------------
Intersegment revenues......... $ --
Identifiable segment assets... $2,468,038
Segment capital expenditures,
net......................... $ 160,416
</TABLE>

F-42
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(19) SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
REHABILITATION
AND PHARMACEUTICAL
RESPIRATORY AND MEDICAL
INPATIENT THERAPY SUPPLY INTERNATIONAL OTHER INTERSEGMENT
SERVICES SERVICES SERVICES OPERATIONS OPERATIONS CORPORATE ELIMINATIONS
----------- ------------- -------------- ------------ ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1997

Total Net Revenues............ $ 1,249,861 $ 466,358 $ 157,336 $ 198,155 $ 165,906 $ -- $ (226,796)
Operating expenses, corporate
general and administrative
expenses, and provision for
losses on accounts
receivable.................. 1,153,712 315,528 135,375 173,546 154,411 71,050 (226,796)
Depreciation and
amortization................ 22,655 4,196 3,311 15,509 2,243 8,716 --
Interest, net................. 4,144 (53) 92 16,608 (91) 53,782 --
----------- ------------- -------------- ------------ ----------- ----------- ------------
Earnings (losses) before
corporate allocations....... 69,350 146,687 18,558 (7,508) 9,343 (133,548) --
Corporate interest
allocation.................. 18,779 8,869 5,169 17,175 3,900 (53,892) --
Corporate management fees
allocation.................. 48,952 18,804 6,162 1,963 1,925 (77,806) --
----------- ------------- -------------- ------------ ----------- ----------- ------------
Net segment earnings
(losses).................... $ 1,619 $ 119,014 $ 7,227 $ (26,646) $ 3,518 $ (1,850) $ --
----------- ------------- -------------- ------------ ----------- ----------- ------------
----------- ------------- -------------- ------------ ----------- ----------- ------------

Intersegment revenues......... $ -- $ 180,303 $ 32,648 $ -- $ 13,845 $ -- $ (226,796)
Identifiable segment assets... $ 611,752 $ 211,526 $ 110,811 $ 566,136 $ 51,739 $ 1,771,041 $ (743,769)
Segment capital expenditures,
net......................... $ 25,104 $ 8,575 $ 4,580 $ 51,231 $ 712 $ 12,960 $ --

FOR THE YEAR ENDED DECEMBER 31, 1996

Total Net Revenues............ $ 833,116 $ 324,336 $ 91,072 $ 61,337 $ 267,965 $ -- $ (261,518)
Operating expenses, corporate
general and administrative
expenses, and provision for
losses on accounts
receivable.................. 790,032 227,373 76,951 54,339 254,631 43,068 (261,518)
Depreciation and
amortization................ 19,047 2,638 1,765 3,454 2,876 4,037 --
Interest, net................. 4,243 (17) (6) 1,122 177 20,380 --
----------- ------------- -------------- ------------ ----------- ----------- ------------
Earnings (losses) before
corporate allocations....... 19,794 94,342 12,362 2,422 10,281 (67,485) --
Corporate interest
allocation.................. 8,532 6,286 2,426 595 3,327 (21,166) --
Corporate management fees..... 33,496 13,389 3,628 5,200 1,692 (57,405) --
----------- ------------- -------------- ------------ ----------- ----------- ------------
Net segment earnings
(losses).................... $ (22,234) $ 74,667 $ 6,308 $ (3,373) $ 5,262 $ 11,086 $ --
----------- ------------- -------------- ------------ ----------- ----------- ------------
----------- ------------- -------------- ------------ ----------- ----------- ------------

Intersegment revenues......... $ -- $ 116,449 $ 20,745 $ -- $ 124,324 $ -- $ (261,518)
Identifiable segment assets... $ 343,343 $ 125,527 $ 49,528 $ 181,297 $ 53,750 $ 982,867 $ (506,886)
Segment capital expenditures,
net......................... $ 36,156 $ 4,265 $ 1,874 $ 19,261 $ 983 $ 13,684 $ --

CONSOLIDATED
------------
<S> <C>
FOR THE YEAR ENDED DECEMBER 31
Total Net Revenues............ $2,010,820
Operating expenses, corporate
general and administrative
expenses, and provision for
losses on accounts
receivable.................. 1,776,826
Depreciation and
amortization................ 56,630
Interest, net................. 74,482
------------
Earnings (losses) before
corporate allocations....... 102,882
Corporate interest
allocation.................. --
Corporate management fees
allocation.................. --
------------
Net segment earnings
(losses).................... $ 102,882
------------
------------
Intersegment revenues......... $ --
Identifiable segment assets... $2,579,236
Segment capital expenditures,
net......................... $ 103,162
FOR THE YEAR ENDED DECEMBER 31
Total Net Revenues............ $1,316,308
Operating expenses, corporate
general and administrative
expenses, and provision for
losses on accounts
receivable.................. 1,184,876
Depreciation and
amortization................ 33,817
Interest, net................. 25,899
------------
Earnings (losses) before
corporate allocations....... 71,716
Corporate interest
allocation.................. --
Corporate management fees..... --
------------
Net segment earnings
(losses).................... $ 71,716
------------
------------
Intersegment revenues......... $ --
Identifiable segment assets... $1,229,426
Segment capital expenditures,
net......................... $ 76,223
</TABLE>

F-43
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998

(19) SEGMENT INFORMATION (CONTINUED)
The following tables reconcile segment earnings (losses) to consolidated
earnings (losses) before income taxes and extraordinary items:

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Net segment earnings (losses)......................... $ (42,968) $ 102,882 $ 71,716
Legal and regulatory matters.......................... (22,456) -- (19,250)
Loss on sale of assets................................ (206,205) (7,000) --
Impairment loss....................................... (397,492) -- --
Restructuring costs................................... (4,558) -- --
Dividends on convertible preferred securities of
subsidiary.......................................... (16,163) -- --
---------- -------- --------
Earnings (losses) before income taxes and
extraordinary loss................................ $ (689,842) $ 95,882 $ 52,466
---------- -------- --------
---------- -------- --------
</TABLE>

(20) SUMMARIZED CONSOLIDATING INFORMATION

In connection with the Company's offering of the 9 1/2% Notes in July 1997
and the 9 3/8% Notes in May, 1998 all direct and indirect subsidiaries of the
Company other than the Company's direct and indirect foreign subsidiaries,
CareerStaff and its direct and indirect subsidiaries, and certain other
immaterial subsidiaries of the Company (the "Guarantors") have, jointly and
severally, unconditionally guaranteed the 9 1/2% Notes and 9 3/8% Notes. These
guarantees are subordinated to all existing and future senior debt and
guarantees of the Guarantors and are unsecured.

The Company conducts all of its business through and derives virtually all
of its income from its subsidiaries. Therefore, the Company's ability to make
required payments with respect to its indebtedness (including the 9 1/2% Notes
and the 9 3/8% Notes) and other obligations depends on the financial results and
condition of its subsidiaries and its ability to receive funds from its
subsidiaries. There are no restrictions on the ability of any of the Company's
subsidiaries to transfer funds to the Company, except as provided by appropriate
law.

Pursuant to Rule 3-10 of Regulation S-X, the following summarized
consolidating information is for the Company, the wholly-owned Guarantors, and
the Company's non-Guarantor subsidiaries with respect to the 9 1/2% Notes and
the 9 3/8% Notes. This summarized financial information has been prepared from
the books and records maintained by the Company, the Guarantors and the
non-Guarantor subsidiaries. The summarized financial information may not
necessarily be indicative of results of operations or financial position had the
Guarantors or non-Guarantor subsidiaries operated as independent entities. The
separate financial statements of the Guarantors are not presented because
management has determined they would not be material to investors.

F-44
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 1998
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------------- ------------ -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents................ $ (9,964) $ 26,406 $ 11,062 $ -- $ 27,504
Accounts receivable, net................. 311 485,293 60,313 (7,588) 538,329
Other receivables........................ 14,304 17,600 16,169 -- 48,073
Inventory, net........................... 13 39,640 9,209 -- 48,862
Prepaids and other assets................ 2,651 9,151 1,289 -- 13,091
Income tax receivable.................... 15,874 -- -- -- 15,874
------------- ------------ -------------- ----------- ------------
Total current assets................... 23,189 578,090 98,042 (7,588) 691,733
------------- ------------ -------------- ----------- ------------
Property and equipment, net.............. 66,341 228,732 306,197 -- 601,270
Goodwill, net............................ -- 669,785 126,160 -- 795,945
Notes receivable......................... 21,999 693 9,642 -- 32,334
Assets held for sale..................... -- 192,447 -- -- 192,447
Other assets, net........................ 75,710 50,287 22,312 -- 148,309
Investment in subsidiaries............... (904) -- -- 904 --
Deferred tax assets...................... 6,000 -- -- -- 6,000
------------- ------------ -------------- ----------- ------------
Total assets........................... $ 192,335 $ 1,720,034 $ 562,353 $ (6,684) $2,468,038
------------- ------------ -------------- ----------- ------------
------------- ------------ -------------- ----------- ------------
Current liabilities:
Current portion of long-term debt........ $ 728,032 $ 57,212 $ 27,377 $ -- $ 812,621
Current portion of obligations under
capital leases......................... 1,134 2,333 236 -- 3,703
Accounts payable......................... 63,170 17,192 21,369 (7,588) 94,143
Accrued compensation and benefits........ 19,160 69,510 13,421 -- 102,091
Accrued interest......................... 19,616 5,957 522 -- 26,095
Accrued self-insurance obligations....... (2,713) 56,241 1,337 -- 54,865
Other accrued liabilities................ 23,699 77,128 37,024 -- 137,851
------------- ------------ -------------- ----------- ------------
Total current liabilities.............. 852,098 285,573 101,286 (7,588) 1,231,369
------------- ------------ -------------- ----------- ------------
Long-term debt, net of current portion... 502,822 162,061 40,770 -- 706,653
Obligations under capital leases, net of
current portion........................ -- 27,731 75,948 -- 103,679
Other long-term liabilities.............. -- 39,123 1,938 -- 41,061
------------- ------------ -------------- ----------- ------------
Total liabilities...................... 1,354,920 514,488 219,942 (7,588) 2,081,762
------------- ------------ -------------- ----------- ------------
Intercompany payables/(receivables)...... (1,541,344) 1,398,795 142,549 -- --
Minority interest........................ -- 6,118 1,399 -- 7,517
Company-obligated manditorily redeemable
convertible preferred securities of a
subsidiary trust holding solely 7%
convertible junior subordinated
debentures of the Company.............. 345,000 -- -- -- 345,000
Total stockholders' equity............... 33,759 (199,367) 198,463 904 33,759
------------- ------------ -------------- ----------- ------------
Total liabilities and stockholders'
equity................................. $ 192,335 $ 1,720,034 $ 562,353 $ (6,684) $2,468,038
------------- ------------ -------------- ----------- ------------
------------- ------------ -------------- ----------- ------------
</TABLE>

F-45
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 1997
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------------- ------------ -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents................ $ (1,581) $ 20,010 $ 2,591 $ -- $ 21,020
Accounts receivable, net................. -- 465,137 58,341 (317) 523,161
Other receivables........................ 11,288 13,848 8,414 -- 33,550
Inventory, net........................... -- 23,321 4,898 -- 28,219
Prepaids and other assets................ 596 7,924 1,701 -- 10,221
Deferred tax assets...................... 16,546 -- -- -- 16,546
------------- ------------ -------------- ----------- ------------
Total current assets................... 26,849 530,240 75,945 (317) 632,717
------------- ------------ -------------- ----------- ------------
Property and equipment, net.............. 30,805 207,488 392,809 -- 631,102
Goodwill, net............................ -- 861,492 169,401 -- 1,030,893
Notes receivable......................... 60,080 17,534 13,448 -- 91,062
Other assets, net........................ 89,193 58,872 23,833 -- 171,898
Investment in subsidiaries............... 611,846 -- -- (611,846) --
Deferred tax assets...................... 19,077 -- 2,487 -- 21,564
------------- ------------ -------------- ----------- ------------
Total assets........................... $ 837,850 $ 1,675,626 $ 677,923 $ (612,163) $2,579,236
------------- ------------ -------------- ----------- ------------
------------- ------------ -------------- ----------- ------------
Current liabilities:
Current portion of long-term debt........ $ 5,000 $ 12,933 $ 38,884 $ -- $ 56,817
Current portion of obligations under
capital leases......................... 262 1,415 377 -- 2,054
Accounts payable......................... 34,031 21,379 6,780 (317) 61,873
Accrued compensation and benefits........ 21,870 50,465 6,625 -- 78,960
Accrued interest......................... 16,477 1,233 2,741 -- 20,451
Accrued self-insurance obligations....... 369 34,187 (202) -- 34,354
Other accrued liabilities................ 6,028 29,876 35,279 -- 71,183
------------- ------------ -------------- ----------- ------------
Total current liabilities.............. 84,037 151,488 90,484 (317) 325,692
------------- ------------ -------------- ----------- ------------
Long-term debt, net of current portion... 1,303,377 93,514 91,970 -- 1,488,861
Obligations under capital leases, net of
current portion........................ 17 2,311 76,782 -- 79,110
Other long-term liabilities.............. -- 41,755 673 -- 42,428
Deferred income taxes.................... (2,480) -- 12,287 -- 9,807
------------- ------------ -------------- ----------- ------------
Total liabilities...................... 1,384,951 289,068 272,196 (317) 1,945,898
------------- ------------ -------------- ----------- ------------
Intercompany payables/(receivables)...... (1,164,154) 1,058,101 113,895 (7,842) --
Minority interest........................ -- -- 16,285 -- 16,285
Total stockholders' equity............... 617,053 328,457 275,547 (604,004) 617,053
------------- ------------ -------------- ----------- ------------
Total liabilities and stockholders'
equity................................. $ 837,850 $ 1,675,626 $ 677,923 $ (612,163) $2,579,236
------------- ------------ -------------- ----------- ------------
------------- ------------ -------------- ----------- ------------
</TABLE>

F-46
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING STATEMENT OF EARNINGS (LOSSES)
FOR THE YEARS ENDED DECEMBER 31, 1998
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
----------- ------------ -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Total net revenues....................... $ 3,106 $ 2,657,853 $ 447,617 $ (20,116) $ 3,088,460
Costs and expenses:
Operating................................ 4,281 2,235,535 409,785 (20,116) 2,629,485
Corporate general and administrative..... 122,081 41,144 17,709 -- 180,934
Provision for losses on accounts
receivable............................. 5,433 73,937 3,713 -- 83,083
Depreciation and amortization............ 10,364 69,928 22,223 -- 102,515
Interest, net............................ 102,745 12,124 20,542 -- 135,411
Loss on sale of assets................... 37,392 157,460 11,353 -- 206,205
Legal and regulatory matters............. 22,050 406 -- -- 22,456
Restructuring............................ 1,003 3,429 126 -- 4,558
Impairment loss.......................... 6,750 330,453 60,289 -- 397,492
Equity interest in losses of
subsidiaries........................... 779,076 -- -- (779,076) --
----------- ------------ -------------- ------------ ------------
Total costs and expenses................. 1,091,175 2,924,416 545,740 (799,192) 3,762,139
----------- ------------ -------------- ------------ ------------
Dividends on convertible preferred
securities of subsidiary............... 16,163 -- -- -- 16,163
Intercompany charges..................... (323,662) 315,450 8,212 -- --
----------- ------------ -------------- ------------ ------------
Earnings (losses) before income taxes and
extraordinary loss..................... (780,570) (582,013) (106,335) 779,076 (689,842)
Income taxes............................. (37,151) 96,222 (5,494) -- 53,577
----------- ------------ -------------- ------------ ------------
Earnings (losses) before extraordinary
loss................................... (743,419) (678,235) (100,841) 779,076 (743,419)
Extraordinary loss....................... 10,274 -- -- -- 10,274
----------- ------------ -------------- ------------ ------------
Net earnings (losses).................... $ (753,693) $ (678,235) $ (100,841) $ 779,076 $ (753,693)
----------- ------------ -------------- ------------ ------------
----------- ------------ -------------- ------------ ------------
</TABLE>

F-47
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING STATEMENT OF EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
----------- ------------ -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Total net revenues......................... $ 2,337 $ 1,671,369 $ 337,114 $ -- $2,010,820
----------- ------------ -------------- ----------- ------------
Costs and expenses:
Operating.................................. -- 1,376,767 286,051 -- 1,662,818
Corporate general and administrative....... 61,687 22,643 13,839 -- 98,169
Provision for losses on accounts
receivable............................... (750) 15,733 856 -- 15,839
Depreciation and amortization.............. 4,574 35,301 16,755 -- 56,630
Interest, net.............................. 52,244 5,646 16,592 -- 74,482
Loss on sale of Canadian operations........ 7,000 -- -- -- 7,000
Equity interest in (earnings) losses of
subsidiaries............................. 22,925 -- -- (22,925) --
----------- ------------ -------------- ----------- ------------
Total costs and expenses................. 147,680 1,456,090 334,093 (22,925) 1,914,938
----------- ------------ -------------- ----------- ------------
Earnings (losses) before income taxes and
intercompany charges..................... (145,343) 215,279 3,021 22,925 95,882
Intercompany charges(1).................... (221,738) 217,578 4,160 -- --
----------- ------------ -------------- ----------- ------------
Earnings (losses) before income taxes...... 76,395 (2,299) (1,139) 22,925 95,882
Income taxes............................... 39,544 935 674 -- 41,153
----------- ------------ -------------- ----------- ------------
Earnings (losses) before extraordinary
loss..................................... 36,851 (3,234) (1,813) 22,925 54,729
Extraordinary loss......................... 2,050 17,878 -- -- 19,928
----------- ------------ -------------- ----------- ------------
Net earnings (losses)...................... $ 34,801 $ (21,112) $ (1,813) $ 22,925 $ 34,801
----------- ------------ -------------- ----------- ------------
----------- ------------ -------------- ----------- ------------
</TABLE>

F-48
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING STATEMENT OF EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
----------- ------------ -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Total net revenues......................... $ 2,373 $ 1,140,879 $ 178,906 $ (5,850) $1,316,308
----------- ------------ -------------- ----------- ------------
Costs and expenses:
Operating.................................. -- 957,831 155,840 (5,850) 1,107,821
Corporate general and administrative....... 40,769 14,224 7,092 -- 62,085
Provision for losses on accounts
receivable............................... -- 14,699 271 -- 14,970
Depreciation and amortization.............. 3,614 25,911 4,292 -- 33,817
Interest, net.............................. 20,770 4,160 969 -- 25,899
Legal and regulatory matters............... 19,250 -- -- -- 19,250
Equity interest in (earnings) losses of
subsidiaries............................. (6,757) -- -- 6,757 --
----------- ------------ -------------- ----------- ------------
Total costs and expenses................. 77,646 1,016,825 168,464 907 1,263,842
----------- ------------ -------------- ----------- ------------
Earnings (losses) before income taxes and
intercompany charges..................... (75,273) 124,054 10,442 (6,757) 52,466
Intercompany charges(1).................... (115,085) 113,361 1,724 -- --
----------- ------------ -------------- ----------- ------------
Earnings (losses) before income taxes...... 39,812 10,693 8,718 (6,757) 52,466
Income taxes............................... 18,276 8,338 4,316 -- 30,930
----------- ------------ -------------- ----------- ------------
Net earnings (losses)...................... $ 21,536 $ 2,355 $ 4,402 $ (6,757) $ 21,536
----------- ------------ -------------- ----------- ------------
----------- ------------ -------------- ----------- ------------
</TABLE>

F-49
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
--------- ----------- -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (losses)........................ $(753,693) $(678,235) $ (100,841) $ 779,076 $ (753,693)
Adjustments to reconcile net earnings
(losses) to net cash (used for) provided by
operating activities-
Equity in earnings of subsidiaries........... 779,076 -- -- (779,076) --
Extraordinary loss........................... 10,274 -- -- -- 10,274
Loss on sale of assets....................... 37,392 157,460 11,353 -- 206,205
Impairment loss.............................. 6,750 330,453 60,289 -- 397,492
Depreciation and amortization................ 10,364 69,928 22,223 -- 102,515
Provision for losses on accounts
receivable................................. 5,433 73,937 3,713 -- 83,083
Other, net................................... 9,572 -- (504) -- 9,068
Changes in operating assets and liabilities:
Accounts receivable.......................... (1,525) (56,853) (3,301) -- (61,679)
Other current assets......................... (5,083) (3,262) (11,212) -- (19,557)
Other current liabilities.................... 88,371 (125,270) (4,631) -- (41,530)
Income taxes payable......................... (30,387) 53,855 (1,226) -- 22,242
--------- ----------- -------------- ----------- ------------
Net cash (used for) provided by operating
activities................................. 156,544 (177,987) (24,137) -- (45,580)
--------- ----------- -------------- ----------- ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net.................... (32,688) (116,920) (10,808) -- (160,416)
Acquisitions, net of cash acquired........... -- (46,249) (14,392) -- (60,641)
Proceeds from the sale and leaseback of
property and equipment..................... -- 16,833 117,542 -- 134,375
Decrease (increase) in long-term notes
receivables................................ (24,686) 14,903 3,806 -- (5,977)
Decrease (increase) in other assets.......... 5,593 (11,282) 12,483 -- 6,794
--------- ----------- -------------- ----------- ------------
Net cash (used for) provided by investing
activities................................. (51,781) (142,715) 108,631 -- (85,865)
--------- ----------- -------------- ----------- ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings.................... 225,781 -- 23,037 -- 248,818
Long-term debt repayments.................... (314,823) (24,725) (99,059) -- (438,607)
Net proceeds from issuance of convertible
trust issued preferred securities of
subsidiary................................. 334,044 -- -- -- 334,044
Net proceeds from issuance of common stock... 2,337 -- -- -- 2,337
Purchases of treasury stock.................. (1,393) -- -- -- (1,393)
Other financing activities................... (18,290) 8,875 1,264 -- (8,151)
Intercompany advances........................ (340,802) 342,948 (2,146) -- --
--------- ----------- -------------- ----------- ------------
Net cash provided by (used for) financing
activities................................. (113,146) 327,098 (76,904) -- 137,048
--------- ----------- -------------- ----------- ------------

Effect of exchange rate on cash and cash
equivalents................................ -- -- 881 -- 881
--------- ----------- -------------- ----------- ------------
Net (decrease) increase in cash and cash
equivalents................................ (8,383) 6,396 8,471 -- 6,484
Cash and cash equivalents at beginning of
period..................................... (1,581) 20,010 2,591 -- 21,020
--------- ----------- -------------- ----------- ------------
Cash and cash equivalents and end of
period..................................... $ (9,964) $ 26,406 $ 11,062 $ -- $ 27,504
--------- ----------- -------------- ----------- ------------
--------- ----------- -------------- ----------- ------------
</TABLE>

F-50
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
--------- ----------- --------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (losses)........................ $ 34,801 $ (21,112) $ (1,813) $ 22,925 $ 34,801
Adjustments to reconcile net earnings
(losses) to net cash provided by (used for)
operating activities-
Equity in earnings of subsidiaries........... 22,925 -- -- (22,925) --
Extraordinary loss........................... 3,059 26,684 -- -- 29,743
Loss of sale on Canadian operations.......... 7,000 -- -- -- 7,000
Depreciation and amortization................ 4,574 35,301 16,755 -- 56,630
Provision for losses on accounts
receivable................................. -- 14,983 856 -- 15,839
Other, net................................... 5,353 (1,697) (344) -- 3,312
Changes in operating assets and liabilities:
Accounts receivable.......................... -- (143,875) (21,091) -- (164,966)
Other current assets......................... 10,960 (8,939) (8,344) -- (6,323)
Other current liabilities.................... 38,152 (22,303) 8,379 -- 24,228
Income taxes payable......................... 30,654 (7,861) (1,324) -- 21,469
--------- ----------- --------------- ----------- ------------
Net cash provided by (used for) operating
activities................................. 157,478 (128,819) (6,926) -- 21,733
--------- ----------- --------------- ----------- ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net.................... (2,900) (47,893) (52,369) -- (103,162)
Acquisitions, net of cash acquired........... -- (346,054) (218,080) -- (564,134)
Proceeds (expenditures) from the sale and
leaseback of property and equipment........ -- 31,179 49,278 -- 80,457
Increase in long-term notes receivables...... (38,392) (5,590) (13,449) -- (57,431)
Other asset expenditures..................... (24,489) (16,285) 4,923 -- (35,851)
--------- ----------- --------------- ----------- ------------
Net cash used for investing activities....... (65,781) (384,643) (229,697) -- (680,121)
--------- ----------- --------------- ----------- ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings.................... 1,793,711 4,508 38,843 -- 1,837,062
Long-term debt repayments.................... (847,114) (53,035) (65,875) -- (966,024)
Repurchase of certain Regency debt........... -- (182,070) -- -- (182,070)
Net proceeds from issuance of common stock... 6,275 -- -- -- 6,275
Purchases of treasury stock.................. (505) -- -- -- (505)
Other financing activities................... (33,369) -- (42) -- (33,411)
Intercompany advances........................ (1,014,502) 753,199 261,303 -- --
--------- ----------- --------------- ----------- ------------
Net cash provided for (used for) financing
activities................................. (95,504) 522,602 234,229 -- 661,327
--------- ----------- --------------- ----------- ------------

Effect of exchange rate on cash and cash
equivalents................................ -- -- 3,201 -- 3,201
--------- ----------- --------------- ----------- ------------
Net increase (decrease) in cash and cash
equivalents................................ (3,807) 9,140 807 -- 6,140
Cash and cash equivalents at beginning of
period..................................... 2,226 10,870 1,784 -- 14,880
--------- ----------- --------------- ----------- ------------
Cash and cash equivalents and end of
period..................................... $ (1,581) $ 20,010 $ 2,591 $ -- $ 21,020
--------- ----------- --------------- ----------- ------------
--------- ----------- --------------- ----------- ------------
</TABLE>

F-51
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMBINED COMBINED
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATION CONSOLIDATED
------------ ------------- --------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (losses)................... $ 21,536 $ 2,355 $ 4,402 $ (6,757) $ 21,536
Adjustments to reconcile net earnings
(losses) to net cash provided by (used
for) operating activities--
Equity in earnings of subsidiaries...... (6,757) -- -- 6,757 --
Depreciation and amortization........... 3,614 25,911 4,292 -- 33,817
Provision for losses on accounts
receivable............................ -- 14,699 271 -- 14,970
Litigation settlement................... (4,750) -- -- -- (4,750)
Other, net.............................. 668 (2,927) 227 -- (2,032)
Changes in operating assets and
liabilities:
Accounts receivable..................... -- (50,266) (6,793) -- (57,059)
Other current assets.................... (5,964) (1,782) 1,050 -- (6,696)
Other current liabilities............... 8,824 (6,344) 782 -- 3,262
Income taxes payable.................... 22,422 (620) 1,962 -- 23,764
------------ ------------- ------- ------------- -------------
Net cash provided by (used for)
operating activities.................. 39,593 (18,974) 6,193 -- 26,812
------------ ------------- ------- ------------- -------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net............... (11,292) (23,410) (41,521) -- (76,223)
Acquistions, net of cash acquired....... -- (28,779) (46,800) -- (75,579)
Investment in OmniCell Technologies..... (25,332) -- -- -- (25,332)
Net proceeds from sale of SunSurgery
Corp.................................. -- 24,828 -- -- 24,828
Proceeds from operations and sale of
assets held for sale.................. -- (3,810) -- -- (3,810)
Proceeds (expenditures) from the sale
and leaseback of property and
equipment............................. -- 8,766 25,837 -- 34,603
Increase in long-term notes
receivables........................... (9,188) 523 -- -- (8,665)
Other asset expenditures................ (2,426) (4,678) (4,907) -- (12,011)
------------ ------------- ------- ------------- -------------
Net cash used for investing
activities............................ (48,238) (26,560) (67,391) -- (142,189)
------------ ------------- ------- ------------- -------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings............... 101,678 955 34,522 -- 137,155
Long-term debt repayments............... (255) (2,110) (1,908) -- (4,273)
Net proceeds from issuance of common
stock................................. 1,582 -- -- -- 1,582
Purchases of treasury stock............. (25,069) -- -- -- (25,069)
Other financing activities.............. (1,835) 11 48 -- (1,776)
Intercompany advances................... (58,583) 29,957 28,626 -- --
------------ ------------- ------- ------------- -------------
Net cash provided for (used for)
financing activities.................. 17,518 28,813 61,288 -- 107,619
------------ ------------- ------- ------------- -------------

Effect of exchange rate on cash and cash
equivalents........................... -- -- (464) -- (464)
------------ ------------- ------- ------------- -------------
Net increase (decrease) in cash and cash
equivalents........................... 8,873 (16,721) (374) -- (8,222)
Cash and cash equivalents at beginning
of period............................. (6,647) 27,591 2,158 -- 23,102
------------ ------------- ------- ------------- -------------
Cash and cash equivalents and end of
period................................ $ 2,226 $ 10,870 $ 1,784 $ -- $ 14,880
------------ ------------- ------- ------------- -------------
------------ ------------- ------- ------------- -------------
</TABLE>

F-52
<PAGE>
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONSOLIDATING STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (CONTINUED)

Through various intercompany agreements entered into by the Company, the
Guarantors and certain of the non-Guarantor subsidiaries, Sun provides
management services, and acts on behalf of the Guarantors and certain of the
non-Guarantor subsidiaries to make financing available for their operations. The
Company charged the Guarantors for management services totaling $124.9 million,
$75.7 million and $82.7 million for the years ended December 31, 1998, 1997 and
1996, respectively. The Company charged the non-Guarantor subsidiaries for
management services totaling $4.4 million, $1.5 million and $1.2 million for the
years ended December 31, 1998, 1997 and 1996, respectively. Intercompany
interest charged to the Guarantors for the years ended December 31, 1998, 1997
and 1996 for advances from the Company were $190.5 million, $141.8 million and
$30.6 million, respectively. Intercompany interest charged to the non-Guarantor
subsidiaries for the years ended December 31, 1998, 1997 and 1996 for advances
from the Company was $3.8 million, $2.7 million and $0.6 million, respectively.

F-53
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

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

We have audited in accordance with generally accepted auditing standards the
consolidated financial statements of Sun Healthcare Group, Inc. and subsidiaries
in this Form 10-K and have issued our report thereon dated April 19, 1999. Our
audits were made for the purpose of forming an opinion on the basic consolidated
financial statements taken as a whole. The schedule listed as Item 14(a)(ii) in
the index of financial statements is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures applied
in our audits of the basic consolidated financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic consolidated financial statements
taken as a whole.

/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP

Albuquerque, New Mexico
April 19, 1999
<PAGE>
SCHEDULE II

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN E
----------- ----------- -------------- COLUMN D -----------
BALANCE AT CHARGED TO ADDITIONS ----------- BALANCE AT
BEGINNING COSTS AND CHARGED TO DEDUCTIONS END OF
DESCRIPTION OF PERIOD EXPENSES OTHER ACCOUNTS OTHER PERIOD
- ------------------------------------------------ ----------- ----------- -------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1998:
Allowance for doubtful accounts............... $ 34,433 $ 86,481 $ 10,726(1) $ (52,625) $ 79,015
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------
Exit costs for acquired business.............. $ 4,800 $ -- $ 2,464(2) $ (4,764) $ 2,500
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------
Notes receivable reserve...................... $ -- $ 1,712 $ -- $ -- $ 1,712
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------
Reserve for assets held for sale.............. $ -- $ 206,205 $ -- $ 206,205
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------
Restructure reserve........................... $ -- $ 4,558 $ -- $ (1,420) $ 3,138
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------

Year ended December 31, 1997:
Allowance for doubtful accounts............... $ 16,877 $ 15,839 $ 10,241 $ (8,524) $ 34,433
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------
Exit costs for acquired business.............. $ -- $ -- $ 13,209(2) $ (8,409) $ 4,800
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------

Year ended December 31, 1996:
Allowance for doubtful accounts............... $ 11,035 $ 14,970 $ 1,394(1) $ (10,522) $ 16,877
----------- ----------- ------- ----------- -----------
----------- ----------- ------- ----------- -----------
</TABLE>

(1) Represents the allowance for doubtful accounts of acquired entities at the
date of acquisition.

(2) Exit cost for acquired businesses are included in the purchase price
allocation.

<PAGE>
EXHIBIT 23

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation by
reference of our reports dated April 19, 1999 included in this Form 10-K into
the Sun Healthcare Group, Inc. and Subsidiaries previously filed Registration
Statements on Form S-8 (No. 33-80540, No. 33-93692, No. 333-03058 and No.
333-38583).

/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP

Albuquerque, New Mexico
April 19, 1999