Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2009

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 001-10315

HealthSouth Corporation

(Exact name of Registrant as specified in its Charter)


Delaware	63-0860407
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

3660 Grandview Parkway, Suite 200 Birmingham, Alabama	35243
(Address of Principal Executive Offices)	(Zip Code)

(205) 967-7116

(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed 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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x

Accelerated filer o

Non-Accelerated filer o

Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No x

The registrant had 88,297,279 shares of common stock outstanding, net of treasury shares, as of July 31, 2009.

TABLE OF CONTENTS

		Page
PART I	Financial Information

Item 1.	Financial Statements (Unaudited)	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	59
Item 4.	Controls and Procedures	60

PART II	Other Information

Item 1.	Legal Proceedings	62
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	62
Item 4.	Submission of Matters to a Vote of Security Holders	62
Item 6.	Exhibits	63

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report contains historical information, as well as forward-looking statements that involve known and unknown risks and relate to future events, our business strategy, our future financial performance, or our projected business results. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “targets,” “potential,” or “continue” or the negative of these terms or other comparable terminology. Such forward-looking statements are necessarily estimates or forecasts based upon current information and involve a number of risks and uncertainties, many of which are beyond our control. Actual events or results may differ materially from the results anticipated in these forward-looking statements as a result of a variety of factors. Any forward-looking statement is based on information current as of the date of this report and speaks only as of the date on which such statement is made. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to, the following:

•

each of the factors discussed in Item 1A, Risk Factors , of our Annual Report on Form 10-K for the year ended December 31, 2008, as well as uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings from time to time with the United States Securities and Exchange Commission, or in materials incorporated therein by reference;

•

changes or delays in, or suspension of, reimbursement for our services by governmental or private payors, including our ability to obtain and retain favorable arrangements with third-party payors;

•

our ability to attract and retain nurses, therapists, and other healthcare professionals in a highly competitive environment with often severe staffing shortages and the impact on our labor expenses from potential union activity and staffing shortages;

•

changes in the regulations of the healthcare industry at either or both of the federal and state levels;

•

competitive pressures in the healthcare industry and our response to those pressures;

•

our ability to successfully access the credit markets on favorable terms; and

•

general conditions in the economy and capital markets.

The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We undertake no duty to update these forward-looking statements, even though our situation may change in the future. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements.

PART 1. FINANCIAL INFORMATION

Item 1.

Financial Statements (Unaudited)

HealthSouth Corporation and Subsidiaries

Condensed Consolidated Balance Sheets

(Unaudited)

	June 30, 2009	December 31, 2008
		(As Adjusted)
	(In Millions, Except Share Data)
Assets
Current assets:
Cash and cash equivalents	$ 49.8	$ 32.2
Restricted cash	71.7	154.0
Restricted marketable securities	21.2	20.3
Accounts receivable, net of allowance for doubtful accounts of $33.0 in 2009;
$31.1 in 2008	244.4	235.8
Insurance recoveries receivable	181.8	182.8
Other current assets	59.3	57.6
Total current assets	628.2	682.7
Property and equipment, net	671.4	673.9
Goodwill	414.7	414.7
Intangible assets, net	39.2	42.8
Investments in and advances to nonconsolidated affiliates	27.8	36.7
Income tax refund receivable	10.5	55.9
Other long-term assets	96.6	91.5
Total assets	$ 1,888.4	$ 1,998.2
Liabilities and Shareholders’ Deficit
Current liabilities:
Current portion of long-term debt	$ 21.8	$ 23.6
Accounts payable	47.8	45.6
Accrued expenses and other current liabilities	342.1	408.5
Government, class action, and related settlements	294.4	268.5
Total current liabilities	706.1	746.2
Long-term debt, net of current portion	1,680.1	1,789.6
Other long-term liabilities	165.1	162.2
	2,551.3	2,698.0
Commitments and contingencies
Convertible perpetual preferred stock, $.10 par value; 1,500,000 shares authorized;
400,000 issued; liquidation preference of $1,000 per share	387.4	387.4
Shareholders’ deficit:
HealthSouth shareholders' deficit:
Common stock, $.01 par value; 200,000,000 shares authorized;
issued: 97,238,725 in 2009; 96,890,924 in 2008	1.0	1.0
Capital in excess of par value	2,950.2	2,956.5
Accumulated deficit	(3,772.8)	(3,812.2)
Accumulated other comprehensive income (loss)	0.5	(3.2)
Treasury stock, at cost (8,938,877 shares in 2009 and 8,872,121 shares
in 2008)	(312.1)	(311.5)
Total HealthSouth shareholders’ deficit	(1,133.2)	(1,169.4)
Noncontrolling interests	82.9	82.2
Total shareholders' deficit	(1,050.3)	(1,087.2)
Total liabilities and shareholders’ deficit	$ 1,888.4	$ 1,998.2

The accompanying notes to condensed consolidated financial

statements are an integral part of these condensed balance sheets.

HealthSouth Corporation and Subsidiaries

Condensed Consolidated Statements of Operations

(Unaudited)

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2009	2008	2009	2008
		(As Adjusted)		(As Adjusted)
	(In Millions, Except Per Share Data)
Net operating revenues	$ 483.7	$ 456.6	$ 958.8	$ 920.8
Operating expenses:
Salaries and benefits	239.1	234.1	473.8	464.5
Other operating expenses	67.6	63.6	134.8	132.4
General and administrative expenses	24.9	25.2	50.4	53.3
Supplies	28.7	27.7	56.2	54.9
Depreciation and amortization	17.7	17.8	35.3	47.4
Impairment of long-lived assets	–	0.6	–	0.6
Occupancy costs	12.1	12.2	24.1	24.2
Provision for doubtful accounts	9.7	6.1	17.6	13.9
Loss on disposal of assets	1.3	0.8	2.3	0.4
Government, class action, and related settlements expense	48.7	(8.6)	32.8	(45.0)
Professional fees—accounting, tax, and legal	(3.3)	5.3	1.5	8.9
Total operating expenses	446.5	384.8	828.8	755.5
(Gain) loss on early extinguishment of debt	(1.3)	3.4	(3.1)	3.7
Interest expense and amortization of debt discounts and fees	31.1	43.4	65.5	90.8
Other income	(1.0)	(1.0)	(0.8)	(1.7)
Loss (gain) on interest rate swaps	3.8	(28.5)	8.8	8.1
Equity in net loss (income) of nonconsolidated affiliates	2.7	(2.7)	0.2	(5.1)
Income from continuing operations before income tax (benefit) expense	1.9	57.2	59.4	69.5
Provision for income tax (benefit) expense	(0.3)	0.7	0.9	0.8
Income from continuing operations	2.2	56.5	58.5	68.7
Income (loss) from discontinued operations, net of tax	1.4	(4.1)	(1.4)	10.1
Net income	3.6	52.4	57.1	78.8
Less: Net income attributable to noncontrolling interests	(9.1)	(8.3)	(17.7)	(14.9)
Net (loss) income attributable to HealthSouth	(5.5)	44.1	39.4	63.9
Less: Convertible perpetual preferred stock dividends	(6.5)	(6.5)	(13.0)	(13.0)
Net (loss) income attributable to HealthSouth
common shareholders	$ (12.0)	$ 37.6	$ 26.4	$ 50.9

Weighted average common shares outstanding:
Basic	87.6	79.5	87.5	79.2
Diluted	101.5	93.0	101.2	92.6

Basic and diluted (loss) earnings per common share:
(Loss) income from continuing operations
attributable to HealthSouth common shareholders	$ (0.15)	$ 0.52	$ 0.32	$ 0.50
Income (loss) from discontinued operations, net of tax,
attributable to HealthSouth common shareholders	0.01	(0.05)	(0.02)	0.14
Net (loss) income per share attributable to HealthSouth common
shareholders	$ (0.14)	$ 0.47	$ 0.30	$ 0.64

Amounts attributable to HealthSouth:
(Loss) income from continuing operations	$ (6.7)	$ 48.3	$ 41.3	$ 52.9
Income (loss) from discontinued operations, net of tax	1.2	(4.2)	(1.9)	11.0
Net (loss) income attributable to HealthSouth	$ (5.5)	$ 44.1	$ 39.4	$ 63.9

The accompanying notes to condensed consolidated financial

statements are an integral part of these condensed statements.

HealthSouth Corporation and Subsidiaries

Condensed Consolidated Statements of Comprehensive (Loss) Income

(Unaudited)

	Three Months Ended			Six Months Ended
	June 30,			June 30,
	2009		2008	2009	2008
			(As Adjusted)		(As Adjusted)
		(In Millions)
COMPREHENSIVE (LOSS) INCOME
Net income	$ 3.6		$ 52.4	$ 57.1	$ 78.8
Other comprehensive income, net of tax:
Net change in foreign currency translation adjustments	–		0.8	–	0.8
Net change in unrealized gain (loss) on available-for-sale securities:
Unrealized net holding gain (loss) arising during the period	1.7		(0.4)	0.1	0.6
Reclassification adjustment for gains (losses) included
in net income	–		–	1.6	(1.4)
Net change in unrealized gain on forward-starting interest
rate swaps:
Unrealized net holding gain arising during the period	2.7		–	1.8	–
Reclassification adjustment for gains included in net income	–		–	0.2	–
Other comprehensive income, net of tax	4.4		0.4	3.7	–
Comprehensive income	8.0		52.8	60.8	78.8
Comprehensive income attributable to noncontrolling interests	(9.1)		(8.3)	(17.7)	(14.9)
Comprehensive (loss) income attributable to
HealthSouth	$ (1.1)		$ 44.5	$ 43.1	$ 63.9

The accompanying notes to condensed consolidated financial

statements are an integral part of these condensed statements.

HealthSouth Corporation and Subsidiaries

Condensed Consolidated Statements of Shareholders’ Deficit

(Unaudited)

	Six Months Ended
	June 30,
	2009	2008
		(As Adjusted)
	(In Millions)
NUMBER OF COMMON SHARES OUTSTANDING
Balance at beginning of period	88.0	78.7
Issuance of common stock	–	8.8
Issuance of restricted stock	0.4	0.4
Other, including receipt of treasury stock	(0.1)	0.2
Balance at end of period	88.3	88.1

COMMON STOCK
Balance at beginning of period	$ 1.0	$ 0.9
Issuance of common stock	–	0.1
Balance at end of period	$ 1.0	$ 1.0

CAPITAL IN EXCESS OF PAR VALUE
Balance at beginning of period	$ 2,956.5	$ 2,820.4
Dividends declared on convertible perpetual preferred stock	(13.0)	(13.0)
Issuance of common stock	–	150.1
Stock-based compensation	6.6	6.0
Other, including restricted stock cancellations	0.1	0.2
Balance at end of period	$ 2,950.2	$ 2,963.7

ACCUMULATED DEFICIT
Balance at beginning of period	$ (3,812.2)	$ (4,064.6)
Net income attributable to HealthSouth	39.4	63.9
Balance at end of period	$ (3,772.8)	$ (4,000.7)

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance at beginning of period	$ (3.2)	$ (0.8)
Net foreign currency translation adjustment,
net of tax	–	0.8
Net change in unrealized gain (loss) on available-for-sale securities,
net of tax	1.7	(0.8)
Net change in unrealized gain on forward-starting interest rate
swaps	2.0	–
Net other comprehensive income (loss) adjustments	3.7	–
Balance at end of period	$ 0.5	$ (0.8)

TREASURY STOCK
Balance at beginning of period	$ (311.5)	$ (310.4)
Receipt of treasury stock	(0.5)	(0.2)
Other, including restricted stock cancellations	(0.1)	(0.1)
Balance at end of period	$ (312.1)	$ (310.7)

Total HealthSouth shareholders' deficit	$ (1,133.2)	$ (1,347.5)

(Continued)

HealthSouth Corporation and Subsidiaries

Condensed Consolidated Statements of Shareholders’ Deficit (Continued)

(Unaudited)

	Six Months Ended
	June 30,
	2009	2008
		(As Adjusted)
	(In Millions)
NONCONTROLLING INTERESTS
Balance at beginning of period	$ 82.2	$ 97.2
Net income attributable to noncontrolling interests	17.7	14.9
Distributions declared	(15.7)	(15.8)
Repurchases of equity interests of consolidated affiliates	(1.5)	–
Settlements with partners	–	4.2
Government, class action, and related settlements	–	(5.3)
Transfer of surgery centers to ASC	–	(6.8)
Other	0.2	(0.5)
Balance at end of period	$ 82.9	$ 87.9

Total shareholders’ deficit	$ (1,050.3)	$ (1,259.6)

The accompanying notes to condensed consolidated financial

statements are an integral part of these condensed statements.

HealthSouth Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Six Months Ended June 30,
	2009	2008
		(As Adjusted)
	(In Millions)
Cash flows from operating activities:
Net income	$ 57.1	$ 78.8
Loss (income) from discontinued operations	1.4	(10.1)
Adjustments to reconcile net income to net cash provided by operating
activities—
Provision for doubtful accounts	17.6	13.9
Provision for government, class action, and related settlements	32.8	(45.0)
UBS Settlement proceeds, gross	100.0	–
Depreciation and amortization	35.3	47.4
Amortization of debt issue costs, debt discounts, and fees	3.2	3.3
Loss on disposal of assets	2.3	0.4
(Gain) loss on early extinguishment of debt	(3.1)	3.7
Loss on interest rate swaps	8.8	8.1
Equity in net loss (income) of nonconsolidated affiliates	0.2	(5.1)
Distributions from nonconsolidated affiliates	3.9	6.0
Stock-based compensation	6.6	6.0
Deferred tax provision	1.9	1.4
Other	0.6	0.1
(Increase) decrease in assets—
Accounts receivable	(26.2)	(33.9)
Other assets	(0.7)	6.2
Income tax refund receivable	45.4	9.4
Increase (decrease) in liabilities—
Accounts payable	2.2	(1.4)
Accrued fees and expenses for derivative plaintiffs' attorneys in
UBS Settlement	(26.2)	–
Other liabilities	(18.2)	(8.3)
Government, class action, and related settlements	(8.7)	(7.4)
Net cash used in operating activities of discontinued operations	(7.0)	(6.5)
Total adjustments	170.7	(1.7)
Net cash provided by operating activities	229.2	67.0

(Continued)

HealthSouth Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Continued)

(Unaudited)

	Six Months Ended June 30,
	2009	2008
		(As Adjusted)
	(In Millions)
Cash flows from investing activities:
Capital expenditures	(34.8)	(18.3)
Proceeds from disposal of assets	0.8	47.2
Net change in restricted cash	(15.7)	17.0
Net settlements on interest rate swap	(19.1)	(6.6)
Net investment in interest rate swap	(6.4)	–
Other	(1.5)	(0.4)
Net cash (used in) provided by investing activities of
discontinued operations	(1.1)	0.7
Net cash (used in) provided by investing activities	(77.8)	39.6

Cash flows from financing activities:
Checks in excess of bank balance	–	(5.5)
Principal payments on debt, including pre-payments	(60.9)	(92.4)
Borrowings on revolving credit facility	10.0	75.0
Payments on revolving credit facility	(50.0)	(150.0)
Principal payments under capital lease obligations	(6.6)	(6.1)
Issuance of common stock	–	150.2
Dividends paid on convertible perpetual preferred stock	(13.0)	(13.0)
Distributions paid to noncontrolling interests of consolidated affiliates	(15.8)	(16.5)
Other	0.7	–
Net cash provided by (used in) financing activities of discontinued
operations	1.8	(2.1)
Net cash used in financing activities	(133.8)	(60.4)
Effect of exchange rate changes on cash and cash equivalents	–	0.8
Increase in cash and cash equivalents	17.6	47.0
Cash and cash equivalents at beginning of period	32.2	19.8
Cash and cash equivalents of divisions and facilities held for sale
at beginning of period	–	0.4
Less: Cash and cash equivalents of divisions and facilities held for
sale at end of period	–	–
Cash and cash equivalents at end of period	$ 49.8	$ 67.2

The accompanying notes to condensed consolidated financial

statements are an integral part of these condensed statements.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

1.	Basis of Presentation:

HealthSouth Corporation, incorporated in Delaware in 1984, including its subsidiaries, is the largest provider of inpatient rehabilitative healthcare services in the United States. We operate inpatient rehabilitation hospitals and long-term acute care hospitals and provide treatment on both an inpatient and outpatient basis. References herein to “HealthSouth,” the “Company,” “we,” “our,” or “us” refer to HealthSouth Corporation and its subsidiaries unless otherwise stated or indicated by context.

The accompanying unaudited condensed consolidated financial statements of HealthSouth Corporation and Subsidiaries should be read in conjunction with the consolidated financial statements and accompanying notes filed with the United States Securities and Exchange Commission (the “SEC”) in HealthSouth’s Annual Report on Form 10-K filed on February 24, 2009 (the “2008 Form 10-K”). The unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the SEC applicable to interim financial information. Certain information and note disclosures included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been omitted in these interim statements, as allowed by such SEC rules and regulations. The condensed consolidated balance sheet as of December 31, 2008 has been derived from audited financial statements, as adjusted for our adoption of Financial Accounting Standards Board (“FASB”) Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 , but it does not include all disclosures required by GAAP. However, we believe the disclosures are adequate to make the information presented not misleading.

The unaudited results of operations for the interim periods shown in these financial statements are not necessarily indicative of operating results for the entire year. In our opinion, the accompanying condensed consolidated financial statements recognize all adjustments of a normal recurring nature considered necessary to fairly state the financial position, results of operations, and cash flows for each interim period presented.

Subsequent events have been evaluated through August 5, 2009, which represents the issuance date of these unaudited condensed consolidated financial statements.

Reclassifications —

Certain financial results have been reclassified to conform to the current year presentation. Such reclassifications primarily relate to rental properties where we terminated the leases associated with certain properties during the first quarter of 2009. In accordance with FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , we reclassified our condensed consolidated balance sheet as of December 31, 2008, our condensed consolidated statements of operations for the three and six months ended June 30, 2008, and our condensed consolidated statement of cash flows for the six months ended June 30, 2008 to include these properties and their results of operations in discontinued operations.

On January 1, 2009, we adopted FASB Statement No. 160. As a result, we have reclassified our noncontrolling interests (formerly known as “minority interests”) as a component of equity and now report net income and comprehensive income attributable to our noncontrolling interests separately from net income and comprehensive income attributable to HealthSouth.

Out-of-Period Adjustments —

During the preparation of our condensed consolidated financial statements for the quarterly period ended June 30, 2009, we identified an error in our consolidated financial statements as of and for the year ended December 31, 2008 and prior periods and our condensed consolidated financial statements as of and for the quarterly period ended March 31, 2009. We corrected this error in our financial statements by adjusting Equity in net loss (income) of nonconsolidated affiliates , which resulted in an understatement of both our Income from continuing operations before income tax (benefit) expense and our Net income of approximately $4.9 million and $4.5 million for the three and six months ended June 30, 2009, respectively. This error related primarily to an approximate $9.6 million overstatement of our investment in a joint venture hospital we account for using the equity method of accounting due to the understatement of prior period income tax provisions of this joint venture hospital and the adjustment of certain liabilities due to this joint venture hospital. We also adjusted Accrued expenses and other current liabilities by approximately $4.7 million due to changes in amounts due to us for expenses paid on behalf of

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

this joint venture hospital. We do not believe these adjustments are material to the condensed consolidated financial statements as of June 30, 2009 and for the three and six months then ended or to any prior years’ consolidated financial statements. As a result, we have not restated any prior period amounts.

Stock-Based Compensation —

In February 2009, we granted 1.7 million shares of restricted common stock to members of our management team and our board of directors. Approximately 0.5 million shares of the restricted stock granted contain only a service condition, while the remaining 1.2 million shares contain a service and either a performance or market condition. Additionally, we granted 0.3 million stock options to members of our management team. The fair value of these awards and options were determined using the policies described in the 2008 Form 10-K.

Recent Accounting Pronouncements —

In April 2009, the FASB issued FASB Staff Position (“FSP”) No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments . This FSP amends the other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. HealthSouth elected to adopt this FSP in the first quarter of 2009. While its adoption did not have a material impact on our financial position, results of operations, or cash flows, it does require interim disclosures related to our available-for-sale equity securities. See Note 3, Cash and Marketable Securities .

In April 2009, the FASB also issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments . This FSP amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments , and Accounting Principles Board Opinion No. 28, Interim Financial Reporting , to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. HealthSouth elected to adopt this FSP in the first quarter of 2009. Its adoption resulted in additional interim disclosures only. See Note 7, Fair Value Measurements .

In May 2009, the FASB issued FASB Statement No. 165, Subsequent Events , to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This Statement is effective for interim or annual financial periods ending after June 15, 2009. Our adoption of this Statement resulted only in additional disclosure regarding the date through which subsequent events have been evaluated in each set of interim or annual financial statements and had no impact on our financial position, results of operations, or cash flows.

In June 2009, the FASB issued FASB Statement No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles . FASB Statement No. 168 establishes the FASB Accounting Standards Codification as the single authoritative source for GAAP. The Codification is effective for financial statements that cover interim and annual periods ending after September 15, 2009. While not intended to change GAAP, the Codification significantly changes the way in which the accounting literature is organized. Because the Codification completely replaces existing standards, it will affect the way GAAP is referenced by companies in their financial statements and accounting policies. Our adoption of this Statement and our use of the Codification beginning in the third quarter of 2009 will not have an impact on our financial position, results of operations, or cash flows.

Since the filing of our 2008 Form 10-K, we do not believe any other recently issued, but not yet effective, accounting standards will have a material effect on our consolidated financial position, results of operations, or cash flows.

2.	Liquidity:

We continue to make progress in improving our leverage and liquidity.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

During the six months ended June 30, 2009, we reduced our total debt by approximately $111 million. In February 2009, we used our federal income tax refund for tax years 1995 through 1999 (see Note 17, Income Taxes , to the consolidated financial statements accompanying our 2008 Form 10-K) along with available cash to reduce our Term Loan Facility (as defined in Note 8, Long-term Debt , to the consolidated financial statements accompanying our 2008 Form 10-K) by $24.5 million and amounts outstanding under our revolving credit facility to zero. In addition, during the first six months of 2009, we used a portion of the net proceeds from our settlement with UBS (see Note 11, Settlements ) to redeem $36.4 million of our Floating Rate Senior Notes due 2014 (as defined in Note 8, Long-term Debt , to the consolidated financial statements accompanying our 2008 Form 10-K). See also Note 5, Long-term Debt .

As of June 30, 2009, we had $49.8 million in Cash and cash equivalents . This amount excludes $71.7 million in Restricted cash and $21.2 million of Restricted marketable securities . Our restricted assetspertain to various obligations we have under partnership agreements and other arrangements, primarily related to our captive insurance company. As of December 31, 2008, our Restricted cash included $97.9 million related to our settlement with UBS (see Note 11, Settlements ).

We have scheduled principal payments of $10.8 million and $21.9 million in the remainder of 2009 and 2010, respectively, related to long-term debt obligations (see Note 5, Long-term Debt ). We do not face substantial near-term refinancing risk, as our revolving credit facility does not expire until 2012, our Term Loan Facility does not mature until 2013, and the majority of our bonds are not due until 2014 and 2016.

Our Credit Agreement (as defined in Note 8, Long-term Debt , to the consolidated financial statements accompanying our 2008 Form 10-K) governs the vast majority of our senior secured borrowings and contains financial covenants that include a leverage ratio and an interest coverage ratio. As of June 30, 2009, we were in compliance with the covenants under our Credit Agreement. If we anticipated a potential covenant violation, we would seek relief from our lenders, which would have some cost to us, and such relief might not be on terms as favorable to those in our existing Credit Agreement. Under such circumstances, there is also the potential our lenders would not grant relief to us which, among other things, would depend on the state of the credit markets at that time. However, we believe we have reduced this risk by significantly lowering our senior secured leverage ratio since the inception of our Credit Agreement.

Our Credit Agreement also contains excess cash flow provisions. To the extent we have available cash at the end of 2009 that has not been used to make qualified capital expenditures or debt reductions, and depending upon our leverage ratio under our Credit Agreement, we may be required to use a portion of our excess cash to reduce amounts outstanding on our Term Loan Facility.

Our primary sources of liquidity are cash on hand, cash flows from operations, and borrowings under our revolving credit facility. We monitor the financial strength of our depositories, creditors, insurance carriers, and other counterparties using publicly available information, as well as qualitative inputs. Based on our current borrowing capacity and compliance with the financial covenants under our Credit Agreement, we do not believe there is significant risk in our ability to make draws under our revolving credit facility, if needed. However, no such assurances can be provided. We continue to analyze our capital structure, and we will use our available cash in a manner that provides the most beneficial impact to our capital structure, including deleveraging.

See Note 1, Summary of Significant Accounting Policies , to the consolidated financial statements accompanying our 2008 Form 10-K for a discussion of risks and uncertainties facing us. Changes in our business or other factors may occur that might have a material adverse impact on our financial position, results of operations, and cash flows.

3.	Cash and Marketable Securities:

As of June 30, 2009 and December 31, 2008, our investments consist of cash and cash equivalents and marketable securities. Our investments in marketable securities are classified as available-for-sale.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

The components of our investments as of June 30, 2009 are as follows (in millions):

	Cash & Cash Equivalents	Restricted Cash	Nonrestricted Marketable Securities	Restricted Marketable Securities	Total
Cash	$ 49.8	$ 71.7	$ –	$ –	$ 121.5
Equity securities	–	–	0.3	21.2	21.5
Total	$ 49.8	$ 71.7	$ 0.3	$ 21.2	$ 143.0

The components of our investments as of December 31, 2008 are as follows (in millions):

	Cash & Cash Equivalents	Restricted Cash	Nonrestricted Marketable Securities	Restricted Marketable Securities	Total
Cash	$ 32.2	$ 154.0	$ –	$ –	$ 186.2
Equity securities	–	–	0.2	20.3	20.5
Total	$ 32.2	$ 154.0	$ 0.2	$ 20.3	$ 206.7

Restricted cash as of December 31, 2008 includes cash associated with the UBS Settlement discussed in Note 11, Settlements . Nonrestricted marketable securities are included in Other current assets in our condensed consolidated balance sheets.

A summary of our restricted marketable securities as of June 30, 2009 is as follows (in millions):

	Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Equity securities	$ 21.2		$ 1.0		$ (1.0)		$ 21.2

A summary of our restricted marketable securities as of December 31, 2008 is as follows (in millions):

	Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Equity securities	$ 21.9		$ 0.4		$ (2.0)		$ 20.3

Cost in the above tables includes adjustments made to the cost basis of our equity securities for other-than-temporary impairments. During the three and six months ended June 30, 2009, we recorded $0.1 million and $0.8 million, respectively, of impairments related to our restricted marketable securities. These impairment charges are included in Other income in our condensed consolidated statements of operations for the three and six months ended June 30, 2009. No impairments were recorded during the three or six months ended June 30, 2008.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Investing information related to our marketable securities is as follows (in millions):

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2009	2008	2009	2008
Nonrestricted:
Gross realized gains – nonrestricted	$ –	$ –	$ –	$ 0.6
Restricted:
Proceeds from sales of restricted
available-for-sale securities	$ 1.2	$ 0.8	$ 1.6	$ 1.3
Gross realized gains - restricted	$ 0.2	$ 0.1	$ 0.2	$ 0.1
Gross realized losses - restricted	$ (0.1)	$ (0.1)	$ (0.2)	$ (0.2)

The following table shows the fair value and gross unrealized losses of our marketable securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by the length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2009 and December 31, 2008 (in millions):

	As of June 30, 2009	As of December 31, 2008
Less than 12 months:
Fair value	$ 14.3	$ 15.5
Gross unrealized losses	$ (1.0)	$ (1.9)
12 months or greater:
Fair value	$ 0.1	$ 0.1
Gross unrealized losses	$ –	$ (0.1)
Total:
Fair value	$ 14.4	$ 15.6
Gross unrealized losses	$ (1.0)	$ (2.0)

Our portfolio of marketable securities is comprised of numerous individual equity securities and mutual funds across a variety of industries. For our marketable securities with unrealized losses that are not deemed to be other-than-temporarily impaired, we examined the severity and duration of the impairments in relation to the cost of the individual investments. We also considered the industry in which each investment is held and the near-term prospects for a recovery in each specific industry. In addition, the majority of our marketable securities with unrealized losses that are not deemed to be other-than-temporarily impaired are investments in mutual funds which are more diversified than a security held in one specific company or industry. Based on our evaluation and our ability and intent to hold these investments for a reasonable period of time sufficient for a potential recovery of fair value, we do not believe these investments are other-than-temporarily impaired at June 30, 2009.

4.	Investments in and Advances to Nonconsolidated Affiliates:

Investments in and advances to nonconsolidated affiliates as of June 30, 2009 represents our investment in 16 partially owned subsidiaries, of which 11 are general or limited partnerships, limited liability companies, or joint ventures in which HealthSouth or one of our subsidiaries is a general or limited partner, managing member, member, or venturer, as applicable. We do not control these affiliates, but have the ability to exercise significant influence over the operating and financial policies of certain of these affiliates. Our ownership percentages in these affiliates range from 4% to 51%. We account for these investments using the cost and equity methods of accounting.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

The following summarizes the combined results of operations of our equity method affiliates (on a 100% basis, in millions):

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2009	2008	2009	2008
Net operating revenues	$ 18.1	$ 19.0	$ 35.5	$ 37.3
Operating expenses	(11.7)	(3.3)	(23.2)	(14.9)
Income from continuing operations	5.3	14.8	10.3	20.5
Net income	5.3	14.8	10.3	20.5

The following summarizes the results of operations of New England Rehabilitation Services of Central Massachusetts, Inc., which qualified during the three months ended June 30, 2009 as a “significant subsidiary” under Regulation S-X promulgated by the SEC and requiring separate disclosure (on a 100% basis, in millions):

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2009	2008	2009	2008
Net operating revenues	$ 9.4	$ 7.6	$ 17.6	$ 15.3
Operating expenses	(6.3)	(5.7)	(12.7)	(11.6)
Income from continuing operations	1.9	1.2	3.1	2.2
Net income	1.9	1.2	3.1	2.2

See also Note 1, Basis of Presentation , “Out-of-Period Adjustments.”

5.	Long-term Debt:

Our long-term debt outstanding consists of the following (in millions):

	June 30, 2009	December 31, 2008
Advances under $400 million revolving credit facility	$ –	$ 40.0
Term Loan Facility	755.1	783.6
Bonds Payable—
8.375% Senior Notes due 2011	0.3	0.3
7.625% Senior Notes due 2012	1.5	1.5
Floating Rate Senior Notes due 2014	329.6	366.0
10.75% Senior Notes due 2016	494.6	494.3
Other notes payable at interest rates from 8.1% to 12.9%	12.5	12.8
Capital lease obligations	108.3	114.7
	1,701.9	1,813.2
Less: Current portion	(21.8)	(23.6)
Long-term debt, net of current portion	$ 1,680.1	$ 1,789.6

For a description of our indebtedness, see Note 8, Long-term Debt , to the consolidated financial statements accompanying our 2008 Form 10-K.

In February 2009, we used our federal income tax refund for tax years 1995 through 1999 (see Note 17, Income Taxes , to the consolidated financial statements accompanying our 2008 Form 10-K) along with available cash to reduce our Term Loan Facility by $24.5 million and amounts outstanding under our revolving credit facility to zero.

During the first and second quarters of 2009, we used a portion of the net proceeds from our settlement with UBS (see Note 11, Settlements ) to redeem $15.4 million and $21.0 million, respectively, of our Floating Rate Senior Notes due 2014.

In addition to the pre-payments discussed above, we also used available cash to make quarterly principal payments on the Term Loan Facility and scheduled principal payments on capital leases during the six months ended June 30, 2009.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

The following chart shows scheduled principal payments due on long-term debt for the next five years and thereafter (in millions):

	Face Amount	Net Amount
July 1 through December 31, 2009	$ 10.8	$ 10.8
2010	21.9	21.9
2011	21.2	21.2
2012	20.6	20.6
2013	737.5	737.5
2014	336.0	336.0
Thereafter	559.9	553.9
Total	$ 1,707.9	$ 1,701.9

The following table provides information regarding our Interest expense and amortization of debt discounts and fees presented in our condensed consolidated statements of operations (in millions):

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2009	2008	2009	2008
Interest expense	$ 29.5	$ 41.7	$ 62.3	$ 87.5
Amortization of debt discounts and fees	1.6	1.7	3.2	3.3
Interest expense and amortization of
debt discounts and fees	$ 31.1	$ 43.4	$ 65.5	$ 90.8

Interest Rate Swaps—

Interest Rate Swaps Not Designated as Hedging Instruments

Based on the requirements under our Credit Agreement, in March 2006, we entered into an interest rate swap to effectively convert the floating rate of a portion of our Credit Agreement to a fixed rate in order to limit the variability of interest-related payments caused by changes in LIBOR. Under this interest rate swap agreement, we pay a fixed rate of 5.2% on an amortizing notional principal of $1.1 billion, while the counterparties to this agreement pay a floating rate based on 3-month LIBOR. The termination date of this swap is March 10, 2011. The fair market value of this swap as of June 30, 2009 and December 31, 2008 was ($68.1) million and ($78.2) million, respectively, and is included in Accrued expenses and other current liabilities in our condensed consolidated balance sheets. See Note 8, Long-term Debt , to the consolidated financial statements accompanying our 2008 Form 10-K for additional information related to this interest rate swap.

In June 2009, we entered into a receive-fixed swap as a mirror offset to $100.0 million of the $1.1 billion interest rate swap discussed above in order to reduce our effective fixed rate to total debt ratio. Under this interest rate swap agreement, we pay a variable rate based on 3-month LIBOR, while the counterparty to this agreement pays a fixed rate of 5.2% on a notional principal of $100.0 million. Net settlements will commence in September 2009 and will be made quarterly thereafter on the same settlement schedule as the $1.1 billion interest rate swap discussed above. The termination date of this swap is March 10, 2011. Our initial net investment in this swap was $6.4 million. The fair market value of this swap as of June 30, 2009 was $6.7 million. Of this amount, $4.3 million is included in Other current assets with the remainder included in Other long-term assets in our condensed consolidated balance sheet.

These interest rate swaps are not designated as a hedge under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities . Therefore, changes in the fair value of these interest rate swaps during the three and six months ended June 30, 2009 and 2008 have been included in current-period earnings as Loss (gain) on interest rate swaps .

During the three and six months ended June 30, 2009, we made net cash settlement payments of $10.6 million and $19.1 million, respectively, to our counterparties. During the three and six months ended June 30, 2008, we made net cash settlement payments of $6.4 million and $6.6 million, respectively, to our counterparties. Net settlement payments or receipts on these swaps are included in the line item Loss (gain) on interest rate swaps in our condensed consolidated statements of operations.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Forward-Starting Interest Rate Swaps Designated as Cash Flow Hedges

In December 2008, we entered into a $100 million forward-starting interest rate swap as a cash flow hedge of future interest payments on our Term Loan Facility. Under this swap agreement, we pay a fixed rate of 2.6% while the counterparty pays a floating rate based on 3-month LIBOR. Net settlements will commence on June 10, 2011. The termination date of this swap is December 12, 2012. The fair market value of this swap as of June 30, 2009 and December 31, 2008 was $1.3 million and ($0.2) million, respectively, and is included in Other long-term assets and Accrued expenses and other current liabilities, respectively, in our condensed consolidated balance sheets.

In March 2009, we entered into an additional $100 million forward-starting interest rate swap as a cash flow hedge of future interest payments on our Term Loan Facility. Under this swap agreement, we pay a fixed rate of 2.9% while the counterparty pays a floating rate based on 3-month LIBOR. Net settlements will commence on June 10, 2011. The termination date of this swap is September 12, 2012. The fair market value of this swap as of June 30, 2009 was $0.5 million and is included in Other long-term assets in our condensed consolidated balance sheet.

Both forward-starting swaps are designated as cash flow hedges under the guidance in FASB Statement No. 133 and are accounted for under the policies described in Note 1, Summary of Significant Accounting Policies , to the consolidated financial statements accompanying our 2008 Form 10-K. The effective portion of changes in the fair value of these cash flow hedges is deferred as a component of other comprehensive income and is reclassified into earnings as part of interest expense in the same period in which the forecasted transaction impacts earnings.

See also Note 7, Fair Value Measurements .

6.	Guarantees:

Primarily in conjunction with the sale of certain facilities, including the sale of our surgery centers, outpatient, and diagnostic divisions during 2007, HealthSouth assigned, or remained as a guarantor on, the leases of certain properties and equipment to certain purchasers and, as a condition of the lease, agreed to act as a guarantor of the purchaser’s performance on the lease. HealthSouth also remained as a guarantor to certain purchase contracts that were assigned to the buyer of our diagnostic division in connection with the sale. Should the purchaser fail to pay the obligations due on these leases or contracts, the lessor or vendor would have contractual recourse against us.

As of June 30, 2009, we were secondarily liable for 90 such guarantees. The remaining terms of these guarantees ranged from one month to 120 months. If we were required to perform under all such guarantees, the maximum amount we would be required to pay approximated $56.4 million.

We have not recorded a liability for these guarantees, as we do not believe it is probable we will have to perform under these agreements. If we are required to perform under these guarantees, we could potentially have recourse against the purchaser for recovery of any amounts paid. In addition, the purchasers of our surgery centers, outpatient, and diagnostic divisions have agreed to seek releases from the lessors and vendors in favor of HealthSouth with respect to the guarantee obligations associated with these divestitures. To the extent the purchasers of these divisions are unable to obtain releases for HealthSouth, the purchasers have agreed to indemnify HealthSouth for damages incurred under the guarantee obligations, if any.

These guarantees are not secured by any assets under the agreements. As of June 30, 2009, we have been required to perform under one such guarantee. Amounts were paid under this guarantee during 2008 and were not material to our financial position, results of operations, or cash flows.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

7. Fair Value Measurements:

Our financial assets and liabilities that are measured at fair value on a recurring basis are as follows (in millions):

		Fair Value Measurements at Reporting Date Using
June 30, 2009	Fair Value	Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)	Valuation Technique ⁽¹⁾
Restricted marketable securities	$ 21.2	$ 21.2	$ –	$ –	M
Other current assets:
Marketable securities	0.3	0.3	–	–	M
June 2009 trading swap	4.3	–	4.3	–	I
Other long-term assets:
December 2008 forward-starting swap	1.3	–	1.3	–	I
March 2009 forward-starting swap	0.5	–	0.5	–	I
June 2009 trading swap	2.4	–	2.4	–	I
Accrued expenses and other current
liabilities:
March 2006 trading swap	(68.1)	–	(68.1)	–	I
Government, class action, and related
settlements:
Securities Litigation Settlement
liability—common stock	(72.5)	(72.5)	–	–	M
Securities Litigation Settlement
liability—common stock
warrants	(35.8)	–	(35.8)	–	I

⁽¹⁾

FASB Statement No. 157, Fair Value Measurements , identifies three valuation techniques: market approach (M), cost approach (C), and income approach (I).

In addition to assets and liabilities recorded at fair value on a recurring basis, we are also required to record assets and liabilities at fair value on a nonrecurring basis. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges or similar adjustments made to the carrying value of the applicable assets. Assets measured at fair value on a nonrecurring basis are as follows (in millions):

		Fair Value Measurements at Reporting
		Date Using			Total Losses
	Net Carrying Value as of June 30, 2009	Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)	Three Months Ended June 30, 2009	Six Months Ended June 30, 2009
Other long-term assets:
Assets held for sale	$ 29.1	$ –	$ 29.1	$ –	$ (0.5)	$ (0.5)

The above losses represented our write-down of certain assets held for sale to their estimated fair value based on offers we received from third parties to acquire the assets. These losses are included in Loss on disposal of assets in our condensed consolidated statements of operations for the three and six months ended June 30, 2009. In addition, during the three and six months ended June 30, 2008, we recorded an impairment charge of $0.6 million. This charge represented our write-down of certain long-lived assets associated with one of our hospitals to their estimated fair value based on an offer we received from a third party to acquire the assets. During the three and six months ended June 30, 2008, we also recorded $0.6 million of impairment charges as part of our results of discontinued operations. See Note 16, Assets Held for Sale and Results of Discontinued Operations , to the consolidated financial statements included in our 2008 Form 10-K.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

The carrying value equals fair value for our financial instruments that are not included in the table below and are classified as current in our condensed consolidated balance sheets. The carrying amounts and estimated fair values for all of our other financial instruments are presented in the following table (in millions):

	As of June 30, 2009		As of December 31, 2008
	Carrying Amount	Estimated Fair Value	Carrying Amount	Estimated Fair Value
Interest rate swap agreements:
March 2006 trading swap	$ (68.1)	$ (68.1)	$ (78.2)	$ (78.2)
December 2008 forward-starting swap	1.3	1.3	(0.2)	(0.2)
March 2009 forward-starting swap	0.5	0.5	–	–
June 2009 trading swap	6.7	6.7	–	–
Long-term debt:
Advances under $400 million revolving
credit facility	–	–	40.0	28.4
Term Loan Facility	755.1	703.0	783.6	597.5
8.375% Senior Notes due 2011	0.3	0.3	0.3	0.3
7.625% Senior Notes due 2012	1.5	1.5	1.5	1.5
Floating Rate Senior Notes due 2014	329.6	300.8	366.0	292.1
10.75% Senior Notes due 2016	494.6	505.6	494.3	459.0
Notes payable to banks and others	12.5	12.5	12.8	12.8
Financial commitments:
Letters of credit	–	95.9	–	152.7

8.	Assets Held for Sale and Results of Discontinued Operations:

During the first quarter of 2009, we terminated the leases associated with certain rental properties. In accordance with FASB Statement No. 144, we reclassified our condensed consolidated balance sheet as of December 31, 2008, our condensed consolidated statements of operations for the three and six months ended June 30, 2008, and our condensed consolidated statement of cash flows for the six months ended June 30, 2008 to include these properties and their results of operations in discontinued operations.

The operating results of discontinued operations are as follows (in millions):

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2009	2008	2009	2008
Net operating revenues	$ 2.5	$ 7.5	$ 5.7	$ 18.3
Costs and expenses	0.9	11.1	6.8	27.1
Impairments	–	0.6	–	0.6
Income (loss) from discontinued
operations	1.6	(4.2)	(1.1)	(9.4)
(Loss) gain on disposal of assets of
discontinued operations	(0.1)	0.1	(0.3)	–
Gain on divestitures of divisions	–	–	–	18.8
Income tax (expense) benefit	(0.1)	–	–	0.7
Income (loss) from discontinued
operations, net of tax	$ 1.4	$ (4.1)	$ (1.4)	$ 10.1

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Assets and liabilities held for sale consist of the following (in millions):

	June 30,	December 31,
	2009	2008
Assets:
Accounts receivable, net	$ 1.2	$ 1.0
Other current assets	1.0	1.8
Total current assets	2.2	2.8
Property and equipment, net	14.3	10.1
Goodwill	14.1	14.1
Other long-term assets	0.7	0.7
Total long-term assets	29.1	24.9
Total assets	$ 31.3	$ 27.7
Liabilities:
Current portion of long-term debt	$ –	$ 1.5
Accounts payable	0.7	0.8
Accrued expenses and other current liabilities	5.5	8.1
Deferred amounts related to sale of surgery centers division	26.5	26.5
Total current liabilities	32.7	36.9
Long-term debt, net of current portion	3.3	2.0
Other long-term liabilities	3.1	2.7
Total long-term liabilities	6.4	4.7
Total liabilities	$ 39.1	$ 41.6

Total current assets and total long-term assets in the above table are included in Other current assets and Other long-term assets , respectively, in our condensed consolidated balance sheets. Total current liabilities and total long-term liabilities in the above table are included in Accrued expenses and other current liabilities and Other long-term liabilities , respectively, in our condensed consolidated balance sheets.

Surgery Centers Division—

As discussed in Note 16, Assets Held for Sale and Results of Discontinued Operations , to the consolidated financial statements accompanying our 2008 Form 10-K, the transaction to sell our surgery centers division to ASC Acquisition LLC (“ASC”) closed on June 29, 2007, other than with respect to certain facilities for which approvals for the transfer to ASC had not yet been received as of such date. In connection with the closing, HealthSouth and ASC agreed, among other things, that HealthSouth would retain its ownership interest in certain surgery centers until regulatory approvals for the transfer of such surgery centers to ASC were received. In that regard, ASC would manage the operations of such surgery centers until such approvals had been received, and HealthSouth and ASC entered into arrangements designed to place them in approximately the same economic position, whether positive or negative, they would have occupied had all regulatory approvals been received prior to closing. Upon receipt of such approvals, HealthSouth’s ownership interest in such facilities would be transferred to ASC. No portion of the purchase price was withheld at closing pending the transfer of these facilities. In the event regulatory approval for the transfer of any such facility is not received prior to December 31, 2009, HealthSouth would be required to return to ASC a portion of the purchase price allocated to such facility.

As of June 30, 2009, one facility in Illinois remained pending due to a relocation project that was completed during the second quarter of 2009. We expect to file the application for change in control for this facility during the third quarter of 2009, and we expect to receive approval for such transfer prior to the end of 2009. In the interim, we will maintain our management agreement with ASC with respect to this facility.

The assets and liabilities presented below for the surgery centers division as of June 30, 2009 and December 31, 2008 include the assets and liabilities associated with the facility that had not been transferred as of those dates, as these assets will not be transferred until approval for such transfer is obtained. As of both balance sheet dates, we had deferred $26.5 million of cash proceeds received at closing associated with the facility that was awaiting regulatory approval for the transfer to ASC as of June 30, 2009. We will continue to report the results of operations of this facility in discontinued operations until the transfer of the facility occurs.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

The assets and liabilities of the surgery centers division reported as held for sale consist of the following (in millions):

	June 30,	December 31,
	2009	2008
Assets:
Accounts receivable, net	$ 1.0	$ 0.5
Other current assets	0.3	0.5
Total current assets	1.3	1.0
Property and equipment, net	5.2	3.9
Goodwill	14.1	14.1
Other long-term assets	0.4	0.4
Total long-term assets	19.7	18.4
Total assets	$ 21.0	$ 19.4
Liabilities:
Current portion of long-term debt	$ –	$ 0.4
Accounts payable	0.4	0.6
Accrued expenses and other current liabilities	2.3	4.5
Deferred amounts related to sale of surgery centers division	26.5	26.5
Total current liabilities	29.2	32.0
Long-term debt, net of current portion	3.3	2.0
Other long-term liabilities	0.5	0.4
Total long-term liabilities	3.8	2.4
Total liabilities	$ 33.0	$ 34.4

The operating results of the surgery centers division included in discontinued operations consist of the following (in millions):

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2009	2008	2009	2008
Net operating revenues	$ 2.2	$ 2.4	$ 4.4	$ 6.4
Costs and expenses	0.3	2.1	2.8	9.5
Impairments	–	0.6	–	0.6
Income (loss) from discontinued
operations	1.9	(0.3)	1.6	(3.7)
Gain on disposal of assets of
discontinued operations	–	0.1	–	0.1
Gain on divestiture of division	–	–	–	19.3
Income tax (expense) benefit	(0.1)	–	(0.1)	0.7
Income (loss) from discontinued
operations, net of tax	$ 1.8	$ (0.2)	$ 1.5	$ 16.4

During the first quarter of 2008, we recorded a $19.3 million post-tax gain on disposal associated with the five Illinois facilities that were transferred during the quarter. We expect to record an additional post-tax gain of approximately $10 million to $16 million for the facility that remains pending in Illinois.

9.	Income Taxes:

Our Provision for income tax benefit of $0.3 million for the three months ended June 30, 2009 includes (1) net current income tax benefit of $0.7 million primarily attributable to state income tax refunds received, or expected to be received, and (2) deferred income tax expense of $0.4 million attributable to increases in basis differences of certain indefinite-lived assets. Our Provision for income tax expense of $0.9 million for the six months ended June 30, 2009 includes (1) net current income tax benefit of $1.0 million primarily attributable to state income tax refunds received, or expected to be received, and (2) deferred income tax expense of $1.9 million attributable to increases in basis differences of certain indefinite-lived assets and a decrease in our deferred tax asset related to the Alternative Minimum Tax Refundable Tax Credit.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

We have significant federal and state net operating losses. We assess the realization of our deferred tax assets quarterly to determine whether an adjustment to our valuation allowance is required. After consideration of all evidence, both positive and negative, management concluded it is more likely than not we will not realize a portion of our deferred tax assets. Therefore, a valuation allowance has been established on substantially all of our net deferred tax assets. No valuation allowance has been provided on deferred assets and liabilities attributable to subsidiaries not included within the federal consolidated group.

We have significant federal and state net operating loss carryforwards (“NOLs”) that expire in various amounts at varying times through 2028. Our utilization of such NOLs is subject to the Internal Revenue Code Section 382 (“Section 382”) limitation and may be limited in the event of certain cumulative changes in ownership interests of significant shareholders over a three-year period in excess of 50%. Section 382 imposes an annual limitation on the use of these losses to an amount equal to the value of a company at the time of an ownership change multiplied by the long-term tax exempt rate. At this time, we do not believe these limitations will limit our ability to use any NOLs before they expire. However, no such assurances can be provided.

Our Provision for income tax expense of $0.7 million and $0.8 million for the three and six months ended June 30, 2008, respectively, includes the following: (1) current income tax expense of $18.9 million and $20.5 million, respectively, attributable to a revision in previously estimated federal income tax refunds and related interest as a result of our settlement with the Internal Revenue Services (the “IRS”) for tax years 2000 through 2003, state income tax expense of subsidiaries which have separate state filing requirements, and federal income taxes for subsidiaries not included in our federal consolidated income tax return and (2) deferred income tax expense of $0.6 million and $1.4 million, respectively, attributable to increases in the basis difference of certain indefinite-lived assets offset by (3) current income tax benefit of $18.8 million and $21.1 million, respectively, attributable to state income tax refunds.

As of December 31, 2008, total remaining gross unrecognized tax benefits were $61.1 million, all of which would affect our effective tax rate if recognized. Total accrued interest expense related to unrecognized tax benefits was $2.9 million as of December 31, 2008. The amount of unrecognized benefits changed during the second quarter of 2009 due primarily to the issuance of a Revenue Agent’s Report by the IRS in April 2009 related to the 2004 tax year which reopened statutes of limitation in certain states where amended returns are required to be filed. Total remaining gross unrecognized tax benefits were $61.2 million as of June 30, 2009, all of which would affect our effective tax rate if recognized. Total accrued interest expense related to unrecognized tax benefits as of June 30, 2009 was $2.9 million.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

A reconciliation of the change in our unrecognized tax benefits from December 31, 2008 to June 30, 2009 is as follows (in millions):

	Gross Unrecognized Income Tax Benefits	Accrued Interest and Penalties
Balance at December 31, 2008	$ 61.1	$ 2.9
Gross amount of increases in unrecognized tax
benefits related to prior periods	0.1	0.3
Gross amount of decreases in unrecognized tax
benefits related to prior periods	(1.2)	–
Decreases in unrecognized tax benefits relating
to settlements with taxing authorities	(2.0)	–
Balance at March 31, 2009	$ 58.0	$ 3.2
Gross amount of increases in unrecognized tax
benefits related to prior periods	4.5	0.2
Gross amount of decreases in unrecognized tax
benefits related to prior periods	(0.4)	(0.5)
Decreases in unrecognized tax benefits relating
to settlements with taxing authorities	(0.9)	–
Balance at June 30, 2009	$ 61.2	$ 2.9

Our continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. For the three and six months ended June 30, 2009 and 2008, we recorded $1.3 million and $1.4 million, respectively, of net interest income as part of our income tax provision. For the three and six months ended June 30, 2008, we recorded $3.9 million and $2.9 million, respectively, of net interest income as part of our income tax provision. Total accrued interest income was $1.4 million and $17.5 million as of June 30, 2009 and December 31, 2008, respectively.

HealthSouth and its subsidiaries’ federal and state income tax returns are periodically examined by various regulatory taxing authorities. In connection with such examinations, we have settled federal income tax examinations with the IRS for all tax years through 2004. In April 2009, the IRS initiated an audit of the 2005 to 2007 tax years.

For the tax years that remain open under the applicable statutes of limitations, amounts related to these unrecognized tax benefits have been considered by management in its estimate of our potential net recovery of prior years’ income taxes. However, at this time, we cannot estimate a range of the reasonably possible change that may occur.

We continue to actively pursue the maximization of our remaining state income tax refund claims. The process of resolving these tax matters with the applicable taxing authorities will continue in 2009. Although management believes its estimates and judgments related to these claims are reasonable, depending on the ultimate resolution of these tax matters, actual amounts recovered could differ from management’s estimates, and such differences could be material.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

10.

(Loss) Earnings per Common Share:

The calculation of earnings per common share is based on the weighted-average number of our common shares outstanding during the applicable period. The calculation for diluted earnings per common share recognizes the effect of all dilutive potential common shares that were outstanding during the respective periods, unless their impact would be antidilutive. The following table sets forth the computation of basic and diluted earnings per common share (in millions, except per share amounts):

	Three Months Ended June 30,		Six Months Ended June 30,
	2009	2008	2009	2008
Numerator:
Income from continuing operations	$ 2.2	$ 56.5	$ 58.5	$ 68.7
Less: Net income attributable to noncontrolling
interests included in continuing operations	(8.9)	(8.2)	(17.2)	(15.8)
Less: Convertible perpetual preferred stock
dividends	(6.5)	(6.5)	(13.0)	(13.0)
(Loss) income from continuing operations
attributable to HealthSouth common
shareholders	(13.2)	41.8	28.3	39.9
Income (loss) from discontinued operations, net
of tax, attributable to HealthSouth common
shareholders	1.2	(4.2)	(1.9)	11.0
Net (loss) income attributable to HealthSouth
common shareholders	$ (12.0)	$ 37.6	$ 26.4	$ 50.9

Denominator:
Basic weighted average common shares outstanding	87.6	79.5	87.5	79.2
Diluted weighted average common shares outstanding	101.5	93.0	101.2	92.6

Basic and diluted earnings per common share:
(Loss) income from continuing operations
attributable to HealthSouth common shareholders	$ (0.15)	$ 0.52	$ 0.32	$ 0.50
Income (loss) from discontinued operations, net
of tax, attributable to HealthSouth common
shareholders	0.01	(0.05)	(0.02)	0.14
Net (loss) income attributable to HealthSouth
common shareholders	$ (0.14)	$ 0.47	$ 0.30	$ 0.64

Diluted earnings per share report the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. These potential shares include dilutive stock options, restricted stock awards, restricted stock units, and convertible perpetual preferred stock. For the three months ended June 30, 2009 and 2008, the number of potential shares approximated 13.9 million and 13.5 million, respectively. For the six months ended June 30, 2009 and 2008, the number of potential shares approximated 13.7 million and 13.4 million, respectively. For the three and six months ended June 30, 2009 and 2008, approximately 13.1 million of the potential shares related to our Convertible perpetual preferred stock. For the three months ended June 30, 2009, including these potential common shares in the denominator resulted in an antidilutive per share amount due to our Loss from continuing operations attributable to HealthSouth common shareholders . For the six months ended June 30, 2009 and the three and six months ended June 30, 2008, adding back the dividends for the Convertible perpetual preferred stock to our Income from continuing operations attributable to HealthSouth common shareholders causes a per share increase when calculating diluted earnings per common share resulting in an antidilutive per share amount. Therefore, basic and diluted earnings per common share are the same for all periods presented.

Options to purchase 2.6 million shares of common stock were outstanding during the three and six months ended June 30, 2009, and options to purchase 2.5 million shares of common stock were outstanding during the three and six months ended June 30, 2008, but were not included in the computation of diluted weighted-average shares because to do so would have been antidilutive.

See Note 18, Earnings (Loss) per Common Share , to the consolidated financial statements accompanying our 2008 Form 10-K for additional information related to common stock, common stock warrants, and convertible perpetual preferred stock. As of June 30, 2009, the shares of common stock and common stock warrants associated

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

with our class action securities litigation have not been issued and are not included in our basic or diluted common shares outstanding. For additional information, see Note 11, Settlements .

11.

Settlements

Securities Litigation Settlement—

On June 24, 2003, the United States District Court for the Northern District of Alabama consolidated a number of separate securities lawsuits filed against us under the caption In re HealthSouth Corp. Securities Litigation , Master Consolidation File No. CV-03-BE-1500-S (the “Consolidated Securities Action”), which the court divided into two subclasses:

•

Complaints based on purchases of our common stock were grouped under the caption In re HealthSouth Corp. Stockholder Litigation , Consolidated Case No. CV-03-BE-1501-S, which was further divided into complaints based on purchases of our common stock in the open market (grouped under the caption In re HealthSouth Corp. Stockholder Litigation, Consolidated Case No. CV-03-BE-1501-S) and claims based on the receipt of our common stock in mergers (grouped under the caption HealthSouth Merger Cases , Consolidated Case No. CV-98-2777-S); and

•

Complaints based on purchases of our debt securities were grouped under the caption In re HealthSouth Corp. Bondholder Litigation , Consolidated Case No. CV-03-BE-1502-S.

The Consolidated Securities Action and the related settlement of that litigation are more fully described in Note 20, Settlements, “Securities Litigation Settlement,” and Note 21, Contingencies and Other Commitments, “Securities Litigation,”to the consolidated financial statements accompanying our 2008 Form 10-K.

Despite approval of the Consolidated Securities Action settlement, there are class members who have elected to opt out of the settlement and pursue claims individually. In addition, AIG Global Investment Corporation (“AIG”), which failed to opt out of the class settlement on a timely basis, has requested that the court allow it to opt out despite missing the district court’s deadline. In an order dated January 11, 2007, the court denied AIG’s request for an expansion of time to opt out. On April 17, 2007, AIG filed a notice of appeal with the Eleventh Circuit Court of Appeals. The appeal was consolidated with the appeal by Mr. Scrushy of one provision in the bar order in the Consolidated Securities Action settlement. On June 17, 2009, the Eleventh Circuit Court of Appeals rejected the two appeals and affirmed the district court’s approval of the settlement.

In connection with the Consolidated Securities Action settlement, we recorded a charge of $215.0 million as Government, class action, and related settlements expense in our 2005 consolidated statement of operations. During each quarter subsequent to the initial recording of this liability, we reduced or increased our liability for this settlement based on the value of our common stock and the associated common stock warrants underlying the settlement. During the three and six months ended June 30, 2009, we increased our liability for this settlement by $48.6 million and $33.7 million, respectively, based on the value of our common stock and the associated common stock warrants at each period end. During the three and six months ended June 30, 2008, we reduced our liability for this settlement by $10.7 million and $43.3 million, respectively, based on the value of our common stock and the associated common stock warrants at each period end. The corresponding liability of $108.3 million and $74.6 million as of June 30, 2009 and December 31, 2008, respectively, is included in Government, class action, and related settlements in our condensed consolidated balance sheets. The charge for this settlement will be revised in future periods to reflect additional changes in the fair value of the common stock and warrants until they are issued. Since the settlement order has been affirmed by the Eleventh Circuit Court of Appeals, we expect to issue the underlying common stock and warrants to purchase shares of common stock in 2009 when the claims administrator begins the distribution of those securities.

In addition, in order to state the total liability related to the Consolidated Securities Action settlement at the aggregate value of the consideration to be exchanged for the securities to be issued by us and the cash to be paid by the insurers, we recorded a $230.0 million liability in Government, class action, and related settlements . We also recorded a related receivable from our insurers in the amount of $230.0 million as Insurance recoveries receivable . During 2008, the United States District Court for the Northern District of Alabama issued three court orders awarding attorneys’ fees and expenses to the stockholder plaintiffs’ lead counsel, bondholder plaintiffs’ counsel, and

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

merger subclass counsel. A portion of the fees and expenses awarded under these court orders was disbursed from the cash portion of the settlement, which has been funded by the insurance carriers and is being held in escrow by the lead attorneys for the federal plaintiffs. We have reduced our liability and corresponding receivable by $48.2 million, including $1.0 million in the first quarter of 2009, for disbursements made per these court orders. We will continue to reduce this liability and receivable in subsequent periods by the amount of any additional funds that are disbursed. Since the settlement order has been affirmed by the Eleventh Circuit Court of Appeals, we expect to remove this liability and corresponding receivable from our condensed consolidated balance sheet during 2009.

UBS Litigation Settlement—

In August 2003, claims on behalf of HealthSouth were brought in the Tucker derivative litigation (described below in Note 12, Contingencies , “Derivative Litigation,”) against various UBS entities, alleging that from at least 1998 through 2002, when those entities served as our investment bankers, they breached their duties of care, suppressed information, and aided and abetted in the ongoing fraud. The claims and counterclaims between HealthSouth and various UBS entities and the related settlement (the “UBS Settlement”) are more fully described in Note 20, Settlements, “UBS Litigation Settlement,” and Note 21, Contingencies and Other Commitments , “Derivative Litigation,”to the consolidated financial statements accompanying our 2008 Form 10-K.

On January 13, 2009, the Circuit Court of Jefferson County, Alabama entered an order approving the UBS Settlement under which we received $100.0 million in cash and a release of all claims by the UBS entities. That order also awarded to the derivative plaintiffs’ attorneys fees and expenses of $26.2 million to be paid from the $100.0 million in cash we received. Pursuant to the Consolidated Securities Action settlement, we are obligated to pay 25% of the net settlement proceeds, after deducting all of our costs and expenses in connection with the Tucker derivative litigation including fees and expenses of the derivative counsel and our counsel, to the plaintiffs in the Consolidated Securities Action. The UBS Settlement does not release our claims against any other defendants in the Tucker derivative litigation, or against our former independent auditor, Ernst & Young, which remain pending in arbitration.

Capstone Litigation Settlement—

In August 2002, claims on behalf of HealthSouth were brought in the Tucker derivative litigation (described below in Note 12, Contingencies , “Derivative Litigation,”) against Capstone Capital Corporation, now known as HR Acquisition I Corp. (“Capstone”), alleging misrepresentations, conspiracy, and aiding and abetting the breach of fiduciary duties by certain of our former executives. In particular, the claims pursued against Capstone relate to the sale and leaseback of 14 properties that we initially owned. On May 8, 2009, the Circuit Court of Jefferson County, Alabama entered an order approving a settlement agreement among us, the derivative plaintiffs and Capstone (the “Capstone Settlement”). The settlement is now final as the deadline for an appeal has passed.

Under the settlement, all claims against Capstone in the Tucker litigation were released, and Capstone agreed to the following:

•

our existing leases on four properties have been restructured on terms more favorable and beneficial to us;

•

our financial obligations on certain other properties have been terminated and liquidated at an amount equal to 70% of the net present value of the future outstanding lease payment, with credit given toward that obligation for existing subtenant rental income assigned to a Capstone affiliate;

•

our obligation on the building lease for another property, and all obligations on an associated ground lease, terminated in June 2009 upon payment by us of $0.5 million and the transfer of unimproved land, valued at $1.5 million, near that property to a Capstone affiliate; and

•

we have been released as guarantor or primary obligor on leases for three other properties previously assigned to third-party purchasers.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Under the settlement, we also paid $1.2 million in fees and expenses to the derivative plaintiffs’ attorneys, and Capstone reimbursed us for half of those fees and expenses.

Amounts recorded during the six months ended June 30, 2009 and related to the Capstone Settlement did not have a material effect on our financial position, results of operations, or cash flows. The Capstone Settlement does not release our claims against any other defendants in the Tucker derivative litigation, or against our former independent auditor, Ernst & Young, which remain pending in arbitration.

Lloyd Noland Foundation Litigation Settlement—

We were named as a defendant in two related lawsuits arising from our operation of the former Lloyd Noland Hospital, later renamed HealthSouth Metro West Hospital, styled The Lloyd Noland Foundation, Inc. v. Tenet Healthcare Corp. v. HealthSouth Corporation , Case No. 2:01-cv-0437-KOB in the United States District for the Northern District of Alabama (the “Federal Case”), filed February 16, 2001, and The Lloyd Noland Foundation v. HealthSouth Corporation , Case No. CV-2004-1638 in the Circuit Court for Jefferson County, Alabama, Bessemer Division (the “Bessemer Case”), filed in Jefferson County on August 27, 2004, and transferred to the Jefferson County, Bessemer Division on December 1, 2004. Tenet Healthcare Corporation (“Tenet”) asserted third-party indemnity claims against us in the Federal Case on July 3, 2001. The Federal Case and the Bessemer Case are more fully described in Note 21, Contingencies and Other Commitments, “Other Litigation,”to the consolidated financial statements accompanying our 2008 Form 10-K.

On December 19, 2008, following a jury trial in the Federal Case, the court entered a judgment against Tenet in favor of the Lloyd Noland Foundation (the “Foundation”) for $7.7 million in damages. Pursuant to the federal trial court’s prior ruling, we would be obligated to indemnify Tenet for $5.1 million of those damages, plus Tenet’s and certain of the Foundation’s reasonable attorneys’ fees and expenses to be determined by the court. An estimate of this total obligation was included in Government, class action, and related settlements in our condensed consolidated balance sheet as of December 31, 2008.

On May 15, 2009, we entered into an agreement with Tenet and the Foundation to settle both the Federal Case and the Bessemer Case. Under the terms of the confidential settlement agreement, those cases were jointly dismissed with prejudice. This settlement did not have a material impact on our financial position, results of operations, or cash flows.

12.

Contingencies:

We operate in a highly regulated and litigious industry. As a result, various lawsuits, claims, and legal and regulatory proceedings have been and can be expected to be instituted or asserted against us. The resolution of any such lawsuits, claims, or legal and regulatory proceedings could materially and adversely affect our financial position, results of operations, and cash flows in a given period.

Derivative Litigation—

All lawsuits purporting to be derivative complaints filed in the Circuit Court of Jefferson County, Alabama since 2002 have been consolidated and stayed in favor of the first-filed action captioned Tucker v. Scrushy , CV-02-5212, filed August 28, 2002. Derivative lawsuits in other jurisdictions have been stayed. The Tucker complaint named as defendants a number of our former officers and directors. Tucker also asserted claims on our behalf against Ernst & Young and UBS entities, as well as against MedCenterDirect.com, Capstone Capital Corporation, and G.G. Enterprises. When originally filed, the primary allegations in the Tucker case involved self-dealing by Mr. Scrushy and other insiders through transactions with various entities allegedly controlled by Mr. Scrushy. The complaint was amended four times to add additional defendants and include claims of accounting fraud, improper Medicare billing practices, and additional self-dealing transactions. On June 18, 2009, the court found Mr. Scrushy liable for, and awarded us, $2.9 billion in damages as a result of breaches of fiduciary duty and fraud he perpetrated from 1996 to 2003. On July 24, 2009, Mr. Scrushy filed a notice of appeal of the trial court’s decision. No assurances can be given as to whether or when any amounts will be received from Mr. Scrushy, nor can we provide any assurances as to the collectibility of any amounts owed from Mr. Scrushy. Therefore, no amounts related to this award are included in our condensed consolidated financial statements. The Tucker derivative litigation and the

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

related settlements to date are more fully described in Note 11, Settlements , to these condensed consolidated financial statements and Note 20, Settlements , and Note 21, Contingencies and Other Commitments ,to the consolidated financial statements accompanying our 2008 Form 10-K.

On January 13, 2009, the Circuit Court of Jefferson County, Alabama approved the agreement among us, the derivative plaintiffs, and UBS Securities to settle the claims against and by UBS Securities in the Tucker litigation. See Note 11, Settlements , “UBS Litigation Settlement” to these condensed consolidated financial statements and Note 20, Settlements , “UBS Litigation Settlement,” and Note 21, Contingencies and Other Commitments , “Derivative Litigation,” to the consolidated financial statements accompanying our 2008 Form 10-K for further discussion of the UBS Settlement. On May 8, 2009, the Circuit Court of Jefferson County, Alabama approved the agreement among us, the derivative plaintiffs, and Capstone to settle the claims against Capstone in the Tucker litigation. See Note 11, Settlements , “Capstone Litigation Settlement,” for further discussion.

The settlements with UBS Securities and Capstone do not release our claims against any other defendants in the Tucker litigation, or against our former independent auditor, Ernst & Young, which remain pending in arbitration. The Tucker derivative claims against Ernst & Young and other defendants listed above remain pending and have moved through fact discovery on an expedited schedule that was coordinated with the federal securities claims by our former stockholders and bondholders against Mr. Scrushy, Ernst & Young, and UBS. We are no longer a party in the federal securities claims action (described in Note 11, Settlements , “Securities Litigation Settlement”) by our former stockholders and bondholders against Mr. Scrushy, Ernst & Young, and UBS and are not a party to or beneficiary of any settlements between the plaintiffs and the remaining defendants.

Litigation By and Against Richard M. Scrushy—

On December 9, 2005, Mr. Scrushy filed a complaint in the Circuit Court of Jefferson County, Alabama, captioned Scrushy v. HealthSouth , CV-05-7364. The complaint alleged that, as a result of Mr. Scrushy’s removal from the position of chief executive officer in March 2003, we owed him “in excess of $70 million” pursuant to an employment agreement dated as of September 17, 2002. On December 28, 2005, we counterclaimed against Mr. Scrushy, asserting claims for breaches of fiduciary duty and fraud arising out of Mr. Scrushy’s tenure with us, and seeking compensatory damages, punitive damages, and disgorgement of wrongfully obtained benefits. We also asserted that any employment agreements with Mr. Scrushy should be void and unenforceable. On July 7, 2009, we filed a motion for summary judgment on all claims by Mr. Scrushy based upon the Tucker court’s June 18, 2009 ruling that Mr. Scrushy’s employment agreements are void and rescinded.

On June 18, 2009, the Circuit Court of Jefferson County, Alabama ruled on our derivative claims against Mr. Scrushy presented during a non-jury trial held May 11 to May 26, 2009. The court held Mr. Scrushy responsible for fraud and breach of fiduciary duties and awarded us $2.9 billion in damages. On July 24, 2009, Mr. Scrushy filed a notice of appeal of the trial court’s decision. At this time, we cannot predict when and to what extent this judgment can be collected. We will pursue collection aggressively and to the fullest extent permitted by law. We are obligated to pay 35% of any recovery from Mr. Scrushy along with reasonable fees to the attorneys for the derivative shareholder plaintiffs. Under the Consolidated Securities Action settlement, we must also pay the federal plaintiffs 25% of any net recovery from Mr. Scrushy. After payment of these obligations and other amounts related to professional fees and expenses, we expect our recovery to be between 40% and 50% of any amounts collected.

In March 2009, Mr. Scrushy filed an arbitration demand claiming that we are obligated under a separate indemnification agreement to indemnify him for certain costs associated with litigation and to advance to him his attorneys’ fees and costs. On May 14, 2009, the arbitrator ruled that we should deposit certain funds for attorneys’ fees in escrow until after a ruling in the Tucker litigation. As a result of the Tucker court’s June 18, 2009 ruling that Mr. Scrushy committed fraud and breached his fiduciary duties, the arbitrator allowed us to withdraw all funds from the escrow. Any future obligation to pay such fees would be tied to the success of his appeal of the June 18, 2009 ruling. As of December 31, 2008, we included an estimate of those legal fees in Accrued expenses and other current liabilities in our condensed consolidated balance sheet. As result of the court ruling that Mr. Scrushy committed fraud and breached his fiduciary duties, we have no obligation to indemnify him for any litigation costs. Therefore, we removed this accrual from our balance sheet and recorded an approximate $6.5 million gain in Professional fees – accounting, tax, and legal during the three and six months ended June 30, 2009.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Litigation By and Against Former Independent Auditor—

In March 2003, claims on behalf of HealthSouth were brought in the Tucker derivative litigation against Ernst & Young, alleging that from 1996 through 2002, when Ernst & Young served as our independent auditor, Ernst & Young acted recklessly and with gross negligence in performing its duties, and specifically that Ernst & Young failed to perform reviews and audits of our financial statements with due professional care as required by law and by its contractual agreements with us. The claims further allege Ernst & Young either knew of or, in the exercise of due care, should have discovered and investigated the fraudulent and improper accounting practices being directed by certain officers and employees, and should have reported them to our board of directors and the Audit Committee. The claims seek compensatory and punitive damages, disgorgement of fees received from us by Ernst & Young, and attorneys’ fees and costs. On March 18, 2005, Ernst & Young filed a lawsuit captioned Ernst & Young LLP v. HealthSouth Corp. , CV-05-1618, in the Circuit Court of Jefferson County, Alabama. The complaint asserts that the filing of the claims against us was for the purpose of suspending any statute of limitations applicable to those claims. The complaint alleges we provided Ernst & Young with fraudulent management representation letters, financial statements, invoices, bank reconciliations, and journal entries in an effort to conceal accounting fraud. Ernst & Young claims that as a result of our actions, Ernst & Young’s reputation has been injured and it has and will incur damages, expense, and legal fees. On April 1, 2005, we answered Ernst & Young’s claims and asserted counterclaims related or identical to those asserted in the Tucker action. Upon Ernst & Young’s motion, the Alabama state court referred Ernst & Young’s claims and our counterclaims to arbitration pursuant to a clause in the engagement agreements between HealthSouth and Ernst & Young. On July 12, 2006, we and the derivative plaintiffs filed an arbitration demand on behalf of HealthSouth against Ernst & Young. On August 7, 2006, Ernst & Young filed an answering statement and counterclaim in the arbitration reasserting the claims made in state court. In August 2006, we and the derivative plaintiffs agreed to jointly prosecute the claims against Ernst & Young in arbitration.

We are vigorously pursuing our claims against Ernst & Young and defending the claims against us. We have initiated the selection process for an arbitration panel under rules of the American Arbitration Association (the “AAA”) that will adjudicate the claims and counterclaims in arbitration. We expect that process to take several months, after which we expect to move the claims to trial before the AAA panel. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or a settlement of this case.

Certain Regulatory Actions—

The False Claims Act, 18 U.S.C. § 287, allows private citizens, called “relators,” to institute civil proceedings alleging violations of the False Claims Act. These qui tam cases are generally sealed by the court at the time of filing. The only parties privy to the information contained in the complaint are the relator, the federal government, and the presiding court. It is possible that qui tam lawsuits have been filed against us and that we are unaware of such filings or have been ordered by the presiding court not to discuss or disclose the filing of such lawsuits. We may be subject to liability under one or more undisclosed qui tam cases brought pursuant to the False Claims Act.

General Medicine Action—

On August 16, 2004, General Medicine, P.C. (“General Medicine”) filed a lawsuit against us captioned General Medicine, P.C. v. HealthSouth Corp. seeking the recovery of allegedly fraudulent transfers involving assets of Horizon/CMS Healthcare Corporation (“Horizon/CMS”), a former subsidiary of HealthSouth. The lawsuit was filed in the Circuit Court of Shelby County, Alabama, but was transferred to the Circuit Court of Jefferson County, Alabama on February 28, 2005, where it was assigned case number CV-05-1483 (the “Alabama Action”).

The underlying claim against Horizon/CMS originates from a services contract entered into in 1995 between General Medicine and Horizon/CMS whereby General Medicine agreed to provide medical director services to skilled nursing facilities owned by Horizon/CMS for a term of three years. Horizon/CMS terminated the agreement six months after it was executed, and General Medicine then initiated a lawsuit in the United States District Court for the Eastern District of Michigan in 1996 (the “Michigan Action”). General Medicine’s complaint in the Michigan Action alleged that Horizon/CMS breached the services contract by wrongfully terminating General Medicine. We acquired Horizon/CMS in 1997 and sold it to Meadowbrook Healthcare, Inc. (“Meadowbrook”) in

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

2001 pursuant to a stock purchase agreement. In 2004, Meadowbrook consented to the entry of a final judgment in the Michigan Action in the amount of $376 million (the “Consent Judgment”) in favor of General Medicine against Horizon/CMS for the alleged wrongful termination of the contract with General Medicine. We were not a party to the Michigan Action or the settlement negotiated by Meadowbrook. The settlement agreement which was the basis for the Consent Judgment provided that Meadowbrook would pay only $0.3 million to General Medicine to settle the Michigan Action. The settlement agreement further provided that General Medicine would seek to recover the remaining balance of the Consent Judgment solely from us. The Alabama Action and the Michigan Action are more fully described in Note 21, Contingencies and Other Commitments , “General Medicine Action,” to the consolidated financial statements accompanying our 2008 Form 10-K.

On May 21, 2009, the court in the Michigan Action granted our motion to set aside the Consent Judgment on grounds that it was the product of fraud on the court and collusion by the parties. In its order setting aside the Consent Judgment, the court directed General Medicine and Horizon/CMS to confer with each other and the court’s case manager to determine what further proceedings are appropriate in the Michigan Action. On June 16, 2009, Horizon/CMS filed a motion for clarification requesting the court rule that Horizon/CMS has fully complied with its obligations under the settlement agreement and is therefore not required to participate in any further proceedings. On June 17, 2009, we filed a motion to intervene in the Michigan Action for the limited purpose of protecting our interests and a motion to dismiss the Michigan Action as settled and as a sanction for General Medicine’s fraud on the court. The court has not yet ruled on the pending motions.

Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or settlement of this case.

United HealthCare Services Litigation—

On March 19, 2009, United HealthCare Services, Inc. and certain affiliates (“United”) filed an initial arbitration demand with the AAA against us relating to disputes over therapy service claims paid from 1997 through 2003. United alleges that during that period we submitted fraudulent claims, or claims otherwise in breach of various provider agreements, for reimbursement of therapy services for patients insured under plans provided or administered by United. United requests an accounting and seeks compensatory damages in excess of $10 million, punitive damages, interest, and attorneys’ fees.

On April 14, 2009, we filed an action in Circuit Court in Jefferson County, Alabama, captioned HealthSouth Corp. v. United Healthcare Services, Inc. , CV-2009-901288, seeking a declaratory judgment that we are not required to arbitrate the claims alleged in United’s arbitration demand, seeking an order enjoining the AAA arbitration, and reserving our claims against United for underpayment and breach of contract. We assert that the AAA lacks jurisdiction to arbitrate these claims because we did not agree to arbitration and because, among other reasons, United’s arbitration demand disregards the conditions precedent to arbitration and other terms contained in the provider agreements upon which United relies, seeks damages expressly excluded from arbitration, and violates state insurance laws which prohibit United from seeking to recoup claims many years after they were submitted and paid. United has not yet answered our complaint, but on May 18, 2009, United filed a motion with the court to compel arbitration of the claims presented in their AAA arbitration demand. On July 9, 2009, the court heard oral argument on United’s motion to compel arbitration. We have requested that the court temporarily enjoin any further AAA proceedings while it considers the parties’ pending motions. At this time, we do not know when the court will rule on the motions pending before it.

On May 1, 2009, we filed our answer requesting that the AAA arbitration be stayed pending the outcome of our action filed in Circuit Court in Jefferson County, challenging, as a preliminary matter, the AAA’s jurisdiction to arbitrate the claims alleged by United, denying the claims asserted by United, raising defenses and asserting counterclaims including breaches of contract, breach of implied covenant of good faith and fair dealing. We request restitution resulting from, among other things, United’s wrongful recoupment and underpayment of paid claims submitted and compensatory damages in excess of $10 million, together with interest and the costs, fees and expenses of arbitration.

On May 16, 2009, United filed with AAA an amended arbitration demand adding certain Select Medical Corporation (“Select”) subsidiaries as named respondents, which, with one exception, are successors to

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

HealthSouth entities that signed one or more of the provider agreements at issue in United’s demand. Pursuant to the Stock Purchase Agreement between us and Select, we are obligated to defend and indemnify Select and its affiliates named in United’s amended arbitration demand. See Note 16, Assets Held for Sale and Results of Discontinued Operations , and Note 21, Contingencies and Other Commitments , “Other Matters,”to the consolidated financial statements accompanying our 2008 Form 10-K and Note 8, Assets Held for Sale and Results of Discontinued Operations , to these condensed consolidated financial statements. On June 11, 2009, answers were filed with AAA on behalf of all HealthSouth and Select respondents. These answers reiterated the denials, defenses, jurisdictional objections and challenges, and counterclaims previously asserted in our initial answer. The Select entities did not assert any counterclaims. AAA has indicated it will request that the parties file contentions regarding the specific locales the parties believe would be appropriate to hear any arbitrations and from where any potential arbitration panels may be selected. Should the arbitration proceed, we intend to vigorously defend ourselves.

Other Litigation—

We have been named as a defendant in a lawsuit brought by individuals in the Circuit Court of Jefferson County, Alabama, Nichols v. HealthSouth Corp. , CV-03-2023, filed March 28, 2003. The plaintiffs alleged that we, some of our former officers, and our former auditor engaged in a scheme to overstate and misrepresent our earnings and financial position. The plaintiffs sought compensatory and punitive damages. The Nichols lawsuit is more fully described in Note 21, Contingencies and Other Commitments , “Other Litigation,” to the consolidated financial statements accompanying our 2008 Form 10-K. The Nichols lawsuit is currently stayed in the Circuit Court. On January 12, 2009, the plaintiffs in that case filed a motion to lift the stay which the court subsequently denied. We intend to vigorously defend ourselves in this case. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or a settlement of this case.

Other Matters—

It is our obligation as a participant in Medicare and other federal healthcare programs to routinely conduct audits and reviews of the accuracy of our billing systems and other regulatory compliance matters. As a result of these reviews, we have made, and will continue to make, disclosures to the United States Department of Health and Human Services Office of Inspector General relating to amounts we suspect represent over-payments from these programs, whether due to inaccurate billing or otherwise. Some of these disclosures have resulted in, or may result in, HealthSouth refunding amounts to Medicare or other federal healthcare programs. See Note 20, Settlements , to the consolidated financial statements accompanying our 2008 Form 10-K for additional information.

The reconstruction of our historical financial records resulted in the restatement of not only our 2001 and 2000 consolidated financial statements, but also the financial statements of certain of our subsidiary partnerships, including partnerships of our divested surgery centers division. We have completed settlement negotiations with outside partners in the majority of our inpatient rehabilitation hospital partnerships. However, negotiations continue with certain of our former subsidiary partnerships, primarily within our surgery centers division. We have and may continue to incur additional charges to reduce the economic impact to our former partners.

We also face certain financial risks and challenges relating to our 2007 divestiture transactions (see Note 16, Assets Held for Sale and Results of Discontinued Operations , to the consolidated financial statements accompanying our 2008 Form 10-K and Note 8, Assets Held for Sale and Results of Discontinued Operations , to these condensed consolidated financial statements) following their closing. These include indemnification obligations, disputes with former partners (as discussed above), and certain contract termination or repurchase rights that may have been triggered by the divestitures, which in the aggregate could have a material adverse effect on our financial position, results of operations, and cash flows. In addition, we continue to seek regulatory approval for the transfer of one surgery center included in the divestiture transactions from the applicable agency.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

13.

Condensed Consolidating Financial Information:

The accompanying condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X, Rule 3-10, “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered.” Each of the subsidiary guarantors is 100% owned by HealthSouth, and all guarantees are full and unconditional and joint and several. HealthSouth’s investments in its consolidated subsidiaries, as well as guarantor subsidiaries’ investments in non-guarantor subsidiaries and non-guarantor subsidiaries’ investments in guarantor subsidiaries, are presented under the equity method of accounting.

As described in Note 8, Long-term Debt , to the consolidated financial statements accompanying our 2008 Form 10-K, the terms of our Credit Agreement restrict us from declaring or paying cash dividends on our common stock unless: (1) we are not in default under our Credit Agreement and (2) the amount of the dividend, when added to the aggregate amount of certain other defined payments made during the same fiscal year, does not exceed certain maximum thresholds. However, as described in Note 9, Convertible Perpetual Preferred Stock , to the consolidated financial statements accompanying our 2008 Form 10-K, our Series A Preferred Stock generally provides for the payment of cash dividends, subject to certain limitations.

HealthSouth Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Condensed Consolidating Balance Sheet

	As of June 30, 2009
	HealthSouth Corporation	Guarantor Subsidiaries	Non Guarantor Subsidiaries	Eliminating Entries	HealthSouth Consolidated
	(In Millions)
Assets
Current assets:
Cash and cash equivalents	$ 46.1	$ 0.9	$ 2.8	$ –	$ 49.8
Restricted cash	2.8	–	68.9	–	71.7
Restricted marketable securities	–	–	21.2	–	21.2
Accounts receivable, net	12.2	161.0	71.2	–	244.4
Insurance recoveries receivable	181.8	–	–	–	181.8
Other current assets	51.8	62.3	59.7	(114.5)	59.3
Total current assets	294.7	224.2	223.8	(114.5)	628.2
Property and equipment, net	42.5	470.5	158.4	–	671.4
Goodwill	–	264.1	150.6	–	414.7
Intangible assets, net	–	32.2