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 September 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 ¨

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 ¨ Non-Accelerated filer ¨ Smaller reporting company ¨

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 93,305,496 shares of common stock outstanding, net of treasury shares, as of October 30, 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	38
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	60
Item 4.	Controls and Procedures	61

PART II	Other Information

Item 1.	Legal Proceedings	62
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	62
Item 5.	Other Matters	62
Item 6.	Exhibits	64

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)

	September 30, 2009			December 31, 2008
				(As Adjusted)
	(In Millions, Except Share Data)
Assets
Current assets:
Cash and cash equivalents	$	117.3		$	32.2
Restricted cash		88.1			154.0
Current portion of restricted marketable securities		7.7			20.3
Accounts receivable, net of allowance for doubtful accounts of $33.6 in 2009; $31.1 in 2008		216.2			235.8
Insurance recoveries receivable		-			182.8
Other current assets		55.0			57.6
Total current assets		484.3			682.7
Property and equipment, net		671.5			673.9
Goodwill		414.7			414.7
Intangible assets, net		37.7			42.8
Investments in and advances to nonconsolidated affiliates		27.6			36.7
Income tax refund receivable		8.6			55.9
Other long-term assets		110.0			91.5
Total assets	$	1,754.4		$	1,998.2
Liabilities and Shareholders’ Deficit
Current liabilities:
Current portion of long-term debt	$	21.9		$	23.6
Accounts payable		50.6			45.6
Accrued expenses and other current liabilities		369.8			408.5
Government, class action, and related settlements		6.1			268.5
Total current liabilities		448.4			746.2
Long-term debt, net of current portion		1,674.8			1,789.6
Other long-term liabilities		165.7			162.2
		2,288.9			2,698.0
Commitments and contingencies
Convertible perpetual preferred stock, $.10 par value; 1,500,000 shares authorized;
400,000 shares 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		2,888.4			2,956.5
Accumulated deficit		(3,756.0	)		(3,812.2	)
Accumulated other comprehensive income (loss)		0.9			(3.2	)
Treasury stock, at cost (3,926,639 shares in 2009 and 8,872,121 shares
in 2008)		(137.0	)		(311.5	)
Total HealthSouth shareholders’ deficit		(1,002.7	)		(1,169.4	)
Noncontrolling interests		80.8			82.2
Total shareholders' deficit		(921.9	)		(1,087.2	)
Total liabilities and shareholders’ deficit	$	1,754.4		$	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						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
				(As Adjusted)						(As Adjusted)
	(In Millions, Except Per Share Data)
Net operating revenues	$	472.7		$	455.5		$	1,431.5		$	1,376.3
Operating expenses:
Salaries and benefits		235.4			236.3			709.2			700.8
Other operating expenses		66.8			68.6			201.6			201.0
General and administrative expenses		26.0			25.5			76.4			78.8
Supplies		27.7			26.2			83.9			81.1
Depreciation and amortization		18.1			17.9			53.4			65.3
Impairment of long-lived assets		4.0			-			4.0			0.6
Occupancy costs		11.8			12.6			35.9			36.8
Provision for doubtful accounts		7.9			6.6			25.5			20.5
Loss on disposal of assets		0.7			0.2			3.0			0.6
Government, class action, and related settlements expense		8.5			17.1			41.3			(27.9	)
Professional fees—accounting, tax, and legal		3.5			4.0			5.0			12.9
Total operating expenses		410.4			415.0			1,239.2			1,170.5
Loss (gain) on early extinguishment of debt		-			2.1			(3.1	)		5.8
Interest expense and amortization of debt discounts and fees		29.5			40.3			95.0			131.1
Other income		(0.6	)		(0.4	)		(1.4	)		(2.1	)
Loss on interest rate swaps		7.9			8.0			16.7			16.1
Equity in net income of nonconsolidated affiliates		(3.0	)		(2.7	)		(2.8	)		(7.8	)
Income (loss) from continuing operations before income tax benefit		28.5			(6.8	)		87.9			62.7
Provision for income tax benefit		(1.7	)		(22.5	)		(0.8	)		(21.7	)
Income from continuing operations		30.2			15.7			88.7			84.4
(Loss) income from discontinued operations, net of tax		(5.4	)		(2.9	)		(6.8	)		7.2
Net income		24.8			12.8			81.9			91.6
Less: Net income attributable to noncontrolling interests		(8.0	)		(6.2	)		(25.7	)		(21.1	)
Net income attributable to HealthSouth		16.8			6.6			56.2			70.5
Less: Convertible perpetual preferred stock dividends		(6.5	)		(6.5	)		(19.5	)		(19.5	)
Net income attributable to HealthSouth
common shareholders	$	10.3		$	0.1		$	36.7		$	51.0

Weighted average common shares outstanding:
Basic		87.6			87.4			87.6			81.6
Diluted		102.2			101.0			101.6			95.1

Basic and diluted earnings per common share:
Income from continuing operations
attributable to HealthSouth common shareholders	$	0.18		$	0.04		$	0.50		$	0.53
(Loss) income from discontinued operations, net of tax,
attributable to HealthSouth common shareholders		(0.06	)		(0.04	)		(0.08	)		0.10
Net income per share attributable to HealthSouth common
shareholders	$	0.12		$	0.00		$	0.42		$	0.63

Amounts attributable to HealthSouth:
Income from continuing operations	$	22.2		$	9.8		$	63.5		$	62.7
(Loss) income from discontinued operations, net of tax		(5.4	)		(3.2	)		(7.3	)		7.8
Net income attributable to HealthSouth	$	16.8		$	6.6		$	56.2		$	70.5

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 Income

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
				(As Adjusted)						(As Adjusted)
	(In Millions)
COMPREHENSIVE INCOME
Net income	$	24.8		$	12.8		$	81.9		$	91.6
Other comprehensive income (loss), net of tax:
Net change in foreign currency translation adjustments		-			-			-			0.8
Net change in unrealized gain (loss) on available-for-sale securities:
Unrealized net holding gain (loss) arising during the period		2.0			(0.6	)		2.1			(0.1	)
Reclassification adjustment for gains (losses) included
in net income		-			-			1.6			(1.3	)
Net change in unrealized (loss) gain on forward-starting interest
rate swaps:
Unrealized net holding (loss) gain arising during the period		(1.6	)		-			0.2			-
Reclassification adjustment for gains included in net income		-			-			0.2			-
Other comprehensive income (loss), net of tax		0.4			(0.6	)		4.1			(0.6	)
Comprehensive income		25.2			12.2			86.0			91.0
Comprehensive income attributable to noncontrolling interests		(8.0	)		(6.2	)		(25.7	)		(21.1	)
Comprehensive income attributable to
HealthSouth	$	17.2		$	6.0		$	60.3		$	69.9

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)




	Nine Months Ended September 30, 2009
	(In Millions)
	HealthSouth Common Shareholders
	Number of Common Shares Outstanding		Common Stock		Capital in Excess of Par Value			Accumulated Deficit			Accumulated Other Comprehensive (Loss) Income			Treasury Stock			Noncontrolling Interests			Total			Comprehensive Income
Balance at beginning of period		88.0	$	1.0	$	2,956.5		$	(3,812.2	)	$	(3.2	)	$	(311.5	)	$	82.2		$	(1,087.2	)
Comprehensive income:
Net income		-		-		-			56.2			-			-			25.7			81.9		$	81.9
Other comprehensive income, net of tax		-		-		-			-			4.1			-			-			4.1			4.1
Comprehensive income																							$	86.0
Common stock issued under Securities Litigation Settlement		5.0		-		(58.7	)		-			-			175.3			-			116.6
Dividends declared on convertible perpetual preferred stock		-		-		(19.5	)		-			-			-			-			(19.5	)
Stock-based compensation		-		-		9.9			-			-			-			-			9.9
Distributions declared		-		-		-			-			-			-			(26.0	)		(26.0	)
Other		0.3		-		0.2			-			-			(0.8	)		(1.1	)		(1.7	)
Balance at end of period		93.3	$	1.0	$	2,888.4		$	(3,756.0	)	$	0.9		$	(137.0	)	$	80.8		$	(921.9	)

(Continued)

HealthSouth Corporation and Subsidiaries

Condensed Consolidated Statements of Shareholders' Deficit (Continued)

(Unaudited)



	Nine Months Ended September 30, 2008
	(In Millions)
	HealthSouth Common Shareholders
	Number of Common Shares Outstanding		Common Stock		Capital in Excess of Par Value			Accumulated Deficit			Accumulated Other Comprehensive Loss			Treasury Stock			Noncontrolling Interests			Total			Comprehensive Income
Balance at beginning of period		78.7	$	0.9	$	2,820.4		$	(4,064.6	)	$	(0.8	)	$	(310.4	)	$	97.2		$	(1,457.3	)
Comprehensive income:
Net income		-		-		-			70.5			-			-			21.1			91.6		$	91.6
Other comprehensive loss, net of tax		-		-		-			-			(0.6	)		-			-			(0.6	)		(0.6	)
Comprehensive income																							$	91.0
Dividends declared on convertible perpetual preferred stock		-		-		(19.5	)		-			-			-			-			(19.5	)
Issuance of common stock		8.8		0.1		150.1			-			-			-			-			150.2
Stock-based compensation		-		-		8.5			-			-			-			-			8.5
Distributions declared		-		-		-			-			-			-			(25.0	)		(25.0	)
Settlements with partners		-		-		-			-			-			-			4.2			4.2
Government, class action, and related settlements		-		-		-			-			-			-			(5.3	)		(5.3	)
Transfer of surgery centers to ASC		-		-		-			-			-			-			(6.8	)		(6.8	)
Other		0.5		-		0.2			-			-			(1.0	)		(0.7	)		(1.5	)
Balance at end of period		88.0	$	1.0	$	2,959.7		$	(3,994.1	)	$	(1.4	)	$	(311.4	)	$	84.7		$	(1,261.5	)

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)

	Nine Months Ended
	September 30,
	2009			2008
				(As Adjusted)
	(In Millions)
Cash flows from operating activities:
Net income	$	81.9		$	91.6
Loss (income) from discontinued operations		6.8			(7.2	)
Adjustments to reconcile net income to net cash provided by operating
activities—
Provision for doubtful accounts		25.5			20.5
Provision for government, class action, and related settlements		41.3			(27.9	)
UBS Settlement proceeds, gross		100.0			-
Depreciation and amortization		53.4			65.3
Amortization of debt issue costs, debt discounts, and fees		4.8			4.9
Impairment of long-lived assets		4.0			0.6
Loss on disposal of assets		3.0			0.6
(Gain) loss on early extinguishment of debt		(3.1	)		5.8
Loss on interest rate swaps		16.7			16.1
Equity in net income of nonconsolidated affiliates		(2.8	)		(7.8	)
Distributions from nonconsolidated affiliates		6.5			7.6
Stock-based compensation		9.9			8.5
Deferred tax provision		2.4			2.0
Other		0.6			0.2
(Increase) decrease in assets—
Accounts receivable		(5.9	)		(27.4	)
Other assets		1.3			6.4
Income tax refund receivable		47.3			(10.4	)
Increase (decrease) in liabilities—
Accounts payable		5.0			(9.3	)
Accrued fees and expenses for derivative plaintiffs' attorneys in		(26.2	)		-
UBS Settlement
Other liabilities		10.3			18.2
Government, class action, and related settlements		(11.0	)		(7.4	)
Net cash used in operating activities of discontinued operations		(9.6	)		(1.6	)
Total adjustments		273.4			64.9
Net cash provided by operating activities		362.1			149.3

(Continued)

HealthSouth Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Continued)

(Unaudited)

	Nine Months Ended
	September 30,
	2009			2008
				(As Adjusted)
	(In Millions)
Cash flows from investing activities:
Capital expenditures		(54.7	)		(39.4	)
Acquisition of business, net of cash acquired		-			(14.6	)
Acquisition of intangible assets		(0.4	)		(18.2	)
Proceeds from disposal of assets		0.9			53.8
Net change in restricted cash		(32.0	)		20.5
Net settlements on interest rate swaps		(30.3	)		(13.9	)
Net investment in interest rate swap		(6.4	)		-
Other		(1.7	)		(0.3	)
Net cash provided by investing activities of discontinued operations		0.2			0.2
Net cash used in investing activities		(124.4	)		(11.9	)

Cash flows from financing activities:
Checks in excess of bank balance		-			(11.4	)
Change in restricted cash for amounts in escrow related to debt		-			(30.3	)
Principal payments on debt, including pre-payments		(62.9	)		(121.5	)
Borrowings on revolving credit facility		10.0			88.0
Payments on revolving credit facility		(50.0	)		(150.0	)
Principal payments under capital lease obligations		(9.9	)		(9.3	)
Issuance of common stock		-			150.2
Dividends paid on convertible perpetual preferred stock		(19.5	)		(19.5	)
Distributions paid to noncontrolling interests of consolidated affiliates		(22.8	)		(26.3	)
Other		1.1			(0.3	)
Net cash provided by (used in) financing activities of discontinued
operations		1.4			(3.0	)
Net cash used in financing activities		(152.6	)		(133.4	)
Effect of exchange rate changes on cash and cash equivalents		-			0.8
Increase in cash and cash equivalents		85.1			4.8
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		-			(0.1	)
Cash and cash equivalents at end of period	$	117.3		$	24.9

Supplemental schedule of noncash financing activities:
Securities Litigation Settlement	$	299.3		$	-

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 recharacterization of minority interests to noncontrolling interest and classification of noncontrolling interest as a component of equity, 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 November 4, 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. We reclassified our condensed consolidated balance sheet as of December 31, 2008, our condensed consolidated statements of operations for the three and nine months ended September 30, 2008, and our condensed consolidated statement of cash flows for the nine months ended September 30, 2008 to include these properties and their results of operations in discontinued operations.

As of January 1, 2009, we 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 income of nonconsolidated affiliates , which resulted in an understatement of both our Income (loss) from continuing operations before income tax benefit and our Net income of approximately $4.5 million for the nine months ended September 30, 2009. 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 this joint venture hospital. We do not believe these adjustments are material to the condensed consolidated financial statements as of September 30, 2009 and for the nine 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 Financial Accounting Standards Board ("FASB") updated 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 guidance was effective for interim and annual reporting periods ended after June 15, 2009, with early adoption permitted. HealthSouth elected to adopt this amended guidance 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 updated guidance on disclosures about fair value of financial instruments. This guidance requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements and was effective for interim reporting periods ended after June 15, 2009, with early adoption permitted. HealthSouth elected to adopt this amended guidance 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 authoritative guidance on 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 guidance was effective for interim or annual financial periods ended after June 15, 2009. Our adoption of this guidance 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 established the FASB Accounting Standards Codification (the "Codification") as the single authoritative source for GAAP. The Codification was effective for financial statements that cover interim and annual periods ended after September 15, 2009. While not intended to change GAAP, the Codification significantly changed the way in which the accounting literature is organized. Because the Codification completely replaced existing standards, it affected the way GAAP is referenced by companies in their financial statements and accounting policies. Our adoption and our use of the Codification beginning in the third quarter of 2009 did 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.

During the nine months ended September 30, 2009, we reduced our total debt by approximately $117 million and increased our Cash and cash equivalents by approximately $85 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, we have 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 September 30, 2009, we had $117.3 million in Cash and cash equivalents . This amount excludes $88.1 million in Restricted cash and $23.3 million of restricted marketable securities. Our restricted assets pertain 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 $6.2 million and $24.9 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, a portion of our Term Loan Facility does not mature until 2013, with the remainder maturing in 2015, depending on certain conditions (see Note 5, Long-term Debt , for a discussion of an amendment and extension related to our Credit Agreement), 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 September 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 September 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.

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

	Cash & Cash Equivalents		Restricted Cash		Nonrestricted Marketable Securities		Restricted Marketable Securities		Total
Cash	$	117.3	$	88.1	$	-	$	-	$	205.4
Equity securities		-		-		0.5		23.3		23.8
Total	$	117.3	$	88.1	$	0.5	$	23.3	$	229.2

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

Approximately $15.6 million of restricted marketable securities are included in Other long-term assets in our condensed consolidated balance sheet as of September 30, 2009. 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 September 30, 2009 is as follows (in millions):

		Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Equity securities		$	21.4			$	2.0			$	(0.1	)		$	23.3

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 nine months ended September 30, 2009, we recorded $0.8 million of impairments related to our restricted marketable securities. These impairment charges are included in Other income in our condensed consolidated statement of operations for the nine months ended September 30, 2009. No impairments were recorded during the three months ended September 30, 2009 or the three or nine months ended September 30, 2008.

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

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2009		2008			2009			2008
Nonrestricted:
Gross realized gains - nonrestricted	$	-	$	-		$	-		$	0.6
Restricted:
Proceeds from sales of restricted
available-for-sale securities	$	0.3	$	1.1		$	1.9		$	2.4
Gross realized gains - restricted	$	0.1	$	0.1		$	0.3		$	0.2
Gross realized losses - restricted	$	-	$	(0.5	)	$	(0.2	)	$	(0.7	)

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 September 30, 2009 and December 31, 2008 (in millions):

	As of September 30, 2009			As of December 31, 2008
Less than 12 months:
Fair value	$	0.4		$	15.5
Gross unrealized losses	$	-		$	(1.9	)
12 months or greater:
Fair value	$	0.6		$	0.1
Gross unrealized losses	$	(0.1	)	$	(0.1	)
Total:
Fair value	$	1.0		$	15.6
Gross unrealized losses	$	(0.1	)	$	(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. 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 September 30, 2009.

4.	Investments in and Advances to Nonconsolidated Affiliates:

Investments in and advances to nonconsolidated affiliates as of September 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.

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

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
Net operating revenues	$	19.3		$	17.9		$	54.8		$	55.2
Operating expenses		(11.3	)		(11.2	)		(34.5	)		(26.1	)
Income from continuing operations		6.5			5.7			16.8			26.2
Net income		6.5			5.7			16.8			26.2

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):

	September 30, 2009			December 31, 2008
Advances under $400 million revolving credit facility	$	-		$	40.0
Term Loan Facility		753.2			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		494.7			494.3
Other notes payable at interest rates from 8.1% to 12.9%		12.5			12.8
Capital lease obligations		104.9			114.7
		1,696.7			1,813.2
Less: Current portion		(21.9	)		(23.6	)
Long-term debt, net of current portion	$	1,674.8		$	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. See Note 2, Liquidity, for a discussion of debt reductions during 2009.

In October 2009, we entered into an agreement with the lenders in our Credit Agreement to extend the maturity of a portion of our Term Loan Facility and to amend certain provisions of the Credit Agreement. The extension provides for a $300.0 million tranche of the Term Loan Facility to have its maturity extended from March 2013 to September 2015 in exchange for a higher interest rate spread on that portion of the loan. In the event we have not fully redeemed or refinanced the Floating Rate Senior Notes due 2014 by March 15, 2014, the extended portion of the Term Loan Facility will mature on that date. The extended portion of the loan now accrues interest at a rate of LIBOR plus 3.75% while the remainder of the Term Loan Facility continues to accrue interest at LIBOR plus 2.25%. Both portions of the Term Loan Facility continue to amortize at the same 0.25% of the principal outstanding per quarter rate. The other amendments to the Credit Agreement primarily allow us to issue senior secured and unsecured notes in the bond market and increase amounts we can spend for acquisitions and selected debt repurchases.

The following chart shows scheduled principal payments due on long-term debt for the next five years and thereafter after the extension of $300.0 million of the Term Loan Facility in October 2009, as discussed above (in millions):

	Face Amount		Net Amount
October 1 through December 31, 2009	$	6.2	$	6.2
2010		24.9		24.9
2011		24.2		24.2
2012		23.6		23.6
2013		440.5		440.5
2014		623.3		623.3
Thereafter		559.9		554.0
Total	$	1,702.6	$	1,696.7

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				Nine Months Ended
	September 30,				September 30,
	2009		2008		2009		2008
Interest expense	$	27.9	$	38.7	$	90.2	$	126.2
Amortization of debt discounts and fees		1.6		1.6		4.8		4.9
Interest expense and amortization of
debt discounts and fees	$	29.5	$	40.3	$	95.0	$	131.1

Interest Rate Swaps—

Interest Rate Swaps Not Designated as Hedging Instruments

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 September 30, 2009 and December 31, 2008 was ($64.7) 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 commenced in September 2009 and are made quarterly 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 September 30, 2009 was $6.5 million. Of this amount, $4.7 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 hedges. Therefore, changes in the fair value of these interest rate swaps during the three and nine months ended September 30, 2009 and 2008 have been included in current-period earnings as Loss on interest rate swaps .

During the three and nine months ended September 30, 2009, we made net cash settlement payments of $11.2 million and $30.3 million, respectively, to our counterparties. During the three and nine months ended September 30, 2008, we made net cash settlement payments of $7.3 million and $13.9 million, respectively, to our counterparties. Net settlement payments or receipts on these swaps are included in the line item Loss on interest rate swaps in our condensed consolidated statements of operations.

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 will pay a fixed rate of 2.6% while the counterparty will pay 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 September 30, 2009 and December 31, 2008 was $0.4 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 will pay a fixed rate of 2.9% while the counterparty will pay 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 September 30, 2009 was ($0.2) million and is included in Accrued expenses and other current liabilities in our condensed consolidated balance sheet.

Both forward-starting swaps are designated as cash flow hedges 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 September 30, 2009, we were secondarily liable for 84 such guarantees. The remaining terms of these guarantees ranged from one month to 117 months. If we were required to perform under all such guarantees, the maximum amount we would be required to pay approximated $51.9 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 September 30, 2009, we have not been required to make any material payments under these agreements.

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
September 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)
Current portion of restricted
marketable securities	$	7.7		$	7.7	$	-		$	-		M
Other current assets:
Marketable securities		0.5			0.5		-			-		M
June 2009 trading swap		4.7			-		4.7			-		I
Other long-term assets:
Restricted marketable securities		15.6			15.6		-			-		M
December 2008 forward-starting swap		0.4			-		0.4			-		I
June 2009 trading swap		1.8			-		1.8			-		I
Accrued expenses and other current
liabilities:
March 2006 trading swap		(64.7	)		-		(64.7	)		-		I
March 2009 forward-starting swap		(0.2	)		-		(0.2	)		-		I

(1)	The three valuation techniques are: 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 September 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 September 30, 2009		Nine Months Ended September 30, 2009
Property and equipment	$	671.5	$	-	$	671.5	$	-	$	4.0	$	4.0
Investments in and advances
to nonconsolidated affiliates		1.7						1.7		0.4		0.4
Other long-term assets:
Assets held for sale		28.0		-		28.0		-		0.4		0.9

The above losses represent our write-down of certain assets to their estimated fair value based on offers we received from third parties to acquire the assets or other market conditions. The $4.0 million charge related to Property and equipment is included in Impairment of long-lived assets in our condensed consolidated statements of operations for the three and nine months ended September 30, 2009. The loss related to Investments in and advances to nonconsolidated affiliates is included in Other Income in our condensed consolidated statements of operations for the three and nine months ended September 30, 2009. The losses related to assets held for sale are included in Loss on disposal of assets in our condensed consolidated statements of operations for the three and nine months ended September 30, 2009. In addition, during the nine months ended September 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 nine months ended September 30, 2008, we also recorded $8.4 million and $9.0 million, respectively, 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.

The loss associated with Investments in and advances to nonconsolidated affiliates resulted from an other-than-temporary impairment of an investment accounted for using the cost method of accounting. The investment was valued using its published net asset value discounted due to recent market fluctuations, the illiquid nature of the investment, and proposed changes to the investment’s structure. More specifically, and because we elected a liquidation option with regard to this investment, we discounted the net asset value of our holdings to account for anticipated sales of assets within this investment at prices lower than the currently stated net asset value.

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 September 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	$	(64.7	)	$	(64.7	)	$	(78.2	)	$	(78.2	)
December 2008 forward-starting swap		0.4			0.4			(0.2	)		(0.2	)
March 2009 forward-starting swap		(0.2	)		(0.2	)		-			-
June 2009 trading swap		6.5			6.5			-			-
Long-term debt:
Advances under $400 million revolving
credit facility		-			-			40.0			28.4
Term Loan Facility		753.2			722.1			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			321.4			366.0			292.1
10.75% Senior Notes due 2016		494.7			542.5			494.3			459.0
Other notes payable		12.5			12.5			12.8			12.8
Financial commitments:
Letters of credit		-			94.1			-			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. As a result, we reclassified our condensed consolidated balance sheet as of December 31, 2008, our condensed consolidated statements of operations for the three and nine months ended September 30, 2008, and our condensed consolidated statement of cash flows for the nine months ended September 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						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
Net operating revenues	$	2.3		$	8.7		$	8.0		$	27.1
Costs and expenses		8.4			3.1			15.2			30.2
Impairments		-			8.4			-			9.0
Loss from discontinued operations		(6.1	)		(2.8	)		(7.2	)		(12.1	)
Gain (loss) on disposal of assets of
discontinued operations		0.7			(0.1	)		0.4			(0.1	)
Gain on divestitures of divisions