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 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.

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 88,069,199 shares of common stock outstanding, net of treasury shares, as of July 31, 2008.

	June 30, 2008	December 31, 2007
	(In Millions, Except Share Data)
Assets
Current assets:
Cash and cash equivalents	$ 67.2	$ 19.8
Restricted cash	46.6	63.6
Restricted marketable securities	29.2	28.9
Accounts receivable, net of allowance for doubtful accounts of $36.6 in 2008;
$37.8 in 2007	240.9	220.2
Insurance recoveries receivable	230.0	230.0
Other current assets	56.6	58.7
Current assets held for sale	7.9	16.2
Total current assets	678.4	637.4
Property and equipment, net	681.5	744.4
Goodwill	406.1	406.1
Intangible assets, net	23.6	26.1
Investment in and advances to nonconsolidated affiliates	41.7	42.7
Assets held for sale	20.8	63.2
Income tax refund receivable	43.2	52.5
Other long-term assets	69.8	78.2
Total assets	$ 1,965.1	$ 2,050.6
Liabilities and Shareholders’ Deficit
Current liabilities:
Current portion of long-term debt	$ 56.7	$ 68.3
Accounts payable	47.7	49.1
Accrued expenses and other current liabilities	342.5	365.5
Government, class action, and related settlements	353.3	400.7
Current liabilities held for sale	39.6	86.9
Total current liabilities	839.8	970.5
Long-term debt, net of current portion	1,827.4	1,974.4
Liabilities held for sale	3.8	4.2
Other long-term liabilities	166.3	171.4
	2,837.3	3,120.5
Commitments and contingencies
Minority interest in equity of consolidated affiliates	87.9	97.2
Convertible perpetual preferred stock, $.10 par value; 1,500,000 shares authorized;
400,000 issued in 2008 and 2007; liquidation preference of $1,000 per share	387.4	387.4
Shareholders’ deficit:
Common stock, $.01 par value; 200,000,000 shares authorized;
issued: 96,883,924 in 2008; 87,514,378 in 2007	1.0	0.9
Capital in excess of par value	2,963.7	2,820.4
Accumulated deficit	(4,000.7)	(4,064.6)
Accumulated other comprehensive loss	(0.8)	(0.8)
Treasury stock, at cost (8,816,125 shares in 2008 and 8,801,665 shares
in 2007)	(310.7)	(310.4)
Total shareholders’ deficit	(1,347.5)	(1,554.5)
Total liabilities and shareholders’ deficit	$ 1,965.1	$ 2,050.6

	Three Months Ended June 30,		Six Months Ended June 30,
	2008	2007	2008	2007
	(In Millions, Except Per Share Data)
Net operating revenues	$ 461.4	$ 438.7	$ 930.4	$ 881.8
Operating expenses:
Salaries and benefits	236.7	217.2	469.6	435.4
Other operating expenses	65.1	58.6	135.5	125.7
General and administrative expenses	25.2	32.9	53.3	76.0
Supplies	28.0	25.4	55.5	51.2
Depreciation and amortization	18.3	20.0	48.4	38.0
Impairment of long-lived assets	0.6	14.7	0.6	14.7
Occupancy costs	12.5	12.8	24.8	25.6
Provision for doubtful accounts	6.7	10.6	14.8	21.0
Loss on disposal of assets	0.8	1.7	0.4	1.7
Government, class action, and related settlements	(8.6)	(25.7)	(45.0)	(37.9)
Professional fees—accounting, tax, and legal	5.3	13.3	8.9	35.1
Total operating expenses	390.6	381.5	766.8	786.5
Loss on early extinguishment of debt	3.4	17.7	3.7	17.7
Interest expense and amortization of debt discounts
and fees	43.5	59.2	90.9	117.7
Other income	(1.0)	(0.5)	(1.7)	(5.2)
(Gain) loss on interest rate swap	(28.5)	(19.0)	8.1	(14.7)
Equity in net income of nonconsolidated affiliates	(2.7)	(2.4)	(5.1)	(5.1)
Minority interests in earnings of consolidated affiliates	8.2	7.8	15.8	16.1
Income (loss) from continuing operations before
income tax expense (benefit)	47.9	(5.6)	51.9	(31.2)
Provision for income tax expense (benefit)	0.7	(10.3)	0.8	(7.0)
Income (loss) from continuing operations	47.2	4.7	51.1	(24.2)
(Loss) income from discontinued operations, net
of income tax benefit	(3.1)	463.6	12.8	435.8
Net income	44.1	468.3	63.9	411.6
Convertible perpetual preferred stock dividends	(6.5)	(6.5)	(13.0)	(13.0)
Net income available to common shareholders	$ 37.6	$ 461.8	$ 50.9	$ 398.6
Comprehensive income:
Net income	$ 44.1	$ 468.3	$ 63.9	$ 411.6
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment	0.8	–	0.8	0.1
Unrealized (loss) gain on available-for-sale securities	(0.4)	0.3	(0.8)	(3.2)
Other comprehensive income (loss), net of tax	0.4	0.3	–	(3.1)
Comprehensive income	$ 44.5	$ 468.6	$ 63.9	$ 408.5

Weighted average common shares outstanding:
Basic	79.5	78.7	79.2	78.8
Diluted	93.0	92.1	92.6	92.1

Basic and diluted earnings per common share:
Income (loss) from continuing operations available
to common shareholders	$ 0.51	$ (0.02)	$ 0.48	$ (0.47)
(Loss) income from discontinued operations,
net of income tax benefit	(0.04)	5.89	0.16	5.53
Net income per share available to common
shareholders	$ 0.47	$ 5.87	$ 0.64	$ 5.06

	Six Months Ended June 30,
	2008	2007
	(In Millions)
Net cash provided by (used in) operating activities	$ 67.0	$ (105.0)

Cash flows from investing activities:
Capital expenditures	(18.7)	(15.2)
Proceeds from disposal of assets	47.2	0.2
Proceeds from sale and maturities of restricted marketable securities	1.3	65.3
Purchase of restricted investments	(2.2)	(10.5)
Net change in restricted cash	17.0	9.4
Net settlements on interest rate swap	(6.6)	1.2
Other	0.5	–
Net cash provided by investing activities of discontinued operations—
Proceeds from divestitures of divisions	–	1,089.4
Other investing activities of discontinued operations	1.1	3.7
Net cash provided by investing activities	39.6	1,143.5

Cash flows from financing activities:
Checks in excess of bank balance	(5.5)	(2.7)
Principal payments on debt, including pre-payments	(92.4)	(865.0)
Borrowings on revolving credit facility	75.0	175.0
Payments on revolving credit facility	(150.0)	(280.0)
Principal payments under capital lease obligations	(7.1)	(6.3)
Issuance of common stock	150.2	–
Dividends paid on convertible perpetual preferred stock	(13.0)	(13.0)
Debt amendment costs	–	(11.2)
Distributions to minority interests of consolidated affiliates	(16.5)	(12.0)
Other	–	0.1
Net cash used in financing activities of discontinued operations	(1.1)	(39.3)
Net cash used in financing activities	(60.4)	(1,054.4)

Effect of exchange rate changes on cash and cash equivalents	0.8	0.1
Increase (decrease) in cash and cash equivalents	47.0	(15.8)
Cash and cash equivalents at beginning of period	19.8	27.1
Cash and cash equivalents of divisions and facilities held for sale at
beginning of period	0.4	14.4
Less: Cash and cash equivalents of divisions and facilities held for sale
at end of period	–	(4.8)
Cash and cash equivalents at end of period	$ 67.2	$ 20.9

HealthSouth Corporation, incorporated in Delaware in 1984, including its subsidiaries, is the largest provider of inpatient rehabilitation 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 26, 2008 (the “2007 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, 2007 has been derived from audited financial statements, 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.

In February 2008, we issued approximately 0.7 million shares of restricted common stock to members of our senior management team. Approximately 0.4 million shares of the restricted stock granted contain only a service condition, while the remaining 0.3 million shares contain a service and either a performance or market condition. The fair value of the awards containing a market condition is calculated using a lattice model. However, these amounts are not material to our financial position, results of operations, or cash flows.

On January 1, 2008, we adopted Financial Accounting Standards Board (“FASB”) Statement No. 157, Fair Value Measurements, which establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. FASB Statement No. 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering assumptions, FASB Statement No. 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Assets and liabilities measured at fair value are based on one or more of three valuation techniques noted in FASB Statement No. 157. The three valuation techniques are as follows:

On a recurring basis, we are required to measure our available-for-sale restricted and nonrestricted marketable securities, the liability for the common stock and related common stock warrants associated with the Securities Litigation Settlement (see Note 11, Settlements), and our interest rate swap at fair value. The fair values of our available-for-sale restricted and nonrestricted marketable securities and the liability for the common stock associated with the Securities Litigation Settlement are determined based on quoted market prices in active markets. The fair value of the liability for the common stock warrants associated with the Securities Litigation Settlement is determined using a Black-Scholes model with weighted-average assumptions for historical volatility of our common stock, the risk-free interest rate, and the expected term of the underlying warrants. The fair value of our interest rate swap is determined using the present value of the fixed leg and floating leg of the swap. The value of the fixed leg is the present value of the known fixed coupon payments discounted at the rates implied by the LIBOR-swap curve. The value of the floating leg is the present value of the floating coupon payments which are derived from the forward LIBOR-swap rates and discounted at rates from the same yield curve. Each series of cash flows is discounted by market rates of interest.

The fair values of our financial assets and liabilities that are measured on a recurring basis are as follows (in millions):

		Fair Value Measurements at Reporting Date Using
June 30, 2008	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	$ 29.2	$ 29.2	$ –	$ –	M
Other current assets:
Marketable securities	0.3	0.3	–	–	M
Accrued expenses and other current
liabilities:
Interest rate swap	(43.0)	–	(43.0)	–	I
Government, class action, and related
settlements:
Securities Litigation Settlement
liability—common stock	(83.5)	(83.5)	–	–	M
Securities Litigation Settlement
liability—common stock
warrants	(33.0)	–	(33.0)	–	I

On a nonrecurring basis, we are required to measure property and equipment, goodwill, other intangible assets, investments in nonconsolidated affiliates, and assets and liabilities of discontinued operations at fair value. The fair value of our property and equipment is determined using discounted cash flows and significant unobservable inputs, unless there is an offer to purchase such assets, which would be the basis for determining fair value. The fair value of our intangible assets, excluding goodwill, is determined using discounted cash flows and significant unobservable inputs. The fair value of our investments in nonconsolidated affiliates is determined using quoted prices in private markets, discounted cash flows or earnings, or market multiples derived from a set of comparables. The fair value of our assets and liabilities of discontinued operations is determined using discounted cash flows and significant unobservable inputs unless there is an offer to purchase such assets and liabilities, which would be the basis for determining fair value. The fair value of our goodwill is determined using discounted cash

flows, and, when available and as appropriate, we use comparative market multiples to corroborate discounted cash flow results. Goodwill is tested for impairment as of October 1^st of each year, absent any impairment indicators.

FASB Staff Position (“FSP”) No. 157-2, Effective Date of FASB Statement No. 157, delayed the effective date of FASB Statement No. 157 by one year for nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. 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, 2007, we recorded impairment charges of $14.7 million related to our long-lived assets. Approximately $14.1 million of these charges related to the Digital Hospital (as defined in Note 5, Property and Equipment, to the consolidated financial statements included in our 2007 Form 10-K). During the second quarter of 2007, we wrote the Digital Hospital down by $14.1 million to its estimated fair value based on an offer we had received from a third party to acquire our corporate campus and the estimated net proceeds we expected to receive from this potential sale transaction.

In December 2007, the FASB issued FASB Statement No. 141 (Revised 2007), Business Combinations. FASB Statement No. 141(R) contains significant changes in the accounting for and reporting of business acquisitions, and it continues the movement toward the greater use of fair values in financial reporting and increased transparency through expanded disclosures. It changes how business acquisitions are accounted for and will impact financial statements at the acquisition date and in subsequent periods. Further, certain of the changes will introduce more volatility into earnings and thus may impact a company’s acquisition strategy. In addition, FASB Statement No. 141(R) will impact the annual goodwill impairment test associated with acquisitions that close both before and after the effective date of the new standard. FASB Statement No. 141(R) will be applied prospectively to business combinations for which the acquisition date is on or after the beginning of an entity’s first annual reporting period beginning on or after December 15, 2008, or January 1, 2009 for HealthSouth. We have not begun evaluating the potential impact, if any, the adoption of FASB Statement No. 141(R) could have on our consolidated financial position, results of operations, and cash flows.

In December 2007, the FASB issued FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51. FASB Statement No. 160 establishes accounting and reporting standards for minority interests (recharacterized as noncontrolling interests and classified as a component of equity) and for the deconsolidation of a subsidiary. FASB Statement No. 160 is effective for fiscal years beginning on or after December 15, 2008, or January 1, 2009 for HealthSouth. The Statement is to be applied prospectively, however the presentation and disclosure requirements of the Statement will need to be applied retrospectively for all periods presented. At this time, we have not completed our evaluation of the impact the adoption of FASB Statement No. 160 will have on our consolidated financial position, results of operations, and cash flows. However, at a minimum, it will change the way in which we account for and report our minority interests.

In March 2008, the FASB issued FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133. FASB Statement No. 161 is intended to help investors better understand how derivative instruments and hedging activities affect an entity’s financial position, operations, and cash flows through enhanced disclosure requirements. The Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, or January 1, 2009 for HealthSouth.

We do not expect FASB Statement No. 161 to significantly change the way in which we currently disclose our derivative instrument. As of June 30, 2008, we maintained only one derivative instrument under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. This instrument is an interest rate swap we are required to maintain under the terms of our Credit Agreement (as defined in Note 8, Long-term Debt, to the consolidated financial statements accompanying our 2007 Form 10-K). For additional information regarding our derivative instrument, see Note 1, Summary of Significant Accounting Policies, “Derivative Instruments,” and Note 8, Long-term Debt, “Interest Rate Swap,” of the notes to the consolidated financial statements included in our 2007 Form 10-K.

In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets. This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under FASB Statement No. 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141(R) and other GAAP. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, or January 1, 2009 for HealthSouth. The guidance within the FSP for determining the useful life of a recognized intangible asset will be applied prospectively to intangible assets acquired after the effective date. The additional disclosure requirements of the FSP will be applied prospectively to all intangible assets recognized as of, and subsequent to, the effective date. We have not begun evaluating the potential impact, if any, the adoption of this FSP could have on our consolidated financial position, results of operations, and cash flows.

Since the filing of our 2007 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.

While we continue to make progress in improving our leverage and liquidity, we remain highly leveraged. During the second quarter of 2008, we used the net proceeds from the sale of our corporate campus (see Note 3, Property and Equipment) and the majority of the net proceeds from our equity offering (see Note 6, Shareholders’ Deficit) to pay down debt (see Note 5, Long-term Debt). Specifically, during the second quarter of 2008, we reduced amounts outstanding on our Term Loan Facility (as defined in Note 8, Long-term Debt, to the consolidated financial statements accompanying our 2007 Form 10-K) by $39.8 million, and amounts outstanding under our revolving credit facility were reduced to zero (excluding approximately $38.4 million utilized under the revolving letter of credit subfacility). We also redeemed approximately $25 million of our 10.75% Senior Notes due 2016.

The remainder of the net proceeds from our equity offering is included in Cash and cash equivalents in the accompanying condensed consolidated balance sheet as of June 30, 2008. These funds may be used to meet pending bond maturities and for other general corporate purposes, with the primary emphasis being further deleveraging. In July 2008, we redeemed an additional $9.6 million of our 10.75% Senior Notes due 2016, bringing the total redemptions of these notes during 2008 to $39.6 million. In addition, we expect to use cash flows from the receipt of additional federal and state income tax refunds to further reduce our debt outstanding. However, no assurances can be given as to whether or when such cash flows will be received.

Our Credit Agreement allows for the net proceeds of asset sales, including the sale of our corporate campus, to be reinvested in capital expenditures or for business development activities, which we plan to do in subsequent periods. As we redeploy the net proceeds received from various transactions or incur seasonal borrowing needs primarily related to interest payments, we may need to make future draws on our revolver. However, we do not believe there is significant risk in our ability to make draws under our revolving credit facility, if needed.

We have scheduled principal payments, including debt maturities, of $42.5 million and $25.6 million in the remainder of 2008 and 2009, respectively, related to long-term debt obligations (see Note 5, Long-term Debt).

As with any company carrying significant debt, our primary risk relating to our high leverage is the possibility that a rapid increase in LIBOR and/or a down-turn in operating earnings could impair our ability to comply with the financial covenants contained within our Credit Agreement. Our primary covenants include a leverage ratio and an interest coverage ratio. To violate the interest coverage ratio, we would need to fail the test for four consecutive quarters. 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 upon the state of the credit markets at that time. A default due to violation of the covenants contained within our Credit Agreement could require us to immediately repay all amounts then outstanding under the Credit Agreement. See Note 1, Summary of Significant Accounting Policies, to the consolidated financial statements accompanying our 2007 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.

In January 2008, we entered into an agreement with Daniel Corporation (“Daniel”), a Birmingham, Alabama-based full-service real estate organization, pursuant to which Daniel acquired our corporate campus, including the Digital Hospital, for a purchase price of $43.5 million in cash. This transaction closed on March 31, 2008. As part of this transaction, we entered into a lease for office space within the property that was sold.

The agreement includes a deferred purchase price component related to the Digital Hospital. If Daniel sells, or otherwise monetizes its interest in, the Digital Hospital for cash consideration to a third party, we are entitled to 40% of the net profit, if any and as defined in the sale agreement, realized by Daniel.

In accordance with FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we reviewed our depreciation estimates of our corporate campus based on the revised salvage value of the campus due to the expected sale transaction. During the first quarter of 2008, we accelerated the depreciation of our corporate campus by approximately $11.0 million so that the net book value of the corporate campus equaled the net proceeds received on the transaction’s closing date.

The proceeds of this transaction were used to reduce our debt outstanding in April 2008 (see Note 5, Long-term Debt).

Investment in and advances to nonconsolidated affiliates as of June 30, 2008 represents our investment in 18 partially owned subsidiaries, of which 13 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):

For a description of our indebtedness, see Note 8, Long-term Debt, to the consolidated financial statements accompanying our 2007 Form 10-K.

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

During the first quarter of 2008, we used drawings under our revolving credit facility to redeem approximately $5 million of our 10.75% Senior Notes due 2016, which carry a higher interest rate than borrowings under our Credit Agreement.

As discussed in Note 3, Property and Equipment, we closed the transaction to sell our corporate campus to Daniel on March 31, 2008. During April 2008, we used the net proceeds from this transaction to reduce amounts outstanding on our revolving credit facility.

As discussed in Note 6, Shareholders’ Deficit, we finalized the issuance and sale of 8.8 million shares of our common stock on June 27, 2008. We used the majority of the net proceeds from the equity offering to reduce amounts outstanding on our Term Loan Facility by $39.8 million, and amounts outstanding under our revolving credit facility were reduced to zero (excluding approximately $38.4 million utilized under the revolving letter of credit subfacility). We also used the net proceeds from the equity offering to redeem $25 million of our 10.75% Senior Notes due 2016.

As a result of the pre-payments and bond redemptions discussed above, we allocated a portion of the debt discounts and fees associated with this debt to the debt that was extinguished and wrote off debt discounts and fees totaling approximately $1.5 million and $1.6 million to Loss on early extinguishment of debt during the three and six months ended June 30, 2008, respectively. Our Loss on early extinguishment of debt for the three and six months ended June 30, 2008 also includes $1.9 million and $2.1 million, respectively, of premiums associated with the redemption of the 10.75% Senior Notes due 2016.

In addition, during July 2008, we redeemed an additional $9.6 million of our 10.75% Senior Notes due 2016. The write off of bond discounts and fees associated with this redemption will not be material to our financial position, results of operations, or cash flows.

Due to the requirements under our Credit Agreement to use the net proceeds from the divestitures of our surgery centers, outpatient, and diagnostic divisions (as discussed in Note 1, Summary of Significant Accounting Policies, to our consolidated financial statements accompanying our 2007 Form 10-K) to repay obligations outstanding under our Credit Agreement, and in accordance with the guidance in Emerging Issues Task Force Issue No. 87-24, “Allocation of Interest to Discontinued Operations,” we allocated the interest expense on the debt that was required to be repaid as a result of the disposal transactions to discontinued operations in all periods presented prior to the closing of the disposal transactions. The following table provides information regarding our total Interest expense and amortization of debt discounts and fees presented in our condensed consolidated statements of operations and comprehensive income for both continuing and discontinued operations (in millions):

	Three Months Ended June 30,		Six Months Ended June 30,
	2008	2007	2008	2007
Continuing operations:
Interest expense	$ 41.8	$ 56.9	$ 87.6	$ 113.3
Amortization of debt discounts	0.2	0.1	0.3	0.3
Amortization of consent fees/bond issue costs	0.5	0.5	1.0	1.0
Amortization of loan fees	1.0	1.7	2.0	3.1
Total interest expense and amortization of
debt discounts and fees for continuing
operations	43.5	59.2	90.9	117.7
Discontinued operations:
Interest expense	0.4	20.1	0.8	44.5
Total interest expense for discontinued
operations	0.4	20.1	0.8	44.5
Total interest expense and amortization of debt
discounts and fees	$ 43.9	$ 79.3	$ 91.7	$ 162.2

Our interest payments increase or decrease in accordance with changes in LIBOR. However, the vast majority of these variable interest payments will be offset by net settlement payments or receipts on our interest rate swap, which are included in the line item (Gain) loss on interest rate swap in our condensed consolidated statements of operations and comprehensive income.

On June 27, 2008, HealthSouth finalized the issuance and sale of 8.8 million shares of its common stock to J.P. Morgan Securities Inc. for net proceeds of approximately $150 million. The Company used the net proceeds of the offering primarily for redemption and repayment of short-term and long-term borrowings. See Note 2, Liquidity, and Note 5, Long-term Debt, for additional information regarding use of the net proceeds.

The effects of this transaction on the number of our common shares outstanding, Common stock, and Capital in excess of par value are as follows (in millions):

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 and servicing 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, 2008, we were secondarily liable for 140 such guarantees. The remaining terms of these guarantees ranged from one month to 213 months. If we were required to perform under all such guarantees, the maximum amount we would be required to pay approximated $104.6 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, 2008, we have been required to perform under one such guarantee. Amounts paid, or to be paid, under this guarantee are not material to our financial position, results of operations, or cash flows.

The operating results of discontinued operations, including the allocation of $18.9 million and $43.0 million, respectively, of interest expense for the three and six months ended June 30, 2007 (as discussed in Note 5, Long-term Debt), are as follows (in millions):

	Three Months Ended June 30,		Six Months Ended June 30,
	2008	2007	2008	2007
Net operating revenues	$ 2.7	$ 246.3	$ 8.7	$ 559.6
Costs and expenses	5.3	236.7	14.8	538.0
Impairments	0.6	–	0.6	35.9
(Loss) income from discontinued
operations	(3.2)	9.6	(6.7)	(14.3)
Gain on disposal of assets of discontinued
operations	0.1	1.5	–	1.5
Gain on divestitures of divisions	–	403.2	18.8	403.2
Income tax benefit	–	49.3	0.7	45.4
(Loss) income from discontinued
operations, net of tax	$ (3.1)	$ 463.6	$ 12.8	$ 435.8

As discussed in Note 12, Contingencies, we have recorded charges related to settlements and ongoing negotiations with certain of our current and former subsidiary partnerships related to the restatement of their historical financial statements. The portion of these charges that is attributable to partnerships of our surgery centers division has been included in our results of discontinued operations. No charges were made to partnerships in our outpatient or diagnostic divisions during the periods presented. We have and may continue to incur additional charges related to these ongoing negotiations with our partners and former partners.

As discussed in Note 1, Summary of Significant Accounting Policies, to the consolidated financial statements accompanying our 2007 Form 10-K, we insure a substantial portion of our professional liability, general liability, and workers’ compensation risks through a self-insured retention program underwritten by our consolidated wholly owned offshore captive insurance subsidiary, HCS, Ltd. (“HCS”), which we fund annually. Expenses for retained professional and general liability risks and workers’ compensation risks associated with our surgery centers, outpatient, and diagnostic divisions have been included in our results of discontinued operations.

	June 30, 2008	December 31, 2007
Assets:
Cash and cash equivalents	$ –	$ 0.4
Restricted cash	–	1.6
Accounts receivable, net	2.8	7.0
Other current assets	5.1	7.2
Total current assets	7.9	16.2
Property and equipment, net	6.1	12.6
Goodwill	13.9	48.8
Intangible assets, net	0.3	1.8
Other long-term assets	0.5	–
Total long-term assets	20.8	63.2
Total assets	$ 28.7	$ 79.4
Liabilities:
Current portion of long-term debt	$ 0.4	$ 0.4
Accounts payable	0.9	1.7
Accrued expenses and other current liabilities	11.8	18.5
Deferred amounts related to sale of surgery centers division	26.5	66.3
Total current liabilities	39.6	86.9
Long-term debt, net of current portion	2.2	2.4
Other long-term liabilities	1.6	1.8
Total long-term liabilities	3.8	4.2
Total liabilities	$ 43.4	$ 91.1

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 in Connecticut, Rhode Island, and Illinois for which approvals for the transfer to ASC had not yet been received as of such date. The purchase price consisted of cash consideration of $920 million, subject to certain adjustments, and a contingent option to acquire up to a 5% equity interest in the new company. The net cash proceeds received at closing, after deducting deal and separation costs, purchase price adjustments, and approximately $15.5 million of debt assumed by ASC, approximated $860.7 million.

As noted above, the closing of the sale of the surgery centers division occurred 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 June 29, 2009, HealthSouth would be required to return to ASC a portion of the purchase price allocated to such facility.

In August and November 2007, we received approval for the transfer of the applicable facilities in Connecticut and Rhode Island, respectively, but approval for the applicable facilities in Illinois remained pending as of December 31, 2007. On January 28, 2008, we received approval for the change in control of five of the six Illinois facilities. The sixth facility has an outstanding relocation project, and we expect to file the application for change in control for this facility when the relocation project is complete, which is expected to be in late 2008 or early 2009. In the interim, we will maintain our management agreement with ASC with respect to this facility.

During 2007, we also reached an agreement with certain of our remaining partners to sell an additional facility to ASC. This facility was an opt-out partnership at the time the original transaction closed with ASC. After deducting deal and separation costs, we received approximately $16.2 million of net cash proceeds in conjunction with the sale of this facility.

The assets and liabilities presented below for the surgery centers division as of June 30, 2008 include the assets and liabilities associated with the facility that had not been transferred as of June 30, 2008, as these assets will not be transferred until approval for such transfer is obtained. The assets and liabilities presented below for the surgery centers division as of December 31, 2007 include the assets and liabilities associated with the facilities that had not been transferred as of that date. As of June 30, 2008, we have deferred approximately $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, 2008. We will continue to report the results of operations of this facility in discontinued operations until the transfer of the facility occurs.

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

	June 30, 2008	December 31, 2007
Assets:
Cash and cash equivalents	$ –	$ 0.4
Restricted cash	–	0.2
Accounts receivable, net	0.3	2.6
Other current assets	0.5	2.0
Total current assets	0.8	5.2
Property and equipment, net	3.4	9.1
Goodwill	13.9	48.8
Intangible assets, net	0.4	1.9
Other long-term assets	–	1.1
Total long-term assets	17.7	60.9
Total assets	$ 18.5	$ 66.1
Liabilities:
Current portion of long-term debt	$ 0.4	$ 0.4
Accounts payable	0.5	1.3
Accrued expenses and other current liabilities	0.6	5.8
Deferred amounts related to sale of surgery centers division	26.5	66.3
Total current liabilities	28.0	73.8
Long-term debt, net of current portion	2.2	2.4
Other long-term liabilities	0.1	0.3
Total long-term liabilities	2.3	2.7
Total liabilities	$ 30.3	$ 76.5

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

	Three Months Ended June 30,		Six Months Ended June 30,
	2008	2007	2008	2007
Net operating revenues	$ 2.4	$ 174.5	$ 6.4	$ 361.3
Costs and expenses	2.2	160.7	9.9	335.2
Impairments	0.6	–	0.6	3.0
(Loss) income from discontinued
operations	(0.4)	13.8	(4.1)	23.1
Gain on disposal of assets of discontinued
operations	0.1	0.3	0.1	1.9
Gain on divestiture of division	–	268.6	19.3	268.6
Income tax benefit	–	52.4	0.7	48.5
(Loss) income from discontinued
operations, net of tax	$ (0.3)	$ 335.1	$ 16.0	$ 342.1

As a result of the disposition of our surgery centers division, we recorded a $329.9 million post-tax gain in the second quarter of 2007, a $49.2 million post-tax gain during the third quarter of 2007, and a $2.8 million post-tax loss during the fourth quarter of 2007, for a total post-tax gain on disposal of approximately $376.3 million during the year ended December 31, 2007. 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.

In connection with the divestiture of our surgery centers division, we entered into a transition services agreement (“TSA”) with ASC whereby we continued to provide back-office services, primarily related to certain information technology and accounting services, related to the operations of our surgery centers division. This TSA expired in June 2008. The compensation we received related to these services was not material to either HealthSouth or the operations of the surgery centers division.

The transaction to sell our outpatient rehabilitation division to Select Medical Corporation (“Select Medical”) closed on May 1, 2007, other than with respect to certain facilities for which approvals for the transfer to Select Medical had not yet been received as of such date. In connection with the closing of the sale of this division, we entered into a letter agreement with Select Medical whereby we agreed, among other things, we would retain certain outpatient facilities until certain state regulatory approvals for the transfer of such facilities to Select Medical were received. In that regard, we entered into agreements with Select Medical whereby Select Medical managed certain operations of the applicable facilities until such approvals were received. Approximately $24 million of the $245 million purchase price was withheld pending the transfer of these facilities. The net cash proceeds received at closing, after deducting deal and separation costs, purchase price adjustments, and approximately $3.2 million of debt assumed by Select Medical, approximated $200.4 million. Subsequent to closing, we received approval and transferred the remaining facilities to Select Medical, and we received additional sale proceeds in November 2007.

The assets and liabilities of the outpatient division reported as held for sale as of June 30, 2008 and December 31, 2007 were not material. The operating results of the outpatient division included in discontinued operations consist of the following (in millions):

	Three Months Ended June 30,		Six Months Ended June 30,
	2008	2007	2008	2007
Net operating revenues	$ 0.2	$ 27.9	$ 1.2	$ 107.6
Costs and expenses	1.3	27.8	1.9	100.4
Impairments	–	–	–	0.2
(Loss) income from discontinued
operations	(1.1)	0.1	(0.7)	7.0
Loss on disposal of assets of discontinued
operations	–	(0.1)	–	(1.3)
Gain on divestiture of division	–	134.6	–	134.6
Income tax expense	–	(4.2)	–	(4.2)
(Loss) income from discontinued
operations, net of tax	$ (1.1)	$ 130.4	$ (0.7)	$ 136.1

As a result of the disposition of our outpatient division, we recorded a $135.0 million post-tax gain in the second quarter of 2007, a $0.4 million post-tax loss in the third quarter of 2007, and a $11.1 million post-tax gain in the fourth quarter of 2007, for a total post-tax gain of $145.7 million during the year ended December 31, 2007.

During 2007, we entered into an agreement with The Gores Group to sell our diagnostic division. This transaction closed on July 31, 2007, other than with respect to one facility for which approval for the transfer had not yet been received as of such date. The net cash proceeds received at closing, after deducting deal and separation costs and purchase price adjustments, approximated $39.7 million. During the first quarter of 2008, we received approval for the transfer of the remaining facility to The Gores Group.

The assets and liabilities of the diagnostic division reported as held for sale as of June 30, 2008 and December 31, 2007 were not material. The operating results of the diagnostic division included in discontinued operations consist of the following (in millions):

	Three Months Ended June 30,		Six Months Ended June 30,
	2008	2007	2008	2007
Net operating revenues	$ 0.1	$ 37.8	$ 0.9	$ 76.6
Costs and expenses	1.7	37.5	2.4	82.1
Impairments	–	–	–	32.7
(Loss) income from discontinued
operations	(1.6)	0.3	(1.5)	(38.2)
Gain on disposal of assets of discontinued
operations	–	1.2	–	1.3
Loss on divestiture of division	–	–	(0.5)	–
Income tax benefit	–	1.0	–	1.0
(Loss) income from discontinued
operations, net of tax	$ (1.6)	$ 2.5	$ (2.0)	$ (35.9)

During the first quarter of 2007, we wrote the intangible assets and certain long-lived assets of our diagnostic division down to their estimated fair value based on the estimated net proceeds to be received from the divestiture of the division. This charge is included in impairments in the above results of operations of our diagnostic division for the six months ended June 30, 2007. As a result of the disposition of our diagnostic division, we recorded an approximate $8.4 million post-tax loss in the third quarter of 2007 and a $0.1 million post-tax gain in the fourth quarter of 2007, for a total post-tax loss of approximately $8.3 million during the year ended December 31, 2007. This loss primarily resulted from working capital adjustments based on the final balance sheet.

During the first quarter of 2008, we recorded an approximate $0.5 million post-tax loss on disposal associated with the remaining facility that received approval for the transfer to The Gores Group during the first quarter of 2008.

In connection with the divestiture of our diagnostic division, we entered into a TSA with an affiliate of The Gores Group whereby we continued to provide back-office services, primarily related to communications support services, related to the operations of our diagnostic division. This TSA expired in January 2008. We also entered into an agreement whereby an affiliate of The Gores Group provides certain services related to the accounts receivable and other assets of operations we retained. This agreement is scheduled to expire in the latter half of 2008, but is subject to a short extension period. The compensation we pay and received related to these services is not material to either HealthSouth or the operations of the diagnostic division.

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 approximately $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 Service (the “IRS”) for the tax years 2000 through 2003 (which included the issuance of a Revenue Agent’s Report, with which HealthSouth agreed, in July 2008), 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 approximately $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 approximately $18.8 million and $21.1 million, respectively, attributable to state income tax refunds.

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.

Our Provision for income tax benefit of $10.3 million and $7.0 million for the three and six months ended June 30, 2007, respectively, consists of the following: (1) current income tax expense of $1.6 million and $3.7 million, respectively, attributable to state income taxes of subsidiaries which have separate state tax filing requirements, income taxes for other subsidiaries that are not included in our federal consolidated income tax return, and interest income accrued with respect to expected income tax refunds resulting from updated prior tax filings which were still in progress during these periods and (2) deferred income tax expense of $0.4 million and $1.6 million, respectively, attributable to future tax liabilities to be incurred by subsidiaries that are not included in our federal consolidated income tax return and increases in the basis difference of certain indefinite-lived assets offset by (3) current income tax benefit of $12.3 million, in both periods, attributable to the utilization of the period’s pre-tax loss from continuing operations to offset the gains attributable to the sale of the surgery centers and outpatient divisions (see Note 8, Assets Held for Sale and Results of Discontinued Operations).

We adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. FASB Interpretation No. 48 clarifies the application of FASB Statement No. 109, Accounting for Income Taxes, by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in a company’s financial statements. As a result of our adoption of FASB Interpretation No. 48, we recognized a $4.2 million increase to reserves for uncertain tax positions. This increase was accounted for as an addition to Accumulated deficit as of January 1, 2007. Including the cumulative effect increase to the reserves for uncertain tax positions, as of January 1, 2007, we had approximately $267.4 million of total gross unrecognized tax benefits, of which approximately $247.0 million would affect our effective tax rate if recognized. The amount of the unrecognized tax benefits changed significantly during the year ended December 31, 2007 due to the settlement with the IRS for the tax years 1996 through 1999, as discussed in Note 17, Income Taxes, to the consolidated financial statements accompanying our 2007 Form 10-K.

As of December 31, 2007, total remaining gross unrecognized tax benefits were $138.2 million, all of which would affect our effective tax rate if recognized. Total accrued interest expense related to unrecognized tax

benefits was $11.7 million as of December 31, 2007. The amount of unrecognized tax benefits changed during the second quarter of 2008 due to the settlement of state income tax refund claims with certain states for tax years 1996 through 1999 and the settlement with the IRS for tax years 2000 through 2003, as discussed above. Total remaining gross unrecognized tax benefits were $77.2 million as of June 30, 2008, all of which would affect our effective tax rate if recognized. Total accrued interest expense related to unrecognized tax benefits at June 30, 2008 was $12.9 million.

A reconciliation of the change in our unrecognized tax benefits from December 31, 2007 to June 30, 2008 is as follows (in millions):

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, 2008, we recorded $3.9 million and $2.9 million, respectively, of interest expense as part of our income tax provision. For the three and six months ended June 30, 2007, we recorded $0.8 million and $1.7 million, respectively, of interest income as part of our income tax provision. Total accrued interest income was $16.6 million and $19.5 million as of June 30, 2008 and December 31, 2007, 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 settled our federal income tax liabilities with the IRS for all tax years through 1999, including receipt of the applicable cash refund for tax years 1996 through 1999 in 2007. As discussed above, the IRS completed its audit of the tax years 2000 through 2003 with the issuance of a Revenue Agent’s Report, with which HealthSouth agreed, in July 2008. However, no assurances can be given as to whether or when the applicable cash refund resulting from this settlement will be received.

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 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 income tax refund claims. The process of resolving these tax matters with the applicable taxing authorities will continue throughout 2008, and will likely extend into 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.

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,
	2008	2007	2008	2007
Numerator:
Income (loss) from continuing operations	$ 47.2	$ 4.7	$ 51.1	$ (24.2)
Less: Convertible perpetual preferred stock
dividends	(6.5)	(6.5)	(13.0)	(13.0)
Income (loss) from continuing operations available
to common shareholders	40.7	(1.8)	38.1	(37.2)
(Loss) income from discontinued operations, net of tax	(3.1)	463.6	12.8	435.8
Net income available to common shareholders	$ 37.6	$ 461.8	$ 50.9	$ 398.6

Denominator:
Basic weighted average common shares outstanding	79.5	78.7	79.2	78.8
Diluted weighted average common shares outstanding	93.0	92.1	92.6	92.1

Basic and diluted earnings per common share:
Income (loss) from continuing operations available
to common shareholders	$ 0.51	$ (0.02)	$ 0.48	$ (0.47)
(Loss) income from discontinued operations, net of tax	(0.04)	5.89	0.16	5.53
Net income available to common shareholders	$ 0.47	$ 5.87	$ 0.64	$ 5.06

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, 2008 and 2007, the number of potential shares approximated 13.5 million and 13.4 million, respectively. For the six months ended June 30, 2008 and 2007, the number of potential shares approximated 13.4 million and 13.3 million, respectively. For the three and six months ended June 30, 2008 and 2007, approximately 13.1 million of the potential shares related to our Convertible perpetual preferred stock. For 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 available to 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 the three and six months ended June 30, 2008. For the three and six months ended June 30, 2007, including these potential common shares in the denominator resulted in an antidilutive per share amount due to our Loss from continuing operations available to common shareholders. Therefore, under the guidance in FASB Statement No. 128, Earnings per Share, basic and diluted earnings per common share amounts are the same for the three and six months ended June 30, 2007.

Options to purchase approximately 2.5 million and 3.7 million shares of common stock were outstanding during the three months ended June 30, 2008 and 2007, respectively, and options to purchase approximately 2.5 million and 3.2 million shares of common stock were outstanding during the six months ended June 30, 2008 and 2007, respectively, but were not included in the computation of diluted weighted-average shares because to do so would have been antidilutive.

In January 2004, we repaid our then-outstanding 3.25% Convertible Debentures using the net proceeds of a loan arranged by Credit Suisse First Boston. In connection with this transaction, we issued warrants to the lender to purchase two million shares of our common stock. Each warrant has a term of ten years from the date of issuance

and an exercise price of $32.50 per share. The warrants were not assumed exercised for dilutive shares outstanding because they were antidilutive in the periods presented.

In March 2006, we issued 400,000 shares of convertible perpetual preferred stock as part of a recapitalization of HealthSouth. We use the if-converted method to include the convertible perpetual preferred stock in our computation of diluted earnings per share.

In September 2006, we agreed to issue approximately 5.0 million shares of common stock and warrants to purchase approximately 8.2 million shares of common stock to settle our class action securities litigation. This agreement received final court approval on January 11, 2007. As of June 30, 2008, these shares of common stock and warrants have not been issued and are not included in our basic or diluted common shares outstanding. For additional information, see Note 11, Settlements.

Due to the equity offering described in Note 6, Shareholders’ Deficit, that was completed on June 27, 2008, our basic and diluted weighted average common shares outstanding will increase going forward.

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”). The Consolidated Securities Action included two prior consolidated cases (In re HealthSouth Corp. Securities Litigation, CV-98-J-2634-S and In re HealthSouth Corp. 2002 Securities Litigation, Consolidated File No. CV-02-BE-2105-S) as well as six lawsuits filed in 2003. Including the cases previously consolidated, the Consolidated Securities Action comprised over 40 separate lawsuits. The court divided the Consolidated Securities Action into two subclasses:

On January 8, 2004, the plaintiffs in the Consolidated Securities Action filed a consolidated class action complaint. The complaint named us as a defendant, as well as more than 30 of our current and former employees, officers and directors, the underwriters of our debt securities, and our former auditor. The complaint alleged, among other things, (1) that we misrepresented or failed to disclose certain material facts concerning our business and financial condition and the impact of the Balanced Budget Act of 1997 on our operations in order to artificially inflate the price of our common stock, (2) that from January 14, 2002 through August 27, 2002, we misrepresented or failed to disclose certain material facts concerning our business and financial condition and the impact of the changes in Medicare reimbursement for outpatient therapy services on our operations in order to artificially inflate the price of our common stock, and that some of the individual defendants sold shares of such stock during the purported class period, and (3) that Richard M. Scrushy, our former chairman and chief executive officer, instructed certain former senior officers and accounting personnel to materially inflate our earnings to match Wall Street analysts’ expectations, and that senior officers of HealthSouth and other members of a self-described “family” held meetings to discuss the means by which our earnings could be inflated and that some of the individual defendants sold shares of our common stock during the purported class period. The consolidated class action complaint asserted

claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933, and claims under Sections 10(b), 14(a), 20(a) and 20A of the Securities Exchange Act of 1934.

On February 22, 2006, we announced we had reached a preliminary agreement in principle with the lead plaintiffs in the Stockholder Securities Action, the Bondholder Securities Action, and the derivative litigation (as discussed in Note 12, Contingencies, “Derivative Litigation”), as well as with our insurance carriers, to settle claims filed in those actions against us and many of our former directors and officers. On September 26, 2006, the plaintiffs in the Stockholder Securities Action and the Bondholder Securities Action, HealthSouth, and certain individual former HealthSouth employees and board members entered into and filed a stipulation of partial settlement of this litigation. We also entered into definitive agreements with the lead plaintiffs in these actions and the derivative actions, as well as certain of our insurance carriers, to settle the litigation. These settlement agreements memorialized the terms contained in the preliminary agreement in principle entered into in February 2006. On September 28, 2006, the United States District Court entered an order preliminarily approving the stipulation and settlement. Following a period to allow class members to opt out of the settlement and for objections to the settlement to be lodged, the Court held a hearing on January 8, 2007 and determined the proposed settlement was fair, reasonable and adequate to the class members and that it should receive final approval. An order approving the settlement was entered on January 11, 2007. Individual class members representing approximately 205,000 shares of common stock and one bondholder with a face value of $1.5 million elected to be excluded from the settlement. The order approving the settlement bars claims by the non-settling defendants arising out of or relating to the Stockholder Securities Action, the Bondholder Securities Action, and the derivative litigation but does not prevent other security holders excluded from the settlement from asserting claims directly against the Company.

Under the settlement agreements, federal securities and fraud claims brought in the Consolidated Securities Action against us and certain of our former directors and officers were settled in exchange for aggregate consideration of $445 million, consisting of HealthSouth common stock and warrants valued at $215 million and cash payments by HealthSouth’s insurance carriers of $230 million. In addition, the settlement agreements provided that the plaintiffs in the Stockholder Securities Action and the Bondholder Securities Action will receive 25% of any net recoveries from future judgments obtained by us or on our behalf with respect to certain claims against Mr. Scrushy (excluding the $48 million judgment against Mr. Scrushy on January 3, 2006, as discussed in Note 12, Contingencies, “Derivative Litigation,”), Ernst & Young LLP, our former auditor, and UBS Securities, LLC (“UBS”), our former primary investment bank, each of which remains a defendant in the derivative actions as well as the Consolidated Securities Action. The settlement agreements were subject to the satisfaction of a number of conditions, including final approval of the United States District Court and the approval of bar orders in the Consolidated Securities Action and the derivative litigation by the United States District Court and the Alabama Circuit Court that would, among other things, preclude certain claims by the non-settling co-defendants against HealthSouth and the insurance carriers relating to matters covered by the settlement agreements. As more fully described in Note 12, Contingencies, that approval was obtained on January 11, 2007. The settlement agreements also required HealthSouth to indemnify the settling insurance carriers, to the extent permitted by law, for any amounts they are legally obligated to pay to any non-settling defendants. As of June 30, 2008, we have not recorded a liability regarding these indemnifications, as we do not believe it is probable we will have to perform under the indemnification portion of these settlement agreements and any amount we would be required to pay is not estimable at this time.

The fund of common stock, warrants, and cash created by settlement of the Consolidated Securities Action (the “Settlement Fund”) and the fund created by our payments under the SEC Settlement (the “Disgorgement Fund”) (see Note 20, Settlements, to the consolidated financial statements accompanying our 2007 Form 10-K) were the subject of a joint order entered in the United States District Court for the Northern District of Alabama on October 3, 2007. The order approved the form and manner of notice, to be provided to potential claimants of the Settlement Fund and the Disgorgement Fund, regarding the proposed plan of allocation in the Consolidated Securities Action and the distribution plan under the SEC Settlement. Pursuant to the order, eligible claimants could have filed objections to the plan of allocation in the Consolidated Securities Action or the distribution plan under the SEC Settlement on or before December 15, 2007. On February 7, 2008, the court held a joint fairness hearing approving the plan of allocation. The distribution agent has begun the process of analyzing and organizing the claims for distribution.

Despite approval of the securities class action settlement, there are class members who have elected to opt out of the securities class action 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 the court’s Partial Final Judgment and Order of Dismissal with Prejudice dated January 11, 2007, the court found that allowing AIG to opt out after the deadline would result in serious prejudice to us and denied AIG’s request for an expansion of time to opt out. On January 26, 2007, AIG moved for reconsideration of the court’s decision on this issue. On March 22, 2007, the district court denied AIG’s motion for reconsideration. On April 17, 2007, AIG filed a notice of appeal with the Eleventh Circuit Court of Appeals. The appeal has been consolidated with the appeal by Mr. Scrushy of one provision in the bar order in the Securities Litigation Settlement, and has been fully briefed. On March 12, 2008, AIG appealed the plan of allocation for settlement proceeds, and on March 24, 2008 that appeal was consolidated with AIG’s appeal of April 17, 2007. On April 18, 2008, AIG dismissed its appeal challenging the plan of allocation. The Eleventh Circuit Court of Appeals has reset the date for oral argument on the Scrushy appeal and the initial AIG appeal for the week of December 1, 2008. If the appellate court were to reverse the district court’s denial of AIG’s motion for reconsideration and allow AIG to opt out despite missing the deadline, AIG would likely bring individual claims alleging substantial damages relating to the purchase by AIG and its affiliates of HealthSouth bonds. If AIG is not successful with an appeal of that denial, AIG’s individual claims would be precluded by the securities class action settlement.

We recorded a charge of $215.0 million as Government, class action, and related settlements 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 months ended June 30, 2008 and 2007, we reduced our liability for this settlement by $10.7 million and $31.5 million, respectively, based on the value of our common stock and the associated common stock warrants at each quarter end. During the six months ended June 30, 2008 and 2007, we reduced our liability for this settlement by $43.3 million and $49.0 million, respectively, based on the value of our common stock and the associated common stock warrants at each quarter end during the period. The corresponding liability of $116.5 million and $159.8 million as of June 30, 2008 and December 31, 2007, respectively, is included in Government, class action, and related settlements in our condensed consolidated balance sheets. The charge for this settlement will continue to be revised in future periods to reflect additional changes in the fair value of the common stock and warrants until they are issued. Distribution of the underlying common stock and warrants to purchase shares of common stock cannot occur until the order described above becomes a final, non-appealable order. At this time, and as noted above, an appeal is outstanding with the Eleventh Circuit Court of Appeals.

In addition, Government, class action, and related settlements in our condensed consolidated balance sheets also includes a liability in the amount of $230.0 million in order to state the total liability related to the securities litigation 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. The related receivable from our insurers in the amount of $230.0 million is included in our condensed consolidated balance sheets as Insurance recoveries receivable.

On May 17, 2006, we announced that we reached a non-prosecution agreement (the “Non-Prosecution Agreement”) with the United States Department of Justice (the “DOJ”) with respect to the accounting fraud committed by members of our former management. We pledged to continue our cooperation with the DOJ and paid $3.0 million to the U.S. Postal Inspection Services Consumer Fraud Fund during the second quarter of 2006 in connection with the execution of the Non-Prosecution Agreement.

Notwithstanding the foregoing, the DOJ has reserved the right to prosecute us for any crimes committed by our employees if we violate the terms of the Non-Prosecution Agreement. The Non-Prosecution Agreement expires on May 17, 2009.

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.

See Note 11, Settlements, of these condensed consolidated financial statements and Note 20, Settlements, “Securities Litigation Settlement,” to the consolidated financial statements accompanying our 2007 Form 10-K for a discussion of the settlement entered into with the lead plaintiffs in certain securities actions.

On November 24, 2004, an individual securities fraud action captioned Burke v. HealthSouth Corp., et al., 04-B-2451 (OES), was filed in the United States District Court of Colorado against us, some of our former directors and officers, and our former auditor. The complaint makes allegations similar to those in the Consolidated Securities Action, as defined in Note 11, Settlements, “Securities Litigation Settlement,” and asserts claims under the federal securities laws and Colorado state law based on the plaintiff’s alleged receipt of unexercised options and the plaintiff’s open-market purchases of our stock. By order dated May 3, 2005, the action was transferred to the United States District Court for the Northern District of Alabama, where it remains pending. The plaintiff in this case has not opted out of the Consolidated Securities Action settlement discussed in Note 11, Settlements, “Securities Litigation Settlement.” Although the deadline for opting out in the Consolidated Securities Action has passed, if the Burke action resumes, we will continue to vigorously defend ourselves in this case. However, based on the stage of litigation, and review of the current facts and circumstances, we are unable to determine an amount of loss or range of possible loss that might result from an adverse judgment or a settlement of this case should litigation continue or whether any resultant liability would have a material adverse effect on our financial position, results of operations, or cash flows.

Between 1998 and 2004, a number of lawsuits purporting to be derivative actions (i.e., lawsuits filed by shareholder plaintiffs on our behalf) were filed in several jurisdictions, including the Circuit Court for Jefferson County, Alabama, the Delaware Court of Chancery, and the United States District Court for the Northern District of Alabama. All 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. The Tucker complaint names as defendants a number of former HealthSouth officers and directors. Tucker also asserts claims on our behalf against Ernst & Young, UBS, as well as against MedCenterDirect.com (“MCD”), Capstone Capital Corp., and G.G. Enterprises. The Tucker complaint originally named UBS Group and UBS Investment Bank as defendants. As a result of the UBS defendants’ representation that UBS is the proper defendant for all claims asserted in the complaint, UBS is presently the named defendant in Tucker.

Two derivative lawsuits filed in the United States District Court for the Northern District of Alabama were consolidated under the caption In re HealthSouth Corp. Derivative Litigation, CV-02-BE-2565. The court stayed further action in this federal consolidated action in deference to litigation filed in state courts in Alabama and Delaware. Two derivative lawsuits filed in the Delaware Court of Chancery were consolidated under the caption In re HealthSouth Corp. Shareholders Litigation, Consolidated Case No. 19896. Plaintiffs’ counsel in this litigation and in Tucker agreed to litigate all claims asserted in those lawsuits in the Tucker litigation, except for claims relating to an agreement to retire a HealthSouth loan to Mr. Scrushy with shares of our stock (the “Buyback Claim”). On November 24, 2003, the court granted the plaintiffs’ motion for summary judgment on the Buyback Claim and rescinded the retirement of Mr. Scrushy’s loan. The court’s judgment was affirmed on appeal. We have collected a judgment of $12.5 million, net of attorneys’ fees awarded by the court. See also Note 10, Shareholders’ Deficit, to the consolidated financial statements accompanying our 2007 Form 10-K.

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 January 3, 2006, the Alabama Circuit Court in the Tucker case granted the plaintiff’s motion for summary judgment against Mr. Scrushy on a claim for the restitution of incentive bonuses Mr. Scrushy received for years 1996 through 2002. Including pre-judgment interest, the court’s total award was approximately $48 million, which amount was affirmed by the Alabama Supreme Court on August 25, 2006. The judgment does not resolve other claims brought by the plaintiffs against Mr. Scrushy. With post-judgment interest, the final judgment amount was approximately $52.8 million.

As of December 31, 2006, we had collected approximately $47.9 million of this judgment and had entered into an agreement with Mr. Scrushy which required him to pledge certain parcels of real estate as security for payment of the remainder of the amount. Of the $47.9 million collected as of December 31, 2006, approximately $14.8 million was collected via Mr. Scrushy’s return of 723,921 shares of HealthSouth common stock and approximately $21.5 million represents the right of offset discussed below under “Litigation Against and by Richard M. Scrushy.” During 2006, we recorded $47.8 million as Recovery of amounts due from Richard M. Scrushy in our consolidated statement of operations, with the remaining $5.0 million of the total award recorded as interest income. The remainder of the amount owed to us by Mr. Scrushy, or $4.9 million plus interest, was received in February 2007.

Additionally, we entered into an agreement with the plaintiffs’ attorneys in the Tucker litigation under which we agreed to pay them a fee of $17.5 million for obtaining this judgment. This fee was included in Professional fees—accounting, tax, and legal in our 2006 consolidated statement of operations. We paid approximately $11.6 million of this fee to the plaintiffs’ attorneys in December 2006, with the remainder paid in February 2007.

On September 26, 2006, certain parties to the Tucker litigation entered into and filed a stipulation of settlement. The substantive terms of the settlement are consistent with the preliminary agreement reached in February 2006. Of the $445 million to be paid in accordance with the settlement of the Consolidated Securities Action, $100 million is being credited to the plaintiffs in the Tucker litigation. On September 27, 2006, the Alabama Circuit Court entered an order preliminarily approving the stipulation and settlement. The Court held a hearing on January 9, 2007 to determine the fairness, reasonableness, and adequacy of the settlement, whether the settlement should be finally approved by the Court, and to hear and determine any objections to the settlement. The settlement was approved, and an order granting such approval was entered on January 11, 2007. All objections to the settlement were withdrawn, and no individual class members opted out of the settlement. Additionally, we reached an agreement with the plaintiffs’ attorneys in the Tucker litigation under which we have agreed to pay them a fee of $15 million in connection with the settlement of the Consolidated Securities Action (which is in addition to the $17.5 million fee discussed above). This fee was included in Professional fees—accounting, tax, and legal in our 2006 consolidated statement of operations. This fee was paid in June 2007.

The Tucker derivative claims against Mr. Scrushy, UBS, Ernst & Young, and other defendants listed above remain pending and have moved through fact discovery on an expedited schedule that has been coordinated with the federal securities claims by former stockholders and bondholders of the Company against Mr. Scrushy, UBS, and Ernst & Young.

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 Mr. Scrushy and certain other 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 HealthSouth’s counterclaims to arbitration pursuant to a clause in the engagement agreements between HealthSouth and Ernst & Young. On July 12, 2006, HealthSouth and Tucker 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, HealthSouth and Tucker 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. 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. Fact discovery relating to the claims has concluded on an expedited schedule coordinated with parallel federal securities laws claims by former stockholders and bondholders of HealthSouth against Ernst & Young and with parallel state law claims pending in the Circuit Court of Jefferson County against UBS.

In March 2003, claims on behalf of HealthSouth were brought in the Tucker 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. As a result of the UBS defendants’ representation that UBS is the proper defendant for all claims asserted in the complaint, UBS is presently the named defendant in Tucker. The claims allege that while the UBS entities were fiduciaries of HealthSouth, they became part of a conspiracy to artificially inflate the market price of HealthSouth stock. The complaint seeks compensatory and punitive damages, disgorgement of fees received from us by UBS entities, and attorneys’ fees and costs. On August 3, 2005, UBS filed counterclaims against us. Those claims include fraud, misrepresentation, negligence, breach of contract, and indemnity against us for allegedly providing UBS with materially false information concerning our financial condition to induce UBS to provide investment banking services. UBS’s counterclaims seek compensatory and punitive damages and a judgment declaring that HealthSouth is liable for any losses, costs, or fees incurred by UBS in connection with its defense of actions relating to the services UBS provided to us. In August 2006, HealthSouth and Tucker agreed to jointly prosecute the claims against UBS in state court.

On November 13, 2007, UBS filed a motion for summary judgment, arguing that the claims against it should be dismissed based upon the doctrines of in pari delicto, unclean hands, and Alabama’s Hinkle rule. After full argument and briefing, on April 18, 2008, the court denied the motion for summary judgment, declining to dismiss the claims against UBS. The case has been set for trial on January 26, 2009.

Additionally, on September 6, 2007, UBS AG, Stamford Branch (“UBS AG”) filed an action against us in the Supreme Court of the State of New York, captioned UBS AG, Stamford Branch v. HealthSouth Corporation, Index No. 602993/07, based on the terms of a credit agreement with MCD (the “New York action”). Prior to ceasing operations in 2003, MCD provided certain services to us relating to the purchase of equipment and supplies. We also previously owned 20.2% of MCD’s equity securities. During 2003, UBS AG called its loan to MCD. In the New York action, UBS AG alleged HealthSouth was the guarantor of the loan and sought recovery of the $20 million principal of its loan to MCD and approximately $8.7 million in interest. However, UBS filed an Answer and Counterclaim in the Tucker derivative litigation admitting that it funded the $20 million loan to MCD. On October 1, 2007, HealthSouth removed UBS AG’s case from New York state court to federal court in the Southern District of New York, which assigned it Case No. 07 cv 8490. On December 17, 2007, UBS AG moved for summary judgment on its claim under the guarantee provisions of the credit agreement with MCD. On January 18, 2008, HealthSouth filed its opposition to UBS AG’s motion for summary judgment, and filed a cross-motion requesting the action be dismissed or stayed in deference to the Tucker derivative litigation, which alleged, among other claims, the loan by UBS AG to MCD was part of a scheme between former disloyal officers at the Company, including Mr. Scrushy, and UBS AG to siphon money from the Company.

On November 16, 2007, after HealthSouth removed UBS AG’s action from New York state court to New York federal court, UBS filed an Amended Answer in the Tucker derivative litigation in Alabama seeking to change its earlier representation in that litigation that it, UBS, made the loan to MCD. Instead, UBS asserted in its Amended Answer that UBS AG made the loan to MCD. The Alabama court struck UBS’s Amended Answer in the Tucker derivative litigation and gave UBS 30 days to amend its counterclaim to assert a breach of the MCD loan agreement in that litigation, or, alternatively, granted UBS AG permission to intervene in the Tucker derivative litigation within 30 days of the order to assert claims for breach of the MCD credit agreement. On March 24, 2008, UBS petitioned the Alabama Supreme Court for writs of mandamus and prohibition to set aside the Alabama court’s February 19, 2008 order, as amended on March 7, 2008. On April 23, 2008, the Alabama Supreme Court denied the petition for writs of mandamus. On April 7, 2008, pursuant to the February 19, 2008 order, as amended on March 7, 2008, UBS amended its counterclaim in the Tucker derivative litigation so as to add claims against HealthSouth for breach of the MCD credit agreement.

In the New York action, the court issued an order on June 6, 2008 granting UBS AG’s motion for summary judgment and denying HealthSouth’s motion to dismiss or stay. Following the entry of an initial judgment in the incorrect amount, the court entered an amended judgment on June 16, 2008 in the amount of approximately $30.3 million in favor of UBS AG and against HealthSouth. HealthSouth moved the court to waive the requirement of a bond for security pending appeal, but in an order issued June 17, 2008, the court refused. On June 30, 2008, however, upon agreement of the parties, the court authorized HealthSouth to issue a letter of credit in the amount of $33.6 million (i.e., 111% of the amended judgment) in lieu of a bond. The letter of credit will operate (as would a bond) to stay the enforcement of the judgment during the pendency of HealthSouth’s appeal. HealthSouth filed its notice of appeal to the U.S. Court of Appeals for the Second Circuit on July 7, 2008. That court has issued a preliminary scheduling order, which establishes a briefing schedule and clarifies that oral argument will occur no later than the week of December 1, 2008.

We are vigorously pursuing our claims against UBS and defending the claims against us. 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. Fact discovery relating to the claims has concluded on an expedited schedule coordinated with parallel federal securities laws claims by former stockholders and bondholders of the Company against UBS and with parallel state law claims pending in arbitration against Ernst & Young. The parties will now complete expert discovery in advance of the January 26, 2009 trial date.

After the dismissal of several lawsuits filed against us by Mr. 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, HealthSouth counterclaimed against Mr. Scrushy, asserting claims for breaches of fiduciary duty and fraud arising out of Mr. Scrushy’s tenure at HealthSouth, and seeking compensatory damages, punitive damages, and disgorgement of wrongfully obtained benefits. Both the claims by Mr. Scrushy and HealthSouth’s counterclaims remain pending in Circuit Court. The Company also asserted that the employment agreement with Mr. Scrushy is void and unenforceable.

On or about December 19, 2005, Mr. Scrushy filed a demand for arbitration with the American Arbitration Association pursuant to an indemnity agreement with us. The arbitration demand sought to require us to pay expenses which he estimated exceeded $31 million incurred by Mr. Scrushy, including attorneys’ fees, in connection with the defense of criminal fraud claims against him and in connection with a preliminary hearing in the SEC litigation.

On October 17, 2006, the arbitrator issued a final award of approximately $17.0 million to Mr. Scrushy and further ruled that Mr. Scrushy was entitled to payment by HealthSouth of approximately $4.0 million in pre-judgment interest and attorneys’ fees and expenses incurred by Scrushy in connection with the arbitration proceeding. On August 31, 2006, HealthSouth and the Tucker plaintiffs filed a joint motion in the Tucker case to offset the entire award to Mr. Scrushy in the arbitration, including fees and interest, against the approximately $48 million judgment against Mr. Scrushy in Tucker for repayment of his bonuses. Mr. Scrushy opposed that effort, and

on October 17, 2006 filed a lawsuit captioned Scrushy v. HealthSouth Corporation, CA No. 2483-N, in the Delaware Court of Chancery for New Castle County seeking confirmation of the arbitration award in that court. A settlement was reached with Mr. Scrushy by which he agreed to an offset of the arbitrator’s award in the amount of $21.5 million, which amount is included in the amount collected from Mr. Scrushy on the Tucker judgment. We accrued an estimate of these legal fees as part of Professional fees—accounting, tax, and legal in our December 31, 2005 and 2004 consolidated statements of operations. While the arbitrator’s ruling provided that we may have an obligation to indemnify Mr. Scrushy for certain costs associated with ongoing litigation, the court’s order approving the settlement of the securities litigation prohibits Mr. Scrushy from seeking indemnity or contribution in the securities class action. This order has been appealed by Mr. Scrushy. As of June 30, 2008 and December 31, 2007, an estimate of these legal fees is included in Accrued expenses and other current liabilities in our condensed consolidated balance sheets.

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 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 other than those discussed in these financial statements 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.

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 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. HealthSouth is informed that, at the time of the termination, General Medicine was providing services to two skilled nursing facilities owned by Horizon/CMS. HealthSouth acquired Horizon/CMS in 1997 and sold it to Meadowbrook Healthcare, Inc. (“Meadowbrook”) in 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. HealthSouth was 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 HealthSouth.

The complaint filed by General Medicine against HealthSouth alleged that while Horizon/CMS was a wholly owned subsidiary of HealthSouth and General Medicine was an existing creditor of Horizon/CMS, we caused Horizon/CMS to transfer its assets to us for less than a reasonably equivalent value or, in the alternative, with the actual intent to defraud creditors of Horizon/CMS, including General Medicine, in violation of the Alabama Uniform Fraudulent Transfer Act. General Medicine’s complaint requested relief including recovery of the unpaid amount of the Consent Judgment, the avoidance of the subject transfers of assets, attachment of the assets transferred to us, appointment of a receiver over the transferred properties, and a monetary judgment for the value of properties transferred.

We filed an answer denying liability to General Medicine, and have asserted counterclaims against General Medicine for fraud, injurious falsehood, tortious interference with business relations, conspiracy, unjust enrichment, and other causes of action. In our counterclaims, we alleged the Consent Judgment is the product of fraud, collusion and bad faith by General Medicine and Meadowbrook and, further, that these parties were guilty of a conspiracy to manufacture a lawsuit against HealthSouth in favor of General Medicine.

The case has now entered the discovery stage. On August 17, 2007, the court entered an order authorizing HealthSouth to seek discovery from General Medicine regarding the facts and circumstances surrounding the Consent Judgment and the basis of the underlying breach of contract claim in the Michigan Action. On April 15, 2008, the court entered an order directing General Medicine to respond to HealthSouth’s discovery requests concerning the factual basis of General Medicine’s underlying claim against Horizon/CMS. In its order of April 15, 2008 (the “Discovery Order”), the court confirmed that HealthSouth is entitled to “fairly broad discovery” concerning General Medicine’s underlying claim against Horizon/CMS that served as the basis for the Consent Judgment. On June 30, 2008, General Medicine filed a Petition for Writ of Mandamus with the Alabama Supreme Court seeking a reversal of the Discovery Order. On July 3, 2008, we filed a motion requesting the Alabama Supreme Court to summarily deny General Medicine’s Petition for Writ of Mandamus. The Alabama Supreme Court issued an order denying General Medicine’s Petition for Writ of Mandamus on July 21, 2008.

General Medicine also filed a Motion for Partial Summary Judgment on April 11, 2008 seeking a determination that HealthSouth did not pay consideration for the assets that Horizon/CMS transferred to HealthSouth while it was a subsidiary of HealthSouth. The court denied General Medicine’s motion on June 13, 2008.

We intend to vigorously defend ourselves against General Medicine’s claim and to vigorously prosecute our counterclaims against General Medicine. 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.

We have been named as a defendant in two lawsuits brought by individuals in the Circuit Court of Jefferson County, Alabama, Nichols v. HealthSouth Corp., CV-03-2023, filed March 28, 2003, and Hilsman v. Ernst & Young, HealthSouth Corp., et al., CV-03-7790, filed December 12, 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. On March 24, 2003, a lawsuit captioned Warren v. HealthSouth Corp., et al., CV-03-5967, was filed in the Circuit Court of Montgomery County, Alabama. The lawsuit, which claimed damages for the defendants’ alleged negligence, wantonness, fraud, and breach of fiduciary duty, was transferred to the Circuit Court of Jefferson County, Alabama. Each of these three lawsuits described in this paragraph was consolidated with the Tucker case for discovery and other pretrial purposes. The plaintiffs in these cases are subject to the Consolidated Securities Action settlement discussed in Note 11, Settlements, “Securities Litigation Settlement,” and thereby foreclosed from pursuing these state court actions based on purchases made during the class period unless they opted out of that settlement. The plaintiffs in Warren v. HealthSouth Corp., et al. did not opt out of the settlement. The plaintiffs in Hilsman v. Ernst & Young, et al. attempted to opt out of the settlement, but their election was deemed invalid by the agent. At present, it is unclear whether the plaintiffs in the Hilsman action will challenge this determination. The Nichols lawsuit asserts claims on behalf of a number of plaintiffs, all but three of whom opted out of the settlement. John Kapoor, who claimed to have purchased over 900,000 shares of stock, attempted to opt-out, but his attempt was deemed invalid by the court. It is unclear whether Mr. Kapoor will challenge this determination. The remaining Nichols plaintiffs that opted out of the settlement claimed losses of approximately $5.4 million. The Nichols case remains stayed in Circuit Court. We intend to vigorously defend ourselves in these cases. 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 these cases.

On June 2, 2006, we were named as a defendant in a lawsuit captioned Brockovich v. HealthSouth Corporation, et al., Case No. SACV06-546-DOC(MLGx), filed under the Medicare Secondary Payor statute, 42 U.S.C. § 1395y(b), in the United States District Court for the Central District of California, Southern Division, against HealthSouth, HealthSouth Hospital Corporation, HCS, and certain insurance companies. The complaint

alleged that HealthSouth charged Medicare to treat illnesses that it caused, at least in part, by medical error or neglect and seeks recovery of unspecified damages. On October 24, 2006, the federal court granted HealthSouth’s motion to dismiss. On November 16, 2006, the plaintiff filed her notice of appeal to the Ninth Circuit Court of Appeals, but on March 18, 2008, the plaintiff withdrew the appeal. The Ninth Circuit entered an order granting the voluntary dismissal of the consolidated appeals on June 10, 2008.

It is our obligation as a participant in Medicare and other federal health care 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 (“HHS-OIG”) 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, the Company refunding amounts to Medicare or other federal health care programs. On December 14, 2007, we agreed to a final settlement of certain self-disclosures which we made to the HHS-OIG in 2004 and 2005 regarding our relationship with certain physicians. Under the terms of the settlement, we paid, in two installments, a total of $14.2 million to the United States. We recorded $5.0 million of the settlement amount in March 2007, $3.0 million in June 2007, and $6.2 million in September 2007, with each charge included in Government, class action, and related settlements in our condensed consolidated statement of operations and comprehensive income for the applicable periods. As of December 31, 2007, we owed approximately $7.1 million under this settlement. This amount is included in Government, class action, and related settlements in our condensed consolidated balance sheet as of December 31, 2007. This amount was paid in March 2008.

In connection with the above settlement, we have entered into a second addendum to our corporate integrity agreement (the “CIA”) with the HHS-OIG. The original CIA had an effective date of January 1, 2005 and a term of five years from that effective date. The term of both addendums to the CIA is concurrent with our existing five-year CIA. The CIA incorporates compliance program changes, annual audits, and reporting obligations, all of which have been materially complied with on a timely basis. Failure to meet our obligations under our CIA could result in stipulated financial penalties. Failure to comply with material terms, however, could lead to exclusion from further participation in federal health care programs, including Medicare and Medicaid, which currently account for a substantial portion of our revenues. See Note 20, Settlements, to the consolidated financial statements accompanying our 2007 Form 10-K.

In addition, 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. During the second quarter of 2008, we 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 divestiture transactions 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 transition of one surgery center included in the divestiture transactions from the applicable agency.

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 2007 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 2007 Form 10-K, our Series A Preferred Stock generally provides for the payment of cash dividends, subject to certain limitations.

	As of June 30, 2008
	HealthSouth Corporation	Guarantor Subsidiaries	Non Guarantor Subsidiaries	Eliminating Entries	HealthSouth Consolidated
	(In Millions)
Assets
Current assets:
Cash and cash equivalents	$ 39.2	$ 16.9	$ 11.1	$ –	$ 67.2
Restricted cash	2.5	–	44.1	–	46.6
Restricted marketable securities	–	–	29.2	–	29.2
Accounts receivable, net	12.4	162.2	66.3	–	240.9
Insurance recoveries receivable	230.0	–	–	–	230.0
Other current assets	52.7	61.3	64.2	(121.6)	56.6
Current assets held for sale	2.0	18.6	2.3	(15.0)	7.9
Total current assets	338.8	259.0	217.2	(136.6)	678.4
Property and equipment, net	31.2	480.9	169.4	–	681.5
Goodwill	–	242.0	164.1	–	406.1
Intangible assets, net	3.2	13.8	6.6	–	23.6
Investment in and advances to
nonconsolidated affiliates	3.2	28.9	9.6	–	41.7
Assets held for sale	1.2	1.1	18.5	–	20.8
Income tax refund receivable	43.2	–	–	–	43.2
Other long-term assets	56.0	204.5	57.4	(248.1)	69.8
Intercompany receivable	1,100.8	–	–	(1,100.8)	–
Total assets	$ 1,577.6	$ 1,230.2	$ 642.8	$ (1,485.5)	$ 1,965.1
Liabilities and Shareholders’
(Deficit) Equity
Current liabilities:
Current portion of long-term debt	$ 43.1	$ 11.7	$ 1.9	$ –	$ 56.7
Accounts payable	13.1	24.7	9.9	–	47.7
Accrued expenses and other
current liabilities	247.6	62.8	62.3	(30.2)	342.5
Government, class action, and
related settlements	353.3	–	–	–	353.3
Current liabilities held for sale	30.9	2.8	20.9	(15.0)	39.6
Total current liabilities	688.0	102.0	95.0	(45.2)	839.8
Long-term debt, net of current portion	1,748.7	80.1	29.6	(31.0)	1,827.4
Liabilities held for sale	1.3	0.2	2.3	–	3.8
Other long-term liabilities	99.7


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)

		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	64
Item 4.	Controls and Procedures	65

PART II	Other Information

Item 1.	Legal Proceedings	66
Item 4.	Submission of Matters to a Vote of Security Holders	66
Item 6.	Exhibits	66

	June 30, 2008	December 31, 2007
Land	$ 62.1	$ 76.2
Buildings	904.4	936.8
Leasehold improvements	25.8	24.1
Furniture, fixtures, and equipment	341.2	345.0
	1,333.5	1,382.1
Less: Accumulated depreciation and amortization	(655.8)	(645.3)
	677.7	736.8
Construction in progress	3.8	7.6
Property and equipment, net	$ 681.5	$ 744.4

	June 30, 2008	December 31, 2007
Advances under $400 million revolving credit facility	$ –	$ 75.0
Term Loan Facility	820.8	862.8
Bonds Payable—
7.000% Senior Notes due 2008	–	5.0
10.750% Senior Subordinated Notes due 2008	30.3	30.3
8.500% Senior Notes due 2008	–	9.4
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	375.0	375.0
10.75% Senior Notes due 2016	528.9	558.2
Notes payable to banks and others at interest rates from 7.9% to 12.9%	13.1	17.0
Capital lease obligations	114.2	108.2
	1,884.1	2,042.7
Less: Current portion	(56.7)	(68.3)
Long-term debt, net of current portion	$ 1,827.4	$ 1,974.4

	Face Amount	Net Amount
July 1 through December 31, 2008	$ 42.5	$ 42.5
2009	25.6	25.6
2010	22.9	22.9
2011	22.0	22.0
2012	20.2	20.2
2013	791.0	791.0
Thereafter	966.9	959.9
Total	$ 1,891.1	$ 1,884.1

	Six Months Ended
	June 30, 2008
NUMBER OF COMMON SHARES OUTSTANDING
Balance at December 31, 2007	78.7
Issuance of common stock	8.8
Issuance of restricted stock	0.4
Other	0.2
Balance at June 30, 2008	88.1

COMMON STOCK
Balance at December 31, 2007	$ 0.9
Issuance of common stock	0.1
Balance at June 30, 2008	$ 1.0

CAPITAL IN EXCESS OF PAR VALUE
Balance at December 31, 2007	$ 2,820.4
Dividends declared on convertible perpetual preferred stock	(13.0)
Issuance of common stock	150.1
Stock issuance costs	(0.2)
Stock issued to employees exercising stock options	0.3
Stock-based compensation	2.7
Restricted stock and other plans, less cancellations	0.1
Amortization of restricted stock	3.3
Balance at June 30, 2008	$ 2,963.7

	Gross Unrecognized Income Tax Benefits	Accrued Interest and Penalties
Balance at December 31, 2007	$ 138.2	$ 11.7
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	(2.6)	–
Balance at March 31, 2008	135.7	12.0
Gross amount of increases in unrecognized tax benefits related to
prior periods	0.2	0.9
Gross amount of decreases in unrecognized tax benefits related to
prior periods	(11.1)	–
Decreases in unrecognized tax benefits relating to settlements with
taxing authorities	(47.6)	–
Balance at June 30, 2008	$ 77.2	$ 12.9