HealthSouth

(HLSH)

was even sicker than some people thought.

The giant health care chain, which has been fighting for its life for nearly a year, revealed on Tuesday that it has now detected up to $4.6 billion worth of improper accounting entries in its past financial statements. Until this week, the company had estimated that its accounting fraud would total at least $1 billion less than that amount.

In its first presentation to the financial community since July, HealthSouth said that a forensic review of the company's books -- now "substantially complete" -- has uncovered $2.5 billion worth of fraudulent entries, up to $1.6 billion in non-GAAP, or generally accepted accounting principles, accounting and $500 million worth of extra goodwill. When the company first launched its review last summer, it had expected to find just $2 billion worth of fraudulent entries and $500 million in non-GAAP accounting.

Shares of HealthSouth -- which bottomed out at 8 cents last year -- tumbled 7.9% to $5.46 following the update.

Nevertheless, HealthSouth insisted this week that it is still on the mend. The company expects to generate nearly $4 billion in revenue -- and clear $650 million in EBITDA, or earnings before interest, taxes, depreciation and amortization -- this year. In the meantime, it has refinanced $355 million worth of debt that it first defaulted on last April. It is now current on all principle and interest payments to its various lenders.

"Today's financing marks an important milestone in HealthSouth's ongoing efforts to complete our restructuring," acting Chairman Joel Gordon announced on Friday. "We believe that this refinancing is a major step towards HealthSouth's recovery."

Yet the company still faces challenges. In a presentation about its different business units, HealthSouth highlighted some of the risks that lie ahead. The company's large inpatient division faces lingering reimbursement threats, and its outpatient satellite clinics are underperforming. Meanwhile, the surgery unit -- one of the company's strongest businesses -- is suffering from margin compression. And the outpatient division has seen revenues fall due to a number of facility shutdowns.

Still, profit margins for outpatient services -- and diagnostics in particular -- are showing signs of improvement. The diagnostic division alone is expected to nearly triple its profit margin, from 4.9% to 14.6%, this year.

"HealthSouth has the second-largest diagnostic imaging network in the U.S.," the company announced during its presentation on Tuesday. "Due to ongoing operational restructuring and new management, fundamentals are significantly improving."

But diagnostics is one of HealthSouth's smallest businesses. And the company faces potentially huge liabilities stemming from government investigations into its other divisions. In addition to the Justice Department -- which is reviewing the accounting fraud -- the federal Medicare program is probing the company for possible billing violations. HealthSouth said on Tuesday that excessive Medicare reimbursements, tied to the fraudulent accounting entries, are "not significant." But it also listed possible Medicare violations as a key concern going forward. Moreover, it apparently tried -- but failed -- to settle its Medicare issues with the government before the accounting scandal erupted last year.

But the company is now more optimistic. It said this week that it has been meeting often with federal authorities and believes that a global settlement is "financially manageable." And it has a profoundly different leadership team that it did when negotiations fell apart last time around.

Of the 66 corporate officers employed by HealthSouth a year ago, only 29 remain. The company has hired a number of top-level managers but continues to seek permanent replacements for senior posts, such as CEO and general counsel, which have yet to be filled.

In the meantime, the company has agreed to shed five of its directors -- two of them already gone -- in an effort to build a more independent board. But some critics have already raised questions about at least one newcomer. They point out that Lee Hillman, who now chairs HealthSouth's audit committee, once had close business ties to ousted HealthSouth CEO Richard Scrushy.

Following Hillman's appointment last fall, the

Associated Press

reported that the new HealthSouth director had served as CEO of

Bally Total Fitness

(BFT)

at a time when Scrushy and some of his colleagues pursued -- but never completed -- a buyout of the company. Hillman also served as an audit partner for Ernst & Young, which was fired last year by HealthSouth after failing to uncover the company's massive accounting fraud.

Hillman has since gone on to fill another board seat, accepting a directorship at

Lawson Products

(LAWS) - Get Report

this month, despite a pledge from HealthSouth's board to limit its outside activities. But the company has kept other commitments. Just last week, in fact, it announced that it had hired a chief compliance officer to strengthen its corporate governance program.

John Markus, the veteran health care attorney tapped for the new post, previously filled a similar position at Fresenius Medical Care. And his experience at the big dialysis chain could prove valuable. While there, Markus inked a record-breaking $486 million deal with the government to settle a host of Medicare fraud charges levied against the company before his arrival on the scene.

Robert May, who currently serves as HealthSouth's interim CEO, recently introduced Markus as an important addition to a new senior management team that will strengthen the company going forward.

"We are committed to ensuring that HealthSouth has the best practices in place in all areas of corporate governance and compliance," May said last week. "Today's announcement reflects HealthSouth's continuous effort to bolster and enhance our ability to serve our stakeholders."

HealthSouth has promised to create a board dominated by independent directors. It has also pledged to implement strict policies for related-party transactions, which have been blamed for stirring up serious conflicts in the past.