10-K

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

x Annual Report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended August 31, 2003

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number: 000-21574

DYNACQ HEALTHCARE, INC.

(Formerly Dynacq International, Inc.)

(Exact name of registrant as specified in its charter)

Delaware	76-0375477
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

10304 Interstate 10 East, Suite 369, Houston, Texas	77029
(Address of Principal Executive Office)	(Zip Code)

TELEPHONE NUMBER: (713) 378-2000

INTERNET WEBSITE: WWW.DYNACQ.COM

Securities registered pursuant to Section 12(b) of the Exchange Act: None

Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock

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 ¨ No x

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨

The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the registrant as of February 27, 2004 was $33,748,333. As of June 30, 2004, registrant had 14,852,072 shares of common stock outstanding, all of one class.

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EXPLANATORY NOTE

We are filing this annual report on Form 10-K in order to reflect the audited consolidated financial statements for the year ended August 31, 2003, the restatement and re-audit of our financial statements for the fiscal year ended August 31, 2002, the restatement of our 2001 financial statements, and the restatement of our selected financial information for fiscal years 1999 and 2000. All financial data in this report reflects the effects of the restatements. See “Recent Developments” below as well as “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 2 to the Consolidated Financial Statements included in this report for details relating to these restatements. As a result of these restatements, investors should not rely upon the Company’s previously filed financial statements for the fiscal years ended August 31, 1999 through 2002.

PART I

This annual report on Form 10-K contains forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. Such forward-looking statements relate to future events or future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements, including the risks and uncertainties described in “Risk Factors” below. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. You must read the following discussion of the results of our business and our operations and financial condition in conjunction with our consolidated financial statements, including the notes, included in this Form 10-K filing.

Item 1. Business

General

Dynacq Healthcare, Inc., a Delaware corporation, is a holding company which through its subsidiaries develops and manages general acute hospitals that provide specialized general surgeries. The Company’s strategy is to develop and operate general acute hospitals designed to handle specialized general surgeries such as bariatric, orthopedic and neuro spine surgeries. The Company’s hospitals include operating rooms, pre- and post-operative space, intensive care units, nursing units, and modern diagnostic facilities. The Company normally does not participate in any managed care contracts nor does it receive a substantial amount of reimbursement from Medicare or Medicaid. Except for emergency room patients, the surgeries are typically pre-certified by the insurance carriers. The bulk of the surgeries are either covered by workers’ compensation insurance or by commercial insurers on an out-of-network health plan basis, and are relatively complex surgeries. The Company believes that, as a result, the per-procedure revenue generated by the Company is comparatively higher than the per-procedure revenue generated by other hospitals. The Company’s facilities are designed to handle complex orthopedic and general surgeries, such as spine and bariatric surgeries.

During the fiscal year ended August 31, 2003 the Company expanded its hospitals from one to three. Other key events in fiscal year 2003 include:

• The Company’s Ambulatory Surgery Center in Pasadena, Texas ceased to operate in November 2002 and consequently surrendered its lease and its license. Vista Hospital in Pasadena, Texas, near Houston (the “Pasadena Facility”) was allowed to modify its hospital license and lease the space previously occupied by the Ambulatory Surgery Center, thereby increasing the Pasadena Facility’s surgical suites from four to eight. The Pasadena Facility contributed 84% of net patient revenues in fiscal year 2003.

• In January 2003, the Company opened its second hospital—Vista Surgical Hospital of Baton Rouge (the “Baton Rouge Facility”), a 49,500 square foot 35-bed facility with four surgical suites on approximately 20 acres of land. The Baton Rouge Facility contributed 12% of net patient revenues in fiscal year 2003.

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• In August 2003, the Company acquired the total assets of a 113-bed hospital (which is now licensed for 79 beds), a medical office building and 22.7 acres of land in the Dallas-Fort Worth area for approximately $8.5 million including the assumption of approximately $2.9 million of liabilities. The Company has completed renovations at that facility, named Vista Hospital of Dallas (the “Garland Facility”), with six surgical suites, and started performing surgical procedures in late November 2003.

• The Company bought approximately four acres in The Woodlands, Texas upon which it expects to build a new hospital. At this time, the project is still in the planning stage.

The Company was incorporated in Nevada in June 1989. In November 2003, the Company reincorporated in Delaware and changed its name from Dynacq International, Inc. to Dynacq Healthcare, Inc. The terms “Company,” “Dynacq,” “our” or “we” as used herein refer to Dynacq Healthcare, Inc. and its affiliates unless otherwise stated or indicated by context. The term “affiliates” means direct and indirect subsidiaries of Dynacq Healthcare, Inc. and partnerships and joint ventures in which subsidiaries are partners, general or limited partners or members.

The Company, through its affiliates, owns or leases 100% of the real estate and owns or leases 100% of the equipment in its facilities. The Company maintains a majority ownership and controlling interest in all of its operating entities. As of August 31, 2003, the Company owned the following percentages of its facilities:

Pasadena Facility(1)	91.5	%
Baton Rouge Facility(2)	97.0	%
Garland Facility(3)	100.0	%
West Houston Facility	100.0	%

⁽¹⁾ The Company purchased an additional 3.5% interest on September 15, 2003, thereby increasing its ownership to 95.0%. The Company purchased the remaining 5% interest in December 2003, thereby increasing its ownership to 100% of this operating entity. The limited partnership was restructured in June 2004 and since then the Company has owned 93% percent of this operating entity. The remaining interests are primarily owned by physicians and by other healthcare professionals. In November 2002, Vista Healthcare, Inc. ceased to operate and surrendered its license. The Pasadena Facility modified its hospital license and leased the space previously occupied by the Ambulatory Surgery Center.

⁽²⁾ The Company purchased the remaining 3% interest in April 2004, thereby increasing its ownership to 100% of this operating entity. The limited liability company was restructured in June 2004 and since then the Company has owned 90% percent of this operating entity. The remaining interests are primarily owned by physicians and by other healthcare professionals.

⁽³⁾ As of July 2004, the Company owned 92% of this operating entity. The remaining interests are primarily owned by physicians and by other healthcare professionals.

Recent Developments

Change in Independent Auditors

Ernst & Young LLP resigned as the Company’s independent auditor effective December 17, 2003. In conjunction with Ernst & Young’s resignation, Ernst & Young advised us that it had identified material weaknesses relating to our internal controls. Please read “Item 9A. Controls and Procedures” for further details. On January 19, 2004, the Audit Committee of the Board of Directors engaged the registered public accounting firm of Killman, Murrell & Company, P.C. as the Company’s new independent auditors for the fiscal year ended August 31, 2003.

SEC Investigation

On December 18, 2003, we received a notice of an informal investigation from the Fort Worth, Texas District Office of the Securities and Exchange Commission requesting our voluntary assistance in providing information regarding reporting of our financial statements, recognition of costs and revenue, accounts receivable,

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allowances for doubtful accounts and our internal controls. We have been cooperating fully with the continuing informal SEC investigation.

SEC Review

Beginning in October 2003, the Division of Corporation Finance of the SEC has been commenting upon Dynacq’s periodic filings.

Restatement of Financial Statements for the Fiscal Years 1999-2002

On April 6, 2004, we announced that in connection with the ongoing review by the Securities and Exchange Commission’s Division of Corporation Finance of our periodic reports, we would restate our financial statements for the fiscal years ended August 31, 2001 and 2002. We have restated and obtained a re-audit of our financial statements for the fiscal year ended August 31, 2002, restated our 2001 financial statements, and restated the selected financial information for fiscal years 1999 and 2000. The re-audit and restatements of the financial statements produced adjustments to previously reported amounts. These adjustments are described in Note 2 to the consolidated financial statements.

The restated financial statements reflect reductions in net income for the fiscal years ended August 31, 2001 and 2002, to approximately $7.7 million and $14.8 million, respectively, which is 30% and 4% less than the previously reported net income, and increases of approximately 11% and 4%, respectively, in the previously reported stockholders’ equity. The reductions in previously reported net income are primarily the result of adjustments for the noncash expensing of stock options issued to non-employees and the related income tax effect.

As part of the audit adjustments, the restated financial statements reflect an increase in stockholders’ equity at August 31, 2000 of 19% due to the correction of the over-accrual of income tax liabilities prior to August 31, 2000. Retained earnings reflect an increase at August 31, 2000 of 11%, consisting of a 24% increase related to the overstatement of income tax liabilities offset by a 13% noncash charge for stock options issued to non-employees prior to August 31, 2000.

None of the restatements has reduced previously reported net revenue, cash flows from operating activities or stockholders’ equity.

Due to the restatements and re-audit, investors should not rely on the Company’s previously issued financial statements for the fiscal years ended August 31, 1999, 2000, 2001 and 2002. Net revenue and net income for the fiscal year ended August 31, 2003, are approximately $90 million and $21 million, respectively, as we stated on December 1, 2003.

Delisting of Common Stock from Nasdaq National Market

On January 21, 2004, we announced that a hearing had been scheduled for February 5, 2004 before the Nasdaq Listing Qualifications Panel (the “Panel”) to review the recent Nasdaq Staff Determination to delist our common stock for failure to comply with certain NASD Marketplace Rules. We requested the hearing in response to a December 2003 Staff Determination that our securities were subject to delisting from the Nasdaq National Market for failure to comply with the filing requirements for continued listing set forth in NASD Marketplace Rule 4310(c)(14), due to our failure to file an Annual Report on Form 10-K for the fiscal year ended August 31, 2003. On January 15, 2004, the Company received notice of an additional Staff Determination that due to our failure to timely file periodic reports, as well as public interest concerns based on the apparent lack of internal controls, we no longer qualified for inclusion in the Nasdaq Stock Market under Nasdaq Marketplace Rules 4300 and 4330(a)(3), which provide broad discretionary authority to deny continued listing of securities in order to maintain the quality of, and the public’s confidence in, the Nasdaq Stock Market.

On April 15, 2004, we announced that the Panel had notified us that our common stock would be delisted from the Nasdaq National Market as of the opening of business on Friday, April 16, 2004. The Panel acknowledged (a) the reports of the special counsel to the audit committee, which found that there were “no questionable, improper/fraudulent actions or practices relating to the potential sale of account receivables” and that there were “no internal control and/or accounting weaknesses other than” one episode of lack of communication among our officers in connection with a proposed transaction, (b) recently adopted internal control procedures which limit the chief executive officer’s authority to enter into contracts in excess of $250,000 and require greater involvement by the

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general counsel in the use of outside counsel and assignment of projects, and (c) resolution to the satisfaction of the Securities and Exchange Commission of certain concerns with respect to public filings, concluding that public interest considerations did not warrant delisting of our common stock. The Panel also acknowledged the significant amounts of time and resources expended by us in an effort to complete the audit committee investigation and the 2003 audit so as to remedy the filing delinquencies. However, in a determination delivered to us on April 14, 2004, the Panel indicated that in light of the length of the ongoing delinquency in our SEC filings and the Panel’s belief that we had failed to offer a definitive plan to fully remedy the filing delinquency within a reasonable period of time, the Panel had determined to deny our request for a further exception to the filing requirements and to delist our common stock.

Following the delisting, our common stock has been quoted on the National Quotation Service Bureau (the “Pink Sheets”) for unsolicited trading. However, our common stock is not eligible for quotation on the OTC Bulletin Board because we do not have publicly available financial statements that are as of a date within six months of the possible quote. Once we have released the required financial statements, our common stock could become eligible for quotation on the OTC Bulletin Board if a market maker makes an application to have the shares quoted and such application is approved by the Nasdaq Compliance Unit. The Company is currently making every effort to file its quarterly reports on Form 10-Q for the first three quarters of fiscal 2004, as soon as possible.

We are making every effort to make our remaining late SEC filings as soon as possible, but have not yet filed our quarterly reports on Form 10-Q for the periods ended November 30, 2003, February 29, 2004 and May 31, 2004. Once we have become current in our SEC filings, we will explore the listing alternatives available to us. However, we cannot assure you that an active trading market will exist for our common stock.

Changes in Directors and Executive Officers

On January 21, 2004, we announced the election of James G. Gerace as a new independent director and a member of our Audit Committee. Mr. Gerace, a graduate of Texas A&M University, is a Certified Public Accountant and mediator with more than 30 years of professional experience at public accounting firms, performing audits, tax planning and related services. He has served on the board of directors of several banks and savings and loan associations. Mr. Gerace was appointed Chairman of the Audit Committee in February 2004.

In July 2003, James N. Baxter was appointed an executive vice president for investor relations. In September 2003, Irvin T. Gregory, who had served as the Company’s Executive Vice President and Chief Development Officer since October 2001, resigned but remained with the Company in a market research capacity until January 2004. He subsequently elected to leave the Company at the conclusion of his employment agreement on January 31, 2004 to pursue his personal investments and business ventures. In December 2003, Tammy Danberg-Farney was appointed Executive Vice President, General Counsel. In January 2004, Richard D. Valentine was appointed Director of Operations and Development. In February 2004, Sarah C. Garvin resigned from her position as Executive Vice President and Chief Operating Officer of the Company in order to pursue a career as a healthcare management consultant focusing on project development. She continues to assist the Company on a consulting basis. Chiu M. Chan, Chief Executive Officer of the Company, is serving as acting Chief Operating Officer until a replacement can be secured.

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Loss of Key Physicians

During the period August 2003 to May 2004 six physicians who had accounted for over 54% of our gross revenues in fiscal 2003 departed from the Pasadena Facility or substantially reduced their surgeries for various reasons. While the Company has added additional physicians in the fourth quarter of fiscal year 2004, the loss of these physicians resulted in a significant reduction in net patient revenues for the first three quarters of fiscal year 2004. While we believe that we will be able to continue to attract and retain additional physicians, the potential loss of physicians who provide significant net patient revenues for the Company will adversely affect our results of operations.

During the fourth quarter of fiscal year 2004, the Pasadena Facility added six physicians to its medical staff: three orthopedic spine surgeons, two general and vascular surgeons and one bariatric surgeon. In addition, one of its bariatric surgeons who had been out for personal reasons returned in late June of 2004.

Unaudited and Unreviewed Financial Information

We expect to file quarterly reports on Form 10-Q for the fiscal quarters ended November 30, 2003, February 29, 2004, and May 31, 2004 as soon as practicable. We expect net income for the quarters ended November 30, 2003, and February 29, 2004, to be approximately $1.2 million and $700,000, respectively, or 75% and 83% lower than the comparable periods in fiscal 2003. The reduction in net income for the fiscal quarter ended November 30, 2003 includes a non cash charge of approximately $624,000 related to stock options previously issued to an employee which were amended in the first quarter of fiscal 2004. Based on unaudited financial statements, which have not been reviewed by our independent auditor but which have been prepared based on the same accounting policies underlying our previously reported and now restated financial statements, we expect a net loss of approximately $2.2 million for the quarter ended May 31, 2004, compared to net income of $6.3 million in the comparable period of fiscal 2003. We expect net revenues of approximately $47.7 million and a net loss of approximately $300,000 for the nine months ended May 31, 2004, compared to $64.7 million and net income of $15.7 million, respectively, in the comparable period in fiscal 2003. These lower results were negatively impacted by operating expenses incurred in the start up of our new Garland facility with minimal offsetting revenue, by a lower level of activity in our Pasadena Facility and by increased legal and auditing fees. Additionally, several long-time members of the physician staff at the Pasadena Facility ceased or reduced their surgeries in that facility at various times during the first three quarters of fiscal 2004. We have been engaged in efforts to recruit new physicians to the staff. While we have added several new physicians to the staffs of each of the three hospitals, including the return of some who had left earlier, we do not currently expect our financial results to improve in the near future.

Any failure to attract and retain physicians on the staff of our hospital could have an adverse impact on our financial situation. We may not be able to improve our financial condition and may incur substantial losses in the future.

Industry Background

The development of proprietary general acute care hospital networks occurred during the 1970s. During the past 20 years, freestanding outpatient surgery centers were developed to compete with these general hospitals for outpatient procedures. Freestanding outpatient surgery centers allowed surgeons to perform outpatient procedures in specialized facilities, designed to improve efficiency and enhance patient care. The Company believes that its operational model allows surgeons to perform inpatient procedures at facilities that provide similar efficiencies as those provided at outpatient surgery centers. The Company believes that the development and acquisition of general acute hospitals focusing on an evolving combination of surgical specialties, such as orthopedics and bariatrics, will continue to aid in the delivery of quality medical care while resulting in profitable operations.

General acute hospitals specializing in specific complex surgical procedures are designed with the goal of improving both physician and facility efficiency. The surgeries performed are primarily non-emergency procedures that are electively scheduled and therefore allow for the full efficiency available through block time/scheduling. Given the opportunity to utilize multiple operating rooms for pre-determined periods of time, the surgeons are able to schedule their time more efficiently and therefore increase the number of surgeries they can perform within a given amount of time. The facility receives the benefit of consistent staffing patterns and greater facility utilization. In addition, the Company believes that, due to the relatively small size of its facilities, many surgeons choose to perform surgeries in the Company’s facilities because their patients prefer the comfort of a more personal atmosphere and the convenience of simplified admission and discharge procedures.

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Pasadena Facility

At August 31, 2003, the Company owned, through its subsidiaries, 91.5% partnership interest in the Pasadena Facility operating entity, and 8.5% was owned by Halcyon, L.L.C., a third party physician group. The Company purchased an additional 3.5% interest on September 15, 2003, thereby increasing its ownership to 95.0%. The remaining 5% interest was purchased in December 2003, thereby increasing its ownership to 100%. The limited partnership was restructured as of June 2004 and since that date the Company has owned 93% percent of this operating entity and the remaining interest is primarily owned by physicians and by other healthcare professionals. The Pasadena Facility’s primary areas of practice include orthopedic surgery, and general surgery, such as spine and bariatric surgeries, and represents approximately 84% of the Company’s fiscal 2003 net patient service revenues. Through its affiliates, the Company owns 100% of the real estate and owns or leases 100% of the equipment and in turn leases the land, hospital facility and equipment to the operating hospital entity. In November 2002, Vista Healthcare, Inc. ceased to operate and surrendered its license. The Pasadena Facility modified its hospital license and leased the space previously occupied by the Ambulatory Surgery Center.

Baton Rouge Facility

In January 2003, the Company opened its second hospital—the Baton Rouge Facility. This facility’s primary areas of practice include bariatric surgery, orthopedic surgery, general surgery, pain management and cosmetic surgery. At August 31, 2003, the Company owned 97% of the operating hospital entity and a physician group owned the remaining 3%. The Company purchased the remaining 3% interest in April 2004, thereby increasing its ownership to 100% of this operating entity. The limited liability company was restructured in June 2004 and since that date the Company has owned 90% percent of this operating entity, and physicians and other healthcare professionals primarily own the remaining 10% interest. The Baton Rouge Facility contributed 12% of net patient revenues in fiscal year 2003. Through its affiliates, the Company owns 100% of the real estate and owns or leases 100% of the equipment and in turn leases the land, hospital facility and equipment to the operating hospital entity.

Garland Facility

In August 2003, the Company, through its subsidiaries, acquired the total assets of a 113-bed hospital (which is now licensed for 79 beds), a medical office building and 22.7 acres of land in the Dallas-Fort Worth area for approximately $8.5 million (comprising of approximately $6.7 million for land and building and $1.7 million for medical equipment and furniture and fixtures), including the assumption of approximately $2.9 million of liabilities. The Company has completed renovations at that facility, with six surgical suites, and started performing surgical procedures in late November 2003. The principal types of surgery to be performed at this facility are expected to be orthopedic surgery, bariatric surgery, general surgery and pain management. As of July 2004, the Company owned 92% of this operating entity, and the remaining interests are primarily owned by physicians and by other healthcare professionals. Through its affiliates, the Company owns 100% of the real estate and owns or leases 100% of the equipment and in turn leases the land, hospital facility and equipment to the operating hospital entity.

West Houston Facility

Vista Surgical Center West (the “West Houston Facility”) was established in March 2001 and is a satellite ambulatory surgical center to the Pasadena Facility and is located in west Houston. The West Houston Facility houses two operating rooms. This facility’s primary areas of practice include orthopedic surgery, general surgery and pain management. The facility also houses Vista Fertility Institute which provides invitro fertilization services to couples who have been unable to conceive through other means. The operating entity is a wholly owned subsidiary of the Company and subleases the premises from a physician who practices there. For fiscal year 2003, the West Houston Facility represented approximately 4% of the Company’s net patient service revenues.

Business Growth Strategy

The Company has focused on developing and expanding its surgical services hospitals. The Company’s current business strategy involves:

Creating and maintaining relationships with quality surgeons;

• Attracting and retaining key management, marketing, and operating personnel at the corporate level;

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• Further developing and refining its hospital prototype to, among other things, enhance the facility design of its hospitals to provide efficient, effective, and quality patient care;

• Adding new capabilities to its existing hospital campuses; and

• Actively seeking and pursuing new opportunities in additional geographic markets.

Creating and Maintaining Relationships with Quality Surgeons

Since physicians provide and influence the direction of healthcare, we have developed our operating model to encourage physicians to affiliate with us and to use our facilities in accordance with their practice needs. Our strategy is to focus on the development of physician partnerships and facilities that will enhance their practices in order to provide high quality healthcare in a friendly environment for the patient. We seek to attract new physicians to our facilities in order to grow or to replace physicians who retire or otherwise depart from time to time. In order to attract new physicians and maintain existing physician relationships, the Company affords them the opportunity to purchase interests in the operating entities of the facilities. By doing so, the physician becomes more integrally involved in the quality of patient care and the overall efficiency of facility operations.

Attracting and Retaining Key Personnel

We place the utmost importance on attracting and retaining key personnel to be able to provide quality facilities to attract and retain top quality physicians. Attracting and retaining the appropriate corporate personnel and quality senior executives is also an important goal of management and essential in expanding our operations.

Further Refining Hospital Design

We believe we attract physicians because we design our facilities, and adopt staffing, scheduling and clinical systems and protocols to increase physician productivity and promote their professional success. We constantly focus our attention on providing physicians with quality facilities designed to improve the physicians’ and their patients’ satisfaction.

Addition of New Capabilities to Existing Hospitals

Our overall strategy is to develop and operate hospitals designed to handle complex surgeries. Currently, some of our more complex surgeries include spine and bariatric surgeries for which we have added more operating rooms and surgical equipment. The Company continues to explore the possibility of adding other types of surgical procedures which would fit our business model.

New Opportunities and Market Expansion

An integral part of our future plans is the acquisition and development of additional hospitals. As opportunities are identified, we plan to acquire and develop additional hospitals using one of three methods: 1) new construction, which generally requires two years to complete; 2) acquisition of assets and renovation, which generally requires four to six months to complete; 3) long-term leases, which is generally less capital-intensive and requires the least amount of time to commence business operations. Criteria examined when exploring new markets include:

• the potential to attract strong physician partners in the market area;

• the revenue potential associated with those partnerships;

• current or expected competition in the marketplace;

• size of the market;

• predominate payor groups in the market area; and

• licensing and regulatory requirements of the market area.

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International Development Opportunities

Our Board of Directors has ratified and approved negotiations for the potential long-term lease of land and procurement of a hospital license for a hospital to be constructed in Shanghai, China. The proposed hospital would be owned by a joint venture company controlled by Dynacq, with several local joint venture partners. While certain approvals from the Beijing and Shanghai governments have been obtained, other required approvals have not. No assurance can be given that the required approvals will be obtained or that the proposed joint venture hospital project can be achieved at all, or if so, on terms deemed favorable to us. The Company is currently negotiating the lease and has made an earnest money deposit of $640,000.

Marketing

Our marketing efforts are directed primarily at physicians and other healthcare professionals, who are principally responsible for referring patients to our facilities. We market our facilities to physicians by emphasizing the high level of patient satisfaction with our hospitals, the quality and responsiveness of our services, and the practice efficiencies provided by our facilities. We believe that providing quality facilities creates a positive environment for patients and physicians. The Company, through its subsidiaries, also has agreements with outside organizations that offer marketing, pre-authorization and follow up support services to prospective bariatric and orthopedic patients in areas serviced by the Pasadena, Garland, and Baton Rouge Facilities. These facilities receive bariatric and orthopedic referrals from other sources and the organizations also refer clients to other area hospitals.

Competition

Presently, the Company operates in the greater Houston, Texas, Baton Rouge, Louisiana, and Dallas-Fort Worth, Texas metropolitan markets. In each market, the Company competes with other providers, including major acute care hospitals. These hospitals may have various competitive advantages over the Company, including their community position, capital resources, surgeon partnerships, and proximity to surgeon office buildings. The Company also encounters competition with other companies for acquisition and development of facilities and for strategic relationships with surgeons.

There are several large publicly-held companies, and numerous privately-held companies, that acquire and develop freestanding private hospitals and outpatient surgery centers. Many of these competitors have greater financial and other resources than the Company. The principal competitive factors that affect the Company’s ability and the ability of its competitors to acquire or develop private hospitals are experience and reputation, and access to capital. Further, some surgeon groups develop surgical facilities without a corporate partner. The Company can provide no assurance that it will be able to successfully compete in these markets.

Government Regulation

Overview

All participants in the healthcare industry are required to comply with extensive government regulation at the federal, state and local levels. Under these laws and regulations, hospitals must meet requirements for licensure and qualify to participate in government programs, including Medicare and Medicaid. These requirements relate to the adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, hospital use, rate-setting, compliance with building codes and environmental protection laws. There are also extensive regulations governing a hospital’s participation in government programs. These laws and regulations are extremely complex and, in many instances, the industry does not have the benefit of significant regulatory or judicial interpretation.

In the event of a determination that we violated applicable laws, rules or regulations or if changes in the regulatory framework occur, we may be subject to criminal penalties and/or civil sanctions and our hospitals could lose their licenses and/or their ability to participate in government programs. In addition, government regulations frequently change and when regulations change, we may be required to make changes in our facilities, equipment, personnel and services so that our hospitals remain licensed and qualified to participate in these programs. One or more of these outcomes could be material to our operations. We believe that our hospitals are in substantial compliance with current applicable federal, state and local regulations and standards.

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State Workers’ Compensation Commissions

A significant amount of our net revenue results from Texas workers’ compensation claims and to a lesser extent, currently from Louisiana workers’ compensation claims. As such, we are subject to the rules and regulations of the Texas and Louisiana’s Workers’ Compensation Commissions (“TWCC” and “LWCC”, respectively).

The Texas Administrative Code provides the specific methodology and procedure for the payment and denial of medical bills by third party payers for medical services to injured workers in Texas. Specifically, for inpatient surgical services, reimbursement is predicated upon the Acute Care Hospital Inpatient Fee Guideline. In April 2004, the TWCC adopted a new Fee Guideline for Ambulatory Surgical Centers which will become effective as of September 1, 2004. Reimbursement for services not identified in an established fee guideline are reimbursed at a “fair and reasonable” rate. “Fair and reasonable” is not a defined term and the only requirement placed upon an outpatient facility is to bill charges at a “usual and customary” level. Our outpatient and ambulatory surgical center facilities bill for services provided to its workers’ compensation patients at its usual and customary level and pursues reimbursement for these services at a “fair and reasonable” rate. Due to the soon to be effective Ambulatory Surgical Center guidelines, it is anticipated that the number of medical fee disputes filed with the commission may increase during the first twelve months after implementation of this new guideline. As of now, the new fee guideline only affects Ambulatory Surgery Centers and therefore only the West Houston Facility will be affected at this time. The TWCC provides the Medical Dispute Resolution process to request proper reimbursement for services pursuant to the Texas Labor Code and the Texas Administrative Code. For example, if a third party payer does not provide the Company proper reimbursement for a claim, we request reconsideration of that payment amount. After that request, if the third party payer has not provided proper reimbursement, we file a request for Medical Dispute Resolution with the TWCC.

The TWCC then reviews the claim to determine if additional payment is warranted pursuant to the statutory and regulatory guidelines and/or fee guidelines implemented by the TWCC. The TWCC then issues a finding and decision, which the non-prevailing party may then appeal to the State Offices of Administrative Hearings. At that point, the parties can pursue an administrative hearing to determine if proper reimbursement was made for services provided to an injured worker. Although this entire process is lengthy, we request optimal reimbursement for services rendered based upon the utilization of this administrative process. Our Company effectively pursues all avenues of reimbursement allowed under the law as mandated by the legislature and state administrative agencies.

The Louisiana Administrative Code provides the specific methodology and procedure for the payment and denial of medical bills by third party payers for medical services to injured workers. Specifically, for inpatient surgical services, reimbursement is predicated upon the hospital reimbursement schedule. In addition, there is also a reimbursement guideline for outpatient services.

We cannot predict the course of future legislation or changes in current administration of the Texas Labor Code and/or Texas Administrative Code or the Louisiana Administrative Code. We expect that there may be changes in the future, but we are unable to predict their impact on our operations.

Licensure, Certification and Accreditation

Our hospitals are subject to periodic inspection by governmental and other authorities to assure continued compliance with the various standards necessary for licensing and accreditation. Moreover, in order to participate in the Medicare and Medicaid programs, each of our hospitals must comply with the applicable regulations of the United States Department of Health and Human Services relating to, among other things, equipment, personnel and standards of medical care, as well as comply with all applicable state and local laws and regulations. We believe that all of our hospitals are in substantial compliance with such regulations and laws and, as such, are certified for participation in the Medicare and Medicaid programs.

We believe that our hospitals are in substantial compliance with current applicable federal, state and local regulations and standards. However, the requirements for licensure, certification and accreditation are subject to change. Consequently, in order for our hospitals to remain licensed, certified and accredited, it may be necessary from time-to-time for us to make material changes in our facilities, equipment, personnel and/or services.

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Professional licensure

Healthcare professionals at our hospitals are required to be individually and currently licensed or certified under applicable state law and may be subject to numerous Medicare and Medicaid participation and reimbursement regulations. We take steps to ensure that all independent physicians and our employees and agents have the necessary licenses and certifications, and we believe that our employees and agents comply with all applicable state licensure laws.

Corporate practice of medicine and fee-splitting

Some states, including Louisiana and Texas, have laws that prohibit unlicensed persons or business entities, including corporations, from employing physicians. Some states also have adopted laws that prohibit direct or indirect payments or fee-splitting arrangements between physicians and unlicensed persons or business entities. Possible sanctions for violations of these restrictions include loss of license, civil and criminal penalties, and rescission of the business arrangements. These laws vary from state to state, are often vague and in most states have seldom been interpreted by the courts or regulatory agencies. We have attempted to structure our arrangements with healthcare providers to avoid the exercise of any responsibility on behalf of the physicians utilizing our hospitals that could be construed as affecting the practice of medicine and to comply with all such applicable state laws. However, we cannot assure you that governmental officials charged with responsibility for enforcing these laws will not assert that we, or the transactions in which we are involved, are in violation of these laws. These laws may also be interpreted by the courts in a manner inconsistent with our interpretations.

Healthcare Program Regulations

Participation in any federal or state healthcare program, including the Medicare and Medicaid programs, is heavily regulated by statute and regulation. If a hospital fails to substantially comply with the numerous conditions of participation in the Medicare and Medicaid programs or performs certain prohibited acts, the hospital’s participation in the federal or state healthcare programs may be terminated, civil or criminal penalties may be imposed under certain provisions of the Social Security Act, or both.

Anti-kickback Statute

Among the provisions of the Social Security Act is a section known as the Anti-Kickback Statute. The Medicare and Medicaid Anti-Fraud and Abuse Amendments to the Social Security Act, or the Anti-kickback Statute, prohibits providers and others from soliciting, receiving, offering or paying, directly or indirectly, any remuneration with the intent of generating referrals or orders for services or items covered by a federal healthcare program. Courts have interpreted this statute broadly. Violations of the Anti-kickback Statute may be punished by a criminal fine of up to $25,000 for each violation, imprisonment up to five years, or both, civil money penalties of up to $50,000 per violation and damages of up to three times the amount of the illegal kickback and/or exclusion from participation in federal healthcare programs, including Medicare and Medicaid.

The Office of Inspector General at the Department of Health and Human Services (the “OIG”), among other regulatory agencies, is responsible for identifying and eliminating fraud, abuse and waste in federal healthcare programs. The OIG carries out this mission through a nationwide program of audits, investigations and inspections. In order to provide guidance to healthcare providers, the OIG has from time to time issued “Special Fraud Alerts” that do not have the force of law, but identify features of arrangements or transactions that may indicate that the arrangements or transactions violate the Anti-kickback Statute or other federal healthcare laws. The OIG has identified several incentive arrangements, which, if accompanied by inappropriate intent, constitute suspect practices, including: (a) payment of any incentive by the hospital each time a physician refers a patient to the hospital, (b) the use of free or significantly discounted office space or equipment in facilities usually located close to the hospital, (c) provision of free or significantly discounted billing, nursing or other staff services, (d) free training for a physician’s office staff in areas such as management techniques and laboratory techniques, (e) guarantees which provide that, if the physician’s income fails to reach a predetermined level, the hospital will pay any portion of the remainder, (f) low-interest or interest-free loans, or loans which may be forgiven if a physician refers patients to the hospital, (g) payment of the costs of a physician’s travel and expenses for conferences, (h) coverage on the hospital’s group health insurance plans at an inappropriately low cost to the physician, (i) payment for services (which may include consultations at the hospital) which require few, if any, substantive duties by the physician, (j) purchasing goods or services from physicians at prices in excess of their fair market value, or (k) certain

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“gainsharing” arrangements, the practice of giving physicians a share of any reduction in a hospital’s costs for patient care attributable in part to the physician’s efforts. The OIG has encouraged persons having information about hospitals who offer the above types of incentives to physicians to report such information to the OIG.

As authorized by Congress, the OIG has published final safe harbor regulations that outline categories of activities that are deemed protected from prosecution under the Anti-kickback Statute. Currently there are statutory exceptions and safe harbors for various activities, including the following: investment interests, space rental, equipment rental, practitioner recruitment, personal services and management contracts, sale of practice, referral services, warranties, discounts, employees, group purchasing organizations, waiver of beneficiary coinsurance and deductible amounts, managed care arrangements, obstetrical malpractice insurance subsidies, investments in group practices, freestanding surgery centers, and referral agreements for specialty services. Compliance with a safe harbor is not mandatory. The fact that a particular conduct or a business arrangement does not fall within a safe harbor does not automatically render the conduct or business arrangement illegal under the Anti-kickback Statute. Such conduct and business arrangements, however, may lead to increased scrutiny by government enforcement authorities.

The safe harbor regulations with respect to investment interests establish two instances in which payments to an investor in a venture will not be treated as a violation of the Anti-Kickback Statute. The first safe harbor is for investment interests in public companies that have total assets exceeding $50 million and whose investment securities are registered pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The second safe harbor or “small entity” safe harbor is for investments in entities as long as the following criteria are met: (i) no more than 40% of the total investment interests of each class of investment interests are held in the previous fiscal year or previous 12-month period by investors who are in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity; (ii) the terms on which an investment interest is offered to a passive investor (e.g., a shareholder or limited partner) who is in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity are no different than the terms offered to other passive investors; (iii) the terms on which an investment interest is offered to an investor who is in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity are not related to the previous or expected volume of referrals, items or services furnished or amount of business otherwise generated from that investor to the entity; (iv) there is no requirement that a passive investor, if any, make referrals to, be in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity as a condition for remaining as an investor; (v) the entity must not market or furnish the entity’s items or services to passive investors differently than to non-investors; (vi) no more than 40% of the gross revenues of the entity in any fiscal year or twelve-month period comes from referrals or business otherwise generated from investors; (vii) the entity or individual acting on behalf of the entity must not loan funds to or guaranty a loan for an investor who is in a position to make or influence referrals to or otherwise generate business for the entity if the investor uses any part of such loan to obtain the investment interest; and (viii) the amount of payment to an investor in return for the investment interest is directly proportional to the amount of the capital investment (including the fair market value of any pre-operational services rendered) of that investor.

We have a variety of financial relationships with physicians who refer patients to our hospitals. Physicians own interests in certain of our hospitals and may also own our stock. We also have medical directorship agreements with some physicians. Although we believe that our arrangements with physicians have been structured to comply with the current law and available interpretations, we cannot assure you that regulatory authorities will not determine that these arrangements violate the Anti-kickback Statute or other applicable laws. Also, the states in which we operate have adopted anti-kickback laws, some of which apply more broadly to all payers, not just to federal healthcare programs. Many of these state laws do not have safe harbor regulations comparable to the federal Anti-kickback Statute and have only rarely been interpreted by the courts or other government agencies. If our arrangements were found to violate any of these anti-kickback laws we could be subject to criminal and civil penalties and/or possible exclusion from participating in Medicare, Medicaid, or other governmental healthcare programs such as workers’ compensation programs.

Stark Law

The Social Security Act also includes certain provisions commonly known as the “Stark Law.” This law prohibits physicians, absent an exception, from referring Medicare and Medicaid patients to entities with which they or any of their immediate family members have a financial relationship if these entities provide certain designated health services that are reimbursable by Medicare, including inpatient and outpatient hospital services. Sanctions for violating the Stark Law include denial of payment, refunding amounts received for services provided pursuant to

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prohibited referrals, civil monetary penalties of up to $15,000 per prohibited service provided, and exclusion from the Medicare and Medicaid programs. The statute also provides for a penalty of up to $100,000 for a circumvention scheme that has the principal purpose of assuring referrals and that, if directly made, would violate the Stark law. There are exceptions to the self-referral prohibition for many of the customary financial arrangements between physicians and providers, including employment contracts, leases and recruitment agreements. There is also an exception for a physician’s ownership interest in an entire hospital, as opposed to an ownership interest in a hospital department.

On March 26, 2004, the Centers for Medicare and Medicaid Services (“CMS”) issued final “Phase II” regulations to clarify parts of the Stark Law and some of the exceptions thereto. These regulations concluded the second phase of a two-phase process. The Phase I regulations largely went into effect on January 4, 2002, except for one provision interpreting the requirement in many Stark Law exceptions that a physician’s compensation must be “set in advance.” The Phase II Regulations became effective on July 26, 2004 and created seven new exceptions. There have been few enforcement actions, and therefore, there is little indication as to how courts will interpret and apply the Stark Law; however, enforcement is expected to increase.

We believe we have structured our financial arrangements with physicians to comply with the statutory exceptions included in the Stark Law and the regulatory exceptions. In particular, we believe that our physician ownership arrangements meet the Stark whole hospital exception. On March 19, 2004, the CMS announced its implementation of a moratorium on physician investment in and referrals to certain specialty hospitals enacted by Congress as part of the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Congress and CMS define specialty hospitals as primarily or exclusively engaged in the care and treatment of one of the following categories: (i) patients with a cardiac condition, (ii) patients with an orthopedic condition or (iii) patients receiving a surgical procedure. The moratorium became effective on December 8, 2003 and expires on June 8, 2005. Congress specifically excluded from the moratorium, hospitals that were in operation before or under development as of November 18, 2003. In determining whether a specialty hospital was “under development” as of November 18, 2003, the CMS considers whether all of the following occurred prior to November 18, 2003: (i) architectural plans were completed, (ii) funding was received, (iii) zoning requirements were met, and (iv) necessary approvals from appropriate state agencies were received. In cases where all of these steps were not completed prior to November 18, 2003, the CMS will make a case-by-case determination as to whether the specialty hospital was “under development” and will consider any other evidence that would indicate the under development status. To request a case-specific determination regarding whether a specialty hospital was under development as of November 18, 2003, an interested party can request a written opinion from the CMS. During the 18-month moratorium, the Medicare Payment Advisory Commission, in consultation with the Comptroller General of the United States, will conduct a study to determine, in addition to other things, the financial impact of physician-owned specialty hospitals on local full-service community hospitals. We cannot predict the results of this study or the action that Congress may take in response to the study.

The Stark Law may also be amended in ways that we cannot predict at this time, including possible changes to the current physician ownership and compensation exceptions. We cannot predict whether any other law or amendment will be enacted or the effect they might have on us.

State Anti-Kickback and Physician Self-Referral Laws

Many states, including those in which we do or expect to do business, have laws that prohibit payment of kickbacks or other remuneration in return for the referral of patients. Some of these laws apply only to services reimbursable under state Medicaid programs. However, a number of these laws apply to all healthcare services in the state, regardless of the source of payment for the service. Based on court and administrative interpretations of the federal Anti-kickback Statute, we believe that the Anti-kickback Statute prohibits payments only if they are intended to induce referrals. However, the laws in most states regarding kickbacks have been subjected to more limited judicial and regulatory interpretation than federal law. Therefore, we can give you no assurances that our activities will be found to be in compliance with these laws. Noncompliance with these laws could subject us to penalties and sanctions and have a material adverse effect on us.

A number of states, including those in which we do or expect to do business, have enacted physician self-referral laws that are similar in purpose to the Stark Law but which impose different restrictions. Some states, for example, only prohibit referrals when the physician’s financial relationship with a healthcare provider is based upon an investment interest. Other state laws apply only to a limited number of designated health services. Some states do

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not prohibit referrals, but require that a patient be informed of the financial relationship before the referral is made. We believe that our operations are in material compliance with the physician self-referral laws of the states in which our hospitals are located.

HIPAA and The Balanced Budget Act of 1997

The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) broadened the scope of certain federal fraud and abuse laws by adding several criminal provisions for healthcare fraud offenses that apply to all health benefit programs. HIPAA also added a prohibition against incentives intended to influence decisions by Medicare beneficiaries as to the provider from which they will receive services. In addition, HIPAA created new enforcement mechanisms to combat fraud and abuse, including the Medicare Integrity Program and an incentive program under which individuals can receive up to $1,000 for providing information on Medicare fraud and abuse that leads to the recovery of at least $100 of Medicare funds. Federal enforcement officials now have the ability to exclude from Medicare and Medicaid any investors, officers and managing employees associated with business entities that have committed healthcare fraud, even if the officer or managing employee had no knowledge of the fraud. HIPAA was followed by The Balanced Budget Act of 1997, which created additional fraud and abuse provisions, including civil penalties for contracting with an individual or entity that the provider knows or should know is excluded from a federal healthcare program.

Other Fraud and Abuse Provisions

The Social Security Act also imposes criminal and civil penalties for making false claims and statements to Medicare and Medicaid. False claims include, but are not limited to, billing for services not rendered or for misrepresenting actual services rendered in order to obtain higher reimbursement, billing for unnecessary goods and services, and cost report fraud. Criminal and civil penalties may be imposed for a number of other prohibited activities, including failure to return known overpayments, certain gainsharing arrangements, and offering remuneration to influence a Medicare or Medicaid beneficiary’s selection of a healthcare provider. Like the Anti-kickback Statute, these provisions are very broad. Careful and accurate coding of claims for reimbursement, as well as accurately preparing cost reports, must be performed to avoid liability.

The Federal False Claims Act and Similar State Laws

A factor affecting the healthcare industry today is the use of the Federal False Claims Act and, in particular, actions brought by individuals on the government’s behalf under the False Claims Act’s “qui tam,” or whistleblower, provisions. Whistleblower provisions allow private individuals to bring actions on behalf of the government alleging that the defendant has defrauded the federal government.

When a defendant is determined by a court of law to be liable under the False Claims Act, the defendant may be required to pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each false claim submitted. There are many potential bases for liability under the False Claims Act. Liability often arises when an entity knowingly submits a false claim for reimbursement to the federal government. The False Claims Act defines the term “knowingly” broadly. Thus, although simple negligence will not give rise to liability under the False Claims Act, submitting a claim with reckless disregard to its truth or falsity constitutes a “knowing” submission under the False Claims Act and, therefore, will qualify for liability.

In some cases, whistleblowers and the federal government have taken the position that providers who allegedly have violated other statutes, such as the Anti-kickback Statute and the Stark Law, have thereby submitted false claims under the False Claims Act. Certain states in which we operate have adopted their own false claims provisions as well as their own whistleblower provisions whereby a private party may file a civil lawsuit in state court.

Health Information Security and Privacy Practices

The Administrative Simplification Provisions of HIPAA also require certain organizations, including us, to implement very significant and potentially expensive new computer systems and business procedures designed to protect each patient’s individual healthcare information. HIPAA requires the Department of Health and Human Services to issue rules to define and implement patient privacy and security standards. Among the standards that the Department of Health and Human Services adopted pursuant to HIPAA are standards for the following:

• electronic transactions and code sets;

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• unique identifiers for providers, employers, health plan and individuals;

• security and electronic signatures;

• privacy; and

• enforcement.

On August 17, 2000, the Department of Health and Human Services finalized the transaction standards. The Administrative Simplification and Compliance Act extended the date by which we must comply with the transaction standards to October 16, 2003, provided we submit a compliance plan to the Secretary of Health and Human Services by October 16, 2002. We submitted a compliance plan by October 16, 2002. The transaction standards require us to use standard code sets established by the rule when transmitting health information in connection with some transactions, including health claims and health payment and remittance advices. We are now in substantial compliance with the standards.

On December 28, 2000, the Department of Health and Human Services published a final rule establishing standards for the privacy of individually identifiable health information. This rule was amended May 31, 2002 and August 14, 2002. These privacy standards apply to all health plans, all healthcare clearinghouses and many healthcare providers, including healthcare providers that transmit health information in an electronic form in connection with certain standard transactions. We are a covered entity under the final rule. The privacy standards protect individually identifiable health information held or disclosed by a covered entity in any form, whether communicated electronically, on paper or orally. These standards not only require our compliance with rules governing the use and disclosure of protected health information, but they also require us to impose those rules, by contract, on any business associate to whom such information is disclosed. A violation of the privacy standards could result in civil money penalties of $100 per incident, up to a maximum of $25,000 per person per year per standard. The final rule also provides for criminal penalties of up to $50,000 and one year in prison for knowingly and improperly obtaining or disclosing protected health information, up to $100,000 and five years in prison for obtaining protected health information under false pretenses, and up to $250,000 and ten years in prison for obtaining or disclosing protected health information with the intent to sell, transfer or use such information for commercial advantage, personal gain or malicious harm. The compliance date for the privacy rule was April 14, 2003.

On February 20, 2003, the Department of Health and Human Services issued a final rule that establishes, in part, standards for the security of health information by health plans, healthcare clearinghouses and healthcare providers that maintain or transmit any health information in electronic form, regardless of format. We are an affected entity under the rule. These security standards required affected entities to establish and maintain reasonable and appropriate administrative, technical and physical safeguards to ensure integrity, confidentiality and the availability of the information. The security standards were designed to protect the health information against reasonably anticipated threats or hazards to the security or integrity of the information and to protect the information against unauthorized use or disclosure. Although the security standards do not reference or advocate a specific technology, and affected entities have the flexibility to choose their own technical solutions, we expect that the security standards will require us to implement significant systems and protocols. The compliance date for the initial implementation of the standards set forth in the security rule is April 20, 2005.

In April 2003, the Department of Health and Human Services published an interim final rule that establishes procedures for the imposition, by the Secretary of Health and Human Services, of civil monetary penalties on entities that violate the administrative simplification provisions of HIPAA. This was the first installment of the enforcement rule. When issued in complete form, the enforcement rule will set forth procedural and substantive requirements for imposition of civil monetary penalties. The act also provides for criminal penalties for violations. We have established a plan and committed the resources necessary to comply with the act. At this time, we anticipate that we will be able to fully comply with the act’s regulations that have been issued and with the proposed regulations. Based on the existing and proposed regulations, we believe that the cost of our compliance with the act will not have a material adverse effect on our results of operations.

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Emergency Medical Treatment and Labor Act

All of our hospitals are subject to the Emergency Medical Treatment and Labor Act (“EMTALA”). This federal law requires any hospital that participates in the Medicare program to conduct an appropriate medical screening examination of every person who presents to the hospital’s emergency department for treatment and, if the patient is suffering from an emergency medical condition, to either stabilize that condition or make an appropriate transfer of the patient to a facility that can handle the condition. The obligation to screen and stabilize emergency medical conditions exists regardless of a patient’s ability to pay for treatment. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer a patient or if the hospital delays appropriate treatment in order to first inquire about the patient’s ability to pay. Penalties for violations of EMTALA include civil monetary penalties and exclusion from participation in the Medicare program. In addition, an injured patient, the patient’s family or a medical facility that suffers a financial loss as a direct result of another hospital’s violation of the law can bring a civil suit against the hospital.

Although we believe that we are currently in substantial compliance with the requirements of EMTALA, we cannot predict any modifications that the CMS will implement in the future. On May 13, 2004, the CMS issued revised interpretive guidelines for surveyors investigating EMTALA complaints. We cannot predict whether we will be in compliance with any new requirements or interpretive guidelines.

In December 2002, the Pasadena Facility was notified by the CMS that it had allegedly violated EMTALA requirements. The Texas Department of Health (“TDH”) conducted an investigation and reported to the CMS that appropriate corrective actions had been taken. As a result of TDH’s findings, the CMS notified the facility in January 2003 that its eligibility for Medicare participation remained in effect, but, as required by §1867(d) of the Social Security Act, the matter would be forwarded to the Quality Improvement Organization (“QIO”) to review the case and report its findings to the OIG for a possible assessment of a civil monetary penalty. The facility met with the QIO on October 3, 2003. As of this date, there has been no report issued by the QIO or any response received from the OIG. The Company does not anticipate that it will incur any material liability that would have an adverse effect on the Company’s operations, cash flows, or financial condition as a result of this proceeding.

The company is in the process of interviewing individuals with strong regulatory backgrounds to fill the position of Regulatory Compliance Officer. This individual(s) will be responsible for ensuring that the company’s facilities remain in compliance and good standing with both state and federal agencies. The company expects to fill this position(s) by the end of the fourth quarter of fiscal 2004.

Healthcare Reform

As one of the largest industries in the United States, healthcare continues to attract significant legislative interest and public attention. In recent years, various legislative proposals have been introduced or proposed in Congress and in some state legislatures that would affect major changes in the healthcare system, either nationally or at the state level. Many states have enacted or are considering enacting measures designed to reduce their Medicaid expenditures and change private healthcare insurance. We cannot predict the course of future healthcare legislation or other changes in the administration or interpretation of governmental healthcare programs and the effect that any legislation, interpretation, or change may have on us.

Certificate of Need

Some states require state approval for construction and expansion of healthcare facilities, including findings of need for additional or expanded healthcare facilities or services. Certificates of need, which are issued by governmental agencies with jurisdiction over healthcare facilities, are sometimes required for capital expenditures exceeding a prescribed amount, changes in bed capacity or services and certain other matters. Following a number of years of decline, the number of states requiring certificates of need is once again on the rise as state legislators are looking at the certificate of need process as a way to contain rising healthcare costs. Currently, we do not operate in any state that requires a certificate of need. Should we desire to expand our operations to any jurisdiction where a certificate of need will be required, we are unable to predict whether we will be able to obtain any such certificate of need.

Conversion Legislation

Many states have enacted or are considering enacting laws affecting the conversion or sale of not-for-profit hospitals. These laws, in general, include provisions relating to attorney general approval, advance notification and community involvement. In addition, state attorneys general in states without specific conversion legislation may exercise authority over these transactions based upon existing law. In many states there has been an increased interest in the oversight of not-for-profit conversions. We may effect a conversion of a not for profit hospital in the future and accordingly, the adoption of conversion legislation and the increased review of not-for-profit hospital

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conversions may increase the cost and difficulty or prevent our completion of transactions with not-for-profit organizations in certain states in the future.

Environmental Regulation

Our hospital operations generate medical waste that must be disposed of in compliance with federal, state and local environmental laws, rules and regulations. These operations, as well as our purchases of hospitals, also are subject to compliance with various other environmental laws, rules and regulations. We believe that the cost of such compliance will not have a material effect on our future capital expenditures, earnings or competitive position.

Insurance

The Company maintains various insurance policies that cover each of its facilities. Specifically, the Company maintains medical malpractice insurance coverage in Texas. The Company has claims-made malpractice coverage and has purchased tail coverage effective through August 12, 2004. The Company in Louisiana is a member of the Louisiana Patient Compensation Fund and purchases insurance through the Louisiana Patient Compensation Fund for medical malpractice. In addition, all physicians granted privileges at the Company’s facilities are required to maintain medical malpractice insurance coverage. The Company also maintains general liability and property insurance coverage for each facility and flood coverage for the Baton Rouge Facility. The Company also maintains workers’ compensation coverage for the Baton Rouge Facility, but does not currently maintain worker’s compensation coverage in Texas. In regard to the Employee Health Insurance Plan, the Company is self insured with specific and aggregate re-insurance with stop loss levels appropriate for the company’s group size. Coverages are maintained in amounts management deems adequate.

Employees

As of June 26, 2004, the Company employed approximately 328 full-time employees and 74 part-time employees, which represents approximately 338 full time equivalent (“FTE”) employees.

Available Information

We file proxy statements and annual, quarterly and current reports with the U.S. Securities and Exchange Commission (SEC). You may read and copy any document that we file at the SEC’s public reference room located at 450 Fifth Street N.W., Washington, D.C. 20549. You may also call the SEC at 1-800-SEC-0330 for information on the operation of the public reference room. Our SEC filings are also available to you free of charge at the SEC’s website at http://www.sec.gov. We also maintain a website at http://www.dynacq.com that includes links to our SEC filings, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports. These reports are available on our website without charge as soon as reasonably practicable after such reports are filed with or furnished to the SEC. Information contained on our website is not part of this report.

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Risk Factors

The value of an investment in Dynacq Healthcare, Inc. will be subject to significant risks that are inherent in our business and the industry in which we operate, and some of which are specific to our Company. If any of the matters described in the risk factors listed below were to occur, our business and financial results could be adversely affected in a material way. This could cause the trading price of our common stock to decline, perhaps significantly. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties, including those that are not presently known or that we currently believe are immaterial, may also adversely affect our business, financial condition or results of operations.

Because we are not current in our periodic SEC filings, we are in default under our reducing revolving line of credit.

We currently have approximately $6.0 million outstanding under our reducing revolving line of credit, which includes a covenant requiring us to timely file our periodic reports with the Securities and Exchange Commission. Because we did not timely file this annual report on Form 10-K and have not yet filed our quarterly reports on Form 10-Q for the fiscal quarters ended November 30, 2003, February 29, 2004 and May 31, 2004, we are in default under the terms of the line of credit. On April 16, 2004, the financial institution submitted to us a notice of default. Since we did not cure the default within 10 days, we are now in default under the line of credit. To this date, the financial institution has not taken any further action. Our indebtedness under our line of credit is secured by substantially all of our assets. If we are unable to repay all outstanding balances, the financial institution could proceed against our assets to satisfy our obligations under the line of credit.

The cash that we generate from our business may not be sufficient to meet our financial obligations or to fund our capital requirements. As a result, we may require additional capital for, among other purposes, implementing our business growth strategy, purchasing equipment and establishing new facilities. We may not be able to obtain additional capital on acceptable terms, if at all. If we are unable to obtain sufficient additional capital in the future, our business could be adversely affected by reducing our ability to increase revenues and profitability. If we are unable to generate sufficient cash flow from operations in the future to repay our indebtedness and to meet our other commitments, we will be required to adopt one or more alternatives, such as refinancing, selling material assets or operations or seeking to raise additional debt or equity capital. These actions may not be effected on a timely basis or on satisfactory terms or at all, and these actions may not enable us to continue to satisfy our capital requirements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Our former and current independent auditors have advised us that they have identified material weaknesses in our internal controls.

In conjunction with Ernst & Young’s resignation, Ernst & Young advised us that it had identified material weaknesses relating to our internal controls. In a letter dated December 23, 2003, Ernst & Young advised us that a material weakness existed as a result of inadequate communication lines and internal controls relating to the authorization, recognition, capture and review of transactions, facts, circumstances and events that may have a material impact on the Company’s financial reporting process. Ernst & Young has also advised us that a material weakness existed as a result of a lack of supervision, review and quality control related to the accounting for income taxes, noting errors in the computation of income taxes. Further, our current independent auditors have orally advised the audit committee that they have identified what they consider to be material weaknesses in our internal controls with respect to:

• the non-compliance by various departments in submitting information in accordance with procedures to ensure proper and timely recording of accounts payable;

• family relationships among certain of our officers and employees;

• the failure to properly utilize the inventory software to track and report our inventory quantities on a real time basis;

• the failure to properly account for stock options issued to non-employees; and

• a lack of supervision, review and quality control related to the accounting for income taxes.

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See “Item 9A. Controls and Procedures” for a discussion of steps we and our Audit Committee are taking in response to these communications.

The failure by the Company to properly and timely address the issues identified by the auditors as material weaknesses could adversely impact the accuracy of future reports and filings and the timeliness of such reports and filings made pursuant to the Securities Exchange Act of 1934. In addition, for the audit of our financial statements for the fiscal year ended August 31, 2005, we must comply with Section 404(a) of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal control over financial reporting and a report by the independent auditors addressing those assessments. While the Company is implementing steps to ensure compliance with Section 404(a) of the Sarbanes-Oxley Act, failure to comply with such requirements could have a material adverse effect on our business.

The restatement of our financial statements for fiscal years 2001 and 2002 and selected financial information for fiscal years 1999 and 2000 exposes us to risks.

In connection with an ongoing review by the Securities and Exchange Commission of our periodic reports, we have restated and obtained a re-audit of our financial statements for the fiscal year ended August 31, 2002, restated our 2001 financial statements, and restated the selected financial information for fiscal years 1999 and 2000. The re-audit and restatements of the financial statements produced adjustments to previously reported amounts. These adjustments are described in Note 2 to the consolidated financial statements. Due to the restatements and re-audit, investors should not rely on the Company’s previously issued financial statements for the fiscal years ended August 31, 1999 through 2002.

The restatement of these financial statements may lead to litigation claims and/or regulatory proceedings against us. The defense of any such claims or proceedings may divert management’s attention and resources away from the business, and we may be required to pay damages if any such claims or proceedings are not resolved in our favor. Any litigation or regulatory proceedings, even if resolved in our favor, could cause us to incur significant legal and other expenses. In addition, we may be the subject of negative publicity focusing on the financial statement inaccuracies and resulting restatement, which could harm our business and reputation.

Our former independent accountant has ceased operations and investors may not be able to recover against them.

KenWood & Associates, P.C., our independent accountants until May 31, 2002, has ceased its audit practice before the Securities and Exchange Commission. KenWood audited our consolidated financial statements as of August 31, 2001, and for the fiscal year then ended, and issued a report dated November 26, 2001, on such financial statements. KenWood has not reissued its report or consented to the incorporation by reference of such report into this annual report on Form 10-K. In connection with the restatement of these consolidated financial statements, our current independent accountants, Killman, Murrell & Company, has audited the adjustments that were applied to restate the 2001 consolidated financial statements, but did not audit or review the 2001 consolidated financial statements other than with respect to such adjustments. Please read Note 2 to the consolidated financial statements for a description of the adjustments applied to restate our financial statements. Because KenWood has ceased operations before the Securities and Exchange Commission, investors may not be able to recover against KenWood for claims arising from KenWood’s provision of auditing services to us, including claims under federal and state securities laws. Because KenWood has not reissued its report or consented to the incorporation by reference of such report into this annual report on Form 10-K, investors may not be able to recover against KenWood under Section 11 of the Securities Act of 1933 for any untrue statements of a material fact contained in the 2001 financial statements audited by KenWood that are included in this report or any omissions to state a material fact required to be stated therein.

Control by single stockholder

Chiu M. Chan beneficially owns an aggregate of approximately 57.9% of the Company’s issued and outstanding common stock. He also serves as our Chairman, Chief Executive Officer and acting Chief Operational Officer. As majority stockholder, he is able to exert significant influence over all matters requiring stockholder approval, including the election and removal of any directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, this stockholder may dictate the day-to-day management of our business. This concentration of ownership could have the effect of delaying, deferring or preventing a change of control, or impeding a merger or consolidation, takeover or other business combination or sale of all or substantially all of our assets. Furthermore, due to this ownership, our public float is limited and as a result the trading price for our

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common stock may be more volatile than it would be if such concentration did not exist. In the event that this stockholder elects to sell significant amounts of shares of common stock in the future, such sales could depress the market price of our common stock, further increasing the volatility of our trading market.

Our common stock has been delisted from the Nasdaq National Market, which could have a material adverse impact on our stock price, our ability to raise capital and increased obligations under state securities laws.

Our common stock was delisted from the Nasdaq National Market as of the opening of business on Friday, April 16, 2004, because we were not able to file our periodic reports with the Securities and Exchange Commission in a timely manner. Our common stock has continued to be quoted on the National Quotation Service Bureau (the “Pink Sheets”) for unsolicited trading. As a result, there is currently no regular public trading market for the Company’s common stock.

We are making every effort to complete the restatements of our financial statements and make our SEC filings as soon as possible, but we have not yet filed our quarterly reports on Form 10-Q for the periods ended November 30, 2003, February 29, 2004, or May 31, 2004. Once we have become current in our SEC filings, we will explore the listing alternatives available to us. However, we cannot assure you that an active trading market will exist for our common stock.

Our failure to relist our common stock on The Nasdaq National Market or a stock exchange could materially adversely affect the liquidity of our common stock and result in a corresponding material reduction in the price of our common stock. In addition, the continued lack of a public trading market for our common stock could materially adversely affect our ability to raise capital through alternative financing sources on terms acceptable to us, or at all, which could materially harm our business. In addition, we may no longer qualify for exemptions from state securities registration requirements. Without an exemption, we may need to file time-consuming and costly registration statements for future securities transactions and issuances and to amend our stock option plans.

We have a limited trading market, which could affect your ability to sell shares of our common stock and the price you may receive for our common stock

Our common stock is currently quoted on the National Quotation Service Bureau (the “Pink Sheets”) for unsolicited trading. There is only limited trading activity in our securities. We do not know if a market for our common stock will be reestablished or that, if reestablished, a market will be sustained. Therefore, investors should realize that they may be unable to sell our common stock if they purchase it. Accordingly, investors must be able to bear the financial risk of losing their entire investment in our common stock.

Even if our common stock were relisted on the Nasdaq National Market System or on a stock exchange, we would have a relatively small public float compared to our market capitalization. Accordingly, we cannot predict the extent to which investors’ interest in our common stock will provide an active and liquid trading market. Due to our limited public float, we may be vulnerable to investors taking a “short position” in our common stock, which would likely have a depressing effect on the price of our common stock and add increased volatility to our trading market. Furthermore, we have been, and in the future may be subject to, class action lawsuits which further increase market volatility. The volatility of the market for our common stock could have a materially adverse effect on our business, results of operations and financial condition.

Future reductions or changes in reimbursement from government or third party payers could adversely impact our operating results.

During fiscal year 2003, our net revenues were derived approximately 52% from state workers’ compensation programs, approximately 37% from commercial payers, and approximately 5% from Medicare and Medicaid programs. In April 2004, the TWCC adopted a new Fee Guideline for Ambulatory Surgical Centers which will become effective as of September 1, 2004. Reimbursement for services not identified in an established fee guideline are reimbursed at a “fair and reasonable” rate. “Fair and reasonable” is not a defined term and the only requirement placed upon an outpatient facility is to bill charges at a “usual and customary” level. Our outpatient and ambulatory surgical center facilities bill for services provided to its workers’ compensation patients at its usual and customary level and pursues reimbursement for these services at a “fair and reasonable” rate. Due to the soon to be effective Ambulatory Surgical Center guidelines, it is anticipated that the number of medical fee disputes filed with the commission may increase during the first twelve months after implementation of this new guideline. As of now, the new fee guideline only affects Ambulatory Surgery Centers and therefore only the West Houston Facility will be affected at this time. In the

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event that additional rule changes are proposed and adopted that revise fee guidelines or reimbursement rates of the current workers’ compensation statutes, our operating results may be adversely affected. While to date no proposed legislation impacts inpatient operations, there can be no assurances that future legislation may not be adopted. Likewise, in the event that commercial payers modify their respective health benefit programs, such changes could have an adverse material affect in our results of operations.

Delayed Reimbursement under Texas Workers’ Compensation Commission Can Adversely Impact Our Collections Experience and Our Liquidity

With respect to our inpatient surgical services, reimbursement is predicated upon the Acute Care Inpatient Hospital Fee Guideline established by the Texas Workers’ Compensation Commission (“TWCC”). Additionally, with respect to inpatient surgical services having total audited charges exceeding $40,000, the Acute Care Inpatient Hospital Fee Guideline requires the carrier to reimburse the provider 75% of total audited charges. Our reimbursement experience indicates that carriers often dispute the bill or provide reimbursement less than the amount the Company believes it is entitled to receive pursuant to the Acute Care Inpatient Hospital Fee Guideline. In such instances, we are relegated to pursuing our claims through the Medical Dispute Resolution (MDR) process. When the Company is required to pursue reimbursement through the MDR process, any such reimbursement therefrom often involves delays and compromises, due to the subjective nature of the administrative process and the lack of established timeframes in which the reimbursement disputes are to be resolved. This results in the aging of our receivables which affect our liquidity and, in some instances, actual recoveries. Any modification to current reimbursement guidelines may reduce the amount of our reimbursement for future services thereby increasing contractual discounts. The fact that our collection process may be longer than other healthcare providers presents inherent risks in ultimate collection.

Limited Operating History of Current Business Strategy

During the last two fiscal years, management has shifted to managing and operating hospitals rather than the operation of infusion therapy and physician practice management. The Company computes its contractual revenue discount based on its evaluation of historical cash collections and the collectibility of outstanding receivables based on a number of factors, including the age of the receivables, whether the receivable is subject to the MDR process and other factors. This evaluation is highly subjective and is subject to change in the future based on management’s evaluation of these factors. Any changes in the estimates applied in evaluating the collectibility of outstanding receivables could materially impact the Company’s reported revenues and profitability. Due to our limited operating history in this healthcare segment, we have limited data upon which to base this evaluation. As our business in this healthcare segment matures, additional data with respect to historical cash collections and the collectibility of outstanding receivables will become available. As the additional collection data becomes available in the future, management may change its estimate of the collectibility of then outstanding receivables which could affect reported net patient revenues and profitability.

If we fail to comply with the extensive laws and complex government regulations applicable to us, we could suffer penalties or be required to make significant changes to our operations.

We are required to comply with extensive and complex laws and regulations at the federal, state and local government levels. We believe we are in substantial compliance with current laws and regulations that relate to, among other things:

• licensure, certification and accreditation;

• billing for services;

• relationships with physicians and other referral sources, including physician self-referral and fraud and abuse;

• adequacy and quality of medical care;

• quality of medical equipment and services;

• qualifications of medical and support personnel;

• confidentiality, maintenance and security issues associated with medical records;

• the screening, stabilization and transfer of patients who have emergency medical conditions;

• building codes;

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• environmental protection;

• clinical research;

• operating policies and procedures; and

• addition of facilities and services.

Many of these laws and regulations are expansive, and we do not always have the benefit of significant regulatory or judicial interpretation of them. In the future, different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs, operating procedures, and contractual arrangements.

If we fail to comply with applicable laws and regulations, we could be subjected to liabilities, including:

• criminal penalties,

• civil penalties, including monetary penalties and the loss of our licenses to operate one or more of our hospitals, and

• exclusion of one or more of our hospitals from participation in the Medicare, Medicaid and other federal and state healthcare programs, such as workers’ compensation program.

A determination that we have violated these laws, or the public announcement that we are being investigated for possible violations of these laws, could have a material adverse effect on our business, financial condition, results of operations or prospects and our business reputation could suffer significantly. In addition, we are unable to predict whether other legislation or regulations at the federal or state level will be adopted, what form such legislation or regulations may take or their impact.

If the Anti-kickback Statute, physician self-referral or other fraud and abuse laws are modified, interpreted differently or if other regulatory restrictions are issued, we could incur significant sanctions and loss of reimbursement.

The federal Anti-kickback Statute prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for referring items or services payable by Medicare, Medicaid or any other federal healthcare program. The Anti-kickback Statute also prohibits any form of remuneration in return for purchasing, leasing, or ordering or arranging for or recommending the purchasing, leasing or ordering of items or services payable by these programs. The Anti-kickback Statute is very broad in scope and many of its provisions have not been uniformly or definitively interpreted by existing case law, regulations or advisory opinions. Violations of the Anti-kickback Statute may result in substantial civil or criminal penalties, including criminal fines of up to $25,000 or imprisonment and civil penalties of up to $50,000 for each violation, plus three times the amount claimed and exclusion from participation in the Medicare, Medicaid, and other federal healthcare reimbursement programs.

The federal physician self-referral law, commonly referred to as the Stark Law, prohibits a physician, absent an exception, from making a referral for a designated health service to an entity if the physician or a member of the physician’s immediate family has a financial relationship with the entity. There are various ownership and compensation arrangement exceptions to the self-referral prohibition. The exception that in the past permitted physicians to invest in our hospitals and make a referral to the hospital include the requirements that the physician be authorized to perform services at the hospital and own an interest in the entire hospital, as opposed to an ownership interest in a department or subdivision of the hospital. This exception is currently suspended during an 18-month moratorium on new specialty hospitals while a governmental study is being conducted.

The results of the study may affect ownership and other investment interests purchased by physicians. This study as well as other possible amendments to the Stark Law could require us, however, to change the manner in which we establish relationships with physicians to develop a hospital. We cannot predict the results of the study or whether any other amendment to the Stark Law will be enacted or the effect they might have on us. Many states in which we operate also have adopted, or are considering adopting, similar physician self-referral laws. Some of these laws prohibit referrals of patients by physicians in certain cases and others require disclosure of the physician’s interest in the healthcare facility if the physician refers a patient to the facility. Some of these state laws apply even if the payment for care does not come from the government.

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Federal law also contains provisions imposing civil monetary penalties for various fraudulent and/or abusive practices, including, among others, hospitals which knowingly make payments to a physician as an inducement to reduce or limit medically necessary care or services provided to Medicare or Medicaid beneficiaries. The OIG issued a Special Advisory Bulletin on physician incentive compensation, referred to as “gainsharing arrangements”, that also warns that other joint ventures between hospitals and physicians may implicate this provision as well as the Anti-kickback Statute, and specifically refers to specialty hospitals. We believe that the ownership distributions paid to physicians by our hospitals do not constitute payments made to physicians under gainsharing arrangements. We cannot assure you, however, that the OIG or any other federal agency charged with enforcement of the Anti-kickback Statute will agree with this interpretation or that new laws or regulations or future changes in the interpretation of existing laws and regulations will not adversely affect our business.

The federal Anti-kickback Statute, the Stark Law and similar federal and state statutes that may also involve private payers are, however, subject to different interpretations with respect to many important provisions. Violations of these laws may result in substantial civil or criminal penalties, including large civil monetary penalties and exclusion from participation in the Medicare, Medicaid and other healthcare programs. Exclusion of our hospitals from these programs could result in significant loss of revenues and consequently would have a material adverse effect on us. In addition, we could be forced to expend considerable resources responding to an investigation or enforcement action under these laws and regulations. Further judicial or agency interpretation of existing laws or further legislative restrictions on physician ownership, investment in, or other financial relationships with healthcare facilities could have a material adverse effect on us.

If we are unable to acquire and develop additional hospitals on favorable terms, we may be unable to execute our acquisition and development strategy, which could limit our future growth.

Our strategy is to increase our revenues and earnings by continuing to acquire and to develop additional hospitals. Our efforts to execute our acquisition and development strategy may be affected by our ability to identify suitable candidates and negotiate and close acquisition and development transactions. We are currently evaluating potential acquisitions and development projects and expect to continue to evaluate acquisitions and development projects in the foreseeable future. The hospitals we develop typically incur losses during the early stages of operation and, unless and until their case loads grow, they generally experience lower total revenues and operating margins than established hospitals. We may not be successful in acquiring additional hospitals, developing hospitals or achieving satisfactory operating results at acquired or newly developed hospitals. Further, assets we acquire in the future may not ultimately produce returns that justify our related investment. If we are not able to execute our acquisition and development strategy, our ability to increase revenues and earnings through future growth would be impaired.

If we are unable to manage growth, we may be unable to achieve our growth strategy.

We expect to continue to expand our operations in the future provided that we have sufficient capital to effect our growth strategy. As a young company, our rapid growth has placed, and will continue to place, increased demands on our management, operational and financial information systems and other resources. Further expansion of our operations will require substantial financial resources and management attention. To accommodate our past and anticipated future growth, and to compete effectively, we will need to continue to implement and improve our management, operational and financial information systems and to expand, train, manage and motivate our workforce. Our personnel, systems, procedures or controls may not be adequate to support our operations in the future. Further, focusing our financial resources and management attention on the expansion of our operations may negatively impact our financial results. Any failure to implement and improve our management, operational and financial information systems, or to expand, train, manage or motivate our workforce, could reduce or prevent our growth.

Our future results could be harmed by economic, political, regulatory and other risks associated with our potential expansion into foreign operations.

Our Board of Directors has ratified and approved negotiations for the potential long-term lease of land and procurement of a hospital license for a hospital to be constructed in Shanghai, China. The proposed hospital would be owned by a joint venture company controlled by Dynacq, with several local joint venture partners. While certain approvals from the Beijing and Shanghai governments have been obtained, other required approvals have not. No assurance can be given that the required approvals will be obtained or that the proposed joint venture hospital project can be achieved at all, or if so, on terms deemed favorable to us. The Company is currently negotiating the

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lease and has made an earnest money deposit of $640,000. We cannot assure you that the required approvals will be confirmed or that the proposed joint venture hospital project can be achieved at all, or if so, that the terms will be favorable to the Company.

There can be no assurance that we will be able to accomplish our expansion plans or successfully conduct our operations in China or in any other future foreign markets. The failure to do so, including the failure to attract patients and to recruit qualified physicians to this facility, could have a material adverse effect on our business, financial condition, and results of operations. In addition, there can be no assurance that we will have sufficient capital to complete the construction and development of the facility in China in a timely manner or at all.

The risks associated with international expansion could adversely affect our ability to expand our business. Expansion of our operations into new markets entails substantial working capital and capital requirements associated with complying with a variety of foreign laws and regulations, complexities related to obtaining agreements from foreign governments and third parties, foreign taxes, and financial risks, such as those related to foreign currency fluctuations. If we expand internationally, we also will be subject to general geopolitical risks, such as political and economic instability and changes in diplomatic relationships. In many market areas, other healthcare facilities and companies already have significant presence, the effect of which could be to make it more difficult for us to attract patients and recruit qualified physicians.

New federal and state legislative and regulatory initiatives relating to patient privacy and electronic data security could require us to expend substantial sums acquiring and implementing new information and transaction systems, which could negatively impact our financial results.

There are currently numerous legislative and regulatory initiatives at the state and federal levels addressing patient privacy concerns and standards for the exchange of electronic health information. These provisions are intended to enhance patient privacy and the effectiveness and efficiency of healthcare claims and payment transactions. In particular, the Administrative Simplification Provisions of the Health Insurance Portability and Accountability Act of 1996 may require us to acquire and implement expensive new computer systems and to adopt business procedures designed to protect the privacy of each of our patient’s individual health information.

On August 17, 2000, the Department of Health and Human Services issued final regulations establishing electronic data transmission standards that healthcare providers must use when submitting or receiving certain healthcare data electronically. Compliance with these regulations was initially required by October 16, 2002. However, on December 27, 2001, President Bush signed into law the Administrative Simplification Compliance Act, which requires that, by October 16, 2002, covered entities must either: (1) be in compliance with the electronic data transmission standards; or (2) submit a summary plan to the Secretary of Health and Human Services describing how the entity will come into full compliance with the standards by October 16, 2003. As of that date, we believe that we are in substantial compliance with the standards.

The Administrative Simplification Provisions of the Health Insurance Portability and Accountability Act also require the Department of Health and Human Services to adopt standards to protect the security and privacy of health-related information. Proposed security standards were published on August 12, 1998, but they have not been finalized. The proposed security standards would require healthcare providers to implement organizational and technical practices to protect the security of patient information. Once the security regulations are finalized, we will have approximately two years to comply with such regulations.

In addition, on December 28, 2000, the Department of Health and Human Services released final regulations regarding the privacy of healthcare information. Although these privacy regulations were effective April 14, 2001, compliance with these regulations was not required until April 14, 2003. The privacy regulations extensively regulate the use and disclosure of individually identifiable healthcare information, whether communicated electronically, on paper or verbally. The regulations also provide patients with significant new rights related to understanding and controlling how their health information is used or disclosed.

These regulations were expected to have a financial impact on the healthcare industry, because they imposed extensive new requirements and restrictions on the use and disclosure of identifiable patient information. Because of the nature of the security and privacy regulations, we cannot predict the total financial or other impact of these regulations on our business and compliance with these regulations could require us to spend substantial sums, which could negatively impact our financial results. We believe that we are in material compliance with existing state and federal regulations relating to patient privacy. However, if we fail to comply with the recently released

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regulations, we could suffer civil penalties up to $25,000 per calendar year for each violation and criminal penalties with fines up to $250,000 per violation. In addition, we will continue to remain subject to state laws that may be more restrictive than the federal privacy regulations.

We are dependent upon establishing and maintaining surgeon relationships

Our continued success will depend upon our ability to continue to develop and maintain productive relationships with surgeons utilizing our facilities. Identifying appropriate surgeons and our surgeon groups and negotiating and implementing affiliations with these groups can be a lengthy process. There can be no assurance that we will be successful in identifying and establishing relationships with these surgeons, and if relationships are established, there can be no assurance that such relationships will be maintained. None of the surgeons or physicians practicing at our hospitals have a legal commitment, or any other obligation or arrangement, that requires the physician to refer patients to any of our hospitals. Our revenues and profitability would be reduced if we lost our relationship with one or more key surgeons or group of surgeons or such surgeons or groups reduce their use of our hospitals.

We are dependent upon the good reputation of our physicians

The success of our business is dependent upon quality medical services being rendered by our physicians. Any negative publicity, whether from civil litigation, allegations of criminal misconduct, or forfeiture of medical licenses, with respect to any of our physicians and/or our facilities could adversely affect our results of operations. This could occur through the loss of a physician who provides significant revenue to the Company, or decisions by patients to use different physicians or facilities with respect to their healthcare needs. In addition, we have been the subject of negative publicity in news reports focusing on our Pasadena Facility, which has harmed our business and reputation. As the patient-physician relationship involves inherent trust and confidence, any negative publicity adversely affecting the reputation of our physicians or our facilities would likely adversely affect our results of operations.

A significant percentage of our revenues are generated through relatively few physicians.

For the fiscal year ended August 31, 2003, approximately 76% of our revenues were generated from 11 surgeons. During the period August 2003 to May 2004 six physicians who had accounted for over 54% of our gross revenues in fiscal 2003, departed from the Pasadena Facility or substantially reduced their surgeries for various reasons. Among these physicians Dr. Eric Scheffey, who had his medical license suspended in August 2003, accounted for 21% of 2003 gross revenues and Dr. Carlos Ferrari, who departed to practice elsewhere, accounted for 10.3% of 2003 gross revenues. The Company has been engaged in efforts to recruit new physicians to the staff. While we believe that we will be able to attract and retain additional physicians, the loss of physicians who provide significant net patient revenues for the Company may adversely affect our results of operations.

Our physicians need to be on the approved doctors’ list

Since September 2003, the TWCC has required that injured employees in Texas receive healthcare from a doctor on the approved doctors’ list (“ADL”), except in an emergency or for the immediate post-injury medical care. Accordingly, doctors on the ADL, whether licensed in Texas or licensed by another jurisdiction, are required to complete training mandated by the TWCC, apply for a certificate of registration and disclose any required financial interests. At this time, we believe that all doctors involved in the care and treatment of patients covered by the Texas Worker’s Compensation Act who maintain medical staff privileges at the Company’s locations have applied to be on the ADL and have either been granted a temporary exception or have been placed on the ADL. The TWCC reserves the right to review a doctor at any time and take action at a later date for all doctors currently placed on the ADL. The failure of any of our physicians to be listed or maintain listing on the ADL could adversely affect our results of operations.

We are dependent on our hospital facilities for a majority of our revenues

In fiscal year 2003, the majority of our revenues were derived from the management and operation of the Pasadena Facility. As the Company has executed its business strategy to open additional facilities and recruit more physicians, it has become less dependent upon the net revenues generated by the Pasadena Facility for its overall financial success. While the departure of several physicians from the Pasadena Facility contributed to its concurrent

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drop in net revenue, our other facilities have increased their net revenue. However, should the results of any one of our current hospital facilities experience a substantial decline in revenue for any reason, our operating results will be materially adversely affected.

If government laws or regulations change, or the enforcement or interpretation of them change, we may be obligated to purchase some or all of the ownership interests of the physicians affiliated with us.

Changes in government regulation or changes in the enforcement or interpretation of existing laws or regulations could obligate us to purchase some or all of the ownership interests of the physicians affiliated with us in the limited partnerships or limited liability companies that own and operate our hospitals. The regulatory changes that could create this obligation include changes that:

• make illegal the referral of Medicare or other patients to our hospitals by physicians affiliated with us;

• create the substantial likelihood that cash distributions from the limited partnerships or limited liability companies through which we operate our hospitals to physicians affiliated with us would be illegal; or

• make illegal the ownership by the physicians affiliated with us of interests in the partnerships or limited liability companies through which we own and operate our hospitals.

At this time, we are not aware of any regulatory amendments or proposed changes that would trigger this obligation. In the event that we are required to purchase all of the physicians’ ownership interests we could be required to use our cash resources for such acquisitions. The creation of these obligations and the possible termination of our affiliation with these physicians could have a material adverse effect on us.

We could be harmed by ongoing Texas Attorney General and SEC investigations.

We have been notified by the Office of the Attorney General of Texas (“AG’s office”) that we are the subject of an investigation of possible violations of the statutes governing the solicitation of patients. We believe that such investigation stems from the same allegations that have been asserted in a private lawsuit currently pending against us. We have denied the allegations in that lawsuit and continue to vigorously defend the suit. We had also previously received an inquiry from the AG’s office requesting documentation related to any instances of deaths occurring at our facilities between January 1, 1999 and January 29, 2004. We are cooperating with the AG’s office on each of these matters, but believe the complaints received by the AG’s office to be without merit. In the event charges are filed against us related to this investigation, we could be subject to significant sanctions and penalties, which could have a material adverse effect on our business and financial condition. Furthermore, our reputation could suffer and any damage to our reputation could cause us to lose existing patients and fail to attract new patients and qualified physicians, which would have a material adverse effect on our business and financial condition. While the Company has denied any wrongdoing and intends to vigorously defend itself, no assurance can be given as to the outcome of this matter or the effect on our business.

On December 18, 2003, we received a notice of an informal investigation from the Fort Worth, Texas District Office of the Securities and Exchange Commission requesting our voluntary assistance in providing information regarding reporting of our financial statements, recognition of costs and revenue, accounts receivable, allowances for doubtful accounts and our internal controls. We have been cooperating fully with the continuing informal SEC investigation. We cannot predict the outcome of this matter or the effect that it may have on us.

Other companies within the healthcare industry also continue to be the subject of federal and state investigations, which increases the risk that we may become subject to investigations in the future.

Both federal and state government agencies, as well as private payers, have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare organizations. These investigations relate to a wide variety of topics, including the following:

• cost reporting and billing practices;

• quality of care;

• financial relationships with referral sources; and

• medical necessity of services provided.

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In addition, the OIG and the Department of Justice have, from time to time, undertaken national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Moreover, another trend impacting healthcare providers is the increased use of the Federal False Claims Act, particularly by individuals who bring actions under that law. Such “qui tam” or “whistleblower” actions allow private individuals to bring actions on behalf of the government alleging that a healthcare provider has defrauded the federal government. If the government intervenes and prevails in the action, the defendant may be required to pay three times the actual damages sustained by the government, plus mandatory civil monetary penalties of between $5,500 and $11,000 for each false claim submitted to the government. As part of the resolution of a qui tam case, the party filing the initial complaint may share in a portion of any settlement or judgment. If the government does not intervene in the action, the qui tam plaintiff may pursue the action independently. Additionally, some states have adopted similar whistleblower and false claims provisions.

Some of our activities could become the subject of governmental investigations or inquiries. For example, a portion of our revenues derive from Medicare and Medicaid billings, and venture arrangements involving physician investors. Any investigations of us, our executives or physicians practicing at our hospitals could result in significant liabilities or penalties to us, as well as adverse publicity.

If we become subject to significant legal actions, we could be subject to substantial uninsured liabilities.

In recent years, physicians, hospitals and other healthcare providers have become subject to an increasing number of legal actions alleging malpractice, product liability or related legal theories. Many of these actions involve large monetary claims and significant defense costs. We do not employ any of the physicians who conduct surgical procedures at our hospitals and the governing documents of each of our hospitals require physicians who conduct surgical procedures at our hospitals to maintain stated amounts of insurance. Additionally, to protect us from the cost of these claims, we maintain professional malpractice liability insurance and general liability insurance coverage in amounts and with deductibles that we believe to be appropriate for our operations. If we become subject to claims, however, our insurance coverage may not be sufficient or continue to be available at a cost allowing us to maintain adequate levels of insurance. If one or more successful claims against us were not covered by or exceeded the coverage of our insurance, we could be adversely affected.

We do not presently carry director and officer liability insurance

We do not presently carry director and officer liability insurance, and, pursuant to indemnification agreements with certain of our officers and directors and our certificate of incorporation and bylaws, we provide for indemnification and advancement of expenses to the full extent permitted by Delaware law. As a result, our assets are at risk in the event of successful claims against us or our officers and directors. Our assets may not be sufficient to satisfy judgments against us and our officers and directors in the event of such successful claims, or to pay for the costs of defense. In addition, our lack of director and officer liability insurance may adversely affect our ability to attract and retain highly qualified directors and officers in the future.

Our hospitals face competition for patients from other hospitals and healthcare providers.

The healthcare business is highly competitive and competition among hospitals and other healthcare providers for patients has intensified in recent years. Generally, other hospitals in the local communities served by most of our hospitals provide services similar to those offered by our hospitals. In addition, the number of freestanding specialty hospitals and surgery and diagnostic centers in the geographic areas in which we operate has increased significantly. As a result, most of our hospitals operate in an increasingly competitive environment. Some of the hospitals that compete with our hospitals are owned by governmental agencies or not-for-profit corporations supported by endowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. Increasingly, we are facing competition by physician-owned freestanding surgery centers that compete for market share in high margin services and for quality physicians and personnel. If our competitors are better able to attract patients, recruit physicians, expand services or obtain favorable managed care contracts at their healthcare facilities, we may experience a decline in patient volume.

Our hospitals face competition for staffing, which may increase our labor costs and reduce profitability.

Our operations are dependent on the effort, abilities and experience of the management and medical support personnel, such as nurses, pharmacists and lab technicians, as well as its physicians. We compete with other healthcare providers in recruiting and retaining qualified management and support personnel responsible for the day-to-day operations of each of our hospitals, including nurses and other non-physician healthcare professionals. In

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some markets, the availability of nurses and other medical support personnel has become a significant operating issue to healthcare providers. This shortage may require us to continue to enhance wages and benefits to recruit and retain nurses and other medical support personnel or to hire more expensive temporary personnel. We also depend on the available labor pool of semi-skilled and unskilled employees in each of the markets in which we operate. If our labor costs increase, we may not be able to raise rates to offset these increased costs. Our failure to recruit and retain qualified management, nurses and other medical support personnel, or to control our labor costs could have a material adverse effect on our results of operations.

Our hospitals are heavily concentrated in Texas and Louisiana, which makes us sensitive to regulatory, economic and competitive changes in those States.

All of our hospitals are currently located in Texas and Louisiana, which makes us particularly sensitive to regulatory, economic, and competition changes in those states. Any material change in the current regulatory, economic or competitive conditions in these states could have a disproportionate effect on our overall business results.

If laws governing the corporate practice of medicine change, we may be required to restructure some of our relationships.

The laws of various states in which we operate or may operate in the future do not permit business corporations to practice medicine, exercise control over physicians who practice medicine or engage in various business practices, such as fee-splitting with physicians. The interpretation and enforcement of these laws vary significantly from state to state. We are not required to obtain a license to practice medicine in any jurisdiction in which we own or operate a hospital or other facility because our hospitals are not engaged in the practice of medicine. The physicians who use our hospitals to provide care to their patients are individually licensed to practice medicine. Except for Medical Directorship Agreements and specialized service agreements, such as anesthesia services, the physicians and physician group practices are not affiliated with us other than through the physicians’ ownership interests in the ventures that own and operate our hospitals.

Although we believe that our arrangements with physicians and physician group practices comply with applicable laws, we cannot assure you that a government agency charged with enforcement of these laws, or a private party, might not assert a contrary position. If our arrangements with these physicians and physician group practices were deemed to violate state corporate practice of medicine, fee-splitting or similar laws, or if new laws were enacted rendering these arrangements illegal, we may be required to restructure our relationships with physicians and physician groups which may have a material adverse effect on our business.

The eighteen-month moratorium on physician investment in and referrals to certain specialty hospitals may affect our development of new facilities.

On March 19, 2004, the Centers for Medicare and Medicaid Services (CMS) announced its implementation of a moratorium on physician investment in and referrals to certain specialty hospitals enacted by Congress as part of the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Congress and CMS define specialty hospitals as primarily or exclusively engaged in the care and treatment of one of the following categories: (i) patients with a cardiac condition, (ii) patients with an orthopedic condition or (iii) patients receiving a surgical procedure. The moratorium became effective on December 8, 2003 and expires on June 8, 2005. Congress specifically excluded from the moratorium, hospitals that were in operation before or under development as of November 18, 2003. In determining whether a specialty hospital was “under development” as of November 18, 2003, the CMS considers whether all of the following occurred prior to November 18, 2003: (i) architectural plans were completed, (ii) funding was received, (iii) zoning requirements were met, and (iv) necessary approvals from appropriate state agencies were received. In cases where all of these steps were not completed prior to November 18, 2003, the CMS will make a case-by-case determination as to whether the specialty hospital was “under development” and will consider any other evidence that would indicate the under development status. To request a case-specific determination regarding whether a specialty hospital was under development as of November 18, 2003, an interested party can request a written opinion from the CMS. During the 18-month moratorium, the Medicare Payment Advisory Commission, in consultation with the Comptroller General of the United States will conduct a study to determine, in addition to other things, the financial impact of physician-owned specialty hospitals on local full-service community hospitals. We cannot predict the results of this study, or the action that Congress may take in response to the study.

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Item 2. Properties

The Pasadena Facility, the office building adjacent to such facility, and the land upon which the facilities are located are owned by a wholly owned subsidiary of the Company. The hospital is approximately 45,000 square feet and the office building is approximately 36,000 square feet. Management believes the facility is adequately covered by insurance. The Baton Rouge Facility, the office building adjacent to such facility, and the approximately 20 acres of land upon which the facilities are located are owned by a wholly owned subsidiary of the Company. The hospital is approximately 49,500 square feet and the office building is approximately 6,900 square feet. The Garland Facility, including an approximately 90,000 square foot hospital, an approximately 27,000 square foot medical office building and approximately 22.7 acres of land in Garland, Texas, are owned by a wholly-owned subsidiary of the Company. The total assets were acquired in August 2003 for approximately $8.5 million including the assumption of approximately $2.9 million of liabilities. The Company has completed renovations at that facility, with six surgical suites, and started performing surgical procedures in late November 2003. In February 2003 a subsidiary of the Company purchased 6.4 acres of land in Slidell, Louisiana for approximately $2.3 million for a possible new hospital. The Company determined that the proposed Slidell hospital project did not fit its current business plan and sold the land in January 2004 for approximately $2.5 million. This property was classified as an asset held for sale as of August 31, 2003. The Company’s obligations under its reducing revolving line of credit are secured by substantially all of the Company’s assets.

During fiscal year 2003, a Company subsidiary purchased approximately four acres of land in The Woodlands, Texas for approximately $3 million with plans to build a new hospital over the next two years on such property. At this time, the project is still in the planning stage.

The Company leases approximately 7,800 square feet for its West Houston Ambulatory Surgery Center as well as its fertility clinic for approximately $16,350 per month pursuant to leases that expire in May 2008.

In July 1996, DPMI leased approximately 3,000 square feet of office space from the City of Pasadena pursuant to a lease expiring in June 2006, requiring lease payments of $10,800 annually.

The Company had previously leased 1,000 square feet of office space for its executive offices on a month-to-month basis for $1,286 per month. As of September 1, 2003, the Company increased its leased space to approximately 7,250 square feet and entered into an 8 year lease for this office space. The Company will pay $1,286 per month for the first year of the lease and $6,525 per month for the remainder of the lease term. The lessor of the office space is Capital Bank, of which Mr. Earl Votaw, one of the Company’s directors, is a director. Management believes that the lease rate being paid is consistent with comparable commercial rates available in the area.

Item 3. Legal Proceedings

In January 2002, the Company, two of its officers, and the spouse of one of the officers were named as defendants in a shareholder class action lawsuit, Hamilton v. Dynacq International, et al., in the United States District Court for the Southern District of Texas alleging violations of federal securities laws and regulations. The suit, in which the plaintiffs sought unspecified damages, payment of costs and expenses and other equitable or injunctive relief, was brought in early 2002 following a sharp high volume increase in short sales of our common stock. The putative class covered those persons who purchased the Company shares between November 29, 1999 and January 16, 2002. The various complaints that were consolidated claimed that the Company violated Sections 10(b) and 20(a) and Rule 10b-5 under the Exchange Act by making materially false or misleading statements or omissions regarding revenues and receivables and regarding whether our operations complied with various federal regulations. The district court consolidated these actions and appointed a lead plaintiff in the matter. The lead plaintiff filed a consolidated amended complaint on September 6, 2002. The Company and its officers moved to dismiss the complaint on February 25, 2003. On August 26, 2003, the Court dismissed with prejudice and denied plaintiffs leave to amend further. The plaintiffs thereafter filed a notice of appeal. In May 2004, the plaintiffs dismissed their appeal, thereby concluding the case.

A separate shareholder derivative action alleging breach of fiduciary duty, abuse of control, gross mismanagement and unjust enrichment, Flory v. Chan, et al., H-02-3123, was also brought in U.S. District Court for the Southern District of Texas in August 2002, but was stayed on November 12, 2002 by the district court pending the outcome of the shareholder class action described above. The plaintiff in the derivative case, who seeks unspecified

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damages and equitable or injunctive relief, and payment of expenses did not make a demand on the Company or its Board of Directors prior to filing suit. It remained stayed pending the plaintiff’s appeal of the dismissal of the shareholder class action. Given the plaintiff’s dismissal of the appeal in the shareholder class action, the Company has moved to dismiss the derivative action. This derivative matter, if it were to proceed, would not seek to recover any damages from the Company, but could expose the Company to bearing some unknown legal or indemnity costs which we cannot predict at this time.

In March 2002, the Company accepted service of a shareholder derivative action, Brill v. Chan, et al., filed on or about February 26, 2002 in the 295th District Court of Harris County, Texas brought on behalf of the Company against its officers and directors, outside auditor, investment bank, and two analysts affiliated with that investment bank. The suit alleges breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence and breach of contract. Plaintiff makes general allegations of the defendants’ alleged misconduct in “(i) causing or allowing the Company to conduct its business in an unsafe, imprudent and unlawful manner; (ii) failing to implement and maintain an adequate internal control system; and (iii) exposing Dynacq to enormous losses,” including allegations that various press releases and/or public statements issued between January 1999 and January 2002 were misleading. Plaintiffs further allege sales by the Company’s insiders while in possession of material non-public information. The plaintiffs made no demand on either the Company or its Board of Directors prior to filing suit. The Company’s Board of Directors appointed a Special Litigation Committee to conduct an investigation and make a determination as to how the Company should proceed on the claims asserted in the state court shareholder derivative case. On February 24, 2003, the Special Litigation Committee adopted a resolution directing the Company’s counsel to seek dismissal or settlement of the state court derivative action. A Stipulation of Settlement was executed by both parties and filed with the Court on September 11, 2003. The final Settlement, which was approved by the Court on November 10, 2003, provided, among other things, that (1) the claims were dismissed with prejudice and (2) defendants agreed to pay the legal fees and expenses of plaintiffs (shareholders), which the Court set at $500,000. Plaintiffs’ counsel offered to accept such payment in Dynacq common stock or in cash, and the payment was made in cash. Among the terms of the Settlement, it was stipulated that, as a result of the prosecution of the lawsuit and/or the work of the Special Litigation Committee of the Board of Directors of Dynacq, Dynacq had implemented and/or had agreed to implement certain procedures relating to its Audit Committee and its accounting for uncollectible accounts and contractual allowances. The Settlement does not require any change in previously reported financial statements. The Company had accrued for this settlement at August 31, 2003. The Company made the payment after August 31, 2003 and the matter is now concluded.

Eight lawsuits were filed in the United States District Court for the Southern District of Texas (Houston Division) between December 24, 2003 and January 26, 2004, alleging federal securities law causes of action against the Company and various current and former officers and directors. The cases were filed as class actions brought on behalf of persons who purchased shares of Company common stock in the open market generally during the period of January 14, 2003 through December 18, 2003. Under the procedures of the Private Securities Litigation Reform Act, certain plaintiffs have filed motions asking to consolidate these actions and be designated as lead plaintiff. The court consolidated the actions and appointed a lead plaintiff in the matter. An amended complaint was filed on June 30, 2004, asserting a class period of November 27, 2002 – December 19, 2003 and naming additional defendants, including Ernst & Young LLP. The amended complaint seeks certification as a class action and alleges that the defendants violated Sections 10(b), 20(a), 20(A) and Rule 10b-5 under the Exchange Act, by publishing materially misleading financial statements which did not comply with generally accepted accounting principles, making materially false or misleading statements or omissions regarding revenues and receivables, operations and financial results and engaging in an intentional fraudulent scheme aimed at inflating the value of Dynacq’s stock. The Company intends to vigorously defend the allegations and will file a motion to dismiss all or some of the claims. The Company cannot predict the ultimate outcome of the lawsuit or whether the lawsuit will have a material adverse effect on the Company’s financial condition.

The Company is named as a defendant in the lawsuit Leo Borrell v. Dynacq International, Inc., NeWeigh, Inc., and Diane Crumley, Vital Weight Control, Inc., d/b/a NeWeigh, and Vista Community Medical Center, L.L.C. (Cause No. 2002-13659) filed in March 2002 in the 281st Judicial District Court of Harris County, Texas. Dr. Borrell is seeking recovery of commissions he alleges are owed pursuant to an oral agreement with the Company. Dr. Borrell has yet to determine the damages that he is seeking. After a significant amount of discovery has been conducted, we believe this case to be without merit, and intend to continue to vigorously defend this matter.

Late in fiscal year 2003, a dispute arose between one of the Company’s subsidiaries and Jane Capital, LLC and Sunbelt Medical Corp. related to the purchase of medical equipment for the Company’s Baton Rouge Facility.

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Because Jane Capital and Sunbelt each demanded identical full payment for the equipment without providing necessary supporting documents, the Company’s subsidiary filed suit in April 2003 in state district court in Harris County, Texas (165^th District) to require Jane Capital, LLC and Sunbelt Medical Corp. to produce the documents, to determine the proper amount owed for the equipment and to whom such amounts were owed and to reimburse the Company for selling it certain defective products. The lawsuit was settled in May 2004. As a result of the settlement, the amount paid by the Company was approximately $1 million less than the amounts claimed by the defendants.

In September 2003, a contractor who operated the pharmacy at the Baton Rouge Facility filed suit against the Company, the CEO, and the Baton Rouge Facility in Louisiana. The lawsuit, case number 598-564, was filed in the Twenty Fourth Judicial District Court for the Parish of Jefferson, State of Louisiana, and alleges that the plaintiff is owed additional fees in excess of $1,000,000 for costs of goods and services rendered. The plaintiff has asserted claims for breach of contract, fraud, negligence, fraudulent misrepresentation, negligent misrepresentation, civil conspiracy and gross negligence. The Company believes the plaintiff’s claims are without merit and intends to continue to vigorously defend the lawsuit. However, we cannot predict the ultimate outcome of the lawsuit or whether the lawsuit will have a material adverse effect on the Company’s financial condition.

In December 2002, the Pasadena Facility was notified by the Centers for Medicare and Medicaid Services (“CMS”) that the Pasadena Facility had allegedly violated requirements of the Emergency Medical Treatment and Labor Act (“EMTALA”). The Texas Department of Health (“TDH”) conducted an investigation and reported to the CMS that appropriate corrective actions had been taken. As a result of TDH’s findings, the CMS notified the facility in January 2003 that its eligibility for Medicare participation remained in effect, but, as required by §1867(d) of the Social Security Act, the matter would be forwarded to the Quality Improvement Organization (“QIO”) to review the case and report its findings to the OIG for a possible assessment of a civil monetary penalty. The facility met with the QIO on October 3, 2003. As of this date, there has been no report issued by the QIO or any response received from the OIG. The Company does not anticipate that it will incur any material liability that would have a material adverse effect on the Company’s operations, cash flows, or financial condition as a result of this proceeding.

On December 18, 2003, we received a notice of an informal investigation from the Fort Worth, Texas District Office of the Securities and Exchange Commission requesting our voluntary assistance in providing information regarding reporting of our financial statements, recognition of costs and revenue, accounts receivable, allowances for doubtful accounts and our internal controls. We have been cooperating fully with the continuing informal SEC investigation.

By letter dated December 9, 2003, the Office of the Attorney General of Texas (“AG’s Office”) requested documentation concerning incidents at Vista Medical Center in Pasadena, Texas, which resulted in death between December 2001 and December 2003. By letter dated January 20, 2004, the AG’s office broadened that inquiry to include all Vista facilities, all incidents resulting in death, and during a broader time period from January 1, 1999 through January 20, 2004. No specific focus or subject of the inquiry was identified and we have received no further correspondence from the AG’s office explaining this request. In February 2004, the Company was notified by the AG’s office that it is the subject of an investigation of possible violations of the statutes governing the solicitation of patients. Based on the documents requested by the AG’s office and communications with Company representatives, the Company believes that such investigation stems from the same allegations that have been asserted in the private lawsuit with Dr. Borrell described above. The Company has denied the allegations in that lawsuit and continues to vigorously defend the suit. The Company is cooperating with the AG’s Office on each of these matters, but believes the complaints received by the AG’s office to be without merit.

From time to time, the Company is involved in litigation and administrative proceedings that are incidental to its business. The Company cannot predict whether any litigation to which it is currently a party will have a material adverse effect on the Company’s results of operations, cash flows, or financial condition.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of the stockholders of the Company in the fiscal quarter ended August 31, 2003. However, on October 24, 2003, we sent a notice and information statement notifying our stockholders that we had received written consents in lieu of a meeting from stockholders representing a majority of our outstanding shares of common stock approving the reincorporation of Dynacq International, Inc., a Nevada corporation (“Dynacq-Nevada” or the “Company”) in Delaware by merger with and into its wholly-owned Delaware

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subsidiary, Dynacq Healthcare, Inc. (“Dynacq-Delaware”). Prior to the mailing of the notice and information statement, certain of our officers and directors and their affiliates, who collectively held a majority of our outstanding common stock, signed written consents approving the reincorporation. As a result, the reincorporation was approved, and neither a meeting of our stockholders nor additional written consents were necessary. The reincorporation was effective at 12:01 a.m., Central Standard Time, on November 14, 2003. As a result of the reincorporation:

• the Company is governed by the laws of the State of Delaware and by a new Certificate of Incorporation and new Bylaws prepared in accordance with Delaware law;

• the Company’s corporate name changed from Dynacq International, Inc. to Dynacq Healthcare, Inc.; and

• the Company’s authorized capital stock decreased from 300,000,000 shares of common stock and 5,000,000 shares of preferred stock to 100,000,000 shares of common stock and 5,000,000 shares of preferred stock.

As of the close of business on September 23, 2003, the record date for shares entitled to notice of and to sign written consents in connection with the reincorporation, there were 14,944,956 shares of our common stock outstanding. The Company received written consents representing 8,824,964 shares of common stock in favor of the approval of the reincorporation.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

The Company’s common stock was delisted from the Nasdaq National Market as of the opening of business on Friday, April 16, 2004. Following the delisting, our common stock has been quoted on the National Quotation Service Bureau (the “Pink Sheets”) for unsolicited trading. As a result, there is no regular public trading market for the Company’s common stock.

The Company’s common stock previously traded under the symbol “DYII” on the Nasdaq National Market System. The following table sets forth the high and low bid price of the common stock for the past two fiscal years and the interim period prior to the delisting of the Company’s common stock, as reported by the Nasdaq National Market. These prices reflect inter-dealer prices, without retail mark-ups, mark-downs or commissions, and may not necessarily represent actual transactions.

	HIGH		LOW
FISCAL YEAR 2004
First quarter	$	27.85	$	15.71
Second quarter		18.84		4.11
Third quarter		9.51		3.30
FISCAL YEAR 2003
First quarter	$	16.18	$	10.40
Second quarter		15.90		13.08
Third quarter		14.74		12.00
Fourth quarter		26.00		12.45
FISCAL YEAR 2002
First quarter	$	25.79	$	11.00
Second quarter		29.25		5.70
Third quarter		18.00		9.06
Fourth quarter		17.25		11.31

As of June 30, 2004, there were approximately 322 record owners of the Company’s common stock. This number does not include stockholders who hold the Company’s securities in nominee accounts with broker-dealer firms or depository institutions.

The Company intends to retain all earnings for operations and expansion of its business and does not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of cash dividends will depend upon the Company’s results of operations, financial condition and capital requirements, as well as such other factors as the Company’s Board of Directors may consider.

Recent Sales of Unregistered Securities

In January 21, 2003, the Company declared a stock dividend of one Dynacq share of non-transferable Series A Preferred stock for every full block of 100 shares of Dynacq common stock payable to stockholders of record at the close of business on February 10, 2003. At the option of the holders, the stock dividend could be redeemed by the Company at a price of $14.50 per share, or converted on a 1-to-1 basis to common stock. Pursuant to this stock dividend, during fiscal year 2003, a total of 129,577 common shares were issued upon conversion and the Company paid approximately $474,000 in cash for shares submitted to us for redemption. No shares of Series A Preferred Stock were outstanding at August 31, 2003. The Company believes that the transactions were exempt from registration under Section 4(2) of the Securities Act, and all issuances were made by officers of the Company who received no commission or other remuneration.

During fiscal year 2002, the Company issued and sold 3,000 shares of common stock in a private placement to two accredited investors, for an aggregate consideration of $13,000 in cash. The Company believes that the transactions were exempt from registration under Section 4(2) of the Securities Act. The Company took steps to ensure that the purchaser was acquiring securities for purposes of investment and not with a view to distribution. All sales of the Company’s securities were made by officers of the Company who received no commission or other remuneration for the solicitation of any person in connection with the respective sales of securities described above.

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Issuer Purchases of Equity Securities

Shares Purchased by the Company During Fiscal Years 2002 and 2003

	Period	Total number of shares purchased	Average price paid per share	Total number of shares purchased as part of publicly announced program(1)	Maximum number of shares that may yet be purchased under the program(1)
September 2001 (9/24/01 – 9/28/01)		6,000	13.58	6,000	494,000
February 2002 (2/1/02 – 2/5/02)		80,000	8.59	86,000	414,000
June 2003 (6/10/03 – 6/30/03)		189,000	14.38	275,000	225,000
July 2003 (7/1/03 – 7/10/03)		72,500	16.60	347,500	152,500

⁽¹⁾ In January 2002, the Board of Directors of the Company authorized the repurchase of up to 500,000 shares of its common stock from time to time in open market transactions at prevailing market prices.

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Item 6. Selected Financial Data

The data that follows should be read in conjunction with our consolidated financial statements and the notes thereto included in Item 8 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

	Years ended August 31,
	2003			2002			2001			2000			1999
Operating Data:
Net patient service revenue	$	89,976,739		$	64,883,235		$	43,803,619		$	26,032,441		$	16,212,656
Cost and expenses		54,509,420			38,755,471			29,400,119			16,881,628			12,575,742
Income from operations		35,467,319			26,127,764			14,403,500			9,150,813			3,636,914
Other income, net		543,187			560,519			591,886			372,840			294,095
Minority interest in earnings		(3,306,882	)		(2,203,418	)		(2,476,750	)		(807,452	)		(146,508	)
Provision for income tax		(12,886,335	)		(9,655,378	)		(4,775,000	)		(3,510,000	)		(1,309,000	)
Extraordinary gain, net of tax(1)		81,317			—			—			—			—
Cumulative effect of a change in accounting principle, net of tax(2)		988,717			—			—			—			—
Net income	$	20,887,323		$	14,829,487		$	7,743,636		$	5,206,201		$	2,475,501
Basic(3):
Income per share before extraordinary gain and cumulative effect of a change in accounting principle	$	1.33		$	1.01		$	0.55		$	0.38		$	0.19
Extraordinary gain	$	0.01		$	—		$	—		$	—		$	—
Effect of a cumulative change in accounting principle	$	0.06		$	—		$	—		$	—		$	—
Weighted average common shares		14,849,504			14,686,236			13,997,861			13,489,586			12,973,442
Dilutive(3):
Income per share before extraordinary gain and cumulative effect of a change in accounting principle	$	1.27		$	0.96		$	0.51		$	0.36		$	0.18
Extraordinary gain	$	0.01		$	—		$	—		$	—		$	—
Effect of a cumulative change in accounting principle	$	0.06		$	—		$	—		$	—		$	—
Weighted average common shares		15,564,217			15,490,068			15,092,433			14,268,390			13,788,794

	As of August 31,
	2003		2002		2001		2000		1999
Balance Sheet Data:
Cash and cash equivalents	$	1,883,833	$	7,583,756	$	5,031,614	$	4,301,523	$	1,163,535
Total assets		88,136,654		53,926,476		38,207,582		23,046,241		15,512,512
Long-term debt		—		—		519,075		387,965		685,487
Total stockholders’ equity		64,787,068		46,492,856		30,625,477		17,274,865		11,722,963

⁽¹⁾ The extraordinary gain relates to purchases of minority interest.

⁽²⁾ Represents elimination of negative goodwill in accordance with the provisions of Statement of Financial Accounting Standards No. 142.

⁽³⁾ Earnings per share have been restated to reflect two-for-one stock splits in March 2001 and in January 2000.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary

Strong Growth in 2003

During the year ended August 31, 2003 the Company greatly expanded its business from two facilities with ten operating rooms to four facilities with 20 operating rooms. In February 2003 the Company began operating a hospital in Baton Rouge, LA (four operating rooms) and in August 2003 the Company acquired a hospital in Garland, TX (six operating rooms), while continuing to expand the activity of the Pasadena Facility (eight operating rooms) and the West Houston Facility (two operating rooms). Primarily because of increased activity at the Pasadena Facility in 2003, with a contribution from the new Baton Rouge Facility, net patient revenues rose 39%, compared to 2002, to $90 million and net income increased 41% to $21 million.

Sharp Decline in 2004

During fiscal 2004 a series of adverse events, as well as the costs of our expansion, has led to a sharp decline in our results.

Decline in 2004 Revenue

• During the period from August 2003 to May 2004 several physicians, including six who accounted for more than 54% of our gross revenues for 2003, left the staff of the Pasadena Facility for various reasons or temporarily substantially reduced their activity for personal reasons.

• Numerous inquiries, reviews, inspections, investigations and litigation and negative media coverage have made recruiting new physicians slow and difficult because of the negative impact on the Company’s reputation. See Item 3 “Legal Proceedings.”

• Revenue contributions from our new Baton Rouge and Garland Facilities have partially offset the physician exodus at the Pasadena Facility, although to date the Garland Facility has performed below our expectations. We estimate that net revenue for the nine months ended May 31, 2004 will be $47.7 million, 26% lower than that of the comparable period in fiscal 2003.

Decline in 2004 Net Income

We expect a net loss of approximately $300,000 for the nine months ended May 31, 2004 (including a $2.2 million net loss in the quarter ended May 31, 2004), compared to net income of $15.2 million in the 2003 period. There are several causes of this decline.

• The departure of physicians at the Pasadena Facility.

• The expected net losses from the launch of the Garland Facility, which incurred the costs of operation for the full first quarter ended November 30, 2003 without significant revenues as we renovated the Facility. Although we began inpatient procedures at the end of November 2003 and have been adding physicians, the Garland Facility has continued to be a drag on earnings.

• A $624,000 noncash charge in the first quarter of fiscal 2004 relating to options previously granted to an employee.

• Increased legal and auditing fees arising from the re-audit and restatement of our financial statements and responding to the numerous inquiries, reviews, inspections, investigations, de-listing proceedings and class action lawsuits.

Outlook for the Fourth Quarter of Fiscal 2004

During the first half of the current quarter ending August 31, 2004 we have added physicians, including some who had left earlier in the year, to the staff of each of our three hospital facilities. While we are continuing our efforts to recruit additional physicians, we do not currently expect our financial results to improve in the near future. The full impact of the recently added physicians will probably not be felt until after August 2004 due to scheduling logistics and summer vacation plans.

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Re-Audit of 2002 and Restatement of 2001 Financial Statements

• Following the resignation of Ernst & Young in December 2003 without completing the audit for fiscal 2003, in January 2004 our Audit Committee engaged Killman, Murrell & Company, P.C. (“KMC”) as our new independent auditors.

• As a result of the re-audit of the 2002 financial statements and the restatement of the 2001 financial statements and certain financial information for 1999 and 2000, audit adjustments primarily related to noncash expensing of stock option grants have reduced previously reported net income for 2001 and 2002 to $7.7 million and $14.8 million, respectively, which is 30% and 4% less than previously reported.

Internal Controls

Both Ernst & Young and KMC have identified material weaknesses and deficiencies in our internal controls. KMC has conducted a substantive audit of the two fiscal years ended August 31, 2003 and audited the adjustments reflected in the restated financial statements for fiscal year 2001 without substantial reliance on the effectiveness of our internal controls. Our Audit Committee is in the process of addressing these issues. See Item 9A “Controls and Procedures.”

Revenue Recognition

Since we are normally not a party to any managed care contracts and do not have significant Medicare/Medicaid cases, we recognize revenue based upon our estimate of the amount of cash which we will collect for the services delivered. We estimate that we will collect the same percentage of our gross invoices for each facility on a case by case basis in each period as we have actually collecting during the trailing 12 months. What we term “contractual allowance” is the amount which must be subtracted from gross billed charges to arrive at the amount of cash which we expect to collect, i.e., net patient service revenue. For the years ended August 31, 2003, 2002 and 2001, our aggregate contractual allowance, as a percentage of gross billed revenues, was 45%, 43% and 41%, respectively.

Accounts Receivable

Because our business is different from virtually all other healthcare facility companies, our accounts receivable look different from most healthcare companies. Our accounts receivable are larger and older than those of typical healthcare companies. We are normally not a party to managed care contracts and do not have significant Medicare/Medicaid cases, which assure relatively quick payment of relatively small amounts of facility reimbursement. The focus of our business is relatively complex cases with corresponding large facility reimbursements. Our 2003 net patient service revenue came 52% from service to injured Texas workers (Worker’s Compensation) and 37% from out-of-network commercial insurance. The principal cases involved were orthopedic spine surgeries and bariatric surgeries for the morbidly obese, respectively.

Following our approach to revenue recognition, we initially subtract the contractual allowance from the gross receivables. Then we subtract an allowance for uncollectible accounts or bad debt reserve, which we estimate at 1% of total outpatient revenue. We believe that this is conservative, since only about 1% of our net patient service revenue is due from individuals. The great bulk is due from insurance carriers.

Because the normal MDR process (described below) can take more than three years to collect valid receivables, we do not arbitrarily write off MDR receivables. We evaluate MDR receivables on a case by case basis to estimate the amount which will be collected. If that estimate is less than the gross receivables net of contractual allowance and allowance for uncollectible accounts, then we will write it down to the estimated collectible amount. To date we have, on average, collected at least the net receivables and have not reduced the net receivables in the last three fiscal years. At each balance sheet date we also separately classify as long-term receivables all receivables which we expect to collect more than one year from the balance sheet date.

Because the MDR system is not generally understood and is important to understanding our financial statements, we have attempted below to give a more detailed description of the MDR process, as well as others of our critical accounting policies and estimates.

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Overview

Approximately 84% and 92% of the Company’s net patient service revenue for fiscal years 2003 and 2002, respectively, were generated at the Company’s Pasadena Facility. The Baton Rouge Facility contributed 12% in net patient service revenue in fiscal year 2003. We believe that the Baton Rouge Facility and the Garland Facility will constitute a larger percentage of our net patient revenues in future periods.

Revenues derived from the Company’s hospital and outpatient surgical facilities consist primarily of facility and service fees. These fees do not include charges from the patient’s physicians, which are billed directly to the patient or the patient’s insurer by the physician. The Company no longer engages in the infusion therapy business and physician practice management, consisting of office space and fee-based management services for physicians, a business that represented 6% of net patient revenues in fiscal year 2001.

An integral part of the Company’s future plans includes the acquisition and development of additional hospitals. As opportunities are identified, the Company plans to acquire or develop additional hospitals using three methods: (1) new construction, which generally requires two years to complete; (2) acquisition of assets and renovation, which generally requires four to six months to complete; and (3) long-term leases, which is generally the least capital-intensive and requires the least time to commence business operations. The Company intends to finance such future acquisitions from its available cash funds, equity financing or debt financings.

The Company’s facilities are designed to handle specialized general surgeries such as bariatric, orthopedic and neuro spine surgeries. The Company, unlike many other healthcare providers, does not normally participate in any managed care contracts, nor does it receive a substantial amount of reimbursement from Medicare or Medicaid. The bulk of the surgeries are either covered by workers’ compensation insurance or by commercial insurers on an out-of-network health plan basis. Except for emergency room patients, the surgeries are typically pre-certified by the insurance carriers. The Company believes that, as a result, the per-procedure revenue generated by the Company is comparatively higher than the per-procedure revenue generated by other hospitals.

During fiscal years 2003 and 2002, approximately 52% and 61% of the Company’s gross revenues came from surgeries covered by workers’ compensation and approximately 37% and 32% came from services covered by commercial and other insurance payers, respectively.

Critical Accounting Policies and Estimates

General

The Consolidated Financial Statements and Notes to Consolidated Financial Statements contain information that is pertinent to the management’s discussion and analysis. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of any contingent assets and liabilities. Management believes these accounting policies involve judgment due to the significant assumptions and estimates necessary in determining the related asset and liability amounts. Management believes it has exercised proper judgment in determining these estimates based on the facts and circumstances available to its management at the time the estimates were made. The significant accounting policies are described in the Company’s financial statements (see Note 1 in Notes to the Consolidated Financial Statements). Of these policies, management believes the following ones may involve a comparatively higher degree of judgment and complexity. We have discussed the development and selection of the critical accounting policies and related disclosures with the audit committee of the Board of Directors.

Revenue Recognition

Background

The Company’s revenue recognition policy is significant because net patient service revenue is a primary component of its results of operations. Revenue is recognized as services are delivered. The determination of the amount of revenue to recognize in connection with the Company’s services is subject to significant judgments and estimates, which are discussed below.

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Revenue Recognition Policy

The Company is normally not a party to any managed care contracts. The Company records revenue pursuant to the following policy. The Company has established billing rates for its medical services which it bills as gross revenue as services are delivered. Gross billed revenues are then reduced by the Company’s estimate of the discount (contractual allowance) to arrive at net patient service revenues. Net patient service revenues represents the Company’s estimate of the amounts ultimately expected to be collected for the services it has delivered.

The table below sets forth the percentage of our gross patient service revenue by financial class for the fiscal years 2003 and 2002:

	2003		2002
Workers’ Compensation	52	%	61	%
Commercial	37	%	32	%
Medicare	4	%	4	%
Medicaid	1	%	—	%
Self-Pay	1	%	1	%
Other	5	%	2	%

Contractual Allowance

The Company computes its contractual allowance based on the ratio of the Company’s historical cash collections during the trailing twelve months on a case by case basis to gross billed revenue on a case by case basis by operating facility. This ratio of cash collections to billed services is then applied to the gross billed services by operating facility. The following table shows gross revenues and contractual allowances for fiscal years 2003, 2002 and 2001:

	August 31,
	2003			2002			2001
Gross billed charges	$	164,343,892		$	113,760,963		$	74,097,035
Contractual allowance		74,367,153			48,877,728			30,293,416
Net revenue	$	89,976,739			64,883,235			43,803,619
Contractual allowance percentage		45	%		43	%		41	%

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Accounts Receivable

Accounts receivable represent net receivables for services provided by the Company. The estimated accounts receivable not expected to be collected within twelve months of the balance sheet date have been shown as long-term receivables and represent receivables in the Medical Dispute Resolution (“MDR”) and legal third party financial class. The contractual allowance is provided as revenue is recognized. At each balance sheet date management reviews the accounts receivables for collectibility. If after the review management believes certain receivables would be uncollectible, the receivable would be written down to the expected collectable amount. Management has not written down any receivables during the three years ended August 31, 2003 as a result of the collectibility test. The following table shows accounts receivable, the contractual allowance, the allowance for uncollectible accounts, net receivables and the contractual allowance as a percent of receivables at August 31, 2003 and 2002:

	2003			2002
Current portion of gross receivables	$	67,483,780		$	46,544,023
Current portion of contractual allowance		(49,602,756	)		(32,958,185	)
Current portion of allowance for uncollectible accounts		(483,278	)		(248,200	)
Net current portion of accounts receivable		17,397,746			13,337,638
Contractual allowance and allowance for uncollectible accounts as a percentage of current gross receivables		74	%		71	%
Long term portion of gross receivables	$	66,064,559		$	36,624,610
Long term portion of contractual allowance		(48,559,583	)		(25,934,171	)
Long term portion of allowance for uncollectible accounts		(473,114	)		(195,305	)
Net long term portion of accounts receivable		17,031,862			10,495,134
Contractual allowance and allowance for uncollectible accounts as a percentage of long term gross receivables		74	%		71	%

The contractual allowance stated as a percentage of gross receivables at the balance sheet dates is larger than the contractual allowance percentage used to reduce gross billed charges due to the application of cash collections to the outstanding gross receivable balances without any adjustment being made to the contractual allowance. The contractual allowance amounts netted against gross receivables are not adjusted until such time as the final collections on the gross receivables is recognized.

Collections for services provided are generally settled or written off as uncollectible against the contractual allowance within six months of the date of service except for services provided to injured workers in Texas. Collections for services provided to injured workers in Texas may take up to three years or longer to be completely adjudicated. Because the Company has in recent years focused on providing services to injured workers in Texas, accounts receivable in the workers compensation and MDR financial classes have increased.

The MDR process is an established reimbursement resolution process available to providers of healthcare services under the regulations guiding reimbursement for services provided to injured workers in the State of Texas. Accounts generally do not become subject to the MDR process prior to being outstanding for at least 90 days subsequent to patient discharge. For medical services provided to injured workers’ in the State of Texas, the MDR process is specifically based upon the administrative and statutory regulations promulgated by the Texas Labor Code and Texas Administrative Code provisions.

If any reimbursement provided by a workers’ compensation carrier is improper pursuant to the statutory or regulatory guidelines administered by the Texas Workers’ Compensation Commission, our facilities request and pursue additional reimbursement. Following is a brief discussion on the time-line of a typical workers’ compensation claim:

• Bills are submitted to a carrier within 21 days of date of service.

• A carrier has 45 days to respond to provider with payment or an explanation of benefits (EOB) indicating the rationale of denial or defense to payment.

• The Company forwards a Request for Reconsideration (RFR) to a carriers after the 45th day of the carrier’s receipt of the bill or after receipt of the explanation of benefits (EOB).

• The carrier has 21 days to respond to the RFR.

• Should the carrier fail to respond, the Company files a request with the MDR Division of the Texas Workers’ Compensation Commission (TWCC). This usually occurs at or about six to eight months after the date of service due to the amount of administrative requirements required before filing the initial request to TWCC.

• Usually 30 to 60 days after filing the initial request with the MDR Division, TWCC will review the MDR and determine if additional information is needed. TWCC then will forward an MR-116 form requesting any additional documentation and rationale for additional reimbursement. The Company has 14 days after the date of receipt of the MR-116 to provide additional documentation.

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• TWCC is not required by the Texas Labor Code or the Texas Administrative Code to provide a Finding and Decision within a specific timeframe. Based upon the historical actions of the TWCC, a Finding and Decision is usually received within 3-6 months after the supplemental documentation was forwarded to TWCC. However, this time period has extended in some cases to one year after the initial request for MDR was filed.

• After receipt of the Finding and Decision by the TWCC, the non-prevailing party has the option of appealing the decision with the State Office of Administrative Hearings (SOAH) within 20 days of receiving the Finding and Decision from TWCC.

• A hearing date with SOAH is assigned generally within 90 days; however, this time period is usually extended 6-9 months depending on discovery requests. After the SOAH contested case hearing, they will issue a decision within 30-60 days after the hearing or after final closing briefs have been filed.

• The SOAH decision may be appealed to the District Court.

Due to the above-referenced length of the life cycle of a workers’ compensation account, the accounts subject to the MDR process are generally older than other accounts receivable. Collection of those accounts can take as many as two to three years past the actual date of service.

Due to a number of factors outside the Company’s control, including changes in the Company’s reimbursement collection experience associated with either potential changes in the reimbursement environment in which the Company operates or otherwise, it is possible that management’s estimates of patient service revenues could change, which could have a material impact on the Company’s revenue and profitability in the future.

Sources of Revenue and Reimbursement

The focal point of our business is providing patient care services, including complex orthopedic and bariatric procedures. The Company pursues optimal reimbursement from third party payers for these services. We do not normally participate in managed care or other contractual reimbursement agreements, principally because they limit reimbursement for the medical services provided. This business model often results in increased amounts of reimbursement for the same or similar procedure, as compared to other healthcare providers. However, there are no contractual or administrative requirements for “prompt payment” of claims by third party payers within a specified time frame. As a result, the Company tends to receive higher amounts of per-procedure reimbursement than that which may be received by other healthcare providers performing similar services. Conversely, despite the increased reimbursement, we may take additional time to collect the expected reimbursement from third party payers.

In addition to the fact that our collection process may be longer than other healthcare providers because of our focus on workers’ compensation and other commercial payers, the collection process can be extended due to our efforts to obtain all optimal reimbursement available to the Company. Specifically, for medical services provided to injured workers, the Company may initially receive reimbursement that may not be within the fee guidelines or regulatory guidelines mandating reimbursement. For such cases in which third party payers did not provide appropriate reimbursement pursuant to these guidelines, the Company pursues further reimbursement. The Company reviews and pursues those particular claims that are determined to warrant additional reimbursement pursuant to the fee or regulatory guidelines. The Company’s pursuit of additional reimbursement amounts that it believes are due under fee or regulatory guidelines may be accomplished through established dispute resolution procedures with applicable regulatory authorities.

Surgeries are typically not scheduled unless they are pre-authorized by the insurance carrier for medical necessity. After the surgery, the Company’s automated computer system generates a statement of billed charges to the third party payer. At that time, the Company also requests payment from patients for any remaining amounts that are the responsibility of the patient.

Allowance for Uncollectible Accounts

The Company has estimated uncollectible accounts expense as 1% of gross outpatient revenue. Through August 31, 2003, the Company has made no charge offs against the allowance for uncollectible accounts, as historically all charge offs have been against the contractual allowance.

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Income Taxes

SFAS 109, Accounting for Income Taxes, establishes financial accounting and reporting standards for the effect of income taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could materially impact our financial position or our results of operations.

Results of Operations

	Years ended August 31,
	2003				2002				2001
Net patient service revenue	$	89,976,739	100	%	$	64,883,235	100	%	$	43,803,619	100	%
Costs and expenses:
Compensation and benefits		14,990,675	17			9,349,770	14			5,849,723	13
Medical services and supplies		16,505,272	18			15,332,788	24			9,299,835	21
Other operating expenses		20,332,589	23			12,652,455	20			13,379,159	31
Provision for uncollectible accounts		512,885	1			250,712	—			58,259	—
Depreciation and amortization		2,167,999	2			1,169,746	2			813,143	2
Total costs and expenses		54,509,420	61			38,755,471	60			29,400,119	67
Income from operations		35,467,319	39			26,127,764	40			14,403,500	33
Income before income tax, minority interests, extraordinary gain and cumulative effect of a change in accounting principle		36,010,506	40			26,688,283	41			14,995,386	34
Provision for income taxes		12,886,335	14			9,655,378	15			4,775,000	11
Minority interest in earnings		3,306,882	4			2,203,418	3			2,476,750	6
Income before extraordinary gain and cumulative effect of a change in accounting principle		19,817,289	22			14,829,487	23			7,743,636	18
Net income	$	20,887,323	23	%	$	14,829,487	23	%	$	7,743,636	18
Operational statistics (Number of procedures):
Inpatient:
Bariatrics		676				411				77
Orthopedics		611				473				320
Other		126				3				9
Total inpatient procedures		1,413				887				406
Outpatient:
Orthopedics		736				1,621				1,488
Other		2,535				1,355				1,576
Total outpatient procedures		3,271				2,976				3,064
Total procedures		4,684				3,863				3,470

Comparison of the Fiscal Years Ended August 31, 2003 and August 31, 2002

Net patient service revenue increased $25,093,504, to $89,976,739 for fiscal year 2003, compared to $64,883,235 for fiscal year 2002 due to an increase in surgical cases from fiscal year 2002. There was an increase of 59% in inpatient procedures from 887 in fiscal year 2002 to 1,413 in fiscal year 2003. The increase is partly attributable to the opening of the Company’s new Baton Rouge Facility, which began operations in January 2003 and contributed $10,838,134 in net patient service revenues. This facility added 199 inpatient procedures, including 173 bariatric and 14 orthopedic procedures for the fiscal year 2003. The Pasadena Facility had a net increase of

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$15,430,128 in net patient service revenues due to increase of 327 inpatient procedures from fiscal year 2002, primarily related to the increase in the bariatric procedures, which increased to 503 in fiscal year 2003 compared to 411 in fiscal year 2002 and orthopedic procedures which increased to 597 in fiscal year 2003 from 473 in fiscal year 2002. The number of outpatient procedures increased by 10% only to 3,271 in fiscal year 2003 from 2,976 in fiscal year 2002, consistent with the Company’s focus on the inpatient surgical operations.

The overall increase in revenue in fiscal year 2003 compared to that of previous years is primarily related to the opening of the Company’s Baton Rouge Facility, which added four additional operating rooms in addition to the eight operating rooms at the Pasadena Facility (including four operating rooms that became part of the Pasadena Facility during fiscal year 2003 after the Company’s former ambulatory surgery center in Pasadena, Texas surrendered its lease and license and the Pasadena Facility applied to have its license expanded to include these additional four operating rooms). In addition, an increase in the number of operating rooms from two to four and the number of special care unit beds from three to five at the Pasadena Facility during fiscal year 2002 were utilized fully for the entire fiscal year 2003. These improvements allowed the existing physicians practicing at our facilities to perform increased procedures as compared to fiscal year 2002. While the number of procedures increased, the larger percentage of bariatric cases in fiscal year 2003 resulted in a lower average reimbursement per procedure, compared to fiscal year 2002.

During the period from August 2003 to May 2004 several physicians, including six who accounted for over 54% of our gross revenues for 2003 left the staff of the Pasadena Facility for various reasons or temporarily reduced their activity for personal reasons. The Company is adding new physicians to minimize the negative impact on revenue, there is no guarantee that it will be successful in its efforts or the time it may take to compensate for the decrease in revenues. The Company’s revenues for fiscal year 2004 will be adversely affected by these events. However, the Company’s Baton Rouge Facility and the newly acquired Garland Facility, is expected to partially offset this decrease in revenues in fiscal year 2004.

For fiscal year 2003, total costs and expenses increased to $54,509,420 from $38,755,471 in fiscal year 2002. The increase is primarily due to significant increases in the hospital activities. The significant increases in the component expense categories of the operating expenses are as follows:

• Compensation and benefits expense increased by $5,640,905 or 60% from fiscal year 2002. The increase is primarily related to the significant increase in surgical activities at the Company’s Pasadena Facility, combined Full Time Equivalents (FTE) with the opening of the Company’s Baton Rouge Facility, which required increased staffing. There was an increase of 160 FTEs from 197 FTEs in fiscal year 2002 to 357 FTEs in fiscal year 2003, of which increase of 88 FTEs was due to the opening of the Baton Rouge Facility in fiscal year 2003.

• Medical services and supplies increased by $1,172,483 or 8% from fiscal year 2002. For the fiscal year 2003, net patient service revenues increased 39%, whereas medical services and supplies increased by 8%. The Pasadena Facility paid approximately $3.6 million for radiology and laboratory services to a contracted outside agency for the fiscal year 2002 compared to $580,000 paid to them during the fiscal year 2003. The Company ceased using the outside agency in November 2002 and performed these services in-house. The net savings in medical services and supplies to the Company by performing these services in-house was approximately $3 million. This decrease in medical services and supplies has been offset by an increase of $2.2 million for the Baton Rouge facility, which became operational in January 2003 and an increase of $2.0 million related to the increased number of inpatient and outpatient procedures performed. The cession of services rendered by the contracted outside agency also increased the Company’s in-house costs for compensation and benefits of approximately $550,000 and other operating expenses of approximately $550,000.

• The supplies inventory on the balance sheet increased by $1,206,308 from $893,727 at August 31, 2002 to $2,100,035 at August 31, 2003. Of the $1,206,308 increase, approximately $478,000 is due to supplies inventory at the Baton Rouge Facility, which became operational in January 2003, approximately $366,000 if for inventory at the Garland Facility, and approximately $362,000 is primarily due to the increased level of activity at the Pasadena Facility during the fiscal year 2003.

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• Other operating expenses, primarily consisting of utilities, insurance, office supplies, lease and rentals, license and other professional fees, increased $7,680,134 or 61% from fiscal year 2002. Professional fees in fiscal year 2003 increased to $9,625,194 from $3,944,498 in fiscal year 2002, primarily related to the Baton Rouge Facility which added $2,838,890 of other professional fees. The additional increase in professional fees was related to the increased activities at the Pasadena Facility, which added $974,086 compared to prior year. Legal and accounting fees increased from $941,852 in fiscal year 2002 to $2,693,117 in fiscal year 2003. The increases in these fees are primarily related to various legal matters and defending lawsuits. Other significant increases relate to utilities and repairs and maintenance, which increased to $839,989 and $745,827, respectively, from $527,972 and $267,179 in fiscal year 2002. These increases are primarily related to the operations at the Company’s Baton Rouge Facility which increased $88,555 in legal fees, $237,215 in utilities and $197,708 in repairs and maintenance.

• Depreciation and amortization expense increased to $2,167,999 in fiscal year 2003 from $1,169,746 in fiscal year 2002. The increase is primarily related to the increase in property and equipment related to the Baton Rouge Facility, which added $3,910,506 in buildings and $5,753,152 in medical equipment and furniture and fixtures during fiscal year 2003.

Provision for income taxes increased to $12,886,335 in fiscal year 2003 from $9,655,378 in fiscal year 2002, related to the increase in pre-tax income. The effective tax rates were 35.8% and 36.2% in fiscal years 2003 and 2002, respectively. Minority interest in earnings increased to $3,306,882 in fiscal year 2003 from $2,203,418 in fiscal year 2002, primarily related to increase in earnings at the Pasadena Facility.

Comparison of the Fiscal Years Ended August 31, 2002 and August 31, 2001

Net patient service revenue increased $21,079,616, to $64,883,235 for fiscal year 2002 compared to $43,803,619 for fiscal year 2001 due to an increase in surgical cases from fiscal year 2001. There was an increase of 118% in inpatient procedures from 406 in fiscal year 2001 to 887 in fiscal year 2002. The number of outpatient procedures decreased marginally by 3% to 2,976 in fiscal year 2002 from 3,064 in fiscal year 2002, consistent with the Company’s focus on the inpatient surgical operations. Net patient service revenue from ambulatory infusion therapy services and physician practice management services decreased to $1,374,178 in fiscal year 2002 from $2,677,027 in fiscal year 2001, since the Company focused on other areas of operations.

The overall increase in net patient service revenue for fiscal year 2002 was the result of the Company’s primary focus on expanding its inpatient hospital operations. During fiscal year 2002, the Company added two physicians to support the bariatric program, part of hospital operations. In addition, operating rooms at the Pasadena Facility were increased from two to four and the numbers of special care unit beds were increased from three to five during fiscal year 2002. These improvements allowed the existing physicians practicing at our facilities to perform increased procedures as compared to fiscal year 2001. While the number of procedures increased, the larger percentage of bariatric cases in fiscal year 2002 resulted in a lower average reimbursement per procedure, compared to fiscal year 2001.

For fiscal year 2002, total costs and expenses increased by $9,355,352 or 32% from fiscal year 2001. The increase is primarily due to significant increases in the hospital activities. The significant increases in the component expense categories of the operating expenses are as follows:

• Compensation and benefits expense increased by $3,500,047 or 60% from fiscal year 2001. The increase is primarily due to the significant increase in surgical activities compared to that of fiscal year 2001, which required increased hospital staffing and an increase in the number of Company employees at the corporate level. For fiscal year 2002, there was an increase of 45 FTEs from 152 FTEs in fiscal year 2001 to 197 FTEs in fiscal year 2002.

• Medical services and supplies increased by $6,032,953 or 65% from fiscal year 2001. The increase is primarily due to the significant increase in surgical activities compared to that of fiscal year 2001.

• Other operating expenses decreased by $726,704 or 5% from fiscal year 2001. The decrease is primarily related to a 2001 charge of approximately $3.7 million of non-cash expensing of stock options issued to non-employees. This decrease is offset by increases in net other operating expenses of approximately $3 million, primarily due to significant increase in operations at the Company’s

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facilities, as well as an increase in general corporate activity compared to such activities in 2001. Contract payments to physicians decreased by $532,679 or 23% from fiscal year 2001, which is attributable to the decrease in activities related to the Company’s physician management practice.

• Depreciation and amortization expense increased to $1,169,746 in fiscal year 2002 from $813,143 in fiscal year 2001, due to the increase of property and equipment purchases in 2002 of $6,968,932.

Provision for income taxes increased from $4,775,000 in fiscal year 2001 to $9,655,378 in fiscal year 2002, related to the increase in net income. The effective tax rates were 36.2% and 31.8% for fiscal years 2002 and 2001, respectively. The increase in the effective income tax rate in 2002 is primarily due to a decrease in minority interest. Minority interest in earnings decreased from $2,476,750 in fiscal year 2001 to $2,203,418 in fiscal year 2002, primarily related to a decrease in minority interest ownership in Pasadena Facility from 30% to 10% during fiscal year 2002.

Liquidity and Capital Resources

The Company maintained sufficient liquidity in fiscal year 2003 to meet its business needs. As of August 31, 2003, its principal source of liquidity included $1,883,833 in cash and cash equivalents. These instruments are short-term, highly liquid instruments and, accordingly, their fair value approximates cost.

Cash flow from operating activities

Total cash flow provided from operating activities was $15,670,918 as of August 31, 2003. The $3,889,351 increase in cash flow from operating activities for fiscal year 2003 is related to an increase of $1,999,798 in accounts payable and $2,666,621 in accrued liabilities. These increases in accounts payable and accrued liabilities are related to the general increase in operating activities, including the opening of the Baton Rouge Facility in fiscal year 2003. The Company had a $500,000 accrual for dismissal or settlement of a state court derivative action. Other increases in accrued liabilities included property taxes payable of approximately $274,000, and also due to increased wages payable and payroll tax payable by approximately $361,000, of which approximately $211,000 relates to the Baton Rouge Facility. Increases in cash flow from operating activities was offset by decreases in cash flow created by the increase of $11,109,721 in accounts receivable and $840,076 in inventory. The increase in accounts receivable is primarily related to an overall increase in volume procedures and patient growth. Of the $840,076 increase in inventory, $477,742 is due to the supplies inventory at the Baton Rouge Facility. The remaining increase is primarily due to the increased level of activity at the Pasadena Facility during the fiscal year 2003. As of August 31, 2003, the Company had $2,000,000 as restricted cash invested in certificate of deposit with a bank, pursuant to the Jane Capital and Sunbelt Medical lawsuit in which it was required by the Court to post an irrevocable letter of credit to support the issuance of a temporary injunction. This case was subsequently settled in May 2004 and the letter of credit was released.

Cash flow from investing activities

Total cash flow used in investing activities was $22,358,159 as of August 31, 2003. The Company expended approximately $17,282,168 in property and equipment additions, of which $1,002,517 is accrued to be paid in fiscal year 2004. The increase in property and equipment includes additions at Baton Rouge of $3,910,506 in buildings, $5,753,152 in medical equipment and furniture and fixtures during fiscal year 2003. The Company also used approximately $6,307,000 to purchase land and building and $1,955,000 to purchase medical equipment at the Garland Facility. The Company used approximately $2,700,000 for building, medical equipment and furniture and fixtures at the Pasadena Facility. The Company purchased land in The Woodlands, Texas and in Slidell, Louisiana for approximately $3,100,000 and $2,300,000, respectively.

Cash flow from financing activities

Total cash flow provided by financing activities was $987,318 as of August 31, 2003. The Company received proceeds of $1,168,554 from the exercise of stock options and used $3,965,610 cash for treasury stock transactions. The Company redeemed 32,656 preferred shares for cash in the amount of $473,511 and drew $6,413,312 from its line of credit to fund the acquisition of the Garland Facility. Other increases in cash flow from financing activities included contributions from minority interest of approximately $946,000, offset by distributions to and purchases of minority interests of $3,077,000.

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The Company had working capital of $12,259,123 as of August 31, 2003, and maintained a liquid position evidenced by a current ratio of approximately 1.6 to 1. During fiscal year 2003, the Company has invested approximately $3,100,000 and $2,300,000 to purchase land in The Woodlands, Texas and in Slidell, Louisiana, respectively. The Company used its available cash funds to finance these transactions. The Company’s management believes that available cash funds and funds generated from operations will be sufficient for the Company to finance working capital requirements for the current fiscal year. Subsequent to the year ended August 31, 2003, the Company sold the land at Slidell, Louisiana for $2.5 million, resulting in a small profit. The Company had determined that the Slidell hospital project was no longer consistent with its current business plan. The project at The Woodlands, Texas is in the planning stage.

The Company has a reducing revolving line of credit with an unrelated financial institution. The line is reduced monthly by an amount equal to 1/180th of the original loan amount. The amount available and drawn under the line of credit at August 31, 2003 is approximately $6.4 million to finance its acquisition of assets in the Garland Facility. The interest rate on the line of credit is a variable rate of 2.3% plus the “dealer commercial paper” rate. The effective interest rate as of August 31, 2003 was 3.32%. The balance owed under the line of credit as of June 18, 2004 was $6,002,214. There can be no assurance that the Company will have sufficient funds available to meet all of its capital needs.

Because we did not timely file this annual report on Form 10-K and have not yet filed our quarterly reports on Form 10-Q for the fiscal quarters ended November 30, 2003, February 29, 2004 and May 31, 2004, we are in default under the terms of the line of credit. On April 16, 2004, the financial institution submitted to us a notice of default. Since we did not cure the default within 10 days, we are now in default under the line of credit. To this date, the financial institution has not taken any further action. Our indebtedness under our line of credit is secured by substantially all of our assets. If we are unable to repay all outstanding balances, the financial institution could proceed against our assets to satisfy our obligations under the line of credit.

Off-Balance Sheet Arrangements and Commitments

The following table summarizes our known contractual obligations at August 31, 2003, and the effect such obligations are expected to have on our liquidity and cash flow in the future periods indicated below:

	Payments due by period
Contractual obligations	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Marketing Obligations	$	9,962,000	$	4,525,000	$	5,437,000	$	—	$	—
Capital Lease Obligations		632,014		161,484		322,968		147,562		—
Operating Lease Obligations		6,717,991		1,899,325		3,012,445		1,545,764		260,457
Purchase Obligations		1,206,000		1,206,000		—		—		—
Other Contractual Obligations		5,148,000		2,044,000		2,549,000		555,000		—
Total	$	23,666,005	$	9,835,809	$	11,321,413	$	2,248,326	$	260,457

The Company has operating leases primarily for medical and office equipment. The Company also incurs rental expense for office space and medical equipment. Operating lease and rental expense was approximately $1,394,000, $963,000 and $244,000 in fiscal years 2003, 2002 and 2001, respectively. Future minimum rental commitments under noncancellable leases for the following fiscal years are: 2004, $1,899,325; 2005, $1,532,719; 2006, $1,479,726; 2007, $1,190,916; 2008, $354,848; and thereafter, $260,457.

Commitments for future additions to medical equipment were approximately $1,206,000 at August 31, 2003, which was guaranteed by the Company on behalf of its subsidiary in the normal course of business. In terms of the guarantee issued, if the Company’s subsidiary does not meet its commitment of purchasing the medical

46

equipment and making the related payments, the Company will be liable to purchase the medical equipment for the same amount.

The Company, through its subsidiary, also has agreements with outside organizations that offer marketing, pre-authorization and follow up support services to prospective bariatric and orthopedic patients in areas serviced by the Pasadena, Garland and Baton Rouge Facilities. These facilities receive bariatric and orthopedic referrals from other sources and the organizations refers clients to other area hospitals. Payments made under these agreements for the fiscal years 2003, 2002 and 2001 were $6,002,000, $4,802,000 and $4,433,000, respectively. Future minimum payments under these agreements for the following fiscal years are: for 2004, $4,525,000; for 2005, $4,500,000; and for 2006, $937,000.

The Company has contracts with doctors to manage various areas of the Company’s hospitals and other service agreements. Payments made under these agreements for the fiscal years ending August 31, 2003, 2002 and 2001 were $1,776,000, $741,000 and $495,000, respectively. Future minimum payments under the terms of these contracts and agreements for the following fiscal years are: for 2004, $2,044,000; for 2005, $1,629,000; for 2006, $920,000; and thereafter $555,000.

Recent Accounting Pronouncements

In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34. FIN 45 clarifies the requirements of SFAS 5, Accounting for Contingencies, relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. The disclosure provisions of FIN 45 are effective for financial statements of periods that end after December 15, 2002. However, the provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002. The Company has adopted the disclosure requirements of FIN 45.

In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) 148, Accounting for Stock-Based Compensation—Transition and Disclosure. SFAS 148 amends SFAS 123 to provide alternative methods of transition to the SFAS 123 fair value method of accounting for stock-based employee compensation. In addition, SFAS 148 requires disclosure of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. As permitted under SFAS 148, the Company adopted the disclosure only provisions of that accounting standard in the third quarter of fiscal year 2003.

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. A variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights, or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate, or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after December 15, 2003. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. As of August 31, 2003, the Company does not have any entities that require disclosure or consolidation as a result of adopting the provisions of FIN 46.

In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). It is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this Statement is not expected to have a significant impact on our financial statements.

47

Inflation

Inflation has not significantly impacted the Company’s financial position or operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market risks relating to the Company’s operations result primarily from changes in interest rates as well as credit risk concentrations. All of the Company’s contracts are denominated in US$ and, therefore, the Company has no foreign currency risk.

Interest Rate Risk

The Company is exposed to market risk from changes in interest rates on funded debt. This exposure relates to the Company’s reducing revolving credit facility. The Company had drawn approximately $6.4 million as of August 31, 2003 from its line of credit. The balance owed under the line of credit as of June 18, 2004 was approximately $6.0 million. There were no borrowings outstanding under the credit facility as of August 31, 2002. Borrowings under the credit facility bear interest at variable rates based on the “dealer commercial paper” rate plus 2.30%. Based on the amount outstanding, a 100 basis point change in the applicable interest rates would not have a material impact on the Company’s annual cash flow or income.

The Company’s cash and cash equivalents are invested in money market accounts. Accordingly, the Company is subject to changes in market interest rates. However, the Company does not believe a change in these rates would have a material adverse effect on the Company’s operating results, financial condition, and cash flows. There is an inherent roll over risk on these funds as they accrue interest at current market rates. The extent of this risk is not quantifiable or predictable due to the variability of future interest rates.

Credit Risks

The Company’s financial instruments that are exposed to concentrations of credit risk consist primarily of trade receivables from various private insurers. The Company monitors its exposure for credit losses and maintains allowances for anticipated losses, but does not require collateral from these parties.

48

Item 8. Financial Statements and Supplementary Data

INDEX TO FINANCIAL STATEMENTS

Below is an index to the consolidated financial statements and notes thereto contained in Item 8, Financial Statements and Supplementary Data.

	PAGE
Report of Independent Registered Public Accounting Firm	50
Consolidated Balance Sheets	51
Consolidated Statements of Operations	53
Consolidated Statements of Stockholders’ Equity	54
Consolidated Statements of Cash Flows	55
Notes to Consolidated Financial Statements	57
Schedule II—Valuation and Qualifying Accounts	82

49

Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors

Dynacq Healthcare, Inc.

Houston, Texas

We have audited the accompanying consolidated balance sheets of Dynacq Healthcare, Inc. (formerly Dynacq International, Inc.) (the “Company”), as of August 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years ended August 31, 2003 and 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. The consolidated financial statements of Dynacq Healthcare, Inc. (formerly Dynacq International, Inc.) as of August 31, 2001, and for the year then ended were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those consolidated financial statements in their report dated November 26, 2001.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Dynacq Healthcare, Inc. (formerly Dynacq International, Inc.) at August 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for the years ended August 31, 2003 and 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, in 2003 the Company changed its method of accounting for negative goodwill.

As discussed above, the consolidated financial statements of Dynacq Healthcare, Inc. (formerly Dynacq International, Inc.) as of August 31, 2001, and for the year then ended were audited by other auditors who have ceased operations. As described in Note 2, these consolidated financial statements have been restated. We audited the adjustments described in Note 2 that were applied to restate the 2001 consolidated financial statements. In our opinion, such adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply procedures to the 2001 consolidated financial statements of the Company other than with respect to such adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2001 consolidated financial statements taken as a whole.

/s/ Killman, Murrell & Company, P. C.

Killman, Murrell & Company, P. C.

Houston, Texas

June 18, 2004

50

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Consolidated Balance Sheets

	August 31,
	2003		2002
Assets
Current assets:
Cash and cash equivalents	$	1,883,833	$	7,583,756
Restricted cash		2,000,000		—
Current portion of accounts receivable, net of contractual allowances of approximately $49,603,000 and $32,958,000 and allowances for uncollectible accounts of approximately $483,000 and $248,000 at August 31, 2003 and 2002, respectively		17,397,746		13,337,638
Inventories		2,100,035		893,728
Prepaid expenses		793,257		222,452
Deferred tax assets		939,655		1,376,522
Income taxes receivable		4,430,485		1,790,370
Asset held for sale		2,315,204		—
Total current assets		31,860,215		25,204,466
Property and equipment, net		38,002,399		16,277,167
Long term portion of accounts receivable, net of contractual allowances of approximately $48,560,000 and $25,934,000 and allowances for uncollectible accounts of approximately $473,000 and $195,000 at August 31, 2003 and 2002, respectively		17,031,862		10,495,134
Long term deferred tax assets		—		748,389
Goodwill		582,547		582,547
Other assets		659,631		618,773
Total assets	$	88,136,654	$	53,926,476

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

51

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Consolidated Balance Sheets (continued)

	August 31,
	2003			2002
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	3,459,881		$	1,460,083
Accrued liabilities		7,403,850			1,552,275
Notes payable		7,083,312			39,075
Current taxes payable		1,524,244			1,307,527
Current portion of capital lease obligations		129,805			—
Total current liabilities		19,601,092			4,358,960
Non-current liabilities:
Negative goodwill, net		—			1,550,910
Deferred tax liabilities		751,273			—
Long-term portion of capital lease obligations		428,587			—
Total liabilities		20,780,952			5,909,870
Minority interests		2,568,634			1,523,750
Commitments and contingencies		—			—
Stockholders’ equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued or outstanding		—			—
Common stock, $.001 par value; 100,000,000 shares authorized, 16,294,343 and 15,901,430 shares issued at August 31, 2003 and 2002, respectively		16,294			15,901
Treasury stock, 1,445,099 and 1,143,592 shares at August 31, 2003 and 2002, respectively, at cost		(5,813,284	)		(1,535,934	)
Additional paid-in capital		17,521,843			13,695,088
Accounts receivable Director					(28,469	)
Retained earnings		53,721,286			35,186,341
Deferred compensation		(659,071	)		(840,071	)
Total stockholders’ equity		64,787,068			46,492,856
Total liabilities and stockholders’ equity	$	88,136,654		$	53,926,476

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

52

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Consolidated Statements of Operations

	Years ended August 31,
	2003			2002			2001
Net patient service revenue	$	89,976,739		$	64,883,235		$	43,803,619
Costs and expenses:
Compensation and benefits		14,990,675			9,349,770			5,849,723
Medical services and supplies		16,505,272			15,332,788			9,299,835
Other operating expenses		20,332,589			12,652,455			13,379,159
Provision for uncollectible accounts		512,885			250,712			58,259
Depreciation and amortization		2,167,999			1,169,746			813,143
Total costs and expenses		54,509,420			38,755,471			29,400,119
Income from operations		35,467,319			26,127,764			14,403,500
Other income (expense):
Rent and other income		471,778			424,472			352,114
Interest income		73,300			163,584			299,901
Interest expense, net of $84,668 capitalized interest in 2003		(1,891	)		(27,537	)		(60,129	)
Total other income, net		543,187			560,519			591,886
Income before income tax, minority interests, extraordinary gain and cumulative effect of a change in accounting principle		36,010,506			26,688,283			14,995,386
Provision for income taxes		12,886,335			9,655,378			4,775,000
Minority interest in earnings		3,306,882			2,203,418			2,476,750
Income before extraordinary gain and cumulative effect of a change in accounting principle		19,817,289			14,829,487			7,743,636
Extraordinary gain, net of $49,681 of income tax expense		81,317			—			—
Income before cumulative effect of a change in accounting principle		19,898,606			14,829,487			7,743,636
Cumulative effect of a change in accounting principle, net of $562,193 income tax expense		988,717			—			—
Net income	$	20,887,323		$	14,829,487		$	7,743,636
Basic earnings per common share:
Income before extraordinary gain and cumulative effect of a change in accounting principle	$	1.33		$	1.01		$	0.55
Extraordinary gain, net of tax		0.01			—			—
Cumulative effect of a change in accounting principle, net of tax		0.06			—			—
Net income	$	1.40		$	1.01		$	0.55
Diluted earnings per common share:
Income before extraordinary gain and cumulative effect of a change in accounting principle	$	1.27		$	0.96		$	0.51
Extraordinary gain, net of tax		0.01			—			—
Cumulative effect of a change in accounting principle, net of tax		0.06			—			—
Net income	$	1.34		$	0.96		$	0.51
Weighted average common shares—basic		14,849,504			14,686,236			13,997,861
Weighted average common shares—diluted		15,564,217			15,490,068			15,092,433

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

53

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Consolidated Statements of Stockholders’ Equity

	Common Stock					Treasury Stock					Additional Paid-In Capital			Retained Earnings			Deferred Compensation			Receivable From Director			Total
	Shares		Amount			Shares		Amount
Balance, August 31, 2000 as previously reported	7,658,856		$	7,659		794,392		$	(1,141,546	)	$	4,309,813		$	11,392,583		$	—		$	—		$	14,568,509
Cancellation of treasury shares	(306,868	)		(307	)	(306,868	)		423,478			(423,171	)		—			—			—			—
Stock options issued to non employees	—			—		—			—			1,478,080			(1,478,080	)		—			—			—
Treasury shares held by subsidiary	—			—		35,672			—			—			—			—			—			—
Overstatement of tax liabilities as of August 31, 2000	—			—		—			—			—			2,706,356			—			—			2,706,356
Balance, August 31, 2000 as restated	7,351,988			7,352		523,196			(718,068	)		5,364,722			12,620,859			—			—			17,274,865
Stock issued for acquisitions	65,751			66		—			—			617,152			—			—			—			617,218
Stock issued for compensation	20,620			21		—			—			173,042			—			—			—			173,063
Common stock sales	21,442			21		—			—			281,079			—			—			—			281,100
Stock issued on exercise of stock options	551,436			551		—			—			788,557			—			—			—			789,108
Stock options issued to non-employees	—			—		—			—			3,686,510			—			—			—			3,686,510
Income tax benefit from exercise of employee stock options	—			—		—			—			108,938			—			—			—			108,938
Stock split	7,641,358			7,641		528,796			—			—			(7,641	)		—			—			—
Treasury shares acquired	—			—		5,600			(48,961	)		—			—			—			—			(48,961	)
Net income	—			—		—			—			—			7,743,636			—			—			7,743,636
Balance, August 31, 2001 as restated	15,652,595			15,652		1,057,592			(767,029	)		11,020,000			20,356,854			—			—			30,625,477
Common stock sales	3,000			3		—			—			13,309			—			—			—			13,312
Stock issued on exercise of stock options	245,835			246		—			—			1,089,050			—			—			—			1,089,296
Stock options issued to non employees	—			—		—			—			385,426			—			—			—			385,426
Income tax benefit from exercise of employee stock options	—			—		—			—			245,334			—			—			—			245,334
Treasury shares acquired	—			—		86,000			(768,905	)		—			—			—			—			(768,905	)
Short-term sale by director	—			—		—			—			32,969			—			—			(28,469	)		4,500
Deferred compensation recognized for options granted	—			—		—			—			909,000			—			(909,000	)		—			—
Deferred compensation amortization	—			—		—			—			—			—			68,929			—			68,929
Net income	—			—		—			—			—			14,829,487			—			—			14,829,487
Balance, August 31, 2002 as restated	15,901,430			15,901		1,143,592			(1,535,934	)		13,695,088			35,186,341			(840,071	)		(28,469	)		46,492,856
Stock issued on exercise of stock options	263,336			263		—			—			1,168,291			—			—			—			1,168,554
Income tax benefit from exercise of employee stock options	—			—		—			—			189,639			—			—			—			189,639
Stock warrants issued to non employees	—			—		—			—			327,758			—			—			—			327,758
Sale of residence	—			—		25,639			(311,740	)		—			—			—			—			(311,740	)
Stock options issued to non employees	—			—		—			—			262,330			—			—			—			262,330
Treasury shares acquired	—			—		261,500			(3,965,610	)		—			—			—			—			(3,965,610	)
Collections from director	—			—		—			—			—			—			—			28,469			28,469
Stock dividend	129,577			130		14,368			—			1,878,737			(1,878,867	)		—			—			—
Preferred Stock Redemption	—			—		—			—			—			(473,511	)		—			—			(473,511	)
Amortization of deferred compensation	—			—		—			—			—			—			181,000			—			181,000
Net income	—			—		—			—			—			20,887,323			—			—			20,887,323
Balance, August 31, 2003	16,294,343		$	16,294		1,445,099		$	(5,813,284	)	$	17,521,843		$	53,721,286		$	(659,071	)	$	—		$	64,787,068

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

54

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Consolidated Statements of Cash Flows

	Years ended August 31
	2003			2002			2001
Cash flows from operating activities
Net income	$	20,887,323		$	14,829,487		$	7,743,636
Adjustments to reconcile net income to net cash provided by operating activities:
Extraordinary gain, net of tax		(81,317	)		—			—
Cumulative effect of a change in accounting principle, net of tax		(988,717	)		—			—
Depreciation and amortization		2,167,999			1,169,746			813,143
Gain on sale of residential property		(145,623	)		—			—
Provision for uncollectible accounts		512,885			250,712			58,259
Deferred income taxes		1,324,656			(2,978,645	)		(1,078,000	)
Minority interests		3,306,882			2,203,418			2,476,750
Expense related to stock options issued to non employees		262,330			385,426			3,686,510
Stock issued for compensation		—			—			173,042
Expense related to issuance of stock warrants		327,758			—			—
Deferred stock compensation amortization		181,000			68,929			—
Changes in operating assets and liabilities:
Restricted cash		(2,000,000	)		—			—
Accounts receivable		(11,109,721	)		(5,089,837	)		(10,352,299	)
Inventories		(840,076	)		(382,480	)		(139,279	)
Prepaid expenses		(570,805	)		(112,459	)		(109,993	)
Income taxes receivable		(2,640,115	)		622,810			(2,413,181	)
Other assets		3,685			(542,788	)		(66,334	)
Accounts payable		1,999,798			661,296			(327,283	)
Accrued liabilities		2,666,621			826,863			43,898
Income taxes payable		406,355			(130,911	)		2,234,495
Net cash provided by operating activities		15,670,918			11,781,567			2,743,364
Cash flows from investing activities
Purchase of property and equipment		(17,282,168	)		(3,595,806	)		(1,163,472	)
Accrued liabilities related to purchase of property and equipment		1,002,517			—			—
Acquisition of Garland properties, net of assumed liabilities		(5,607,406	)		—			—
Acquisition of Vista Diagnostic Clinic		(471,102	)		—			—
Acquisition of Baton Rouge Facility		—			(3,373,126	)		—
Acquisitions of Surgi+Group and Piney Point		—			—			(1,008,333	)
Net cash used in investing activities		(22,358,159	)		(6,968,932	)		(2,171,805	)

55

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Consolidated Statements of Cash Flows (continued)

	Years ended August 31
	2003			2002			2001
Cash flows from financing activities
Principal payments on long-term debt	$	(39,075	)	$	(708,697	)	$	(537,715	)
Payments on capital leases		(13,821	)		—			—
Proceeds from note payable		6,413,312			—			600,000
Proceeds from exercise of stock options		1,168,554			1,102,609			1,070,208
Proceeds from short-term sale by director		28,469			4,500			—
Acquisition of treasury shares		(3,965,610	)		(768,905	)		(48,961	)
Preferred stock redemption		(473,511	)		—			—
Contributions from minority interest holders		946,000			—			—
Distributions to minority interest holders		(2,827,000	)		(1,300,000	)		(875,000	)
Purchase of minority interests		(250,000	)		(590,000	)		(50,000	)
Net cash provided by (used in) financing activities		987,318			(2,260,493	)		158,532
Net (decrease) increase in cash and cash equivalents		(5,699,923	)		2,552,142			730,091
Cash and cash equivalents at beginning of year		7,583,756			5,031,614			4,301,523
Cash and cash equivalents at end of year	$	1,883,833		$	7,583,756		$	5,031,614
Supplemental cash flow disclosures
Cash paid during year for:
Interest	$	48,562		$	27,539		$	74,724
Income taxes	$	13,804,485		$	12,218,229		$	6,057,347
Non cash investing and financing activities:
Decrease in minority interest from acquisition	$	—		$	(710,437	)	$	—
Increase in negative goodwill due to minority interest acquisition		—			710,437			—
Paid in capital from short-term sale		—			32,969			—
Accounts receivable from director		—			(32,969	)		—
Paid in capital from deferred compensation		—			909,000			—
Non cash increase in deferred compensation		—			(909,000	)		—
Sale of property for treasury stock		311,740			—			—
Treasury stock received for property		(311,740	)		—			—
Paid in capital from stock dividend		1,878,737			—			—
Common stock increase for stock dividend		130			—			7,641
Decrease in retained earnings for stock dividend		(1,878,867	)		—			(7,641	)
Capital lease issued for fixed assets		572,212			—			—
Assets acquired for capital leases		(572,212	)		—			—
Reduction in minority interest		—			—			(617,218	)
Stock issued for acquisition of Surgi+Group		—			—			380,000
Stock issued for acquisition of Piney Point		—			—			141,667
Stock issued for purchase of minority interests		—			—			95,551
	$	—		$	—		$	—

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

56

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements

August 31, 2003

1. Significant Accounting Policies

Business and Organization

Dynacq Healthcare, Inc. is a holding company which through its subsidiaries develops and manages general acute hospitals that provide specialized general surgeries, such as neurospine, bariatric and orthopedic surgeries. For fiscal year 2003, the surgical hospital and outpatient surgical centers are the predominant revenue generating segments. Hereinafter, the “Company” will refer to Dynacq Healthcare, Inc., its wholly or majority owned subsidiaries, unless the context dictates or requires otherwise.

The Company was incorporated under the laws of the State of Utah in September 1983, reincorporated in Colorado in 1987, and reincorporated in Nevada in 1989. The Company was reincorporated in Delaware and its corporate name was changed from Dynacq International, Inc. to Dynacq Healthcare, Inc. in November 2003 to better reflect the Company’s business. In connection with the reincorporation in Delaware, the number of authorized common shares was reduced to 100,000,000.

In May 1998, Doctors Practice Management, Inc. (DPMI), a wholly owned subsidiary of the Company, organized Vista Community Medical Center, L.L.C., a Texas limited liability company, for the purpose of operating a hospital (the “Pasadena Facility”). In June 2003, the Pasadena Facility was converted to a limited liability partnership. As of August 31, 2003 and 2002, the Company through its subsidiaries has a 91.5% and 90% ownership interest in the Pasadena Facility, respectively.

During March 2001, DPMI organized Vista Surgical Center West, L.L.C., a Texas limited liability company, for the purpose of acquiring and operating Piney Point Surgery Center (the “West Houston Facility”). The West Houston Facility is a fully operational ambulatory surgical center in Houston, Texas.

In October 2001, a wholly owned subsidiary of the Company organized Vista Hospital of Baton Rouge, L.L.C. for the purpose of acquiring and operating a surgical hospital in Baton Rouge, Louisiana (the “Baton Rouge Facility”). As of August 31, 2003, the Company has a 97% membership interest in the Baton Rouge Facility.

In July 2003, the Company through its subsidiaries, organized Vista Hospital of Dallas, LP for the purposes of acquiring and operating a surgical hospital in Garland, Texas, (the “Garland Facility”), and has 100% partnership interest in it as of August 31, 2003.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly and majority owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States for annual financial information and with the instructions to Form 10-K and Article 3 and 3-A of Regulation S-X. The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as general and administrative by the Company would include the corporate office costs, including advertising and marketing expenses, which were approximately $12.6 million, $9.9 million and $6.7 million for the fiscal years 2003, 2002 and 2001, respectively.

The Company operates in one line of business and its strategy is to develop and manage general acute care hospitals that provide specialized general surgeries. The Company manages these hospitals on an individual basis. The hospitals’ economic characteristics, nature of their operations, regulatory environment in which they operate and the way in which they are managed are all similar. Accordingly, the Company aggregates its hospitals into a

57

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

single reportable segment as that term is defined by SFAS No. 131 “Disclosures About Segments of an Enterprise and Related Information.” The Company operates one remaining ambulatory surgical center in its West Houston Facility.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant of the Company’s estimates is the determination of revenue to recognize for the services the Company provides and the determination of the contractual allowance. See “Revenue Recognition” below for further discussion. Actual results could differ materially from those estimates used in preparation of these financial statements.

Cash and Cash Equivalents

The Company considers all highly liquid investments with maturities of three months or less on the date of purchase, to be cash equivalents. Cash equivalents are carried at cost, which approximates fair value.

Inventories

Inventories, consisting primarily of medical supplies, are stated at the lower of cost or market, with cost determined by use of the average cost method.

Property and Equipment

Property and equipment are stated at cost. Maintenance and repairs are charged to expense as incurred. Expenditures, which extend the physical or economic life of the assets, are capitalized and depreciated.

Depreciation is computed using the straight-line method over the estimated useful lives of the assets ranging from five to 39 years. The Company has classified its assets into three categories. The categories are listed below, along with the useful life and the weighted average useful life for each category. Interest capitalized in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 34, “Capitalization of Interest Cost” was $84,668 in the fiscal year ended August 31, 2003.

	Useful Life	Weighted Average Useful Life
Land	N/A	N/A
Buildings and improvements	39 years	39 years
Equipment, furniture and fixtures	5-7 years	5.2 years

The Company also leases equipment under capital leases. Such assets are amortized on a straight-line basis over the lesser of the term of the lease or the remaining useful life of the assets.

Impairment of Long-lived Assets

The Company routinely evaluates the carrying value of its long-lived assets. The Company would record an impairment loss when events or circumstances indicate that a long-lived asset’s carrying value may not be recovered. These events may include changes in the manner in which we intend to use an asset or decisions to sell an asset. To date, the Company has not recognized any impairment charges.

58

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

Revenue Recognition

Background

The Company’s revenue recognition policy is significant because net patient service revenue is a primary component of its results of operations. Revenue is recognized as services are delivered. The determination of the amount of revenue to be recognized in connection with the Company’s services is subject to significant judgments and estimates, which are discussed below.

Revenue Recognition Policy

The Company is normally not a party to any managed care contracts. The Company records revenue pursuant to the following policy. The Company has established billing rates for its medical services which it bills as gross revenue as services are delivered. Gross billed revenues are then reduced by the Company’s estimate of the discount (contractual allowance) to arrive at net patient service revenues. Net patient service revenues represents the Company’s estimate of the amounts ultimately expected to be collected for the services it has delivered.

The table below sets forth the percentage of our gross patient service revenue by financial class for the fiscal years 2003 and 2002:

	2003		2002
Workers’ Compensation	52	%	61	%
Commercial	37	%	32	%
Medicare	4	%	4	%
Medicaid	1	%	—	%
Self-Pay	1	%	1	%
Other	5	%	2	%

Contractual Allowance

The Company computes its contractual allowance based on the ratio of the Company’s historical cash collections during the trailing twelve months on a case by case basis to gross billed revenue on a case by case basis by operating facility. This ratio of cash collections to billed services is then applied to the gross billed services by operating facility. The following table shows gross revenues and contractual allowances for fiscal years 2003, 2002 and 2001:

	August 31,
	2003			2002			2001
Gross billed charges	$	164,343,892		$	113,760,963		$	74,097,035
Contractual allowance		74,367,153			48,877,728			30,293,416
Net revenue	$	89,976,739		$	64,883,235		$	43,803,619
Contractual allowance percentage		45	%		43	%		41	%

Accounts Receivable

Accounts receivable represent net receivables for services provided by the Company. The estimated accounts receivable not expected to be collected within twelve months of the balance sheet date have been shown as long-term receivables and represent receivables in the Medical Dispute Resolution (“MDR”) and legal third party financial class. The contractual allowance is provided as revenue is recognized. At each balance sheet date management reviews the accounts receivables for collectability. If after the review management believes certain receivables would be uncollectible, the receivable would be written down to the expected collectable amount. Management has not written down any receivables during the three years ended August 31, 2003 as a result of the collectability test. The following table shows accounts receivable, the contractual allowance, the allowance for

59

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

uncollectible accounts, net receivables and the contractual allowance as a percent of receivables as August 31, 2003 and 2002:

	2003			2002
Current portion of gross receivables	$	67,483,780		$	46,544,023
Current portion of contractual allowance		(49,602,756	)		(32,958,185	)
Current portion of allowance for uncollectible accounts		(483,278	)		(248,200	)
Net current portion of accounts receivable	$	17,397,746		$	13,337,638
Contractual allowance and allowance for uncollectible accounts as a percentage of current gross receivables		74	%		71	%
Long term portion of gross receivables	$	66,064,559		$	36,624,610
Long term portion of contractual allowance		(48,559,583	)		(25,934,171	)
Long term portion of allowance for uncollectible accounts		(473,114	)		(195,305	)
Net long term portion of accounts receivable	$	17,031,862		$	10,495,134
Contractual allowance and allowance for uncollectible accounts as a percentage of long term gross receivables		74	%		71	%

The contractual allowance stated as a percentage of gross receivables at the balance sheet dates is larger than the contractual allowance percentage used to reduce gross billed charges due to the application of cash collections to the outstanding gross receivable balances without any adjustment being made to the contractual allowance. The contractual allowance amounts netted against gross receivables are not adjusted until such time as the final collections on the receivables is recognized.

Collections for services provided are generally settled or written off as uncollectible against the contractual allowance within six months of the date of service except for services provided to injured workers in Texas. Collections for services provided to injured workers in Texas may take up to three years or longer to be completely adjudicated. Because the Company has in recent years focused on providing services to injured workers in Texas, accounts receivable in the workers compensation and MDR financial classes have increased.

The MDR process is an established reimbursement resolution process available to providers of healthcare services under the regulations guiding reimbursement for services provided to injured workers in the State of Texas. Accounts generally do not become subject to the MDR process prior to being outstanding for at least 90 days subsequent to patient discharge. For medical services provided to injured workers’ in the state of Texas, the MDR process is specifically based upon the administrative and statutory regulations promulgated by the Texas Labor Code and Texas Administrative Code provisions.

Due to a number of factors outside the Company’s control, including a change in the Company’s reimbursement collection experience associated with potential changes in the reimbursement environment in which the Company operates, it is possible that management’s estimates of patient service revenues could change, which could have a material impact on the Company’s revenue and profitability in the future.

Allowance for Uncollectible Accounts

The Company has estimated uncollectible accounts expense as 1% of gross outpatient revenue. Through August 31, 2003, the Company has made no charge offs against the allowance for uncollectible accounts, as historically all charge offs have been against the contractual allowance.

Stock Based Compensation

The Company accounts for stock-based compensation to employees using the intrinsic value method prescribed in APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. Compensation cost, if any is measured as the excess of the fair value of the Company’s stock at the date of grant

60

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

over the amount an employee must pay to acquire the stock. Statement of Financial Accounting Standards (“SFAS”) 123, Accounting for Stock-Based Compensation, amended by SFAS 148, Accounting for Stock-Based Compensation - Transition and Disclosure, established accounting and disclosure requirements using a fair value based method of accounting for stock-based employee compensation; however, it allows an entity to continue to measure compensation for those plans using the intrinsic value method of accounting prescribed by APB Opinion No. 25. The Company has elected to continue to measure compensation under the APB Opinion No. 25, and has adopted the disclosure requirements of SFAS No. 123 and SFAS No. 148.

If the fair value of the stock options granted to employees during a fiscal year had been recognized as compensation expense on a straight-line basis over the vesting period of the grants, stock-based compensation costs would have impacted our net income and earnings per common share for the fiscal years ended August 31 as follows:

	2003			2002			2001
Net income as reported	$	20,887,323		$	14,829,487		$	7,743,636
Add: stock-based compensation costs included in reported net income, net of taxes		117,650			44,804			—
Deduct: stock based compensation costs, net of taxes under SFAS 123		(284,073	)		(95,921	)		(1,213,566	)
Pro forma net income	$	20,720,900		$	14,778,370		$	6,530,070
Per share information:
Basic, as reported	$	1.40		$	1.01		$	0.55
Basic, pro forma	$	1.39		$	1.00		$	0.46
Diluted, as reported	$	1.34		$	.96		$	0.51
Diluted, pro forma	$	1.33		$	95		$	0.43

The fair value of the stock-based awards was estimated using the Black-Scholes model with the following weighted average assumptions for fiscal years ended August 31:

	Options
	2003			2002			2001
Estimated fair value	$	5.59		$	12.34		$	1.80
Expected life (years)		4.53			4.29			3.00
Risk free interest rate		4.25	%		4.00	%		6.00	%
Volatility		40	%		143	%		52	%
Dividend yield		—	%		—	%		—	%

Goodwill and Negative Goodwill

The Company adopted the provisions of SFAS 141, Business Combinations and SFAS 142, Goodwill and Other Intangible Assets effective September 1, 2002. Upon adoption, the Company discontinued amortization of goodwill and conducted a review for impairment. The Company eliminated negative goodwill as a cumulative effect of a change in accounting principle. SFAS 142 requires that impairment tests are performed at least annually. The impairment tests done upon adoption of the standard and at the end of the fiscal year indicated no impairment of goodwill. Amortization of goodwill in the amount of $51,813 and $27,208 was recorded for the years ended 2002 and 2001, respectively. Amortization of negative goodwill in the amount of $126,470 and $78,411 was recorded for the years ended 2002 and 2001, respectively.

The changes in the carrying amount of goodwill as of August 31, 2003, are as follows:

	Goodwill		Negative Goodwill
Balance at August 31, 2002	$	582,547	$	(1,550,910	)
Write-off of negative goodwill		—		1,550,910
Balance at August 31, 2003	$	582,547	$	—

61

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

The following table presents income before extraordinary gain and cumulative effect of a change in accounting principle, and earnings per common share for the years ended August 31, 2002 and 2001, as if goodwill had not been amortized during those periods, compared with those amounts reported for the year ended August 31, 2003:

	Years ended August 31,
	2003		2002			2001
Income before extraordinary gain and cumulative effect of a change in accounting principle	$	19,817,289	$	14,829,487		$	7,743,636
Add back: Goodwill amortization		—		51,813			27,208
Less: Tax effect of goodwill amortization		—		(18,135	)		(9,523	)
Adjusted income before extraordinary gain and cumulative effect of a change in accounting principle	$	19,817,289	$	14,863,165		$	7,761,321
Basic earnings per share:
Income before extraordinary gain and cumulative effect of a change in accounting principle	$	1.33	$	1.01		$	0.55
Add back: Goodwill amortization		—		—			—
Less: Tax effect of goodwill amortization		—		—			—
Adjusted income before extraordinary gain and cumulative effect of a change in accounting principle	$	1.33	$	1.01		$	0.55
Diluted earnings per share:
Income before extraordinary gain and cumulative effect of a change in accounting principle	$	1.27	$	0.96		$	0.51
Add back: Goodwill amortization		—		—			—
Less: Tax effect of goodwill amortization		—		—			—
Adjusted income before extraordinary gain and cumulative effect of a change in accounting principle	$	1.27	$	0.96		$	0.51

Advertising Costs

Advertising and marketing costs in the amounts of $6,110,000, $5,188,000 and $4,614,000 for the years ending August 31, 2003, 2002 and 2001 respectively were expensed as incurred.

Income Taxes

The Company uses the liability method in accounting for income taxes. Under this method, deferred tax liabilities or assets are determined based on differences between the income tax basis and the financial reporting basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

Minority Interests

The equity of minority investors (minority investors are generally physician groups and other healthcare providers that perform surgeries at the Company’s facilities) in certain subsidiaries of the Company is reported on the consolidated balance sheets as minority interests. Minority interests reported in the consolidated income statements reflect the respective interests in the income or loss of the limited partnerships or limited liability companies attributable to the minority investors (equity interests ranged from 2.14% to 8.5% at August 31, 2003). During 2002, the Company purchased minority interests from certain minority interest holders at an amount that was $710,437 less than the net book value of the minority interest liability on the date of purchase. The $710,437 was recorded as negative goodwill on the date of acquisition and was being amortized to income over a period of 14 years in accordance with the treatment of the excess of fair market value received over cost as promulgated by Accounting Principles Board Opinion 16. This accounting treatment changed on September 1, 2002 when the Company adopted SFAS 141. During 2003, the Company purchased minority interest from certain minority interest

62

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

holders at an amount that was $130,998 less than the net book value of the minority interest liability on the date of purchase. The $130,998 less applicable income taxes of $49,681 has been recorded as an extraordinary gain during 2003. The partnership agreement provided a means for the minority interest holders to be cashed out at the net book value. The amounts paid the minority interest holders was less than the buy out amount that was called for in the partnership agreements. Legal counsel has advised the Company that the acquisitions were negotiated transactions occurring outside the partnership agreement.

The following table sets forth the activity in the minority interest liability account for the fiscal years ending August 31, 2003 and 2002:

Balance August 31, 2001	$	(1,920,769	)
Earnings allocated to minority interest holders		(2,203,418	)
Distributions to minority interest holders		1,300,000
Acquisition of Vista Surgical Center West minority interest		406,438
Acquisition of 20% of Vista Community Medical Center Hospital minority interest		893,999
Balance August 31, 2002		(1,523,750	)
Earnings allocated to minority interest holders		(3,306,882	)
Acquisition of 1.5% of Vista Community Medical Center Hospital minority interest		380,998
Distribution to minority interest holders		2,827,000
Capital contributions received from new partners		(946,000	)
Balance August 31, 2003	$	(2,568,634	)

Net Income Per Share

Basic net income per share has been computed using the weighted average number of common shares outstanding during the period. Diluted net income per share has been calculated to give effect to the dilutive effect of common stock equivalents consisting of stock options and warrants. The weighted average number of basic and diluted shares outstanding for earnings per share calculations has been changed from the number of shares as shown in previously issued financial statements for fiscal year ending 2002 and 2001. The following table presents the outstanding shares as previously reported and the restated amounts:

	2002	2001
Basic weighted average shares outstanding as previously reported	14,759,404	14,614,692
Basic weighted average shares outstanding as restated	14,686,236	13,997,861
Diluted weighted average shares outstanding as previously reported	15,047,829	14,673,775
Diluted weighted average shares outstanding as restated	15,490,068	15,092,433

Recent Accounting Pronouncements

In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34. FIN 45 clarifies the requirements of SFAS 5, Accounting for Contingencies, relating to the guarantor’s accounting for, and disclosure

63

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

of, the issuance of certain types of guarantees. The disclosure provisions of FIN 45 are effective for financial statements of periods that end after December 15, 2002. However, the provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002. The Company has adopted the disclosure requirements of FIN 45.

In December 2002, the FASB issued SFAS 148, Accounting for Stock-Based Compensation—Transition and Disclosure. SFAS 148 amends SFAS 123 to provide alternative methods of transition to the SFAS 123 fair value method of accounting for stock-based employee compensation. In addition, SFAS 148 requires disclosure of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. As permitted under SFAS 148, the Company adopted the disclosure only provisions of that accounting standard in the third quarter of fiscal year 2003.

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. A variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights, or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate, or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after December 15, 2003. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. As of August 31, 2003, the Company does not have any entities that require disclosure or consolidation as a result of adopting the provisions of FIN 46.

In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). It is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this Statement is not expected to have a significant impact on our financial statements.

64

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

2. Restatements

During the course of the audit of the fiscal year ending August 31, 2003 financial statements, errors were discovered in the previously issued financial statements. The following table sets forth the capital section as reported and reflects the adjustments to the previously reported amounts:

	Common Stock Shares		Common Stock Amount					Treasury Stock Shares		Treasury Stock Amount					Additional Paid-in Capital					Retained Earnings					Receivable From Director			Deferred Compensation
Balance as reported August 31, 2000	7,658,856		$	7,659				794,392		$	(1,141,546	)			$	4,309,813				$	11,392,583				$	—		$	—
Cancellation of treasury shares	(306,868	)		(307	)	(a	)	(306,868	)		423,478		(a	)		(423,171	)	(a	)		—					—			—
Addition of treasury shares held by a subsidiary	—			—				35,672			—		(b	)		—					—					—			—
Fair value of stock options issued to non employees	—			—				—			—					1,478,080		(c	)		(1,478,080	)	(c	)		—			—
Over statement of tax liabilities as of August 31, 2000	—			—				—			—					—					2,706,356		(d	)		—			—
Balance as restated August 31, 2000	7,351,988		$	7,352				523,196		$	(718,068	)			$	5,364,722				$	12,620,859				$	—		$	—
Balance as reported August 31, 2001	16,266,331		$	16,266				1,599,984		$	(1,190,507	)			$	6,690,042				$	22,445,443				$	—		$	(416,061	)
Cumulative effect of changes prior to August 31, 2001	(306,868	)		(307	)			(271,196	)		423,478					1,054,910					1,228,276					—			—
Fair value of stock options issued to non employees	—			—				—			—					3,686,510		(e	)		(3,686,510	)	(e	)		—			—
Elimination of deferred compensation	—			—				—			—					(520,400	)	(f	)		104,339		(f	)		—			416,061		(f	)
Change in income tax provision	—			—				—			—					—					265,000		(g	)		—			—
Income tax benefit of stock options	—			—				—			—					108,938		(h	)		—					—			—
Change in stock split in 2000	(306,868	)		(307	)	(i	)	(271,196	)		—		(l	)		—					306		(i	)		—			—
Balance as restated August 31, 2001	15,652,595		$	15,652				1,057,592		$	(767,029	)			$	11,020,000				$	20,356,854				$	—		$	—
Balance as reported August 31, 2002	16,515,166		$	16,515				1,685,984		$	(1,959,412	)			$	9,778,701				$	37,884,622				$	—		$	(1,152,053	)
Cumulative effect of changes prior to August 31, 2001	(613,736	)		(614	)			(542,392	)		423,478					4,329,958					(2,088,589	)				—			416,062
Fair value of stock options issued to non employees	—			—				—			—					385,426		(j	)		—					—			—
Change in income tax benefit associated with stock options issued to employees	—			—				—			—					(827,466	)	(k	)		—					—			—
Short-term sale gains by director	—			—				—			—					28,469		(l	)		—					(28,469	)(l)		—
Decrease in deferred compensation amortization	—			—				—			—					—					—					—			(104,080	)	(m	)
Changes in net income:
Increase in compensation	—			—				—			—					—					(158,453	)	(n	)		—			—
Increase in other operating expenses	—			—				—			—					—					(714,116	)	(o	)		—			—
Decrease in depreciation and amortization expense	—			—				—			—					—					43,827		(p	)		—			—
Decrease in provision for income taxes	—			—				—			—					—					389,081		(q	)		—			—
Increase in minority interest expense	—			—				—			—					—					(170,031	)	(r	)		—			—
Balance as restated August 31, 2002	15,901,430		$	15,901				1,143,592		$	(1,535,934	)			$	13,695,088				$	35,186,341				$	(28,469	)	$	(840,071	)

65

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

(a) The Company was showing as issued 306,868 shares of common stock outstanding that the transfer agent did not show as outstanding. In addition the Company was showing 306,868 treasury shares which could not be accounted for. This adjusts the number of shares the Company has issued and outstanding and the number of shares the Company holds as treasury shares. This correction had no effect on the shares shown as issued and outstanding for purposes of earnings per share calculations.

(b) One of the Company’s subsidiaries has held shares of the Company’s common stock for a number of years. This adjusts the number of treasury shares held by the Company. The cost of these shares had been included in the cost of treasury shares.

(c) The Company had recorded no compensation cost associated with stock options granted to non employees prior to September 1, 2000. This adjustment represents the fair value of stock options granted to non employees for all years prior to September 1, 2000. The fair value of the options was estimated using the Black Scholes option pricing model with the following weighted average assumptions: estimated fair value $3.12; expected life 0.84 years; risk free interest rate 4.25%; volatility 87%.

(d) This represents the overstatement of tax liabilities as of August 31, 2000.

(e) Represents the fair value of stock options granted to non employees during the year ended August 31, 2001. The Company had recorded deferred compensation expense of $520,400 applicable to 108,000 stock options granted to 13 non employees which was valued on the grant date and was being amortized over a period of 5 years. Upon reexamination the measurement date for those options should have been the vesting date, which was 6 months after the grant date. The correct expense calculated on the vesting date for this 108,000 shares was $1,798,200. There were another 84,000 additional options granted to non employees which should have been expensed. The value of these 84,000 options were $1,398,600. The fair value of the 192,000 options has been estimated using the Black Scholes option pricing model with the following weighted average assumptions: estimated fair value $16.65; expected life six months; risk free interest rate 4.25% volatility 72.8%. An expense charge of $489,710 has been recognized as the intrinsic value of 37,392 shares issued below market value or as gift shares.

(f) Represents the elimination of deferred compensation expense recorded by the Company for non employees which had been accounted for as if the options were granted to employees. The compensation expenses associated with these options is now included in (c) above.

(g) The provision for income taxes was changed due to the expensing of stock options for the year ended August 31, 2001, related income tax benefits of those options and other items.

(h) Represents the revised income tax benefit of certain income tax deductions related to employee stock options which are not charged against operations.

(i) Represents an adjustment to the amount of the stock dividend recorded because of the effective cancellation of treasury shares before the stock split.

(j) Represents the fair value of stock options issued to non employees during the year ended August 31, 2002.

(k) Represents the change in the income tax benefit related to stock option expense taken in the tax return which is not charged against operations.

(l) Represents a receivable for gains made by a director on the short-term sale of shares of the Company’s common stock during the year ending August 31, 2002 for which payments were not received by the Company until the year ending August 31, 2003.

66

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

(m) Represents the elimination of the amortization of deferred compensation associated with non employees which had been recorded as applicable to employees.

(n) Represents the expensing of the fair value of 54,000 stock options issued to non employees and other net credit adjustments to compensation of $122,884. The Company had recorded the amortization of deferred compensation associated with stock options granted to non employees in the amount of $104,080. The $104,080 was based on incorrect assumptions as to the measurement date and the vesting period. Upon reexamination, the expense associated with these 54,000 options was $356,985. The fair value of the options was estimated using the Black Scholes option pricing model with the following weighted average assumptions: estimated fair value $14.08; expected life 1.52 years; risk free interest rate 4.25%; volatility 130%. An expense charge of $28,440 was recorded for the sale of stock at below the fair market value on the date of sale.

(o) Represents increases to other operating expenses consisting primarily of the write off of organization costs and other capitalized assets of $213,000, the recording of expenses found in the search for unrecorded liabilities of $364,000, the recording of estimated tax penalties of $58,000, a net reduction in prepaid expenses of $41,000, a reduction of the accrual for property taxes of $(68,000) and other changes of $106,000.

(p) Represents a change in depreciation expense caused by the aggregating of various depreciable costs.

(q) Represents a decrease in the income tax provision as previously reported.

(r) Represents an increase in minority interest expense due to a change in the profits of the Pasadena facility.

(s) The sum of these changes reflect the adjustments set forth in (o) above plus reclassification and elimination adjustments which have no effect on net income.

67

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

The following sets forth the Statements of Operations for the years ended August 31, 2002 and 2001 as previously reported and applicable restatement adjustments for those years:

	Year Ended August 31, 2002									Year Ended August 31, 2001
	As Reported			Restatement Adjustments			As Restated			As Reported			Restatement Adjustments			As Restated
Net patient service revenue	$	64,883,235		$	—		$	64,883,235		$	43,803,619		$	—		$	43,803,619
Costs and expenses:
Compensation and benefits		9,191,317			158,453	(n)		9,349,770			5,954,061			(104,338	)(f)		5,849,723
Medical services and supplies		15,332,788						15,332,788			9,299,835						9,299,835
Other operating expenses		11,646,317			1,006,138	(s)		12,652,455			9,692,649			3,686,510	(e)		13,379,159
Provision for uncollectible accounts		350,018			(99,306	)(s)		250,712			58,259						58,259
Depreciation and amortization		1,213,573			(43,827	)(p)		1,169,746			813,143						813,143
Total costs and expenses		37,734,013			1,021,458			38,755,471			25,817,947			3,582,172			29,400,119
Income from operations		27,149,222			(1,021,458	)		26,127,764			17,985,672			(3,582,172	)		14,403,500
Other income (expense):
Rent and other income		231,756			192,716	(s)		424,472			352,114						352,114
Interest income		163,584						163,584			299,901						299,901
Interest expense		(27,537	)					(27,537	)		(60,129	)					(60,129	)
Total other income, net		367,803			192,716			560,519			591,886						591,886
Income before income tax and minority interests		27,517,025			(828,742	)		26,688,283			18,577,558			(3,582,172	)		14,995,386
Provision for income taxes		10,044,459			389,081	(q)		9,655,378			5,040,000			265,000	(g)		4,775,000
Minority interest in earnings		2,033,387			(170,031	)(r)		2,203,418			2,476,750						2,476,750
Net income	$	15,439,179		$	(609,692	)	$	14,829,487		$	11,060,808		$	(3,317,172	)	$	7,743,636
Basic earnings per common share	$	1.05		$	(0.04	)	$	1.01		$	0.76		$	(0.21	)	$	0.55
Diluted earnings per common share	$	1.03		$	(0.07	)	$	0.96		$	0.75		$	(0.24	)	$	0.51
Weighted average common shares—basic		14,759,404			(73,168	)		14,686,236			14,614,692			(616,831	)		13,997,861
Weighted average common shares—diluted		15,047,829			442,239			15,490,068			14,673,775			418,658			15,092,433

68

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

3. Acquisitions

The Garland Facility

In August 2003 the Company acquired the assets of a 113-bed hospital (which is now licensed for 79 beds), a medical office building and 22.7 acres of land in the Dallas-Fort Worth area for cash of approximately $5.6 million. The Company has since completed renovations at that facility, named Vista Hospital of Dallas (the “Garland Facility”), with six surgical suites, and started performing surgical procedures in late November 2003.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

Current assets	$	416,000
Property, plant and equipment		8,044,000
Total assets acquired		8,460,000
Current liabilities assumed		2,183,000
Debt assumed		670,000
Net assets acquired	$	5,607,000

Vista Diagnostic Center

During the year ended August 31, 2003, the Company acquired assets valued at approximately $471,000 from Vista Diagnostic Center (“VDC”), an unrelated company which provided laboratory and radiology services to the Pasadena Facility. The Pasadena Facility did not acquire any interest in VDC, nor did VDC ever have an interest in the Pasadena Facility. The assets included primarily medical and diagnostic equipment as well as furniture and fixtures. The consideration paid for this purchase was equal to the estimated fair value of the assets at the purchase date. In connection with the asset acquisition, the Company also assumed three operating leases related to medical equipment with required minimum lease payments of $466,000 in 2003, $438,000 in 2004, $89,000 in 2005 and $59,000 in 2006. The Company has begun using the newly acquired assets to provide laboratory and radiology services at the Pasadena Facility and has discontinued using the services of VDC.

Baton Rouge Facility

During 2002, the Company acquired the land and building located in Baton Rouge, Louisiana known as Charis Hospital for $3,373,126 in cash. In January 2003, this facility was reopened as the Baton Rouge Facility, as a 35-bed hospital and four operating rooms.

69

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

4. Property and Equipment

At August 31, property and equipment consisted of the following:

	2003			2002
Land	$	8,608,309		$	507,113
Buildings and improvements		20,266,452			8,482,622
Equipment, furniture and fixtures		16,195,660			7,156,190
		45,070,421			16,145,925
Less accumulated depreciation and amortization		(7,249,485	)		(5,173,001	)
Construction in progress		181,463			5,304,243
Net property and equipment	$	38,002,399		$	16,277,167

For the years ended August 31, 2003, 2002, and 2001, depreciation expense was $2,161,166, $1,190,344, and $853,770, respectively.

5. Asset held for sale

The Company entered into a letter of intent with a Nevada Limited Liability Company of which a former Executive officer of the Company is a member to sell land located in Slidell, Louisiana at August 31, 2003. The Company decided not to develop this hospital in Louisiana because it did not fit its current business plan. The carrying value of the land of $2,315,204 is shown as “Asset held for sale” on the statement of financial position. On January 23, 2004, the transaction was closed and the Company recognized a gain of $185,000 upon closing.

6. Notes payable

At August 31, long-term debt consisted of the following:

	2003		2002
Note payable to a former shareholder, payable in monthly installments of $10,007, including interest at 11.5%, through December 2002, uncollateralized	$	—	$	39,075
Note payable to former owners of the Garland facility, due August 14, 2004 together with interest at the rate of a major banks prime plus 1 %		670,000		—
Revolving line of credit with a financial institution payable at variable monthly installments, including variable interest of 2.3% plus the “Dealer Commercial Paper” rate, due on demand or July 2011, collateralized by substantially all of the Company’s assets. The effective interest rate at August 31, 2003 was 3.32%.		6,413,312		—
	$	7,083,312	$	39,075

The Company has a revolving line of credit with a financial institution. The amount available and drawn under the line of credit at August 31, 2003 is approximately $6.4 million which was used to finance its acquisition of the Garland Facility. The interest rate on the line of credit is a variable rate of 2.3% plus the “Dealer Commercial Paper” rate. The effective interest rate at August 31, 2003 was 3.32%. The balance owed under the line of credit as of June 18, 2004 was approximately $6,002,214.

The Company is in default under the terms of the line of credit, as the Company has not timely filed this annual report on Form 10-K and have not yet filed its quarterly reports on Form 10-Q for the fiscal quarters ended November 30, 2003, February 29, 2004 and May 31, 2004. On April 16, 2004, the financial institution submitted to the Company a notice of default. Since the Company did not cure the default within 10 days, the Company is now in default under the line of credit. To this date, the financial institution has not taken any further action. The Company’s indebtedness under its line of credit is secured by substantially all of its assets. If the Company is

70

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

unable to repay all outstanding balances, the financial institution could proceed against the Company’s assets to satisfy its obligations under the line of credit.

7. Income Taxes

The provision for income tax expense consisted of the following:

	Year Ended August 31
	2003		2002			2001
Current tax expense:
Federal	$	10,262,114	$	11,142,485		$	5,315,000
State		1,299,565		1,491,538			538,000
Total current		11,561,679		12,634,023			5,853,000
Deferred tax expense (benefit):
Federal		1,167,273		(2,653,852	)		(926,000	)
State		157,383		(324,793	)		(152,000	)
Total deferred		1,324,656		(2,978,645	)		(1,078,000	)
Total income tax expense	$	12,886,335	$	9,655,378		$	4,775,000

As of August 31, 2003, 2002 and 2001, income tax benefits of $189,639 and $245,334 and $108,938, respectively, resulting from deductions relating to nonqualified stock option exercises and disqualifying dispositions of certain employee incentive stock options were recorded as increases in stockholders’ equity.

The components of the provision for deferred income taxes, at August 31 were as follows:

	2003			2002			2001
Applicable to:
Differences between revenues and expenses recognized for federal income tax and financial reporting purposes	$	448,327		$	(3,326,701	)	$	(435,303	)
Stock options		127,834			683,376			(673,472	)
Allowance for uncollectible accounts		(194,512	)		(95,083	)		(22,095	)
Employee deferred compensation		(94,785	)
Difference in method of computing depreciation for tax and financial reporting purposes		880,510			189,883			139,632
Other		157,282			(430,120	)		(86,762	)
	$	1,324,656		$	(2,978,645	)	$	(1,078,000	)

Significant components of the Company’s deferred tax liabilities and assets were as follows at August 31, 2003:

	Current			Noncurrent
Deferred tax liabilities:
Depreciation	$	—		$	(1,285,346	)
Negative goodwill		—			(416,324	)
Deferred tax assets:
Stock options		298,020			—
Revenue and expense differences		374,036			—
Allowance for uncollectible accounts		362,712			—
Other		(95,113	)		255,400
Minority interest		—			694,997
Net deferred tax asset (liability)	$	939,665		$	(751,273	)

71

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

Significant components of the Company’s deferred tax liabilities and assets were as follows at August 31, 2002:

	Current			Noncurrent
Deferred tax liabilities:
Basis in property and equipment	$	—		$	(404,837	)
Deferred tax assets:
Stock options		425,854			—
Allowance for uncollectible accounts		168,200
Revenue and expense differences		922,363			323,068
Minority interest					462,708
Other		(139,895	)		367,450
Net deferred tax asset	$	1,376,522		$	748,389

The following table reconciles the federal statutory income tax rate and the Company’s effective income tax rate:

	2003		2002		2001
Provision for income taxes at federal statutory rate	35.0	%	35.0	%	35.0	%
State tax provision, net of federal benefits	2.2		3.6		3.2
Minority interest in income of partnership	(5.7	)	(5.3	)	(10.6	)
Other differences	4.3		2.9		4.2
Effective tax rate	35.8	%	36.2	%	31.8	%

The Company has restated its income tax provisions for the fiscal years ended August 31, 2002 and 2001. Those restatements were necessary to give income tax effect to the restatement adjustments for each year and to adjust approximately $2,700,000 over accrual of the income tax liabilities arising prior to August 31, 2000.

8. Related Party Transactions

The Company leased a residential house to its Chief Executive Officer (CEO), Mr. Chiu M. Chan at a monthly rate of $1,400 per month through April 2003. In April 2003, the Company consummated the sale of a house to Chiu M. Chan. The house was sold to Mr. Chan in exchange for the transfer of his right to receive 25,639 shares of Dynacq common stock held by Mr. Chan. The contract, which was signed on April 10, 2003, valued the property at $311,740, which was 10% more than the 2002 appraised value of $283,400. The shares of common stock were valued at 90% of the closing price of Dynacq common stock on April 10, 2003. In addition, the Company paid the 2003 property taxes. A gain on the sale of the house in the amount of $145,623 was recorded in 2003.

The Company had previously leased 1,000 square feet of office space for its executive offices on a month-to-month basis for $1,286 per month. As of September 1, 2003, the Company increased its leased space to approximately 7,250 square feet and entered into an 8-year lease for this office space. The Company will pay $1,286 per month for the first year of the lease and $6,525 per month for the remainder of the lease term. The lessor of the office space is Capital Bank, of which Mr. Earl Votaw, one of the Company’s directors, is a director. Management believes that the lease rate being paid is consistent with comparable commercial rates available in the area.

Since May 2002, when Dr. Ping Chu became a director, he has paid the Company $26,870 and $17,631 during fiscal years ended August 31, 2003 and 2002, respectively for rent and management fees. As of August 31, 2003 and 2002, the Company had accounts receivable from Dr. Chu of $22,277 and $99,476, respectively. Included in the accounts receivable balance were amounts applicable to Dr. Chu’s staffs’ payroll for which he reimburses the Company in the ordinary course of business.

72

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

In January 2004, the Company completed a sale of land (“Asset held for sale” in 2003) located in Slidell, Louisiana to HealthGroup Partners, L.L.C. for $2.5 million. An investor in HealthGroup Partners, L.L.C. was previously an executive officer of the Company.

9. Stockholders’ Equity and Stock Option Plans

Preferred Stock

In January 1992, the board of directors approved an amendment to the Company’s articles of incorporation to authorize 5,000,000 shares of undesignated preferred stock, for which the board of directors is authorized to fix the designation, powers, preferences and rights. There are no shares of preferred stock issued or outstanding as of August 31, 2003.

In February 2003, the Board of Directors designated 200,000 of the undesignated preferred stock as “Series A Preferred Stock” and declared a stock dividend equal to one share of Series A Preferred Stock for every full block of 100 shares of common stock. The Series A Preferred Stock could either be redeemed for cash at $14.50 per share or if not redeemed by June 10, 2003, would be automatically converted into one share of the Company’s common stock. As a result of this action the Company redeemed 32,656 shares for cash in the amount of $473,511 (which has been shown in the accompanying statement of stockholders’ equity as a preferred stock redemption) and issued 129,577 shares of common stock in conversion of the unredeemed Series A Preferred Stock.

Treasury Stock

Pursuant to the Company’s announced 500,000 common stock buy-back program in January 2002, the Company bought back 261,500 and 86,000 shares of its common stock in fiscal year 2003 and 2002, respectively at an average cost of $13.62 for a total purchase of $4,734,515. The Company acquired 103,176 shares of its common stock as treasury shares during December 2003 for $1,611,165 in cash.

Stock Option Plans

The Company’s 1995 Non-qualified Plan and the 2000 Incentive Plan (the “Plans”) provide for options and other stock-based awards that may be granted to eligible employees, officers, consultants, and non-employee directors of the Company or its subsidiaries. The Company had reserved 6,000,000 shares of common stock for future issuance under the Plans. As of August 31, 2003, there remains 3,797,146 shares which can be issued under the Plans, after giving effect to stock splits and shares issued under the Plans. All awards previously granted to employees under the Plans have been stock options, primarily intended to qualify as “incentive stock options” within the meaning of Section 422 of the Internal Revenue Code (the “Code”). The Plans also permit stock awards, stock appreciation rights, performance units, and other stock-based awards, all of which may or may not be subject to the achievement of one or more performance objectives.

The purposes of the Plans generally are to retain and attract persons of training, experience, and ability to serve as employees of the Company and its subsidiaries and to serve as non employee directors of the Company, to encourage the sense of proprietorship of such persons and to stimulate the active interest of such persons in the development and financial success of the Company and its subsidiaries.

The Plans are administered by the Compensation Committee of the board of directors (the “Committee”). The Committee has the power to determine which eligible employees will receive awards, the timing and manner of the grant of such awards, the exercise price of stock options (which may not be less than market value on the date of grant), the number of shares, and all of the terms of the awards. The Company may at any time amend or terminate the Plans. However, no amendment that would impair the rights of any participant, with respect to outstanding grants, can be made without the participant’s prior consent. Stockholder approval of an amendment to the Plans is necessary only when required by applicable law or stock exchange rules.

73

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

The following summarizes stock option activity and related information:

	Years ended August 31
	2003				2002				2001
	Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
	(Share Amounts In Thousands)
Outstanding—beginning of year:	1,104		$	4.69	1,469		$	3.78	827		$	1.13
Granted	422			14.67	174			6.07	1,229			4.44
Exercised	(263	)		4.44	(246	)		4.44	(551	)		1.43
Canceled	(62	)		4.96	(293	)		1.15	(36	)		1.26
Outstanding—end of year	1,201		$	8.25	1,104		$	4.69	1,469		$	3.78
Exercisable—end of year	687		$	4.65	956		$	4.48	1,469		$	3.78

The following summarizes information related to stock options outstanding at August 31, 2003:

	Options Outstanding				Options Exercisable
Range of Exercise Prices	Shares	Weighted Average Remaining Contractual Life (Years)	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
	(Share Amounts In Thousands)
$ 4.44	625	2.3	$	4.44	625	$	4.44
$ 6.07	154	4.2		6.07	52		6.07
$10.73	51	4.2		10.73	10		10.73
$12.25	171	4.7		12.25	—		—
$17.75	200	5.4		17.75	—		—
Total	1,201	3.7	$	8.25	687	$	4.65

On April 15, 2002 the Company granted an employee an option that was in the money on the date of grant. The difference in the market value and the grant price on the grant date was $909,000 which has been recorded as deferred compensation expense in the capital section and is being amortized to expense over the vesting period of 5 years. Amortization expense of $181,000 and $68,929 has been recorded as compensation expense in the years 2003 and 2002, respectively.

During the three fiscal years ended August 31, 2003, the Company granted stock options to non-employees. The fair value of such stock options (calculated using the Black Scholes model) has been charged to expense with a corresponding credit to additional paid-in capital. The Company recorded expense associated with stock options issued to non employees of $262,330, $385,426 and $3,686,510 during the three year period ended August 31, 2003. During October 2002, the Company issued warrants to acquire 61,149 shares of the Company’s common stock at a price of $10.95 per share. The warrants vested immediately and were exercisable through October 2005. The value of the warrants using the Black Scholes pricing model was calculated to be $327,758 which has been charged to expense and credited to additional paid-in capital. The warrants were subsequently returned to the Company, however, since they vested immediately no reversal of the compensation expense has been recorded.

During the period September 1, 2003 through June 18, 2004, the Company issued 105,500 shares of its common stock upon the exercise of stock options for cash consideration of $500,806.

74

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

10. Employee Benefit Plan

The Company sponsors a 401(k) defined contribution plan covering substantially all employees of the Company and provides for voluntary contributions by these employees, subject to certain limits. The plan was effective June 1, 2001. The Company makes discretionary contributions to the plan. The Company’s contributions for fiscal years 2003 and 2002 were $54,874 and $43,940, respectively.

11. Net Income Per Share

The numerator used in the calculations of both basic and diluted net income per share for all periods presented was net income. The denominator for each period presented was determined as follows:

	Years ended August 31
	2003	2002	2001
Denominator:
Basic net income per share—weighted average shares outstanding	14,849,504	14,686,236	13,997,861
Effect of dilutive securities:
Common stock options—treasury stock method	714,713	803,832	1,094,572
Diluted net income per share—weighted average shares outstanding	15,564,217	15,490,068	15,092,433

12. Accrued Liabilities

Accrued liabilities at August 31 are as follows:

	2003		2002
Accruals for Garland Facility	$	2,283,285	$	—
Payroll and related taxes		907,159		545,766
Baton Rouge Facility lawsuit settlement		775,000		—
Property taxes		513,445		239,164
Settlement of shareholder derivative lawsuit		500,000		—
Accruals for equipment		127,233		—
Accrued interest		37,997		—
Franchise taxes payable		20,000		—
Year-end accruals of expenses and other		2,239,731		767,345
Total accrued liabilities	$	7,403,850	$	1,552,275

13. Commitments and Contingencies

Leases

As of August 31, 2003, the following assets are under capital lease obligations and included in property and equipment for medical:

Medical equipment	$	620,111
Less accumulated amortization		(41,341	)
	$	578,770

Amortization expense for assets recorded under capital leases is included in depreciation expense.

75

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

Future minimum payments, by year and in the aggregate, required under capital lease obligations and noncancellable operating leases for certain facilities and equipment consist of the following at August 31, 2003:

Year ending August 31	Capital Lease			Operating Leases
2004	$	161,484		$	1,899,325
2005		161,484			1,532,719
2006		161,484			1,479,726
2007		147,562			1,190,916
2008		—			354,848
Thereafter		—			260,457
		632,014		$	6,717,991
Less imputed interest included in minimum lease payments		(73,622	)
Present value of minimum lease payments		558,392
Less current portion		(129,805	)
	$	428,587

Total rent and lease expenses paid by the Company, for the fiscal years 2003, 2002, and 2001, was approximately $1,394,396, $963,000, and $244,000, respectively.

Commitments for future additions to medical equipment were approximately $1,206,000 at August 31, 2003, which was guaranteed by the Company on behalf of its subsidiary in the normal course of business. In terms of the guarantee issued, if the Company’s subsidiary does not meet its commitment of purchasing the medical equipment and making the related payments, the Company will be liable to purchase the medical equipment for the same amount.

The Company, through its subsidiary, also has agreements with outside organizations that offer marketing, pre-authorization and follow up support services to prospective bariatric and orthopedic patients in areas serviced by the Pasadena, Garland and Baton Rouge Facilities. These facilities receive bariatric and orthopedic referrals from these and other sources and the organizations refers clients to other area hospitals. Payments made under these agreements for the fiscal years 2003, 2002 and 2001 were $6,002,000, $4,802,000 and $4,433,000, respectively. Future minimum payments under these agreements for the following fiscal years are: 2004, $4,525,000; 2005, $4,500,000; and 2006, $937,000.

The Company has contracts with Doctors to manage various areas of the Company’s hospitals and other service agreements. Payments made under these agreements for the fiscal years ending August 31, 2003, 2002 and 2001 were $1,776,000, $741,000 and $495,000, respectively. Future minimum payments under the terms of these contracts and agreements for the following fiscal years are 2004, $2,044,000, 2005, $1,629,000, 2006, $920,000 and thereafter $555,000.

Risks and Uncertainties

The Company maintains various insurance policies that cover each of its facilities. Specifically, the Company maintains medical malpractice insurance coverage in Texas. The Company has claims-made malpractice coverage and has purchased tail coverage effective through August 12, 2004. The Company in Louisiana is a member of the Louisiana Patient Compensation Fund and purchases insurance through the Louisiana Patient Compensation Fund for medical malpractice. In addition, all physicians granted privileges at the Company’s facilities are required to maintain medical malpractice insurance coverage. The Company also maintains general liability and property insurance coverage for each facility and flood coverage for the Baton Rouge Facility. The Company also maintains workers’ compensation coverage for the Baton Rouge Facility, but does not currently maintain worker’s compensation coverage in Texas. In regard to the Employee Health Insurance Plan, the Company is self insured with specific and aggregate re-insurance with stop loss levels appropriate for the company’s group size. Coverages are maintained in amounts management deems adequate.

76

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

In January 2002, the Company, two of its officers, and the spouse of one of the officers were named as defendants in a shareholder class action lawsuit in the United States District Court for the Southern District of Texas alleging violations of federal securities laws and regulations. The putative class covered those persons who purchased the Company shares between November 29, 1999 and January 16, 2002. The various complaints that were consolidated claimed that the Company violated Sections 10(b) and 20(a) and Rule 10b-5 under the Exchange Act by making materially false or misleading statements or omissions regarding revenues and receivables and regarding whether our operations complied with various federal regulations. The district court consolidated these actions and appointed a lead plaintiff in the matter. The lead plaintiff filed a consolidated amended complaint on September 6, 2002. The Company and its officers moved to dismiss the complaint on February 25, 2003. On August 26, 2003, the Court granted the Motion to Dismiss and denied Plaintiffs leave to amend further. The Plaintiffs thereafter filed a notice of appeal. In May 2004, the Plaintiffs dismissed their appeal, thereby concluding the case.

A separate shareholder derivative action was also brought in federal court, but was stayed pending resolution of the shareholder class action described above. The Plaintiff in the derivative case did not make a demand on the Company or its Board of Directors prior to filing suit. It remained stayed pending the plaintiff’s appeal of the dismissal of the shareholder class action. Given the Plaintiff’s dismissal of the appeal in the shareholder class action, the Company has moved to dismiss the derivative action. This derivative matter, if it were to proceed, would not seek to recover any damages from the Company, but could expose the Company to bearing some unknown legal or indemnity costs which we cannot predict at this time.

In March 2002, the Company accepted service of a shareholder derivative action filed on or about February 26, 2002 in the 295th District Court of Harris County, Texas brought on behalf of the Company against its officers and directors, outside auditor, investment bank, and two analysts affiliated with that investment bank. The suit alleges breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence and breach of contract. Plaintiff makes general allegations of the defendants’ alleged misconduct in “(i) causing or allowing the Company to conduct its business in an unsafe, imprudent and unlawful manner; (ii) failing to implement and maintain an adequate internal control system; and (iii) exposing Dynacq to enormous losses,” including allegations that various press releases and/or public statements issued between January 1999 and January 2002 were misleading. Plaintiffs further allege sales by the Company’s insiders while in possession of material non-public information. The plaintiffs made no demand on either the Company or its Board of Directors prior to filing suit. The Company’s Board of Directors appointed a Special Litigation Committee to conduct an investigation and make a determination as to how the Company should proceed on the claims asserted in the state court shareholder derivative case. On February 24, 2003, the Special Litigation Committee adopted a resolution directing the Company’s counsel to seek dismissal or settlement of the state court derivative action. A Stipulation of Settlement was executed by both parties and filed with the Court on September 11, 2003. The final Settlement, which was approved by the Court on November 10, 2003, provided, among other things, that (1) the claims were dismissed with prejudice and (2) defendants agreed to pay the legal fees and expenses of plaintiffs (shareholders), which the Court set at $500,000. The Company had accrued for this settlement at August 31, 2003. The Company made the payment and the matter is now concluded.

Eight lawsuits were filed in the United States District Court for the Southern District of Texas (Houston Division) between December 24, 2003 and January 26, 2004, alleging federal securities law causes of action against the Company and various current and former officers and directors. The cases were filed as class actions brought on behalf of persons who purchased shares of Company’s common stock in the open market generally during the period of January 14, 2003 through December 18, 2003. Under the procedures of the Private Securities Litigation Reform Act, certain plaintiffs have filed motions asking to consolidate these actions and be designated as lead plaintiff. The district court consolidated the actions and appointed a lead plaintiff in the matter. An amended complaint was filed on June 30, 2004 asserting a class period of November 27, 2002 – December 19, 2003 and naming additional defendants, including Ernst & Young LLP. The amended complaint seeks certification as a class action and alleges that the defendants violated Sections 10(b), 20(a), 20(A) and Rule 10b-5 under the Exchange Act, by publishing materially misleading financial statements which did not comply with generally accepted accounting principles, making materially false or misleading statements or omissions regarding revenues and receivables, operations and

77

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

financial results and engaging in an intentional fraudulent scheme aimed at inflating the value of Dynacq’s stock. The Company intends to vigorously defend the allegations and will file a motion to dismiss all or some of the claims. The Company cannot predict the ultimate outcome of the lawsuit or whether the lawsuit will have a material adverse effect on the Company’s financial condition.

The Company is named as a defendant in the lawsuit Leo Borrell v. Dynacq International, Inc., NeWeigh, Inc., and Diane Crumley, Vital Weight Control, Inc., d/b/a NeWeigh, and Vista Community Medical Center, L.L.C. (Cause No. 2002-13659) filed in the 281st Judicial District Court of Harris County, Texas. Dr. Borrell is seeking recovery of commissions he alleges are owed pursuant to an oral agreement with the Company. Dr. Borrell has yet to determine the damages that he is seeking. After a significant amount of discovery has been conducted, we believe this case to be without merit, and intend to continue to vigorously defend this matter.

Late in fiscal year 2003, a dispute arose between one of the Company’s subsidiaries and Jane Capital, LLC and Sunbelt Medical Corp. related to the purchase of medical equipment for the Company’s Baton Rouge Facility. Because Jane Capital and Sunbelt each demanded identical full payment for the equipment without providing necessary supporting documents, the Company’s subsidiary filed suit in Harris County, Texas to require Jane Capital, LLC and Sunbelt Medical Corp. to produce the documents, to determine the proper amount owed for the equipment and to whom such amounts were owed and to reimburse the Company for selling it certain defective products. The lawsuit was settled in May 2004. As a result of the settlement, the amount paid by the Company was approximately $1 million less than the amounts claimed by the defendants.

In the first quarter of fiscal 2004, a contractor who operated the pharmacy at the Baton Rouge Facility filed suit against the Company, the CEO, and the Baton Rouge Facility in Louisiana alleging that it was owed additional fees in excess of $1,000,000 for costs of goods and services. The Plaintiff has asserted claims for breach of contract, fraud, negligence, fraudulent misrepresentation, negligent misrepresentation, civil conspiracy and gross negligence. The Company believes the Defendant’s claims are without merit and intends to continue to vigorously dispute the allegations. However, we cannot predict the ultimate outcome of the lawsuit or whether the lawsuit will have a material adverse effect on the Company’s financial condition.

In December 2002, the Pasadena Facility was notified by the CMS that it had allegedly violated EMTALA requirements. The Texas Department of Health (“TDH”) conducted an investigation and reported to the CMS that appropriate corrective actions had been taken. As a result of TDH’s findings, the CMS notified the facility in January 2003 that its eligibility for Medicare participation remained in effect, but, as required by §1867(d) of the Social Security Act, the matter would be forwarded to the Quality Improvement Organization (“QIO”) to review the case and report its findings to the OIG for a possible assessment of a civil monetary penalty. The facility met with the QIO on October 3, 2003. As of this date, there has been no report issued by the QIO or any response received from the OIG. The Company does not anticipate that it will incur any material liability that would have an adverse effect on the Company’s operations, cash flows, or financial condition as a result of this proceeding.

On December 18, 2003, we received a notice of an informal investigation from the Fort Worth, Texas District Office of the Securities and Exchange Commission requesting our voluntary assistance in providing information regarding reporting of our financial statements, recognition of costs and revenue, accounts receivable, allowances for doubtful accounts and our internal controls. We have been cooperating fully with the continuing informal SEC investigation.

By letter dated December 9, 2003, the Office of the Attorney General of Texas (“AG’s Office”) requested documentation concerning incidents at Vista Medical Center in Pasadena, Texas, which resulted in death between December 2001 and December 2003. By letter dated January 20, 2004, the AG’s office broadened that inquiry to include all Vista facilities, all incidents resulting in death, and during a broader time period from January 1, 1999 through January 20, 2004. No specific focus or subject of the inquiry was identified and we have received no further correspondence from the AG’s office explaining this request. In February 2004, the Company was notified by the AG’s office that it is the subject of an investigation of possible violations of the statutes governing the solicitation of patients. Based on the documents requested by the AG’s office and communications with Company

78

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

representatives, the Company believes that such investigation stems from the same allegations that have been asserted in the private lawsuit with Dr. Borrell described above. The Company has denied the allegations in that lawsuit and continues to vigorously defend the suit. The Company is cooperating with the AG’s Office on each of these matters, but believes the complaints received by the AG’s office to be without merit.

From time to time, the Company is involved in litigation and administrative proceedings that are incidental to its business. The Company cannot predict whether any litigation to which it is currently a party will have a material adverse effect on the Company’s results of operations, cash flows, or financial condition.

14. Concentrations of Credit Risk and Fair Value of Financial Instruments

The Company has financial instruments that are exposed to concentrations of credit risk and consist primarily of cash investments and trade accounts receivable. The Company routinely maintains cash and temporary cash investments at certain financial institutions in amounts substantially in excess of FDIC and Securities Investor Protection Corporation (“SIPC”) insurance limits; however, management believes that these financial institutions are of high quality and the risk of loss is minimal. At August 31, 2003, the Company had cash balances in excess of the FDIC and SIPC limits of $5,035,724.

As is customary in the healthcare business, the Company has accounts receivable from various third party payers. The Company does not request collateral from its customers and continually monitors its exposure for credit losses and maintains allowances for anticipated losses. Receivables from third party payers are normally in excess of 90% of the total receivables at any point in time. The mix of gross receivables from self-pay patients and third-party payers at August 31, 2003 and 2002 is as follows:

	2003		2002
Workers’ compensation	14	%	21	%
Workers’ compensation subject to Medical Dispute Resolution process	55	%	49	%
Commercial	16	%	15	%
Medicare	4	%	4	%
Medicaid	1	%	—	%
Self-pay	1	%	1	%
Other	9	%	10	%
	100	%	100	%

We had no major third party payers (customers) representing greater than 10% of the Company’s revenue or receivables for the years ended August 31, 2003 and 2002.

The carrying amounts of cash and cash equivalents, current receivables, accounts payable and accrued liabilities approximate fair value due to the short-term nature of these instruments. The carrying amounts of the Company’s short-term borrowings, at August 31, 2003 and 2002, approximate their fair value.

79

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

15. Quarterly Financial Data (unaudited)

	Three months ended
	November 30		February 28		May 31		August 31
Year ended August 31, 2003
Revenues	$	17,933,926	$	21,127,507	$	25,606,146	$	25,309,160
Income from operations(1)		7,480,286		7,933,921		11,119,271		8,933,841	(2)
Income before extraordinary gain and cumulative effect of a change in accounting principle(1)		4,173,100		4,122,741		6,396,834		5,124,614
Net income(1)		5,161,817		4,122,741		6,396,834		5,205,931
Basic net income per common share before extraordinary gain and cumulative effect of a change in accounting principle		0.28		0.28		0.43		0.34
Diluted net income per common share before extraordinary gain and cumulative effect of a change in accounting principle(1)		0.27		0.26		0.41		0.33
Year ended August 31, 2002
Revenues	$	13,854,531	$	15,036,293	$	19,621,751	$	16,370,660
Income from operations(3)		6,101,089		6,310,222		7,475,993		6,800,979
Net income		3,377,615		3,542,027		4,127,165		3,782,680
Basic net income per share(4)		0.23		0.24		0.28		0.26
Diluted net income per share(4)		0.22		0.23		0.27		0.24

⁽¹⁾ Income from operations, income before extraordinary gain and cumulative effect of a change in accounting principle and net income have been restated to reflect audit adjustments for depreciation expense and income taxes for the first three quarters of fiscal year 2003.

⁽²⁾ The decrease in the fourth quarter income from operations as compared to the third quarter is the result of the accrual of $500,000 for the settlement of the shareholder derivative action and the accrual of other legal fees and expenses associated with the Company defending this and other lawsuits.

⁽³⁾ In connection with the reaudit of the August 31, 2002 fiscal year, the quarterly income from operations has been restated to reflect the reclassification of franchise taxes as income taxes for all quarters. All of the year end audit adjustments have been reflected in the fourth quarter.

⁽⁴⁾ Basic net income per share and diluted income per share have been restated to reflect the audit adjustments and the restated number of shares outstanding.

Cash flows during the quarters ended February 28, 2003 and May 31, 2003

Due to a classification error during the second and third fiscal quarters of 2003, the following amounts of accrued liabilities were included as “net cash provided by operating activities”. The accrued liabilities for purchase of property and equipment should have been classified as “net cash used in investing activities”, and for preferred stock redemption as “net cash used in financing activities”.

	Six months ended February 28, 2003		Nine months ended May 31, 2003
Accrued liabilities for purchase of property and equipment	$	4,370,727	$	2,494,593
Accrued liabilities for preferred stock redemption		—		433,927

Following is the summary of net cash changes due to operating, investing and financing activities with the above amounts reclassed properly:

	Six months ended February 28, 2003			Nine months ended May 31, 2003
Net cash provided by operating activities	$	7,496,459		$	11,106,866
Net cash used in investing activities		(10,734,391	)		(13,768,382	)
Net cash provided by (used in) financing activities		585,891			(780,646	)

There is no impact of these reclasses to fiscal year 2003, prior years or prior years’ quarters.

16. Subsequent events

Subsequent to August 31, 2003, the Company entered into an additional management support and marketing services agreement, a physicians assistance agreement and a consulting agreement which have future minimum payment requirements of $2,613,000 in 2004, $2,565,000 in 2005, $2,510,000 in 2006 and $300,000 in 2007.

The Company has been notified by the Office of the Attorney General of Texas (“AG’s office”) that it is the subject of an investigation of possible violations of the statutes governing the solicitation of patients. The Company believes that such investigation stems from the same allegations that have been asserted in a private lawsuit currently pending against the Company. The Company has denied the allegations in that lawsuit and continues to vigorously defend the suit. The Company had also previously received an inquiry from the AG’s office

80

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Notes to Consolidated Financial Statements (continued)

August 31, 2003

requesting documentation related to any instances of deaths occurring at the Company’s facilities between January 1, 1999 and January 29, 2004. The Company is cooperating with the AG’s office on each of these matters, but believes the complaints received by the AG’s office to be without merit. In the event charges are filed against the Company related to this investigation, the Company could be subject to significant sanctions and penalties, which could have a material adverse effect on the Company’s business and financial condition. Furthermore, the Company’s reputation could suffer and any damage to the Company’s reputation could cause the Company to lose existing patients and fail to attract new patients and qualified physicians, which would have a material adverse effect on the Company’s business and financial condition. While the Company has denied any wrongdoing and intends to vigorously defend itself, no assurance can be given as to the outcome of this matter or the effect on its business.

On December 18, 2003, the Company received a notice of an informal investigation from the Fort Worth, Texas District Office of the Securities and Exchange Commission requesting the Company’s voluntary assistance in providing information regarding reporting of the Company’s financial statements, recognition of costs and revenue, accounts receivable, allowances for doubtful accounts and the Company’s internal controls. The Company has been cooperating fully with the continuing informal SEC investigation. The Company cannot predict the outcome of this matter or the effect that it may have on it.

In April 2004, the Texas Workers Compensation Commission adopted a new Fee Guideline for Ambulatory Surgical Centers, which will become effective as of September 1, 2004. The new fee guideline only affects Ambulatory Surgical Centers and therefore only the West Houston Facility will be affected at this time.

Dr. Eric Scheffey, a physician who had accounted for approximately 21% of the Company’s gross patient revenues during each of the fiscal years 2003 and 2002, had his medical license suspended in August 2003 and has not provided medical services at the Company’s facilities since that time. In addition, several physicians, including four physicians who accounted for approximately 28% and 25% of the Company’s gross patient revenues during fiscal years 2003 and 2002 respectively, departed to pursue other interests or substantially reduced their cases at the Pasadena facility, during the fiscal year 2004. While the Company has added additional physicians in the fourth quarter of fiscal year 2004, the loss of these physicians resulted in a significant reduction in net patient revenues for the first three quarters of fiscal year 2004. While the Company believes that it will be able to continue to attract and retain additional physicians, the potential loss of physicians who provide significant net patient revenues for the Company will adversely affect its results of operations.

The Company’s common stock was delisted from the Nasdaq National Market as of the opening of business on Friday, April 16, 2004, because of the lateness of its filings of periodic reports with the Securities and Exchange Commission. While the Company’s common stock has continued to be quoted on the National Quotation Service Bureau (the “Pink Sheets”) for unsolicited trading, there is currently no regular public trading market for the Company’s common stock.

In January 2004, the Company put up a $640,000 earnest money deposit to acquire a land lease to build and develop a hospital to be constructed in Shanghai, China.

During September 2004, the Company amended an existing stock option accounted for under APB No. 25. As a result the Company will take a non-cash charge of $624,000 net of tax during the first quarter of 2004.

Subsequent to August 31, 2003, the Company acquired the remaining minority interests in the Pasadena and Baton Rouge facilities and then restructured the ownership of those facilities and the Garland facility such that the Company owns 93% of the Pasadena facility, 90% of the Baton Rouge facility and 92% of the Garland facility.

81

Dynacq Healthcare, Inc.

(formerly Dynacq International, Inc.)

Schedule II—Valuation and Qualifying Accounts

For the Years Ended August 31, 2003, 2002 and 2001

	Balance at Beginning of Period		Charged to Costs and Expenses		Charged to Other Accounts(1)		Deductions(2)			Balance at End of Period
2003
Contractual allowances	$	58,892,356	$	—	$	74,367,153	$	(35,097,170	)	$	98,162,339
Allowance for uncollectible accounts(3)		443,505		512,887		—		—			956,392
2002
Contractual allowances	$	50,177,205	$	—	$	48,877,728	$	(40,162,577	)	$	58,892,356
Allowance for uncollectible accounts(3)		192,793		250,712		—		—			443,505
2001
Contractual allowances	$	28,353,464	$	—	$	30,293,416	$	(8,469,675	)	$	50,177,205
Allowance for uncollectible accounts(3)		134,534		58,259		—		—			192,793

⁽¹⁾ The amounts charged to contractual allowance are 45%, 43% and 41% of gross billed charges for fiscal years 2003, 2002 and 2001, respectively.

⁽²⁾ Reflects adjustment to the contractual allowance upon receipt of cash and settlement of account receivable. When cash is received for a particular account receivable and the Company considers the cash payment to be the final settlement of the account balance, the gross receivable is eliminated and the contractual allowance is reduced by the difference of the gross receivable and the cash collected.

⁽³⁾ The Company currently estimates uncollectible accounts expense on a monthly basis as 1% of gross outpatient revenue. Through August 31, 2003, the Company has made no charge offs against the allowance for uncollectible accounts, as historically all charge offs have been against the contractual allowance.

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

On December 17, 2003, Ernst & Young LLP notified the Company that it resigned as the Company’s independent auditor effective immediately. On December 24, 2003, the Company filed a Form 8-K reporting Ernst & Young’s resignation as the Company’s independent auditor. On April 6, 2004, the Company filed a Form 8-K/A restating and supplementing the information provided in the Form 8-K dated December 24, 2003.

Ernst & Young was engaged as the Company’s independent auditor on May 31, 2002. Ernst & Young’s report on the financial statements for the fiscal year ended August 31, 2002 contained no adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles. See Note 2 to the consolidated financial statements for additional information regarding the financial statements for the fiscal year ended August 31, 2002. As of December 17, 2003, Ernst & Young had not completed its audit work with respect to the Company’s August 31, 2003 financial statements.

The Audit Committee of the Company’s Board of Directors was informed of, but did not recommend or approve, Ernst & Young’s resignation.

During the Company’s fiscal year ended August 31, 2002 and the subsequent interim periods preceding Ernst & Young’s resignation, there were no disagreements between the Company and Ernst & Young on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to Ernst & Young’s satisfaction, would have caused Ernst & Young to make reference to the subject matter of the disagreement in connection with their report.

On December 15, 2003, Ernst & Young orally communicated to certain officers of the Company Ernst & Young’s concerns relating to the Company’s disclosure controls, accounting controls and controls over safeguarding of assets. Ernst & Young’s concerns arose as a result of a transaction related to the sale of certain Company receivables to a foreign entity which is not a financial institution; the transaction did not appear to Ernst & Young to be in the ordinary course of the Company’s business.

On December 17, 2003, Ernst & Young orally informed the Company that the Company lacked the internal controls necessary to develop reliable financial statements. By letter dated December 23, 2003, Ernst & Young advised the Board of Directors of its conclusion that material weaknesses in internal control had come to its attention during the course of performing its audit of the Company’s financial statements for the year ended August 31, 2003, specifically noting (a) “inadequate communication lines and internal controls relating to the authorization, recognition, capture and review of transactions, facts, circumstances and events that may have a material impact on the Company’s financial reporting process and (b) a lack of supervision, review and quality control related to the accounting for income taxes, including the preparation of the federal income tax provision in accordance with SFAS No. 109, Accounting for Income Taxes.”

In connection with (a) above, Ernst & Young stated “Specifically in November 2003, the Company’s Chief Executive Officer negotiated a significant transaction to sell certain accounts receivable to another entity. This transaction was not disclosed to the Company’s Chief Financial Officer, the Company’s independent auditors nor the Company’s Board of Directors prior to its execution and represents significant deficiencies in the Company’s disclosure controls, accounting controls and controls over the safeguarding of its assets.”

Certain circumstances underlying the transaction in question were as follows: (i) funds in an amount equal to the proposed purchase price were deposited into the Company’s bank account on November 26, 2003, (ii) neither the Chief Financial Officer nor the Board of Directors of the Company had been advised of the transaction in advance, nor had the Board of Directors authorized the transaction in advance, (iii) the receipt of funds had not been recorded in the Company’s accounting records, (iv) Ernst & Young had initially been advised by outside counsel to the Company that the transaction had closed, and (v) on December 11, 2003, the Company’s Board of Directors, pending negotiation of acceptable companion agreements and subject to certain other conditions, authorized officers of the Company to execute and deliver Bills of Sale effective as of November 26, 2003, to effect the transaction.

As of December 15, 2003, open issues still existed between the Company and the proposed purchaser with respect to the procedure, responsibility, and compensation to the Company for collecting the subject receivables. The open issues were never resolved, and the proposed sale of receivables by the Company was never concluded. Negotiations with the proposed purchaser have terminated, and the funds were returned.

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The receivables involved in the proposed transaction had a face value of approximately $34 million, but, having remained outstanding in excess of eighteen months, had previously been written down to a book value of $1.7 million (which constituted approximately 2% of total assets as of August 31, 2003), with a proposed sale price of $3.4 million. If such sale had been concluded prior to the filing of this Form 10-K for the year ended August 31, 2003, the completed transaction would be reported as a subsequent event. During the fiscal year ended August 31, 2003 and thereafter to date, there were no other transactions or events similar to those involved in the proposed sale of receivables by the Company.

Neither the Company’s Board of Directors nor the Audit Committee of the Company’s Board of Directors has discussed with Ernst & Young its conclusions concerning the lack of internal controls. The Company has authorized Ernst & Young to respond fully to the inquiries of the successor accountant regarding Ernst & Young’s statement that the Company lacks the internal controls necessary to develop reliable financial statements.

The Company has previously provided Ernst & Young with a copy of the foregoing disclosures, and a copy of Ernst & Young’s letter regarding the change in certifying accountant was filed as Exhibit 16.1 to the Form 8-K/A.

On January 19, 2004, the Audit Committee of the Board of Directors engaged the registered public accounting firm of Killman, Murrell & Company, P.C. (“KMC”) as the Company’s new independent accountant for the fiscal year ended August 31, 2003. During the two most recent fiscal years ended August 31, 2002 and August 31, 2003 and the subsequent interim period prior to the Company’s engagement of KMC, the Company did not consult with KMC regarding the application of accounting principles to a specific transaction, either completed or proposed, the type of audit opinion that might be rendered on the Company’s consolidated financial statements, or the advice of the Company’s former independent accountant that the Company lacks internal controls necessary to develop reliable financial statements.

Item 9A. Controls and Procedures

We have restated and obtained a re-audit of our previously reported financial statements for the fiscal year ended August 31, 2002, restated our 2001 financial statements, and restated the selected financial information for fiscal years 1999 and 2000 because of accounting errors identified in those financial statements. (For a discussion of the individual restatement adjustments, see “Item 8. Financial Statements—Note 2. Restatements”). The restatements arose out of the review of our accounting records and accounting policies by our current outside auditors, which was initiated in response to issues raised by our former outside auditors. Please see “Change in Independent Auditors” above for a discussion of the issues raised by our former outside auditors.

In addition, the Audit Committee, with assistance from special legal counsel, conducted its own independent investigation. With respect to the material weaknesses identified by Ernst & Young, the independent investigation conducted by the special counsel to the Audit Committee concluded that no lack of internal controls existed with respect to inadequate communication lines and lack of internal controls with respect to authorization and review of transactions. Furthermore, the board of directors of the Company has adopted a policy that requires that any transaction in excess of $250,000 requires prior board approval. With respect to lack of supervision, review and quality control related to income tax reporting identified by Ernst & Young, the Company has engaged its current independent auditors to prepare the Company’s income tax returns for the fiscal year ended August 31, 2003. The restated financial statements reflect audit adjustments with respect to income taxes. See Note 2 to the consolidated financial statements.

Further, our current independent auditors have orally advised the audit committee on July 19, 2004 that they have identified what they consider to be material weaknesses in our internal controls as set forth under “—Changes in Internal Controls” below.

(a) Evaluation of Disclosure Controls and Procedures

Our management carried out an evaluation, with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of August 31, 2003, the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, including consideration of the matters described in subsection (b) below, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of August 31,

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2003. KMC’s audit of the two fiscal years ended August 31, 2003 was conducted as a substantive audit without reliance on the Company’s internal controls. Similarly, KMC expects to conduct a substantive audit for fiscal year 2004, pending the Company’s progress in establishing internal controls. The Company has taken the following initial steps to address the issues identified as material weaknesses and to enhance the effectiveness of its internal controls:

• Appointment of James G. Gerace, a certified public accountant, to the Board of Directors, to serve as the chair of the Audit Committee, with the Board having made the determination that Mr. Gerace meets the standards of an “audit committee financial expert” as set forth in the rules promulgated by the Securities and Exchange Commission;

• appointed a general counsel who communicates directly with the Audit Committee and with the Board of Directors; and

• established an internal audit department, recently engaged an interim internal auditor and compliance officer and is searching for a head of internal audit.

The Company is in the process of adopting more rigorous policies and procedures with respect to its disclosure and financial reporting review process and we have recently engaged an outside consulting firm as an internal audit and compliance advisor to assist the company in implementing effective compliance structures, including the company’s Sarbanes-Oxley compliance program. The Company is committed to fully instituting enhanced disclosure controls and procedures that are designed to ensure that the information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of “disclosure controls and procedures” in Rule 13a-14(c).

(b) Changes in Internal Controls

In connection with the audit of our financial statements for fiscal year ended August 31, 2003 and the re-audit of our financial statements for the fiscal year ended August 31, 2002, our current outside auditors have identified and brought to the attention of the audit committee what they consider to be material weaknesses in our internal controls relating to:

• the non-compliance by various departments in submitting information in accordance with procedures to ensure proper and timely recording of accounts payable;

• family relationships among certain of our officers and employees; and

• the failure to properly utilize the inventory software to track and report our inventory quantities on a real time basis;

• the failure to properly account for stock options issued to non-employees; and

• lack of supervision, review and quality control related to the accounting for income taxes.

Based on discussions with our outside auditors and the Audit Committee of our Board of Directors, we worked to identify the nature, scope and materiality of the issues identified as material weaknesses in our internal controls and their impact on our fiscal year 2003 financial statements and to determine the extent to which these issues might adversely affect our disclosure controls and procedures. Based on further detailed review of our internal controls as they relate to inventory and accounts payable during the fourth quarter of fiscal 2003, we determined that that the accounts payable process had failed to record certain liabilities on a timely basis and the inventory management system had failed to track inventory on a continuous basis. We quantified this internal control weakness relating to accounts payable recordation by reconciling our liabilities to our subsequent payments. We quantified the inventory process control weakness by taking complete physical inventories at the end of each quarter and reconciling the physical counts to our records.

The Company believes such deficiencies were attributable to the following factors: the available software generally used in hospitals of our size is ineffective to properly track accounts payable and inventory and limited human resources in the Company’s accounting and financial reporting function with which we responded to the

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Company’s rapid growth in business operations during the course of fiscal year 2003.

We have implemented the following changes to our internal controls:

• Beginning the first quarter of fiscal 2004 we switched to a more effective and reliable software system for consolidating financial information;

• We have implemented a new software to more efficiently and timely calculate fixed assets both for book and tax purposes;

• Our accounts payable data are now being entered into the system immediately;

• We have implemented more efficient and timely procedures for monthly closings;

• We have engaged our current outside auditors to prepare our income tax returns; and

• Our board of directors has adopted a policy that prohibits any issuance of stock options to non-employees other than non-employee directors.

Correcting the identified material weaknesses and addressing the other issues identified by our independent auditors, responding to the findings of the internal review and the independent investigation and continuously strengthening our internal controls and financial reporting capabilities are our highest priorities.

In light of these issues identified as material weaknesses and the requirements enacted by the Sarbanes-Oxley Act of 2002 and the related rules and regulations adopted by the SEC, our Chief Executive Officer and Chief Financial Officer concluded that, as of August 31, 2003, there were material weaknesses and deficiencies in our internal controls. Despite those material weaknesses and deficiencies in our internal controls as of such date, management believes that there are no material inaccuracies, or omissions of material facts necessary to make the statements included in this report not misleading in light of the circumstances under which they are made.

In addition to identifying the internal control weaknesses relating to inventory and the accounts payable process, our outside auditors tested our other internal controls to determine whether there were other such material weaknesses aside from the inventory and accounts payable weaknesses mentioned above that affected our financial statements for the fiscal year ended August 31, 2003. This evaluation included substantial efforts to restate our 2002 and 2001 financial statements and to restate selected financial information for 2000 and 1999 and an effort to identify the internal controls over financial reporting that could or should have prevented or mitigated the error. These efforts and the audit of the restated 2002 financial statements were designed to provide reasonable assurance that we have recorded all material adjustments. In particular, our outside auditors tested our other internal controls by reviewing processes, analytical reviews and substantive testing and by reviewing disbursement activity subsequent to fiscal year-end 2003. Based on these tests, our auditors have advised us that they did not identify any other material weaknesses in internal controls.

Our Audit Committee and senior management are committed to a sound internal control environment. We have committed considerable resources to date on the aforementioned reviews and remedies. We are continuing our thorough review of our internal and disclosure controls including, but not limited to, information technology systems and financial reporting as part of the Company’s compliance with Section 404 of the Sarbanes-Oxley Act of 2002, but at this time we have not completed our review of the existing controls and their effectiveness and, therefore, cannot assure you that these controls and procedures will fully satisfy the requirements of Section 404.

Other than the changes described above, there were no changes in the Company’s internal control over financial reporting during the Company’s fiscal year ended August 31, 2003 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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PART III

Item 10. Directors and Executive Officers of the Registrant

The Board of Directors currently consists of six members. Pursuant to our Bylaws, the members of the Board of Directors serve for one-year terms.

Directors

Chiu M. Chan, age 51, has served as a director and as our president, secretary, and chief executive officer since July 1992. Mr. Chan is a registered pharmacist and during the period from May 1978 to July 1992 was employed by various healthcare service organizations in Houston, Texas. Mr. Chan earned a Bachelor of Science degree in Pharmacy from the University of Houston. Chiu M. Chan is not related to Philip S. Chan. Since January 2004, Mr. Chan has also been serving as our acting chief operating officer.

Philip S. Chan, age 53, has served as a director and as our vice president of finance, chief financial officer, and treasurer since July 1992. Mr. Chan earned advanced accounting degrees from the University of Houston and is a CPA in the State of Texas. Prior to his employment with Dynacq, Mr. Chan has previous corporate and outside accounting experience. Philip S. Chan is not related to Chiu M. Chan.

Stephen L. Huber, age 54, has served as a director of Dynacq since July 1992. Mr. Huber is a registered pharmacist and earned a Bachelor of Science degree in Pharmacy from the University of Houston. Since December 1991, Mr. Huber served as the Deputy Division Head for patient care services at the University of Texas M.D. Anderson Cancer Center. Mr. Huber joined M.D. Anderson in 1984 as Assistant Director of Operations. In 1999, Mr. Huber joined Cortex Communications, Inc., a medical education company, as president and chief operating officer. In 2001, Mr. Huber joined Medicus International, a global medical communications company as its senior vice president. Mr. Huber continues to serve as a research consultant to M.D. Anderson.

Earl R. Votaw, age 77, has served as a director of Dynacq since July 1992. Mr. Votaw earned a Bachelor of Arts degree from the University of the Americas in Mexico City and a certificate of graduation from the Graduate School of Mortgage Banking from Northwestern University of Chicago. Prior to his retirement in December 1993, Mr. Votaw served as a director and as the president and chief executive officer of Capital Bank, a Texas chartered bank located in Houston, Texas, where he still serves as a director. Mr. Votaw also serves as a director of Capital Bancorp.

Ping S. Chu, age 53, has served as a director of Dynacq since May 2002. Dr. Chu received his Ph.D. degree in chemistry from Massachusetts Institute of Technology before he went to medical school at the University of Miami, Florida. Dr. Chu finished his oncology training at M.D. Anderson Cancer Center in 1989 and has been in solo private practice since completion. Dr. Chu is board certified in internal medicine and medical oncology.

James G. Gerace, age 66, has served as a director of Dynacq since January 2004. Mr. Gerace received his degree in Business Administration with a major in accounting from Texas A & M University in 1961. He is a Certified Public Accountant and mediator with more than thirty years of professional experience at public accounting firms, performing audits, tax planning and related services. He has served on the Board of Directors of several banks and savings and loan associations and has maintained his own private CPA firm for approximately the last thirty-five years.

Audit Committee

The Board of Directors has a standing Audit Committee. The Audit Committee of the Board of Directors is currently comprised of Messrs. Huber, Votaw, Chu and Gerace. The Board has determined that Mr. Gerace, who serves as the Chairman of the Audit Committee, qualifies as an “audit committee financial expert” as that term is defined by applicable SEC rules and that Mr. Gerace is independent under the Nasdaq rules.

Executive Officers

The following sets forth the name, age, present title, principal occupation, and certain biographical information for the past five years for our executive officers. Please refer to the director biographies of Messrs. Chiu Chan and Philip Chan.

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James N. Baxter, age 62, has served as an executive vice president for Dynacq since July 2003. From April to July 2003, Mr. Baxter was an independent consultant to Dynacq. From 1993 to 2003, Mr. Baxter was President of Global Investment Alliance Inc., a private company engaged in investments. From 1994 to 1999, Mr. Baxter was President of GIA Securities Inc., a broker-dealer engaged in private placement finance.

Tammy Danberg-Farney, age 37, has served as an executive vice president, general counsel for Dynacq since December 2003. From 1995 to 2001, Ms. Danberg-Farney served as an associate with the Carter Law Firm; from 2001 to 2002 she maintained her own private law practice; from 2002-2003 she served as counsel at the law firm of Fulbright & Jaworski L.L.P. and from August 2003 to December 2003, she served as a staff attorney at Doctors Practice Management, Inc., a wholly-owned subsidiary of the Company.

Richard D. Valentine, age 49, has served as Director of Operations and Development for Dynacq since January 2004. From April 2002 to January 2004, Mr. Valentine served as Vice President of Marketing and Operations for Dynacq. Mr. Valentine served as CEO and co-owner of Pine Haven Healthcare from 1996-2000. In addition, Mr. Valentine served as CEO and co-owner of Houston Community Hospital from 2000-2002.

Code of Ethics

The Company has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. The Company has filed a copy of its code of ethics as an exhibit to this report.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Exchange Act requires our directors, executive officers, and the persons who beneficially own more than ten percent of our common stock, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Copies of all filed reports are required to be furnished to us. Based solely on the reports received by us and on the representations of the reporting persons, we believe that these persons have complied with all applicable filing requirements during the fiscal year ended August 31, 2003, except: (a) Mr. Philip S. Chan failed to timely file a Form 4 to report one transaction in August 2003, (b) Ms. Garvin failed to timely file a Form 4 to report one transaction in June 2003, and (c) Mr. Baxter failed to timely file a Form 3 in July 2003.

Item 11. Executive Compensation

Compensation of Directors

Messrs. Chiu M. Chan and Philip S. Chan receive compensation only as officers of Dynacq. Commencing January 2003, Messrs. Chu, Votaw and Huber began to receive a fee of $1,200 per month in exchange for their service on the Audit Committee. Effective January 2004, the board of directors appointed Mr. James G. Gerace as an independent director, and increased the stipend for all the independent directors to $5,000 per month.

From September 2002 until December 2002, Mr. Huber received $4,000 for consulting services. Mr. Huber no longer receives any consulting fees.

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Executive Compensation

The following table contains compensation data for our named executive officers for the fiscal years ended August 31, 2003, 2002, and 2001.

SUMMARY COMPENSATION TABLE

		Annual Compensation (1)				Long Term Compensation Awards
Name and Principal Position	Year	Salary ($)	Bonus ($)	Other Annual Compensation ($)		Securities Underlying Options (#)		All Other Compensation
Chiu M. Chan,	2003	180,000	—			—
President and CEO	2002	180,000	—			—
	2001	180,000	—			200,000	(2)
Philip S. Chan, CFO	2003	180,000	—			—
	2002	180,000	—			—
	2001	180,000	—			220,000	(2)
Sarah C. Garvin (3)	2003	180,000	—	18,000	(4)	—
	2002	180,000	—	15,000	(4)	—
	2001	120,000	—	9,000	(4)	200,000	(2)
Irvin T. Gregory (5)	2003	180,000	—	26,500	(6)	—
	2002	180,000	—	28,200	(6)	—
	2001	120,000	—	28,350	(6)	200,000	(2)
Richard D. Valentine	2003	175,000	—			—
Director of Operations and Development	2002	123,958	—			100,000	(7)

⁽¹⁾ Excludes perquisites and other personal benefits unless such compensation was greater than $50,000 or 10% of the total annual salary and bonus of the individual.

⁽²⁾ Represents individual option grants made in December 2000, with exercise prices of $4.4375 per share, expiring in December 2005, which vested as follows: (a) 60,000 shares in December 2001, (b) 60,000 shares in December 2002, and (c) 80,000 shares in December 2003. Mr. Philip S. Chan received an additional option grant for 20,000 shares in December 2000.

⁽³⁾ Ms. Garvin resigned from her position as Executive Vice President and Chief Operating Officer in February 2004.

⁽⁴⁾ Represents auto allowance.

⁽⁵⁾ Mr. Gregory resigned from his position as Executive Vice President and Chief Development Officer in September 2003.

⁽⁶⁾ Represents auto, rent and other allowances.

⁽⁷⁾ Represents an option to purchase 100,000 shares, with an exercise price of $6.07 per share, which was $9.09 less than the market price on the grant date, vesting 20% for each of the five years vesting period starting April 14, 2003 through April 14, 2007.

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Stock Options

The following table sets forth information concerning the option issuances to our named executive officers for the fiscal year ended August 31, 2003.

OPTION GRANTS IN LAST FISCAL YEAR

	Individual Grants				Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term (1)
Name	Number of Securities Underlying Options/SARs Granted (#)	Percent of Total Options / SARs Granted to Employees in Fiscal Year	Exercise or Base Price ($/Sh)	Expiration Date	5% ($)	10% ($)
Chiu M. Chan	—	—	—	—	—	—
Philip S. Chan	—	—	—	—	—	—
Sarah C. Garvin(2)	—	—	—	—	—	—
Irvin T. Gregory(3)	—	—	—	—	—	—
Richard D. Valentine	—	—	—	—	—	—

⁽¹⁾ The 5% and 10% assumed rates of appreciation are prescribed by the rules and regulations of the SEC and do not represent our estimate or projection of the future trading prices of our common stock. We can provide no assurance that any of the values reflected in this table will be achieved.

⁽²⁾ Ms. Garvin resigned from her position as Executive Vice President and Chief Operating Officer in February 2004.

⁽³⁾ Mr. Gregory resigned from his position as Executive Vice President and Chief Development Officer in September 2003.

The following table sets forth information concerning option exercises during the fiscal year ended August 31, 2003 and option holdings as of August 31, 2003 with respect to our named executive officers.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES

Name	Shares Acquired on Exercise (#)	Value Realized ($)(2)	Number of Securities Underlying Unexercised Options at FY-End (#)		Value of Unexercised In-the- Money Options at FY-End ($)
			Exercisable	Unexercisable	Exercisable	Unexercisable(1)
Chiu M. Chan	—	—	120,000	80,000	2,370,300	1,580,200
Philip S. Chan	22,500	434,555	117,500	80,000	2,320,919	1,580,200
Sarah C. Garvin(3)	120,000	1,236,640	—	80,000	—	1,580,200
Irvin T. Gregory(4)	77,466	935,737	—	80,000	—	1,580,200
Richard D. Valentine	—	—	20,000	80,000	362,400	1,449,600

⁽¹⁾ Based on the fair market value of our common stock on August 29, 2003 of $24.19 per share less the exercise price payable for such shares.

⁽²⁾ Based on the fair market value of our common stock on the respective dates of exercise less the exercise price payable for such shares.

⁽³⁾ Ms. Garvin resigned from her position as Executive Vice President and Chief Operating Officer in February 2004.

⁽⁴⁾ Mr. Gregory resigned from his position as Executive Vice President and Chief Development Officer in September 2003.

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Employment Contracts and Change-In-Control Arrangements

Mr. Baxter entered into a three-year employment agreement with Dynacq in August 2003, which provides for a base salary of $160,000 per year and an automobile allowance of $20,000 per year. The employment agreement also provides for the payment of relocation expenses in the amount of $10,000 and country club membership fees, as well as participation in employee benefit plans offered by the Company to its officers. Mr. Baxter’s compensation also includes an option to purchase 100,000 shares of common stock, with an exercise price of $17.75 per share, vesting as follows: (a) 30,000 shares on July 31, 2004, (b) 30,000 shares on July 31, 2005 and (c) 40,000 shares on July 31, 2006. Upon termination of employment, any vested options may be exercised for 90 days after the date of termination and then will lapse. In addition, if Mr. Baxter is terminated without cause, he will receive six months severance pay and will have three months after the date of termination to exercise a portion of the options which would have been exercisable following the year the termination occurred determined by multiplying the fraction, the numerator of which is the total number of days of employment in the applicable year of termination divided by 365 days, multiplied by the total number of options which would have vested that year.

Ms. Danberg-Farney entered into a two-year employment agreement with DPMI on August 1, 2003, which will automatically renew for additional two-year terms unless written notice is given by either party 30 days prior to the expiration of the initial or any subsequent term. The employment agreement provides for an initial annual salary of $120,000 for the first 90 days of employment, which increased to $150,000 after such initial 90-day period. The employment agreement also provides for participation in employee benefit plans offered by the Company to its officers. Ms. Danberg-Farney’s compensation also includes an option to purchase up to 100,000 shares of Dynacq’s common stock, which will vest in increments of 20,000 shares on each August 1^st following her start date and have an exercise price of $17.75, the average price per share of Dynacq common stock on August 1, 2003. Upon termination of employment, any vested options may be exercised within 90 days after the date of termination and then will lapse. In addition, if Ms. Danberg-Farney is terminated for cause, her rights to exercise any vested options will be terminated.

Mr. Valentine entered into a five-year employment agreement with Dynacq in April 2002, which provides for a base salary of $175,000 per year and the opportunity to receive an annual bonus of 50% of his annual salary based on objective performance parameters, the satisfaction of such parameters determined in the discretion of the Board of Directors. The employment agreement also provides an automobile allowance of $750 per month, as well as participation in employee benefit plans offered by the Company to its employees. Mr. Valentine’s compensation also includes an option to purchase 100,000 shares of common stock of the Company, the terms of which are described in footnote 6 to the “Summary Compensation Table.” The employment agreement provides that, if the Company enters into employment or incentive agreements with its key employees, Mr. Valentine will have the opportunity to negotiate for substantially equivalent terms. The employment agreement also contains a covenant not to compete with the Company during the period of employment and for a period of two years following the termination for any reason. If Mr. Valentine is terminated for cause, he will be entitled to receive his base salary on a pro rata basis to the date of termination. If Mr. Valentine is terminated without cause, he will receive six months severance pay, he will have three months after the date of termination to exercise any outstanding options (which will immediately vest on the date of such termination without cause), and the non-competition covenant contained in his employment agreement will be terminated. In the event of a change of control, as defined in the employment agreement, all of Mr. Valentine’s outstanding options will immediately vest and become exercisable and, if he is terminated within six months following such change of control, Mr. Valentine will receive six months severance pay in addition to the consideration for his non-competition covenant equal to 18 months salary, if the covenant is not waived by the Company or its successor.

Ms. Garvin, who resigned from her position as an executive officer in February 2004, had entered into a three-year employment agreement with Dynacq in December 2000, which provided for a base salary of $120,000. Pursuant to that agreement, Ms. Garvin received an expense allowance and an automobile allowance. Ms. Garvin’s compensation included an option to purchase 200,000 shares of common stock, which were fully vested prior to Ms. Garvin’s resignation and which are described in the “Summary Compensation Table.” The employment agreement provided for the accelerated vesting of options if Ms. Garvin was terminated without cause, or if a change of control of the Company occurred. In addition, if Ms. Garvin had been terminated without cause, she would have received a severance payment of $60,000. Upon the expiration or termination of the employment agreement, Dynacq had the option of exercising a non-compete provision, which would have prevented Ms. Garvin from competing with the

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Company for a period of two years, in exchange for payment, on a monthly basis, of Ms. Garvin’s base salary on termination for the non-compete period. Upon the expiration of her employment agreement, Ms. Garvin remained as an executive officer until February 2004 when she resigned from her position and entered into a 30-month consulting agreement with the Company. She will continue to assist the Company on a consulting basis and will receive $10,500 per month for 18 months and $10,000 per month for the remaining 12 months of the agreement. The Consulting Agreement provides that Ms. Garvin shall not directly compete against the Company within a 25 mile radius of any location where the Company currently operates or currently intends to operate for the duration of the Consulting Agreement.

Mr. Gregory, who resigned from his position as an executive officer in September 2003, but remained as an employee of the Company until January 2004, had entered into a three-year employment agreement with Dynacq in December 2000, on the same terms and conditions as Ms. Garvin. The Company did not exercise its option to require a non-compete period.

Our 2000 Stock Option Plan provides for accelerated vesting of the shares of common stock subject to outstanding options in connection with certain changes in control of Dynacq.

Compensation Committee Interlocks and Insider Participation

The Compensation Committee, which recommends compensation levels for our executive officers and is authorized to consider and make grants of options pursuant to any approved stock option plan and to administer the plans, is comprised of Messrs. Gerace, Huber, Votaw and Dr. Chu. None of these gentlemen have been an officer or employee of Dynacq or any of its subsidiaries.

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Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

As of June 30, 2004, 14,852,072 shares of our common stock were outstanding. The following table sets forth, as of June 30, 2004, information with respect to shares beneficially owned by: (a) each person who is known by us to be the beneficial owner of more than 5% of our outstanding shares of common stock, (b) each of our directors and the named executive officers named in the Summary Compensation Table below, and (c) all current directors and executive officers as a group.

Beneficial ownership has been determined in accordance with Rule 13d-3 under the Exchange Act. Under this rule, some shares may be deemed to be beneficially owned by more than one person (if, for example, persons share the power to vote or the power to dispose of the shares). In addition, shares are deemed to be beneficially owned by a person if the person has the right to acquire shares (for example, upon exercise of an option) within sixty days of the date as of which the information is provided. In computing the percentage ownership of any person, the amount of shares is deemed to include the amount of shares beneficially owned by such person by reason of such acquisition rights. As a result, the percentage of outstanding shares of any person as shown in the following table does not necessarily reflect the person’s actual voting power at any particular date.

To our knowledge, except as indicated in the footnotes to this table and pursuant to applicable community property laws, the persons named in the table have sole voting and investing power with respect to all shares of common stock shown as beneficially owned by them. All share numbers reflect two separate two-for-one stock dividends effected January 2000 and March 2001.

	SHARES BENEFICIALLY OWNED AS OF JUNE 30, 2004
BENEFICIAL OWNER(1)	NUMBER OF SHARES(2)		PERCENT OF CLASS
Chiu M. Chan	8,803,131	(3)	56.8	%
Philip S. Chan	517,744	(4)	3.3	%
Stephen L. Huber	20,000	(5)	Less than 1	%
Earl R. Votaw	36,800		Less than 1	%
Ping S. Chu	196,973	(6)	1.3	%
James G. Gerace	—		—	%
Richard D. Valentine	20,000		Less than 1	%
Sarah C. Garvin(7)	—		—	%
Irvin T. Gregory(8)	58,466		Less than 1	%
All directors and executive officers as a group (11 persons)	9,705,114	(9)	62.7	%

⁽¹⁾ The address for each named person is 10304 Interstate 10 East, Houston, Texas 77029.

⁽²⁾ Beneficial ownership is determined in accordance with SEC rules, and includes shares of stock underlying outstanding options that are currently exercisable or will become exercisable within 60 days of June 30, 2004.

⁽³⁾ Includes 200,000 shares underlying options, which are currently exercisable, 1,610,205 shares held by Mr. Chan’s spouse and 204,811 shares held by Mr. Chan’s son.

⁽⁴⁾ Includes 197,500 shares underlying options, which are currently exercisable.

⁽⁵⁾ Consists of options to purchase 20,000 shares of common stock, which are currently exercisable.

⁽⁶⁾ Includes 404 shares held by one of Dr. Chu’s daughters and 404 shares held by another of Dr. Chu’s daughters.

⁽⁷⁾ Ms. Garvin resigned from her position as Executive Vice President and Chief Operating Officer in February 2004.

⁽⁸⁾ Mr. Gregory resigned from his position as Executive Vice President and Chief Development Officer in September 2003.

⁽⁹⁾ Includes 487,500 shares underlying options, which are currently exercisable.

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SECURITIES TO BE ISSUED UNDER EQUITY COMPENSATION PLANS

The following table sets forth, as of August 31, 2003, the number of shares of our common stock that may be issued upon the exercise of outstanding options issued under equity compensation plans, the weighted average exercise price of those options and the number of shares of common stock remaining available for future issuance under equity compensation plans.

Plan Category	(a) Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights	(b) Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights	(c) Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans (excluding securities reflected in column (a))
Equity Compensation Plans approved by security holders:
•      2000 Stock Incentive Plan	1,116,511	8.45	3,452,318
Equity Compensation Plan not approved by security holders:
•      1995 Non-Qualified Stock Option Plan for Consultants and Non-Employee Directors	84,000	5.49	344,828
Total	1,200,511	8.25	3,797,146

The 1995 Non-Qualified Stock Option Plan for Consultants and Non-Employee Directors authorizes the issuance of non-qualified stock options to purchase up to 1,000,000 (after adjusting for stock splits) shares of our common stock to consultants and non-employee directors of the Company and its subsidiaries. The table above sets forth the number of shares subject to outstanding options and the number of shares remaining available for issuance under this plan. The board of directors may determine the terms of the options granted under the plan, except that the plan specifically provides that:

• the exercise price of the option may not be less than 100% of the fair market value of our common stock on the date of the grant,

• no option granted under the plan will be exercisable prior to six months from the date of grant,

• in the event of a participant’s death, options that vested prior to the participant’s death may be exercised by a participant’s personal representative for one year after death,

• in the event that a participant ceases to be a consultant or a director of the Company, options that vested prior to such termination are exercisable remain exercisable for 30 days after the termination, and

• no stock option is exercisable more than 10 years after the date of grant.

Item 13. Certain Relationships and Related Transactions

The Company had previously leased 1,000 square feet of office space for its executive offices on a month-to-month basis for $1,286 per month. As of September 1, 2003, the Company increased its leased space to approximately 7,250 square feet and entered into an 8 year lease for this office space. The Company will pay $1,286 per month for the first year of the lease and $6,525 per month for the remainder of the lease term. The lessor of the office space is Capital Bank, of which Mr. Earl Votaw, one of the Company’s directors, is a director. Management believes that the lease rate being paid is consistent with comparable commercial rates available in the area.

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The Company leased a residential house to its Chief Executive Officer (CEO), Mr. Chiu M. Chan at a monthly rate of $1,400 per month through April 2003. In April 2003, the Company consummated the sale of a house to Chiu M. Chan. The house was sold to Mr. Chan in exchange for the transfer of his right to receive 25,639 shares of Dynacq common stock held by Mr. Chan. The contract, which was signed on April 10, 2003, valued the property at $311,740, which was 10% more than the 2002 appraised value of $283,400. The shares of common stock were valued at 90% of the closing price of Dynacq common stock on April 10, 2003. In addition, the Company paid the 2003 property taxes.

Seven members of Mr. Chiu Chan’s immediate family (four brothers-in-law and three sisters-in-law), are employed by the Company or its subsidiaries. Such family members received an aggregate of $279,528 in compensation from the Company or its subsidiaries in fiscal year 2003, or 1.9% of the total Company payroll.

Three members of Mr. Philip Chan’s immediate family (his sister and two sister-in-laws) are employed by the Company or its subsidiaries. Such family members received an aggregate of $106,700 in compensation from the Company or its subsidiaries in fiscal year 2003, or 0.7% of the total Company payroll.

In late January 2004, just prior to Mr. Gregory’s departure from the Company but after he ceased to be an executive officer of the Company, the Company completed the sale of its land for the previously proposed hospital site in Slidell, Louisiana to HealthGroup Partners, L.L.C. for $2.5 million, resulting in a small profit. We had determined that the Slidell hospital project was no longer consistent with our current business plan. At the time of the transaction, Mr. Gregory was an investor in Healthgroup Partners, L.L.C. and is now the President and CEO.

Since May 2002, when Dr. Ping Chu became a director, he has paid the Company $26,870 and $17,631 during fiscal years ended August 31, 2003 and 2002, respectively for rent and management fees. As of August 31, 2003 and 2002, the Company had accounts receivable from Dr. Chu of $22,277 and $99,476, respectively. Included in the accounts receivable balance were amounts applicable to Dr. Chu’s staffs’ payroll for which he reimburses the Company in the ordinary course of business. Dr. Chu is currently a member of our audit committee.

Item 14. Principal Accounting Fees and Services

Aggregate fees for professional services rendered by KenWood & Associates, P.C. (KenWood) and Ernst & Young LLP for the fiscal years ended August 31, 2002 and 2003, were as follows:

	2002			2003
Audit Fee	$	262,400	(1)	$	435,700	(2)
Tax Fees		9,700			—
All Other Fees	$	115,700		$	67,460

⁽¹⁾ Of this amount, $208,000 represents fees paid to Ernst & Young for professional services rendered for the audit of our annual financial statements for the fiscal year ended August 31, 2002 and the review of the financial statements included in our quarterly report for the fiscal quarter ended May 31, 2002. During the fiscal year ended August 31, 2002, KenWood provided professional services in connection with the reviews of the financial statements included in our quarterly reports for the periods ended November 30, 2001 and February 28, 2002, and the aggregate fees billed by KenWood for such services was $54,400.

⁽²⁾ Of this amount, $410,145 represents fees paid to Ernst & Young for professional services rendered for the audit of our annual financial statements for the fiscal year ended August 31, 2003 and the review of the financial statements included in our quarterly reports for the fiscal quarters ended November 30, 2002, February 28, 2003 and May 31, 2003. During the fiscal year ended August 31, 2003, KenWood provided professional services in connection with the reviews of the financial statements included in our quarterly

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reports for the periods prior to February 28, 2002, and the aggregate fees billed by KenWood for such services was $25,553.

Audit Fees for the fiscal years ended August 31, 2002 and 2003 represent the aggregate fees billed for professional services rendered by Ernst & Young and KenWood, as applicable, for the audit of our annual financial statements and review of financial statements included in our quarterly reports on Form 10-Q or services that are normally provided in connection with statutory and regulatory filings or engagements for those fiscal years.

Tax-Related Fees for the fiscal years ended August 30, 2002 and 2003, represent the aggregate fees billed for professional services rendered by Ernst & Young for tax compliance.

All Other Fees for the fiscal years ended August 31, 2002 and 2003, represent the aggregate fees billed for services rendered by Ernst & Young, for litigation support services.

Audit Committee Pre-Approval Policies and Procedures

All audit and non-audit services performed by the independent auditor are pre-approved by the Audit Committee, which considers, among other things, the possible effect of the performance of such services on the auditors’ independence. The Audit Committee’s charter provides that the Audit Committee may delegate to any of its members the authority to pre-approve any services performed by the independent auditor, provided that such approval is presented to the Audit Committee at its next scheduled meeting. All of the audit-related, tax and all other services described above were pre-approved by the full Audit Committee.

Item 15. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K

(a)(1) Financial Statements: See Index to Consolidated Financial Statements under Item 8 on Page 49 of this Report.

(a)(2) Financial Statement Schedule: See Schedule II on Page 82 of this Report.

(a)(3) Exhibits. The following exhibits are to be filed as part of the annual report:

EXHIBIT NO.	IDENTIFICATION OF EXHIBIT
Exhibit   3.1	Certificate of Incorporation, incorporated by reference to the Definitive Information Statement filed October 21, 2003, SEC File No. 000-21574.
Exhibit   3.2	Bylaws, incorporated by reference to the Definitive Information Statement filed October 21, 2003, SEC File # 222-21574.
Exhibit 10.1	1995 Non-Qualified Stock Option Plan for Consultants and Non-Employee Directors, filed with the Company’s Annual Report on Form 10-K for the fiscal year 1996.
Exhibit 10.2	The Company’s Year 2000 Stock Incentive Plan adopted on August 29, 2000, and incorporated by reference as Appendix B from the Company’s Definitive Proxy Statement on Schedule 14A filed August 9, 2000.
Exhibit 10.3	Purchase Agreement entered into by and among the Company and Charis Hospital, LLC, filed with the Company’s Annual Report on Form 10-KSB for the fiscal year 2001.
Exhibit 10.4	Unimproved Commercial Property Earnest Money Contract dated August 30, 2002 relating to purchase of Raw Land in The Woodlands, Texas.
Exhibit 10.5	Second Amendment to Unimproved Commercial Property Earnest Money Contract dated December 4, 2002 relating to purchase of Raw Land in The Woodlands, Texas.
Exhibit 10.6	General Warranty Deed by Vision Park Joint Venture to Vista Land Equipment, L.L.C. dated December 9, 2002
Exhibit 10.7	Hospital Program Management Agreement dated November 15, 2002 between the Company and Vital Weight Control, Inc.

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EXHIBIT NO.	IDENTIFICATION OF EXHIBIT
Exhibit 10.8	Cash Sale of Raw Land in Slidell, Louisiana dated February 18, 2003.
Exhibit 10.9	Asset Purchase Agreement dated June 30, 2003 between Tomaszek Management L.L.C. and Vista Land And Equipment.
Exhibit 10.10	Asset Purchase Agreement dated July 31, 2003 relating to the Garland facility.
Exhibit 10.11	Bill of Sale dated August 29, 2003 for equipment relating to the Garland facility.
Exhibit 10.12	Management Support and Marketing Agreement dated October 15, 2003 between the Company and Medical Multimedia Advertising, Inc. and Addendum thereto.
Exhibit 10.13	Cash Sale Agreement of Raw Land in Slidell, Louisiana dated January 23, 2004.
Exhibit 10.14	Consulting Agreement dated February 1, 2004 between Sarah Garvin and the Company.
Exhibit 10.15	Employment Agreement dated August 1, 2003 between James Baxter and the Company.
Exhibit 10.16	Employment Agreement dated April 15, 2002 between Richard D. Valentine and the Company.
Exhibit 10.17	Employment Agreement dated August 1, 2003 between Tammy Danberg-Farney and the Company.
Exhibit 10.18	WCMA Reducing Revolver Loan and Security Agreement No. 582-07653 dated as of May 18, 2001 between Dynacq International, Inc. and Merrill Lynch Business Financial Services, Inc.
Exhibit 14.1	Code of Ethics for Principal Executive and Senior Financial Officers.
Exhibit 21.1	Listing of subsidiaries.
Exhibit 23.1	Consent of Killman, Murrell and Company, P.C.
Exhibit 31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 99.1	Audit Committee Charter

(b) Reports on Form 8-K. The Company filed the following reports on Form 8-K during the last quarter of the period covered by this report:

• On July 17, 2003 pursuant to Item 12 of the report containing a copy of the Company’s press release dated July 14, 2003 titled “Dynacq Reports 52% Increase in Third Quarter Net Income to $6.3 Million”.

• On August 1, 2003 pursuant to Item 9 of the report containing a copy of the Company’s press release dated July 31, 2003 titled “Dynacq Comments on News Reports Regarding New Baton Rouge Hospital—Texas Judge Orders Withdrawal of Louisiana Motion to Sequester Equipment”.

• On August 1, 2003 pursuant to Item 9 of the report containing a copy of the Company’s press release dated August 1, 2003 titled “Dynacq Agrees to Acquire Hospital in Dallas-Ft. Worth Area”.

• On August 19, 2003 pursuant to Item 9 of the report containing a copy of the Company’s press release dated August 18, 2003 titled “Dynacq Affiliate Acquires Dallas-Ft. Worth Hospital—Fortune Names Dynacq Ninth Fastest Growing Company in America”.

• On August 29, 2003 pursuant to Item 9 of the report containing a copy of the Company’s press release dated August 27, 2003 titled “Federal Judge Dismisses Class Action against Dynacq International”.

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SIGNATURES

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

	Dynacq Healthcare, Inc.
Date: July 30, 2004	By:	/s/    CHIU M. CHAN
		Chiu M. Chan, President

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/    CHIU M. CHAN          Chiu M. Chan	Chairman of the Board, CEO, President, and Secretary	July 30, 2004
(Principal Executive Officer)
/s/    PHILIP S. CHAN         Philip S. Chan	Director, Vice President - Finance, CFO, and Treasurer	July 30, 2004
(Principal Financial and Accounting Officer)
/s/    STEPHEN L. HUBER         Stephen L. Huber	Director	July 30, 2004
/s/    EARL R. VOTAW         Earl R. Votaw	Director	July 30, 2004
/s/    PING S. CHU         Ping S. Chu	Director	July 30, 2004
/s/    JAMES G. GERACE         James G. Gerace	Director	July 30, 2004

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EXHIBIT INDEX

EXHIBIT NO.	IDENTIFICATION OF EXHIBIT
Exhibit   3.1	Certificate of Incorporation, incorporated by reference to the Definitive Information Statement filed October 21, 2003, SEC File No. 000-21574.
Exhibit   3.2	Bylaws, incorporated by reference to the Definitive Information Statement filed October 21, 2003, SEC File # 222-21574.
Exhibit 10.1	1995 Non-Qualified Stock Option Plan for Consultants and Non-Employee Directors, filed with the Company’s Annual Report on Form 10-K for the fiscal year 1996.
Exhibit 10.2	The Company’s Year 2000 Stock Incentive Plan adopted on August 29, 2000, and incorporated by reference as Appendix B from the Company’s Definitive Proxy Statement on Schedule 14A filed August 9, 2000.
Exhibit 10.3	Purchase Agreement entered into by and among the Company and Charis Hospital, LLC, filed with the Company’s Annual Report on Form 10-KSB for the fiscal year 2001.
Exhibit 10.4	Unimproved Commercial Property Earnest Money Contract dated August 30, 2002 relating to purchase of Raw Land in The Woodlands, Texas.
Exhibit 10.5	Second Amendment to Unimproved Commercial Property Earnest Money Contract dated December 4, 2002 relating to purchase of Raw Land in The Woodlands, Texas.
Exhibit 10.6	General Warranty Deed by Vision Park Joint Venture to Vista Land Equipment, L.L.C. dated December 9, 2002
Exhibit 10.7	Hospital Program Management Agreement dated November 15, 2002 between the Company and Vital Weight Control, Inc.
Exhibit 10.8	Cash Sale of Raw Land in Slidell, Louisiana dated February 18, 2003.
Exhibit 10.9	Asset Purchase Agreement dated June 30, 2003 between Tomaszek Management L.L.C. and Vista Land And Equipment.
Exhibit 10.10	Asset Purchase Agreement dated July 31, 2003 relating to the Garland facility.
Exhibit 10.11	Bill of Sale dated August 29, 2003 for equipment relating to the Garland facility.
Exhibit 10.12	Management Support and Marketing Agreement dated October 15, 2003 between the Company and Medical Multimedia Advertising, Inc. and Addendum thereto.
Exhibit 10.13	Cash Sale Agreement of Raw Land in Slidell, Louisiana dated January 23, 2004.
Exhibit 10.14	Consulting Agreement dated February 1, 2004 between Sarah Garvin and the Company.
Exhibit 10.15	Employment Agreement dated August 1, 2003 between James Baxter and the Company.
Exhibit 10.16	Employment Agreement dated April 15, 2002 between Richard D. Valentine and the Company.
Exhibit 10.17	Employment Agreement dated August 1, 2003 between Tammy Danberg-Farney and the Company.
Exhibit 10.18	WCMA Reducing Revolver Loan and Security Agreement No. 582-07653 dated as of May 18, 2001 between Dynacq International, Inc. and Merrill Lynch Business Financial Services, Inc.
Exhibit 14.1	Code of Ethics for Principal Executive and Senior Financial Officers.
Exhibit 21.1	Listing of subsidiaries.
Exhibit 23.1	Consent of Killman, Murrell & Co., P.C.
Exhibit 31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 99.1	Audit Committee Charter

EX-10.4

Exhibit 10.4

UNIMPROVED COMMERCIAL PROPERTY EARNEST MONEY CONTRACT

1. PARTIES: Subject to the further terms and conditions hereof, Vision Park Joint Venture (“Seller”) agrees to sell and convey to Dynacq International, Inc., a Nevada Corporation (“Buyer”) and Buyer agrees to buy from Seller the property described below.

2. PROPERTY: The land (the “Land”) situated in Montgomery County, Texas, being 6.00 acres more or less, as described on attached Exhibit “A”, together with all rights, privileges and appurtenances pertaining thereto, including but not limited to all of Seller’s right, title, and interest in any minerals, utilities, adjacent streets, alleys, strips, gores, and right-of-ways. All property sold, granted or transferred by this contract (this “Contract”) is called the “Property”.

The property shall be subject, however, to the Permitted Exceptions (hereinafter defined), which shall include but not be limited to the City of Shenandoah Development Requirements, Vision Park developments (Vision Park PDD) and $0.50 per square foot charge (approximately 261,360 X 0.50 = $130,680.00) for Vision Park Boulevard landscape and irrigation as required by Vision Real Estate & Development, Inc. (“Irrigation Charge”) which sum shall be paid by Buyer at the time of Closing (hereinafter defined).

3. CONTRACT PURCHASE PRICE: The purchase price for the Property shall be the product of $9.50 per square foot times the total number of net square feet, as hereinafter defined in paragraph 22, contained in the Land. The Purchase Price shall be payable in cash, cashier’s check, federal wire transfer funds, or other immediately available funds at the Closing, subject to any adjustments and credits provided in this Agreement. If there are any mortgages or other liens affecting the Property, the Seller shall pay off and obtain recordable releases and terminations of all such mortgages and liens, whether the Purchases Price is sufficient to pay off such mortgages and other liens, and Seller shall be responsible for any prepayment premiums, documents preparations fees, any fees to record any releases or terminations, and other fees charged by mortgages in connection with this transaction.

4. FINANCING: N/A

5. EARNEST MONEY: Buyer shall deposit the sum of Fifty Thousand and No/100 Dollars ($50,000.00) as Earnest Money (herein so called) with Charter Title Company at 4265 San Felipe, Suite 350, Houston, Texas 77027, as Escrow Agent (herein so called), within seven (7) days after execution of this Contract by both parties. The Earnest Money shall be placed in and interest-bearing account by the Escrow Agent, and any interest thereon shall be part of the Earnest Money. If Buyer fails to deposit the Earnest Money, as required by this Contract, or by any addendum, Seller may terminate this Contract, as its sole remedy, by providing written notice to Buyer.

The date of deposit with the Escrow Agent of this fully signed Contract and the Earnest money shall be the Effective Date of this Contract. At the closing, the Earnest money together with all interest earned thereon, shall be applied and credited to the Purchase Price, but otherwise the Earnest Money and interest to be earned thereon shall be held and disbursed by the Escrow Agent in strict accordance with the terms of this Contract.

6. TITLE: Seller shall furnish to Buyer:

A. At Seller’s expense, an Owner’s Policy of Title Insurance (the “Title Policy”) issued by Charter Title Company (the “Title Company”) and in the amount of the Purchase Price and dated at Closing, insuring Buyer’s fee simple title to the Property to be good and indefeasible subject only to standard preprinted exceptions and the Permitted Exceptions; provided, however:

(1) the exception as to the area and boundaries shall be deleted except for “any shortages in area”; and if deleted, the cost of such deletion shall be an expense of Buyer.

(2) the exception as to taxes shall be limited to taxes for the current year not yet due and payable and subsequent years, and subsequent assessments for prior years due to changes in land usage to ownership.

(3) Any exceptions as to parties or tenants in possession shall be deleted at Seller’s expense.

B. Abstracts of Title: None Required

7. PROPERTY CONDITION: EXCEPT AS OTHER WISE EXPRESSLY SET FORTH IN THIS CONTRACT, SELLER HAS NOT MADE, DOES NOT MAKE AND SPECIFICALLY NEGATES, DISCLAIMS ANY AND ALL REPRESENTATIONS, WARRANTIES (OTHER THAN THE WARRANTY OF TITLE TO BE SET FORTH IN THE DEED), PROMISES, COVENANTS, AGREEMENTS OR GUARANTIES OF ANY KIND OR CHARACTER WHATSOEVER, WHETHER EXPRESS OR IMPLIED, ORAL OR WRITTEN, PAST, PRESENT OF FUTURE, OF, AS TO, CONCERNING OR WITH RESPECT TO (A) THE VALUE, NATURE QUALITY OR CONDITION OF THE PROPERTY, INCLUDING, WITHOUT LIMITATION, THE WATER, SOIL AND GEOLOGY, (B) THE INCOME TO BE DERIVED FROM THE PROPERTY, (C) THE SUITABILITY OF THE PROPERTY FOR ANY AND ALL ACTIVITIES AND USES WHICH BUYER MAY CONDUCT THEREON, (D) THE COMPLIANCE OF OR BY THE PROPERTY OR ITS OPERATION WITH ANY LAWS, RULES, ORDINANCES OR REGULATIONS OF ANY APPLICABLE GOVERNMENTAL AUTHORITY OR BODY, (E) THE HABIT ABILITY, MERCHANT ABILITY, MARKET ABILITY, PROFIT ABILITY OR FITNESS FOR A PARTICULAR PURPOSE OF THE PROPERTY (F) THE MANNER OR QUALITY OF THE CONSTRUCTION OR MATERIALS, IF

ANY, INCORPORATED INTO THE PROPERTY, (G) THE MANNER, QUALITY, STATE OR REPAIR OF LACK OF REPAIR OF ANY PORTION, COMPONENT OR ASPECT OF THE PROPERTY, OR (H) ANY OTHER MATTER WITH RESPECT TO THE PROPERTY, AND SPECIFICALLY, THAT SELLER HAS NOT MADE, DOES NOT MAKE AND SPECIFICALLY DISCLAIMS ANY REPRESENTATIONS REGARDING COMPLIANCE WITH ANY ENVIRONMENTAL REQUIREMENTS, PROTECTION, POLLUTION OR LAND USE LAWS, RULES, REGULATIONS, OR ORDERS INCLUDING THE EXISTENCE IN OR ON THE PROPERTY OF HAZARDOUS MATERIALS. BUYER ACKNOWLEDGES AND AGREES HAVING BEEN GIVEN THE OPPORTUNITY TO INSPECT THE PROPERTY AND EXCEPT AS OTHERWISE SET FORTH HEREIN, BUYER IS RELYING SOLELY ON ITS OWN INVESTIGATION OF THE PROPERTY AND NOT ON ANY INFORMATION PROVIDED OR TO BE PROVIDED BY SELLER AND ACCEPTS THE PROPERTY “AS IS, WHERE IS, WITH ALL FAULTS.” BUYER FURTHER ACKNOWLEDGES AND AGREES THAT ANY INFORMATION PROVIDED OR TO BE PROVIDED WITH RESPECT TO THE PROPERTY WAS OBTAINED FORM A VARIETY OF SOURCES AND THAT SELLER HAS NOT MADE ANY INDEPENDENT INVESTIGATION OR VERIFICATION OF SUCH INFORMATION AND MAKES NO REPRESENTATIONS AS TO THE ACCURACY OF COMPLETENESS OF SUCH INFORMATION. SELLER IS NOT LIABLE OR BOUND IN ANY MANNER BY ANY VERBAL OR WRITTEN STATEMENTS, REPRESENTATIONS, OR INFORMATION PERTAINING TO THE PROPERTY, OR THE OPERATION THEREOF, FURNISHED BY ANY REAL ESTATE BROKER, AGENT, EMPLOYEE, SERVANT OR OTHER PERSON. BUYER FURTHER ACKNOWLEDGES AND AGREES THAT, TO THE MAXIMUM EXTENT PERMITTED BY LAW, THE SALE OF THE PROPERTY AS PROVIDED FOR HEREIN IS MADE ON AN “AS IS WHERE IS” BASIS WITH ALL FAULTS. This Paragraph 7 shall appear in substantially the same form in the deed.

8. BROKER’S FEE: Buyer and Seller represent that they have not engaged any agent or broker incident to the sale of the Property. In the event any claim or demand is made by any real estate agent or other person claiming by, through or under Buyer or Seller, each shall indemnify and hold the other harmless from and against any claim or demand and all expenses related thereto, including without limitations, court costs and attorneys’ fees.

9. CLOSING: The closing of the sale (the “Closing”) shall be at the office of the Escrow Agent at 4265 San Felipe, Suite 350, Houston, Texas 77027 on the one hundredth (100th) day following the Effective Date of this Contract (the “Closing Date”) at 10:00 A.M., unless the Seller and Buyer mutually agree in writing to another date or time or unless this Contract is sooner terminated in accordance

with its provisions. If either part fails to close by the Closing Date, the non-defaulting party may exercise the remedies in Paragraph 15 of this Contact.

At Closing, Seller will execute and deliver to Buyer, at Seller’s expense, a special warranty deed. The deed must include a vendor’s lien if any part of the Purchase Price is financed. The deed must convey good an indefeasible title to the Property and show no exceptions other than the Permitted Exceptions.

At Closing, Seller, at Seller’s expense, will also execute and/or deliver:

(1) tax statements showing no delinquent taxes on the Property;

(2) to the extent assignable, an assignment to Buyer, without warranty, of any licenses and permits related to the Property;

(3) evidence that the person executing this Contract and the closing documents is legally capable and authorized to bind Seller;

(4) any notices, statements, certificates, or other documents reasonably required by this Contract or law necessary to convey the Property;

(5) an Affidavit stating that Seller is not a “foreign person” as that term is used and defined in the Internal Revenue Code, Section 1445, as the same may be amended; and

(6) The Title Policy.

At Closing, Buyer will:

(1) pay the Purchase Price and the Irrigation Charge (less a credit for the Earnest Money and interest earned thereon);

(2) deliver evidence that the person executing this Contract is legally capable and authorized to bind Buyer; and

(3) execute and deliver any notices, statements, certificates, or other documents reasonably required by this Contract or law necessary to close the sale.

All closing documents shall be subject to review and approval by Buyer, Seller and their attorneys.

10. POSSESSIONS: Possession of the property shall be delivered to Buyer at Closing and upon payment of the Purchase Price as set forth in Section 3.

11. SPECIAL PROVISIONS:

A. EASEMENTS:

Road Right of Way to adjacent acreage south of “the Land” along western property line, details to be agreed to by both parties prior to closing.

12. SALE EXPENSES TO BE PAID IN CASH AT OR PRIOR TO CLOSING:

A. SELLER’S EXPENSES: Cost of releasing liens and recording releases; tax statements; 1/2 of any escrow fee; preparation of deed; other expenses stipulated to be paid by Seller under other provisions of this Contract.

B. BUYER’S EXPENSES: Application, origination, processing, commitment and loan discount fees; private mortgage insurance premiums; expenses incident to new loan(s) (e.q., preparation of any note, deed of trust and other a loan documents, recording fees, copies of restriction and easements, Mortgagee Title Policies, credit reports, photos) if applicable; 1/2 of any escrow fee; expenses stipulated to be paid by Buyer under other provisions of this Contract.

C. Each party shall pay its own attorney’s fees.

D. Except as otherwise set out in this Contract, all other expenses shall be paid as is customary in Montgomery County, Texas.

13. PRORATIONS AND ROLLBACKS TAXES:

A. Assessments (except as otherwise set out in this Contract), current taxes, and any rents and maintenance fees shall be prorated through the date of Closing. If ad valorem taxes for the year in which the sale is closed are not available on the Closing Date, proration of taxes shall be made on the basis of taxes assessed for the previous year and any necessary cash adjustments of such proration shall be made between Seller and Buyer after Closing when actual tax amounts are available. This provision shall survive Closing.

B. If this sale of Buyer’s of the Property after Closing result in the assessment of additional taxes, penalties or interest for periods prior to Closing, such additional taxes, penalties or interest shall be the obligation of Buyer. If Seller’s change in use of the Property prior to Closing or denial of a special use valuation on the Property claimed by Seller results in the assessment of additional taxes, penalties or interest for periods prior to Closing such additional taxes, penalties or interest shall be the obligation of Seller, and such obligation shall survive Closing.

14. TITLE AND SURVEY APPROVAL

A. Seller shall deliver to Buyer within fifteen (15) days after the Effective Date a Commitment for Title Insurance (the “Commitment”) and legible copies of all recorded instruments affecting the Property and recited as exceptions in the Commitment (the “exception documents”). Buyer shall have twenty (20) days after receipt of the last of such Commitment, exception documents and the hereinafter described Survey to make written objections to any matter shown in or on such Commitment, exception documents or survey to Seller. Buyer’s failure to a object within the time provided shall be a waiver of the right to object. If Buyer makes objections to the Commitment within the specified time period, Seller shall have fifteen (15) days form the date Seller receives the objections to notify Buyer in writing of which objections, if any, Seller is willing to cure. If Seller fails to respond, or if Seller refuses to cure any or all of Buyer’s objections, or if Seller is unable to eliminate Buyer’s objections on or before the expiration of thirty (30) days after Seller’s receipt of Buyer’s written objections, then Buyer shall have five (5) days in which to notify Seller in writing that it does not which to proceed with the sale contemplated in this Contract, in which event this Contract shall terminate at Buyer’s option and the Earnest Money shall be refunded to Buyer, or Buyer may accept such title as Seller can deliver. If Buyer fails to timely notify Seller of its election to terminate this Contract in accordance with this Paragraph 14.A, Buyer will be deemed to have waived its objections. Those exceptions which Buyer is deemed to have accepted or waived or to which Buyer fails to object shall be the “Permitted Exceptions.”

B. No Abstract is to be furnished

15. DEFAULT:

A. In the event that performance of this Contract is tendered by Seller and the sale is not consummated through default on the part of Buyer at Closing, Seller as its sloe remedies, may terminate this Contract and receive the Earnest Money as liquidated damages, thereby releasing Buyer and Seller from this Contract, except for matter which expressly survive termination of this Contract as set out in this Contract.

B. If Seller is unable through no fault of its own, within the time required, to deliver the Commitment, Buyer may either terminate this Contract and receive the Earnest Money as the sole remedy or extend the time for performance of an additional fifteen (15) days and the Closing Date shall be extended as necessary.

C. If Seller fails to comply herewith for any other reason, Seller shall be in default, and Buyer as its sole remedies may terminate this Contract and receive the Earnest Money, thereby releasing Seller an Buyer from this Contract, except for matter which expressly survive termination of this Contract as set out in this Contract; or Buyer may obtain specific performance

of this Contract; or pursue any other legal remedy to which Buyer may be entitled.

16. ATTORNEY’S FEE: If Buyer, Seller or Escrow Agent is a prevailing party in any legal proceeding brought under or with relation to this Contract or transaction, such prevailing party shall be additionally entitled to recover court costs, reasonable attorneys’ fees and all other litigation expenses form the non-prevailing parties. This provision shall survive Closing or any termination of this Contract.

17. ESCROW: The Earnest Money is deposited with Escrow Agent with the understanding that Escrow Agent is not (a) a party to this Contract and does not assume or have any liability for performance or non-performance of any party to this Contract, (b) liable for interest on the funds held unless required in Paragraph 5 and (c) liable for any loss of escrow funds caused by the failure of any banking institution in which such funds have been deposited unless such banking institution is acting as Escrow Agent. If both parties make demand for the payment of the Earnest Money, Escrow Agent has the right to require from all parties a written release of liability of Escrow Agent which authorized the disbursement of the Earnest Money. If only one party makes demand for payment of the Earnest money, Escrow Agent shall give notice to the other party of such demand. Escrow Agent is authorized and directed to honor such demand unless the other party objects to Escrow Agent in writing within thirty (30) days after Escrow Agent’s notice has been forwarded to the other party. At Closing, the Earnest Money shall be applied first to any cash down payment, then to Buyer’s closing costs and any excess refunded to Buyer. Any refund or payment of the Earnest Money under this Contract shall be reduced by the amount of any actual expenses incurred on behalf of the party receiving the Earnest Money, and Escrow Agent shall pay the same to the creditor entitled thereto. Notices under this Paragraph 17 must be sent by certified mail, returned receipt requested. Notices to escrow agent are effective upon receipt by escrow agent.

18. SELLER’S REPRESENTATIONS, WARRANTIES AND COVENANTS:

18.01  Seller’s Representative and Warranties. Seller hereby represents and warrants to, and covenants with, Buyer as to the Effective Date and at Closing that:

(a) Seller is the legal fee simple titleholder of the Property and has good, indefeasible title to the Property free and clear of all liens, encumbrances, leases and agreements of any kind, except those exceptions of public record in Montgomery County, Texas (subject to the release of any such exceptions as is required pursuant to other provisions of this Contract).

(b) The Property is not under lease.

(c) There is no action, suit, proceeding or claim affecting the Property or any portion thereof or affecting Seller and relating to the

ownership, operation, use of, occupancy of, the Property pending, or being prosecuted in any court or by or before any federal, state, county, or municipal department, commission, board, bureau or agency or other governmental entity or, to the knowledge of Seller, is any such action, suit, proceeding or claim threatened or asserted.

(d) No attachments, executions, assignments for the benefit of creditors, receiverships, conservatorship or voluntary or involuntary proceedings in bankruptcy or pursuant to any other debtor relief law have been filed by or to the best of Seller’s knowledge are contemplated against Seller or the Property or are pending by or against Seller or the Property; and

(e) To the best of Seller’s knowledge, there are no parties in possession of any portion of the Property as lessees, tenants at sufferance, or trespassers.

(f) To the best of Seller’s knowledge, there are (i) no condemnation or similar proceedings or any assessments pending or threatened affecting the Property, or any part thereof; or (ii) no contemplated public improvements in, about, or adjacent to the Land pending, threatened or contemplated by any governmental authority.

(g) Seller has paid, through the current year, all taxes, charges, debts and other assessments due by the Seller with respect to the Property;

(h) Seller has received no written notice of any existing condition with respect to the Property or its operation which violates any governmental code regulation, law, statute ordinance; or any restrictive covenant.

(i) Except for City of Shenandoah, Texas, water and sewer tap fees, Seller is aware of no assessments by governmental agencies for matter already completed, including but not limited to, sewer, water lines and storm drainage systems completed prior to Closing, but which have not been assessed.

(j) There is no litigation affecting the Property, and there is no pending or threatened litigation.

18.02.  Agreements of Seller.

From the Effective Date until the Closing Date or earlier termination of this Contract, Seller shall:

(a) Keep, maintain, and repair the Property in substantially its current condition and comply with all regulations, ordinances and restrictions affecting the Property;

(b) Not enter into any written or oral service contract or other agreement with respect to the Property except in the ordinary course of business that will not be fully performed by Seller on or before the Closing Date, or that will not cancelable by Buyer without liability on or after the Closing Date, without the prior written consent of Buyer;

(c) Advise Buyer promptly of any litigation, arbitration, administrative hearing or legislation before any governmental body or agency or by or with any other party of which Seller becomes aware, concerning or affecting the Property, which is instituted or threatened before, on or after the Effective Date.

(d) Not take, or omit to take, any action that would have the effect of violating any of the representations, warranties, covenants, and agreements of Seller contained in this Contract.

(e) Not enter into any lease or other occupancy agreement affecting the Property without the prior written consent of Buyer.

(f) Not file any restrictive covenants or impose, by grant or otherwise, any deed restrictions affecting the Property without the prior written consent of Buyer.

19. USE CONDITIONS, UTILITIES AND FLOOD PLAIN:

Intentionally Deleted.

19. INSPECTION PERIOD:

A. BUYER’S RIGHT TO TERMINATE: Buyer may terminate this Contract for any reason, by giving written notice to Seller on or before ninety (90) days following the Effective Date of this Contract (the “Inspection Period”). Upon such termination, the Earnest Money and all interest earned thereon shall be refunded to Buyer, and such refund shall not be subject to satisfaction of any of the matters in Paragraph 20B below.

B. ENTRY ONTO THE PROPERTY: Buyer and Buyer’s agents and inspectors may enter the Property before Closing to inspect it, subject to the following:

(1) Buyer must deliver evidence to Seller that Buyer has insurance for its proposed inspection activities, in amounts and with coverages reasonably satisfactory to Seller;

(2) Buyer may not unreasonably interfere with existing operations or occupants of the Property, if any;

(3) Buyer must notify Seller in advance of Buyer’s plans to conduct tests so that Seller may be present during the tests;

(4) If the property is altered because of Buyer’s inspection, Buyer must return the Property substantially to its condition as of the Effective Date promptly after the alteration occurs;

(5) Buyer must deliver to Seller copies of all inspection reports that Buyer prepared or receives from third-party consultant or contractors within ten (10) days of their preparation or receipt; and,

(6) Buyer must abide by any entry rules reasonably imposed by Seller.

C. BUYER’S INDEMNITY OF SELLER: Buyer will indemnify, defend, and hold Seller harmless from any loss, attorney’s fees, expenses, or claims arising out of Buyer’s investigation of the Property, due to injury to persons or physical damage to Property, except for existing conditions discovered by Buyer’s inspection or due to the willful misconduct or negligence of Seller or Seller’s agents.

21. CONDITIONS PRECEDENT TO CLOSING:

Buyer shall not be obligated to perform under this Contract unless all the representations, warranties, covenants, and agreements of Seller contained in this Contract are true and correct in all material respects as of the Effective Date and the Closing, and unless Seller, on or prior to the Closing, has met, complied with, and performed in all material respects all conditions or agreements on its part required by this Contract.

If the condition precedent set out in the preceding paragraph has not been satisfied, where applicable, or waived by Buyer, the Buyer may, by giving written notice to Seller, terminate this contract on or before the Closing. On Buyer’s termination, the Earnest Money and any interest accrued thereon shall be immediately returned to Buyer by the Title Company. If the Earnest Money is properly returnable to Buyer, then Seller, shall, on written request from Buyer, promptly issue instructions necessary to cause the Title Company to return to Buyer the Earnest Money.

22. PROPERTY SURVEY:

SURVEY REQUIRED:

Within twenty (20) days after the Effective Date hereof, Seller shall cause to be delivered to Buyer, Seller and the Title Company at the expense of Seller a current survey of the Property, together with a metes and bounds or platted lot description, prepared by a Registered Professional Land Surveyor acceptable to the parties and the issuer of any Title Policy (the “Survey”). The surveyor shall certify to the Buyer, Seller and the Title Company that: (a) the Survey was made and staked on the ground and all corners are marked with permanent monuments; (b) the Survey shows the location of all improvements, highways, streets, roads, railroads, rivers, creeks or other waterways, fences, (and previous fences where there is evidence thereof on the ground), easements (visible and apparent easements as well as recorded easements), setback lines and rights-of-way on or adjacent to the Property with all easements and right-of-way referenced to their recording information; (c) there are no visible discrepancies, conflicts, or encroachments, except as shown on the survey plat; (d) the property does or does not lie in the 100-year Flood Plain, of if a portion lies within the Flood Plain, the Survey plat shall designate the location and area of the 100-year Flood Plain; (e) the survey is a true, correct, and accurate representation of the Property; (f) the Survey sets forth a metes and bounds description of the Property; and (g) that the Survey complies with the standards of a Category IA, Condition II survey as prescribed by the Texas Society of Professional Surveyors. If the legal description determined by the Survey differs from Paragraph 2 (or Exhibit “A” hereto), the survey description as approved by Buyer, Seller and the Title Company shall replace the description in Paragraph 2 and on Exhibit “A” hereto. The Surveyor shall certify the number of square feet contained within the Property after deduction for areas within the wetlands footage (as hereinafter defined), if any, the one hundred year flood plain as designated by the Federal Emergency Management Agency or the Army Corps of Engineers, if any, and any existing street, road, highway, easement, right-of-way building setback line imposed by plat or restrictive covenant and not imposed by ordinance or other law, statue or regulation, boundary dispute or encroachment on or affecting the Property (hereinafter referred to as “net square feet”).

Buyer, at its option and expense, may obtain a delineation of the wetlands on the Property, if any. The delineation must be approved in writing by the Army Corps of Engineers. The approved delineation must be made in such a manner that the delineated wetlands shall be reflected on the survey so that the surveyor preparing the survey is able to determine the number of square feet of the Property delineated as wetlands. The number of square feet of approved delineated wetlands is referred to as herein as “Wetlands Footage.” In the event that (i) Buyer does not obtain a delineation of wetlands on the Property approved by the Army Corps of Engineers on or before the expiration of the Inspection Period, or (ii) the approved delineation of wetlands obtained by Buyer indicates that there is no wetlands on the Property, or (iii) the approved delineated wetlands is not reflected on the survey so that the survey is able to determine the wetlands footage, then notwithstanding whether wetlands exist on the Property or not, there

shall be no deduction with respect to wetlands for purposes of determining net square feet.

If the total number of square feet of land deducted by the surveyor for purposes of determining net square feet exceeds twenty-six thousand (26,000.) square feet, then Buyer shall have the right to terminate this Contract by written notice to the other party in which event the Earnest Money shall be refunded to Buyer and the parties released from any further liability hereunder.

23. ASSIGNMENT: Buyer may not assign this Contract without the prior express written consent of Seller, which shall not be unreasonably withheld. Notwithstanding the foregoing, Buyer may assign this Contract to any of its wholly owned subsidiaries or affiliated companies without the consent of Seller.

24. “FOREIGN PERSON” FEDERAL TAX REQUIREMENT: Seller hereby states that is not a “foreign person” within the meaning of Section 1445 of the Internal Revenue Code.

25. NOTICES: All notices shall be in writing and shall be effective when mailed by certified mail return receipt requested to or delivered at or sent by facsimile transmission to the address shown below. Either party may change its address for notice by sending notice of such address change to other party in accordance with this Paragraph, and such change of address shall become effective 5 days after such notice is sent or delivered.

To Buyer:	Dynacq International, Inc.
	4301 Vista Road
	Pasadena, Texas 77504
	Telephone: 713-378-2000
	Facsimile: 713-378-3166
	Attn: Irvin Gregory
With a copy to:	Hal R. Gordon, Esq.
	1800 Bering, Ste 650
	Houston, Texas 77057
	Telephone: 713-974-0011
	Facsimile: 713-974-0096
To Seller:	Vision Park Joint Venture
	Attn: Jim Galloway
	P.O. Box 7856
	The Woodlands, Texas 77387-7856
	Telephone: 936-321-8880
	Facsimile: 936-321-8882

26. TIME FOR ACCEPTANCE: The execution of this Contract by the first party constitutes an offer to buy or sell the Property. Unless the other party accepts by 5:00 p.m., in the time zone in which the Property is located, on or before August 30, 2002 the offer will lapse and become null and void at Buyer’s option.

27. TIME FOR PERFORMANCE: Time is of the essence in this Contract and strict compliance with the times for performance is required. If the last day to perform under a provision of this Contract falls on a Saturday, Sunday, or legal holiday, the time for performance is extended until the next day which is not a Saturday, Sunday, or legal holiday.

28. AGREEMENT OF PARTIES: This Contract contains the entire agreement of the parties and cannot be changed except by their written agreement. This Contract supercedes any prior understanding or written or oral agreements between the parties respecting the within subject matter or concerning the Property. This Contract shall be binding upon the legal representatives, successors or permitted assigns of the parties. Addenda which are a part of this Contract are: Exhibit “A” Property Description

29. CONSULT YOUR ATTORNEY: This is intended to be a legally binding contract. READ IT CAREFULLY. If you do not understand the effect of any part of this Contract, consult you attorney BEFORE signing.

30. SURVIVAL: The covenants, agreements, representations and warranties made by Seller in this Contract shall survive the Closing hereunder.

31. SEVERABILITY AND VENUE: If any provision of this Contract is held to be illegal, invalid or unenforceable under present or future laws, such provision shall be fully serverable, and this Contract shall be construed and enforced as if such illegal, invalid or unenforceable provision has never comprised a part of the Contract. VENUE FOR ANY LEGAL ACTION ARISING OUT OF THIS CONTRACT SHALL BE IN MONTGOMERY COUNTY, TEXAS. This Contract is to be construed in accordance with the laws of the State of Texas.

32. FACSIMILE COPIES: The parties hereto agree that an executed facsimile copy of this Contract or an amendment thereto shall be binding on the party executing and delivering this Contract or any amendment thereto by facsimile copy.

33. COUNTERPARTS: If this Contract is executed in a number of identical counterparts each counterpart is an original and all counterparts, collectively, constitute one agreement.

34. CONDEMNATION: If before Closing, condemnation proceedings are commenced against any part of the Property, Buyer may:

A. terminate this Contract by providing written notice to Seller within 15 days after Buyer is advised of the condemnation proceedings and the Earnest Money will be refunded to Buyer; or

B. appear and defend in the condemnation proceedings and any award will, at Buyer’s elections, belong to:

(1) Seller and the Purchase Price will be reduced by the same amount; or

(2) Buyer and the Purchase Price will not be reduced.

35. INDEPENDENT CONSIDERATION:

Contemporaneously with the execution of this Contract, Buyer hereby delivers to Seller a check in the amount of $100.00 (“Independent Consideration”) which amount has been bargained for and agreed to as consideration for Buyer’s exclusive option to purchase the Property and for Seller’s execution and delivery of this Contract. The Independent Consideration is in addition to and independent of any other consideration or payment.

BUYER : Dynacq International, Inc.
By:	/s/    IRVIN T. GREGORY
Name:	Irvin T. Gregory
Title:	EVP Development
Date:	08-29-2002

SELLER: VISION PARK JOINT VENTURE
By:	/s/    JIM GALLOWAY
Name:	Jim Galloway
Title:	President
Date:	8-30-2002

EX-10.5

Exhibit 10.5

SECOND AMENDMENT TO UNIMPROVED COMMERCIAL PROPERTY EARNEST MONEY CONTRACT

This Second Amendment to Unimproved Commercial Property Earnest Money Contract (“Second Amendment”) dated as of December 4, 2002, is entered into between Vision Park Joint Venture (“Seller”) and Dynacq International, Inc. (“Buyer”).

A. Buyer and Seller have entered into an Unimproved Commercial Property Earnest Money Contract, the effective date of which is August 30, 2002 (“Agreement”), with respect to the purchase and sell of certain real property more fully described in the Agreement (the “Property”).

B. The Agreement originally called for the Buyer to purchase 6.00 acres, more or less, as described on the exhibit attached as Exhibit “A” to the Agreement. The Buyer has requested and the Seller has agreed, that the Buyer shall purchase 4.00 acres, more or less, not 6.00 acres.

C. In consideration of $10.00 and other good valuable consideration, the Agreement is hereby amended to provide hat the Exhibit “A” attached hereto, describing 4.00 acres of land, is hereby replaced as a description of the Property to be sold under the Agreement.

D. Except as expressly amended hereby, the Agreement and all rights and powers created thereby or hereunder remain in full force and effect.

E. Signatures hereon by facsimile transmission shall be considered as original.

SELLER:
VISION PARK JOINT VENTURE
By:	/s/    JIM GALLOWAY, PRESIDENT

BUYER:
DYNACQ INTERNATIONAL, INC.
By:	/s/    CHANTELL PRESTON, VICE PRESIDENT OF DEVELOPMENT

EX-10.6

Exhibit 10.6

GENERAL WARRANTY DEED

(Cash)

THE STATE OF TEXAS	§
	§	KNOW ALL MEN BY THESE PRESENTS:
COUNTY OF MONTGOMERY	§

THAT THE UNDERSIGNED, Vision Park Joint Venture, hereinafter referred to as “Grantor,” whether one or more, for and in consideration of the sum of TEN DOLLARS ($10.00) cash, and other good and valuable consideration in hand paid by the Grantee, herein named, the receipt and sufficiency of which is hereby fully acknowledged and confessed, has GRANTED, SOLD and CONVEYED, and by these presents does hereby GRANT, SELL and CONVEY unto Vista Land and Equipment, L.L.C., herein referred to as “Grantee,” whether one or more, the real property described as follows:

4.000 acres of land situated in the William McDermott Survey, Abstract Number 389, Montgomery County, Texas, being a portion of Restricted Reserve “A” of Vision Park Three, a subdivision as shown on map or plat recorded under Cabinet R, Sheets 37 and 38 of the Montgomery County Map Records, said 4.000 acres of land being more particularly described by metes and bounds on Exhibit “A” attached hereto and made a part hereof.

This conveyance, however, is made and accepted subject to any and all validly existing encumbrances, shown on the attached Exhibit “B”.

TO HAVE AND TO HOLD the above described premises, together with all and singular the rights and appurtenances thereto in anywise belonging unto the said Grantee, Grantee’s heirs, executors, administrators, successors and/or assigns forever; and Grantor does hereby bind Grantor, Grantor’s heirs, executors, administrators, successors and/or assigns to WARRANT AND FOREVER DEFEND all and singular the said premises unto the said Grantee, Grantee’s heirs, executors, administrators, successors and/or assigns, against every person whomsoever claiming or to claim the same or any part thereof.

Current ad valorem taxes on said property having been prorated, the payment thereof is assumed by Grantee.

EXECUTED this 9^th day of December, 2002.

VISION PARK JOINT VENTURE A Texas joint venture
By:	VISION REAL ESTATE & DEVELOPMENT, INC. A Texas Corporation, Joint Venturer
By:	/s/    Jim Galloway
	Jim Galloway, President

Grantee’s Address:

THE STATE OF TEXAS	§
	§
COUNTY OF HARRIS	§

The foregoing instrument was acknowledged before me on the 9th day of December, 2002, by Jim Galloway, President of Vision Real Estate & Development, Inc., Joint Venturer of Vision Park Joint Venture, on behalf of said joint venture.

/s/    Ann D. Golbraith

Notary Public, State of Texas

My Commission Expires:                 illegible                

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GF No.: 02150584

EXHIBIT “A”

4.000 acres of land situated in the William McDermott survey, Abstract Number 389, Montgomery County, Texas, being a portion of Restricted Reserve “A” of Vision Park Three, a subdivision as shown on map or plat recorded under Cabinet R, Sheets 37 and 38 of the Montgomery County Map Records, said 4.000 acres of land being more particularly described by metes and bounds as follows:

BEGINNING at a 5/8 inch iron rod with cap found in the Southerly right-of-way line of Vision Park Boulevard (80 foot right-of-way) for the Northwesterly corner of Commercial Reserve “E” of Vision Park One Replat, a subdivision as shown on map or plat recorded under Cabinet Q, Sheets 128 and 129 of the Montgomery County Map Records and the most Northerly Northeast corner of said Restricted Reserve “A” of Vision Park Three;

Thence, S 00° 18’ 18” E, along the Westerly line of said Commercial Reserve “E”, a distance of 326.14 feet to a 3/8 inch iron rod found for the Southwesterly corner of said Commercial Reserve “E”;

Thence, N 89°34’ 39” E, along the Southerly line of said Commercial Reserve “E”, a distance of 38.00 feet to a 5/8 inch iron rod with cap set for the Northwesterly corner of that certain called 5.5062 acres of land as described in deed and recorded in the Official Public Records of Real Property of Montgomery County, Texas, under County Clerk’s File Number 9727855;

Thence, S 00°46’ 20” E, along the Westerly line of said 5.5062 acres, a distance of 192.41 feet to a 5/8 inch iron rod with cap set for the Southwesterly corner of said 5.5062 acres and the Northwesterly corner of that certain called 5.9875 acres of land as described in deed and recorded in the Official Public Records of Real Property of Montgomery County, Texas, under County Clerk’s File Number 9333767;

Thence, S 01°02’ 44” E, along the Westerly line of said 5.9875 acres, a distance of 7.29 feet to a 5/8 inch iron rod with cap set for corner;

Thence, S 89°31’ 33” W, a distance of 471.48 feet to a 5/8 inch iron rod with cap set for corner;

Thence, N 00°44’ 49” W, a distance of 202.80 feet to a 5/8 inch iron rod with cap set in the Southeasterly right-of-way line of said Vision Park Boulevard;

Thence, N 48°46’ 28” E, along the Southeasterly right-of-way line of said Vision Park Boulevard, a distance of 403.31 feet to a 5/8 inch iron rod with cap found for a point of curvature to the right;

Thence, in a Northeasterly direction, continuing along the Southeasterly right-of-way line of said Vision Park Boulevard, with said curve to the right having a central angle of 31°41’ 49”, a radius of 260.00 feet, an arc length of 143.84 feet, a chord bearing of N 64°37’ 22” E and a chord distance of 142.01 feet to the POINT OF BEGINNING and containing 4.000 acres of land.

Exhibit A, Page 1

EXHIBIT “B”

Special Exceptions

1. A landscape buffer and utility easement 10 feet wide along the northwest portion (front) of subject property, as reflected by the recorded plat.

2. A drainage easement 30 feet wide along a portion of the east property line, as reflected by the recorded plat.

3. A right-of-way easement being 10 feet in width along the east side property line, granted to Entergy Gulf States, Inc. as described in instrument recorded under Montgomery County Clerk’s File No. 2002-061409.

4. An easement for drainage purposes extending a distance of 15 feet on each side of the center line of all natural water courses, as reflected by the recorded plat.

5. ½ of all oil, gas, and other minerals, the royalties, bonuses, rentals and all other rights in connection with same are excepted herefrom as set forth in instrument recorded in Volume 839, Page 882 of the Deed Records of Montgomery County, Texas. Title to said interest not checked subsequent to date of aforesaid instrument.

6. Mineral Lease dated January 15, 1990, executed by David H. Johnston and wife, Pauline Johnston, Lessor to El Tres Exploration, Inc., Lessee, recorded under Montgomery County Clerk’s File No. 9018676. Title to said interest not checked subsequent to date of aforesaid instrument.

Waiver of surface rights contained therein.

7. Building set back line of 25 feet along the northwest portion (front) of subject property, as set out on the recorded plat.

8. Building set back line of 10 feet along the rear (South) property line and 5 feet in width along both side property lines (east and west), as set out on the dedication of the recorded plat.

9. City of Shenandoah Annexation Ordinance No. 0-01010, as certified and described in instrument recorded under Montgomery County Clerk’s file No. 2001-051351.

10. Affidavit of no unrecorded leases or rental agreements with rights of tenants in possession, recorded under Montgomery County Clerk’s File No. 2001-031677.

11. All oil, gas and other minerals, the royalties, bonuses, rentals and all other rights in connection with same are excepted herefrom as set forth in instrument filed for record under County Clerk’s File No(s) 2001-031665 of the Official Public Records of Real Property of Montgomery County, Texas. Title to said interest no checked subsequent to date of aforesaid instrument.

Waiver of surface rights contained therein.

Exhibit B, Page 1

12. Road easement 20 feet in width located over and across subject property as shown on map recorded in Cabinet R, Sheets 37 and 38 of the Map Records of Montgomery County, Texas.

Exhibit B, Page 2

EX-10.7

Exhibit 10.7

HOSPITAL PROGRAM MANAGEMENT AGREEMENT

This Hospital Program Management Agreement (this “Agreement”) is entered into this 15^th day of November, 2002, but effective the 15^th day of November, 2002, (the “Effective Date”) by and between Doctor’s Practice Management, Inc., a Texas corporation (hereinafter referred to as the “DPM”), and Vital Weight Control, Inc., a Texas corporation (hereinafter referred to as “Manager”).

W I T N E S S E T H

WHEREAS, DPM desires to operate a gastroplasty or stomach stapling program involving surgical intervention for morbid obesity through gastric bypass with Roux-en-Y gastroenterostomy, silastic ring gastroplasty, and all related, consequential and incidental surgical procedures, including gall bladder removal (the “Program” or the “Gastroplasty Program”) using an interdisciplinary approach for the treatment of morbidly obese patients at its facilities known as Vista Community Medical Center, located in Pasadena, Texas, and Vista Hospital of Baton Rouge, located in Baton Rouge, Louisiana (the “Initial Hospitals^”) and at such additional DPM affiliated hospital facilities as shall be subsequently implemented as provided herein (the “Additional Hospitals”) (the Initial Hospitals and the Additional Hospitals shall individually referred to herein as a “Hospital” and shall collectively be referred to herein as the “Hospitals”); and,

WHEREAS, Manager is in the business of managing, marketing and clinical coordination of Gastroplasty Programs (other than patient medical care) for the treatment of morbid obesity through the use of gastroplasty or stomach stapling; and

WHEREAS, DPM is seeking to contract the services of Manager to manage, market and coordinate this Gastroplasty Program (EXCEPT FOR THE RENDERING OF INPATIENT AND OUTPATIENT HOSPITAL SERVICES DIRECTLY TO THE PATIENT WHICH SHALL REMAIN THE SOLE RESPONSIBILITY OF THE HOSPITAL AT ALL TIMES) in accordance with the management goals of the Program outlined in Exhibit A hereto (the “Program Goals”); and

WHEREAS, Manager and Vista Community Medical Center, an affiliate of DPM, have in effect as of the Effective Date hereof an Agreement, dated May 15, 2001, pursuant to which Manager manages the Program at the DPM hospital in Pasadena, Texas, and it is the intent of the parties hereto that such agreement be terminated as of the Effective Date hereof and replaced with this Agreement; and

WHEREAS, the parties to this Agreement desire to enter into this Agreement in order to provide a full statement of their respective responsibilities in connection with the operation of the Program during the term of this Agreement.

NOW, THEREFORE, in consideration of the above recitals, the terms and conditions hereinafter set forth, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:

1. DIRECTOR OF PROGRAM

Manager shall provide a qualified individual to serve as the program director of the Program (the “Director”) and to operate the Program in a manner consistent with the philosophy of the Administration of the Hospitals (“Administration”); provided, however, that DPM must give prior written approval of the Director that Manager provides unless the Director is Diane Crumley. Manager employs and will provide the services stated herein through Director who agrees to serve as the Director and who agrees to oversee the provision of services hereunder, including but not limited to the services set forth in Section 2.1 hereof.

2. MANAGER’S DUTIES AND RESPONSIBILITIES TO HOSPITALS

2.1. Services

For the benefit of the Hospitals and the Program, Manager will perform the following specific responsibilities, either directly or through an affiliate of Manager, subject to the general oversight and direction of each Administration:

(a) Work with the Administration to manage, design, develop, plan, implement, and evaluate specific Program marketing, services, policies, and procedures to carry out the Program Goals;

(b) Work with other Hospital personnel and departments to ensure that Program philosophy is adhered to and non-medical services are provided according to established policies and procedures;

(c) Establish procedures as part of the Hospitals’ overall patient care evaluation program, to evaluate the consistency and quality of all non-medical services provided in the Program;

(d) Assist the Administration as reasonably required by the Administration, in the performance of utilization review and cost containment functions relating to the Program;

(e) Prepare and submit to the Administration or to the Hospitals’ Medical Staff all reports of activities of the Program, as such reports may reasonably be requested by the Administration or the Medical Staffs and analyzing and interpreting such reports as reasonably requested;

(f) Maintain continuous liaison with the Administration in regard to patient care, professional conduct, coordination of Hospital personnel and development of clinical or other research projects relating to the Program;

(g) Provide such technical advice and assistance as may reasonably be requested by the Administration to facilitate Program implementation and/or expansion;

(h) Conduct the Program in a cost efficient and effective manner, subject to budgetary systems and constraints established by the Administration, and otherwise assist the Administration in containing Program costs;

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(i) Participate, as reasonably requested by the Administration, in the preparation of operating and capital budgets for the Program (including projections of both revenues and expenditures);

(j) Use best efforts to elevate the standing of Hospitals and the Medical Staffs with respect to services provided in the Program by publication of unusual or interesting studies made in the Program;

(k) Initiate new procedures of demonstrated value, and carry out original studies with respect to services provided in the Program;

(l) To cooperate in the furtherance of teaching and educational functions of the Hospitals and the Medical Staff;

(m) Participate in the development and presentation of programs related to the marketing of the Program’s services and enhancing the Hospitals’ community relations;

(n) Assist in the design and development of patient information forms, medical record forms, and consent forms for use in the Program including allowing the Hospitals the use during the term of this Agreement of Manager’s copyrighted forms;

(o) Screen patients before Admission to the Program in accordance with the Hospital’s final screening policies and procedures, including insurance precertification;

(p) Undertake activities, as authorized by the Administration, involving professional contracts with physicians, hospitals, public health agencies, nursing associates, and state and local medical societies in order to apprize such individuals and groups of the nature and availability of the Program and facilities of Hospitals and to facilitate the exchange of information with regard to the Program, patient care, administration, medical policy, and utilization review (it being provided, however, that Manager shall have no authority to bind Hospitals to any contract nor incur debt on behalf of Hospitals); and

(q) Assist the Administration in representing the Program before the medical staff, as necessary.

(r) Assist Hospitals in providing support services to surgeons providing care to Program patients.

2.2. Program Advertising and Marketing

Manager shall be responsible, at its expense, for developing and placing all advertising for the Program with the media. The content of the advertising shall be subject to DPM’s prior review and approval; provided, however, that if DPM fails to respond to a request for approval of advertising content within ten (10) business days, the approval of DPM shall be deemed to have been given. Manager shall retain ownership and any other rights with respect to advertising and marketing materials for the Program.

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2.3. Time and Efforts Requirements

Manager and its appointed Director shall devote sufficient time and their best efforts to fulfilling the responsibilities of the Program as set forth in this Agreement such as to permit ample time for the performance of all of the duties normally associated therewith, to meet the needs of the Program and Hospital, and to perform duties and conduct the Program in accordance with the provisions of Section 2.1. In performing the management duties under this Agreement, Manager shall use its best efforts to perform each of its duties in a competent and timely fashion. In the event that Manager has engaged third parties to perform one or more services contemplated hereunder under the supervision of Manager, Manager shall use its best efforts to cause such third parties to deliver each service in a competent and timely fashion. Nothing contained in this Agreement shall be construed to constitute Manager as a guarantor with respect to any obligations of DPM or the Hospitals or with respect to the profitability of the Program or the Hospitals.

2.4. Standards of Practice and Compliance with Laws

Manager and its appointed Director as well as all of its other employees and subcontractors shall perform their duties under this Agreement and conduct the Program in accordance with (i) applicable federal and state statutes and regulations, (ii) standards and recommendations of the Joint Commission on Accreditation of Healthcare Organizations, (iii) Medical Staff Bylaws, (iv) Rules and Regulations of the Hospital and the Medical Staff, and (v) the policies of Hospital, the Medical Staff, and the Program as may be in effect from time to time. It is specifically agreed and understood any remuneration of Manager’s employees or subcontractors based directly or indirectly on the volume or value of the business generated for a Hospital is strictly prohibited.

2.5. License to Use Name

During the term of this Agreement, Manager shall provide to DPM a limited license for the use of the name “NeWeigh” as may be necessary for each Hospital^’s operation of the Program. Such use shall at all times be subject to the prior written approval of Manager. Upon the expiration or termination of this Agreement for any reason, such license shall immediately cease, and DPM shall have no further rights to use the NeWeigh name or any NeWeigh materials.

3. INDEPENDENT CONTRACTOR

In the performance of this Agreement, it is mutually understood and agreed that Manager and its employees, including its appointed Director, are at all times acting and performing as an independent contractor and not as an employee, joint venturer, agent, partner or lessee of DPM or Hospitals. Neither DPM nor Hospitals shall exercise any control or direction over the specific methods by which Manager and Director perform their services hereunder; the sole interest and responsibility of DPM and Hospitals shall be to ensure that the services covered by this Agreement are rendered in accordance with the terms and conditions hereof. Manager and its personnel shall not have any claim under this Agreement or otherwise against DPM or Hospitals for Worker’s Compensation, unemployment compensation, vacation pay, sick leave,

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retirement benefits, social security benefits, disability insurance benefits, unemployment insurance benefits, or other employee benefits, all of which shall be the sole responsibility of Manager. DPM shall not withhold on behalf of Manager or any of its personnel any sums for income tax, unemployment insurance, Social Security, or otherwise pursuant to any law or requirement of any government agency, and all such withholding, if any is required, shall be the sole responsibility of Manager. Manager shall indemnify and hold harmless DPM and each of the Hospitals from any and all loss or liability, if any, arising with respect to any of the foregoing benefits or withholding requirements.

4. DPM’S DUTIES AND RESPONSIBILITIES TO MANAGER

4.1. Services and Facilities

(a) At all times during the term of this Agreement, DPM shall either furnish, at its expense, or reimburse Manager amounts it expends for the performance of Manager’s responsibilities hereunder, such as fully built out office space, facilities, equipment, utilities, furniture, fixtures, office supplies, and other services as may be reasonably required to operate the Program at each Hospital. To the extent possible, Manager shall make all purchases through DPM or its affiliates. Any purchases of any nature made by Manager not utilizing DPM’s or its affiliates’ purchasing departments shall require the prior written approval of DPM if the purchase exceeds $2,500. If written approval or disapproval is not received within ten (10) business days of Manager’s written request, then, in such event, DPM’ s approval shall be deemed given.

(b) Manager will be responsible for providing, at its expense, the computer software to be used by the Program. Notwithstanding the foregoing, Manager may agree to allow DPM to utilize certain items of equipment, furniture, and computers for the benefit of the Programs, as set forth on Exhibit B hereto. In the event that Exhibit B is not attached hereto at the time of execution of this Agreement, DPM and Manager agree to complete and sign Exhibit B within 30 days of the execution of this Agreement. Exhibit B may be modified from time to time by mutual agreement of the parties. Manager shall provide such items at its expense, provided that DPM shall be responsible for any required maintenance and repair. Upon the termination of the Program at any location or the expiration or termination of this Agreement for any reason, DPM shall incur the cost to return Manager’s property to a location to be identified by Manager in Houston, Texas.

(c) In the event that Manager and DPM agree to offer the Program at Additional Hospitals, Manager will assist DPM in developing, budgets and related financial information concerning the operation of such Programs.

4.2. Exclusivity

(a) DPM represents and agrees that during the term of this Agreement Manager shall have the exclusive right to provide Program services for DPM, its affiliates, and subsidiaries.

(b) Manager represents and agrees that, during the term of this Agreement, it will not provide Program services for gastroplasty patients for any hospital located within

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(i) Harris, Ft. Bend, Montgomery, and Brazoria Counties, Texas, as long as the Pasadena Hospital Program is in effect, or (ii) the Louisiana state parishes listed on Exhibit C hereto as long as the Baton Rouge Hospital Program is in effect. In addition, Manager agrees that, during the term of this Agreement, if an Additional Hospital Program is implemented under this Agreement, Manager will not provide Program services for gastroplasty patients for any hospital located within twenty-five (25) miles of such Additional Hospital; provided, however, that such restriction shall not be applicable if Manager has a program in place in that geographic area prior to the addition of the new Program hereunder. Provided further, that the restrictions contained in this subparagraph shall not be applicable when (a) a Hospital does not belong to a patient’s plan and the patient either does not have out of network benefits or is unwilling to use out of network benefits, or (b) for any other reason, a Hospital is unable to accommodate a particular patient shall be excluded from the terms of this provision.

4.3. Compensation

(a) As compensation for the services rendered by Manager pursuant to this Agreement for the Initial Hospitals, DPM shall pay as a Program management fee the following monthly amounts, due and payable, in advance, on the 15^th day of each and every month:

Month One	$	322,500.00
Month Two	$	337,500.00
Month Three	$	352,500.00
Month Four and Remainder of Term	$	375,000.00

The payment for Month One shall be due upon the execution of this Agreement. In the event that the effective date hereof is other than the 15^th of the month, the compensation for such period preceding the 15^th of the month shall be prorated, based on the Month One amount, for the days between the effective date hereof and the next following 15^th of the month, and shall be payable together with the Month One compensation at the time of execution of this Agreement.

The parties hereby stipulate that the Program management fees represent fair consideration for the services provided by Manager with respect to the Program. Time is of the essence for the terms of this Section 4.3.

(b) Notwithstanding the provisions of paragraph (a) above, in the event the term of this Agreement is extended pursuant to Section 5.2 hereof, the parties will use their best efforts to mutually agree with respect to the monthly fee to be paid pursuant to paragraph (a) above for any months extending beyond the Initial Term (as defined below).

(c) During the Initial Term hereof, DPM shall have the option to expand the Program to up to three (3) Additional Hospitals subject to the same terms and conditions set forth herein with respect to the Initial Hospitals In the event that DPM desires to so expand, the monthly management fee shall increase by $187,500.00 for each Additional Hospital, payable as set forth above; provided, that if any such Additional Hospital is located outside a radius of 500 miles from Houston, Texas, then the parties will mutually agree upon an additional reasonable

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travel allowance to be paid to Manager. Any such agreement with respect to Additional Hospitals shall be made in writing, executed by both parties, and constitute an addendum to this Agreement.

4.4. Books and Records

(a) Manager recognizes that the Centers for Medicare & Medicaid Services (CMS) require that persons and entities that provide services to the health care providers maintain records reflecting the costs associated with such services. Therefore, Manager agrees to allow the Comptroller General of the United States, the Department of Health and Human Services, and their duly authorized representatives access to books, documents and records until the expiration of four (4) years after the services are furnished under this Contract. The types of records covered by this clause, the persons entitled to access, and the manner of which the records may be requested and reproduced shall be governed by 42 C.F.R. 420.300-420.304, as amended from time to time (the “Regulations”). The sole purpose of this Section 4.4 is to comply with the Regulations. This Section 4.4 shall not be interpreted to require Manager to provide access to its records or to any persons or entities, other than those set forth in the Regulations. Subsequent amendments to or repeal of the Regulations shall be deemed to govern the obligations created in this paragraph as of the effective date of amendment or repeal. Upon written request of the Secretary of Health and Human Services or the Controller General or any of their duly authorized representatives, Manager shall make available to the Secretary those contracts, books, documents and records necessary to verify the nature and extent of the cost of providing his or her services. If Manager carries out any of the duties of this Agreement through a subcontract with a value of Ten Thousand ($10,000.00) Dollars or more over a twelve (12) month period with a related individual or organizations, Manager agrees to include this requirement in any such subcontract. This section is included pursuant to and is governed by the requirements of Section 1861(v)(1) of the Social Security Act and regulations promulgated thereunder. The parties agree that any attorney-client, accountant-client or other legal privileges shall not be deemed waived by virtue of this Agreement.

(b) Upon reasonable notice to DPM, Manager shall be entitled to examine the books and records of each Hospital as they relate to charges and revenues received attributable to the efforts of Manager and the Program.

(c) The parties acknowledge that the compliance date for the Privacy Regulations issued pursuant to the federal Health Insurance Portability and Accountability Act is April 14, 2003. The parties agree to follow any procedures and enter into any agreements required by the Privacy Regulations.

4.5. Covenants of DPM

DPM covenants and agrees as follows:

(a) Hospitals shall secure one or more board eligible or certified surgeons to perform all surgical procedures associated with the Gastroplasty Program, which surgeon(s) has been qualified and accepted by the appropriate Hospital’s Medical Staff Credentialing Committee.

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(b) Hospitals shall promptly advise Manager of any material changes in their screening and financial policies and procedures.

(c) In the event that any one or more of the surgeons associated with the Gastroplasty Program have any financial relationship with DPM, an affiliate of DPM, or a Hospital, whether through ownership or compensation, DPM represents that it will not make any distributions or pay any compensation to any such surgeon based upon the volume or value of the surgeon’s referrals or admission of patients, including Gastroplasty Program patients, to any Hospital.

5. TERM AND TERMINATION

5.1. Term

The term of this Agreement shall commence upon the Effective Date and shall continue in effect for a period of thirty-six (36) months thereafter (“Initial Term”), unless terminated sooner or extended pursuant to the terms of this Agreement. At any time during the ninety (90) day period preceding the expiration of this Agreement, this Agreement may be renewed, upon the mutual written agreement of DPM and Manager, for an additional thirty-six (36) month period, unless terminated sooner pursuant to the terms of this Agreement.

5.2. Extended Term

In the event that one or more Programs are implemented at Additional Hospitals within the first eighteen (18) months of the Agreement, pursuant to Section 4.3(c), then the term of this Agreement shall continue in effect for a period of thirty-six (36) months from the date that the latest of any such additional Programs are commenced (the “Extended Term”); provided, however, that this Agreement shall automatically terminate at the end of the Initial Term if the parties are unable to mutually agree to the compensation to be paid Manager for the Extended Term pursuant to Section 4.3(b) hereof.

5.3. Grounds for Termination

(a) In the event of a material breach of this Agreement by either party, the other party shall have the right to terminate this Agreement by service of written notice upon the defaulting party (the “Default Notice”). In the event such breach is not cured within thirty (30) days after service of the Default Notice, this Agreement shall automatically terminate at the election of the non-defaulting party upon the giving of a written notice of termination to the breaching party not later than thirty (30) days after the service of the Default Notice.

(b) In the event of the nonpayment by DPM of any amounts due hereunder on the due date thereof, Manager shall have the right to terminate this Agreement by service of written notice upon DPM. In the event such breach is not cured within ten (10) days after service of such notice, this Agreement may be immediately terminated by Manager.

(c) The termination of this Agreement or the decision to terminate a Program at a particular Hospital may be made at any time by mutual consent embodied in a written agreement signed by an authorized representative of each of the parties hereto.

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(d) In addition, either party may terminate this Agreement immediately at any time upon the happening of any of the following occurrences or acts:

(i) Either party ceases to function as a going concern or conduct its operations in the normal course of business;

(ii) The (a) suspension, liquidation or dissolution, or notice thereof, of substantially all of a party’s usual business without the prior written consent of the other party hereto, (b) an assignment by a party for the benefit of its creditors, or (c) in the event of the filing of a voluntary or involuntary petition under the provisions of the U.S. Federal Bankruptcy Act or amendments thereto, or any application for or appointment of a receiver for the property of a party, the filing of which remains unsatisfied and discharged at the end of sixty (60) days after the occurrence of such event;

(iii) Either party, without the other party’s prior written consent, attempts to partially or wholly assign its rights or delegate its duties under this Agreement;

(iv) Either party is convicted of any illegal activity which could, in the reasonable opinion of the other party, jeopardize or adversely affect the business reputation of the other party; or

(v) Either party is prevented from substantially performing its obligations under this Agreement by any applicable law enacted or by any applicable order, rule, regulation, decree or ordinance promulgated by any appropriate governmental authority.

(e) In the event any of the following occur with respect to a particular Hospital, either party may terminate this Agreement immediately with respect to the provision of the Program at such Hospital:

(i) In the event of a Hospital’s failure to maintain professional liability insurance coverage on its own operations, as required pursuant to Section 6.1 hereof, and Hospital fails to cure such failure within ten (10) days of Hospital losing its insurance coverage; or

(ii) If any of the Hospital’s applicable licenses, permits, or certifications from any person, entity, or agency, including, but not limited to, any state agency, federal agency, or any other agreement, which is essential for the operation of the Hospital, is at any time suspended, terminated, or revoked and is not fully reinstated within ninety (90) days.

(f) DPM shall have the unilateral right to terminate a Program at any Hospital at any time by giving Manager written notice of such termination, which notice shall state the date of termination. Notice of termination shall not be effective until payment to Manager in the amount of $1,125,000.00 for each Program location that DPM wishes to terminate.

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(g) In the event that certain Guaranty agreement, effective concurrent with the effective date hereof, pursuant to which Dynacq International, Inc. guarantees the obligations of DPM hereunder, is not properly executed and delivered to Manager within seven (7) days of the effective date hereof, Manager may immediately terminate this Agreement with written notice to DPM.

5.4. Effects of Termination

The expiration or earlier termination of this Agreement shall not release or discharge either party from any obligation, debt or liability which shall have previously accrued and remain to be performed upon the date of such expiration or termination. Upon expiration or termination of this Agreement or a Hospital Program, Manager shall retain the right to any telephone or facsimile numbers used by the Program. In addition, Manager shall have the right to assume the lease for any office space in which the Program has operated that is not in a building owned or operated exclusively by DPM or an affiliate.

6. INSURANCE AND INDEMNIFICATION

6.1. Insurance.

At all times during the term of this Agreement and for a period of three (3) years following the termination or expiration of this Agreement for any reason, DPM shall maintain or cause to be maintained, at its expense, professional liability coverage for Manager and its affiliates, for services furnished during the term of this Agreement, in such amounts and under such terms of coverage as DPM shall provide for Hospitals’ operations and activities. NeWeigh will furnish DPM information necessary for DPM to obtain insurance for NeWeigh. During the term of this Agreement, DPM shall also maintain or caused to be maintained professional liability coverage, including through a self-insurance plan, on the Hospitals’ and their personnel and operations. In the event that any of the Hospitals should receive notice of the impending termination of its professional liability coverage, DPM shall immediately provide notice thereof to NeWeigh.

6.2. Indemnification

DPM hereby agrees to indemnify, defend, and hold Manager, its shareholders, directors, officers, employees, and affiliates (the “Indemnified Parties”) free and harmless from and against any and all liability, loss, damage, claim, or cause of action (whether or not well-founded) (collectively, “Claims”), including reasonable attorney’s fees and costs, which may result from (i) any act or omission of DPM, Hospitals, their employees, contractors, or agents arising or otherwise related to this Agreement, and (ii) any other Claim against the Indemnified Parties that arises as a result of Manager’s operation of the Programs on behalf of Hospitals, including but not limited to, claims arising under the Texas Deceptive Trade Practices Act. To be entitled to such indemnification, the Indemnified Party shall give DPM prompt written notice of any assertion by a third party of any claim with respect to which the Indemnified Party might bring a claim for indemnification hereunder, and, in all events, must supply such written notice to DPM within the applicable period for defense of such claim. The Indemnified Party may elect to retain and direct the actions of legal counsel of its own choosing, the expense of which shall

10

be borne by DPM, provided that the hourly rate for such counsel shall not exceed $300.00 per hour. The right to indemnification conferred herein shall include the right to be paid or reimbursed by DPM the reasonable expenses incurred by the Indemnified Party if it is or is threatened to be made a named defendant or respondent in any proceeding in advance of the final disposition of the proceeding and without any determination as to the Indemnified Party’s ultimate entitlement to indemnification.

Notwithstanding the foregoing, Manager or any Indemnified Party shall not be entitled to any indemnification under this section for Claims arising out of Manager’s or any Indemnified Party’s negligence, willful misconduct, or criminal acts (collectively, “Manager Acts”) in their provision of services or products under this Agreement. Provided, however, that DPM shall defend Manager or an Indemnified Party with respect to any Claim, including potential Manager Acts, and, if a court determines that Manager or an Indemnified Party has committed a Manager Act, then Manager will reimburse DPM for all costs it has incurred to defend Manager or an Indemnified Party. Provided, further, that DPM shall not be required to indemnify or defend Manager or an Indemnified Party. if the Claim is brought only against Manager or an Indemnified Party, and not against DPM, its affiliates, a Hospital, or a physician practicing at a Hospital, and the Claim does not relate in any manner to a situation in which medical malpractice may be an issue.

7. NON-SOLICITATION

7.1. By Manager.

During the term of this Agreement, or the term of this Agreement as extended, and for a twelve (12) month period commencing on the date of the expiration or earlier termination of this Agreement, Manager shall not, without the prior written consent of DPM, employ or contract with, or solicit for employment or contract, any employee or independent contractor of DPM or any affiliate (other than persons who were employees of or had a contract with Manager immediately prior to their employment by or contract with DPM or an affiliate and other than persons recruited by Manager and placed in the employment of DPM or an affiliate by Manager) to provide services similar to those provided in this Agreement. Manager acknowledges that a breach of this Section 7.1 by Manager will result in irreparable injury to DPM, the precise amount of which is not readily ascertainable in monetary damages, and that DPM, in addition to any other remedies, shall be entitled to injunctive relief.

7.2. By DPM

During the term of this Agreement, or the term of this Agreement as extended, and for a twelve (12) month period commencing on the date of the expiration or earlier termination of this Agreement, neither DPM, Hospitals, nor any affiliate (the “Non-Soliciting Parties”) thereof shall, without the prior written consent of Manager employ or contract with, or solicit for employment or contract, any employee or independent contractor of Manager to provide services similar to those provided in this Agreement (other than persons who were employees of, or had a contract with the Non-Soliciting Parties), immediately prior to their employment by or those who had a contract with Manager and other than persons recruited by the Non-Soliciting Parties. The Non-Soliciting Parties acknowledge that a breach of this

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Section 7.2 by the Non-Soliciting Parties will result in irreparable injury to Manager, the precise amount of which is not readily ascertainable in monetary damages, and that Manager, in addition to any other remedies, shall be entitled to injunctive relief.

8. CONFIDENTIAL INFORMATION

Manager and DPM recognize and understand that, during the term of this Agreement, or the term of this Agreement as extended, each shall receive, have access to, and otherwise become acquainted with various trade secrets, materials, patient information, and other proprietary information relating to DPM and Manager which is of a secret or confidential nature (“Confidential Information”). During and after the term of this Agreement, DPM, Hospitals, and Manager shall not use Confidential Information for any purposes other than the performance of this Agreement, and shall not disclose such Confidential Information received by DPM, Hospitals, and Manager to any third party, without the prior written consent of DPM or Manager, as the case may be. Provided, however, that either party may divulge Confidential Information to the minimum extent necessary to comply with any applicable statute, governmental rule or regulation or valid Court order. Confidential Information does not include, however, information which (a) is or becomes generally available to the public other than as a result of a disclosure by either party or its Representatives (as defined below), (b) was available to the non-disclosing party on a nonconfidential basis prior to its disclosure to such party by the disclosing party or its Representative, or (c) becomes available to the non-disclosing party on a nonconfidential basis from a person, other than the disclosing party or its Representative, who is not known by the non-disclosing party to be bound by a confidentiality agreement with such disclosing party or otherwise prohibited from transmitting the information to the non-disclosing party. As used in this Agreement, the term “Representative^” means, as to any party, such party’s affiliates and its directors, officers, employees, agents, advisors (including, without limitation, financial advisors, counsel and accountants), and controlling persons.

DPM and Manager each acknowledge that a breach of this Section 8 by either party will result in irreparable injury to the other party, the precise amount of which is not readily ascertainable in monetary damages, and that the parties hereto, in addition to any other remedies, shall be entitled to injunctive relief.

9. NOTICES

All notices which either party is required or may desire to give to the other party under or in conjunction with this Agreement shall be in writing, and shall be deemed to have been duly given on the date of delivery if delivered in person to the party named below, or as of the date indicated on a return receipt if by certified or registered mail, postage prepaid, return receipt requested, addressed as follows:

If to DPM: Doctor’s Practice Management, Inc. 4301 Vista Road Pasadena, Texas 77504 Attention: President

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If to Manager: NeWeigh 10738 Braes forest Houston, Texas 77071 Attention: Diane Crumley

or to such other addresses or persons as may be designated by DPM or Manager from time to time in accordance with the provisions of this Section 9.

10. ENTIRE AGREEMENT; AMENDMENTS

This Agreement supersedes any and all other agreements, whether oral or written, between the parties with respect to the subject matter hereof and there are no representations, covenants or undertakings other than those expressly set forth in this Agreement. This Agreement may not be modified or amended except by a written document executed by both parties to this Agreement, and such written modification(s) shall be attached hereto.

11. STATE LAW: SEVERABILITY

This Agreement shall be construed and governed by the laws of the State of Texas. In the event any provision of this Agreement is rendered invalid or unenforceable by the enactment of any applicable statute or ordinance or by any regulation duly promulgated or is made or declared unenforceable by any court of competent jurisdiction, the remainder of this Agreement shall, subject to the following, remain in full force and effect. The parties agree that venue for any proceeding arising hereunder shall lie exclusively in Harris County, Texas, and venue for any litigation arising for enforcement of this Agreement shall lie exclusively in the state district courts of Harris County, Texas.

12. CATASTROPHE

In the event that any Hospital facilities are partially damaged or destroyed by fire, earthquake or other catastrophe, and such damage is sufficient to render the facilities unusable for Program purposes but not entirely or substantially destroyed, this Agreement shall be suspended until such time as DPM determines that the premises or the facilities shall again be usable. In the event that DPM determines that the affected Hospital facilities have been entirely or substantially destroyed by fire, earthquake, or other catastrophe, this Agreement may be terminated by either party upon at least ten (10) days’ prior written notice to the other; or, in the alternative, this Agreement shall be suspended until such time as DPM shall erect or otherwise acquire new facilities with accommodations substantially similar to those provided herein for the use of Manager, provided that DPM gives written notice to Manager that it shall erect or otherwise acquire such facilities. Nothing in this Agreement shall obligate DPM to erect or otherwise acquire such facilities.

13. NON-WAIVER

The waiver by either party of any breach of any term, covenant or condition contained herein shall not be deemed to be a waiver of any subsequent breach of the same or any other term, covenant or condition contained herein. The subsequent acceptance of performance

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hereunder by a party shall not be deemed to be a waiver of any preceding breach by the other party of any term, covenant or condition of this Agreement, other than the failure of such party to perform the particular duties so accepted, regardless of such party’s knowledge of such preceding breach at the time of acceptance of such performance.

14. CAPTIONS

Any captions to or hearing of the articles, sections, subsections, paragraphs, or subparagraphs of this Agreement are solely for the convenience of the parties, are not a part of this Agreement, and shall not be used for the interpretation or determination of validity of this Agreement or any provision hereof.

15. ASSIGNMENT

Neither party shall assign any rights or delegate any duties under this Agreement without the prior written consent of the other party, except that either party may assign its rights and delegate its duties under this Agreement in the event of any transfer of all or substantially all of its stock or assets without the prior written consent of the other party. Any unauthorized attempted assignment by either party shall be void and of no force and effect and shall constitute a material breach of this Agreement. All covenants, conditions and provisions of this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and assigns.

16. COUNTERPARTS

This Agreement may be executed in counterparts, each of which shall be deemed to be an original, and all of such counterparts shall together constitute one and the same Agreement.

17. THIRD PARTY BENEFICIARIES

This Agreement is solely for the benefit of the parties and their officers, directors and employees to the extent named herein. No other third party is granted or shall have any rights by virtue of this Agreement.

18. AFFILIATE

For purposes of this Agreement, the term “affiliate” shall mean any wholly-owned subsidiary of an entity or any entity with common ownership or common control.

19. ALTERNATIVE DISPUTE RESOLUTION

The parties agree to submit any dispute arising under this Agreement to voluntary mediation before a mediator to be mutually acceptable to both parties. The parties shall share equally in the cost of the mediator, and each party shall incur the cost of its own legal representation. In the event the dispute is not resolved through mediation, the parties agree to submit the dispute to binding arbitration before a mutually acceptable arbitrator in accordance with the rules of the American Arbitration Association. Unless otherwise ordered by the arbitrator, the parties shall share equally in the cost of the arbitration and each party shall incur

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the cost of its own legal representation. Judgment upon any award rendered by an arbitrator may be entered in any court having jurisdiction. Notwithstanding anything to the contrary herein, this provision shall not be applicable to the rights of any party to seek an equitable remedy to enforce the terms of this Agreement, including but not limited to Section 8 of this Agreement.

20. CONFIDENTIALITY OF THIS AGREEMENT

It is the express intent of the parties that the terms and conditions of this Agreement shall not be disclosed except in response to a request from a valid subpoena, a request from a government agency, by mutual written consent of both parties, or as otherwise specifically provided herein. The parties also agree that the parties may disclose the terms of this Agreement to its officers, affiliates, directors, attorneys and to those employees who are necessary to carry out the terms of the Agreement.

IN WITNESS WHEREOF the parties hereto have caused this Agreement to be executed on the 15^th day of November, 2002.

MANAGER:
VITAL WEIGHT CONTROL, INC. a Texas Corporation
By:	/s/    Diane Crumley
Name:	Diane Crumley
Title:	President
DPM:
DOCTOR’S PRACTICE MANAGEMENT, INC.
By:	/s/    Philip S. Chan
Name:	Philip S. Chan
Title:	Chief Financial Officer

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EX-10.8

Exhibit 10.8

CASH SALE	*     UNITED STATES OF AMERICA
	*
BY	*     STATE OF LOUISIANA
	*
JANICE SEAL SMITH and the	*     PARISH OF ORLEANS
SUCCESSION OF JOHNNY F. SMITH	*
	*
TO	*
	*
VISTA HOLDINGS, LLC	*

BE IT KNOWN, that on this 18th day of February 2003, before me, Roy E. Biossman, a Notary Public duly commissioned and qualified in and for the aforesaid State and Parish, and in the presence of the undersigned, competent witnesses.

PERSONALLY CAME AND APPEARED:

JANICE SEAL SMITH, a person of the full age of majority and a resident and domiciliary of the Parish of St. Tammany, State of Louisiana, whose permanent mailing address is 310 Howze Beach Lane, Slidell, Louisiana 70461, and whose U.S. taxpayer identification number is ###-##-####, herein represented by Chris Jean, her Agent and Attorney-in-Fact, pursuant to General Procuration dated August 5, 2002, recorded in the conveyance and mortgage records of St. Tammany Parish, on August 19, 2002, at Instrument No. 1319193; and the said Agent declared under oath unto me, Notary, on behalf of his principal that she has been married three times, first to Tommy Lee Rose, from whom she was divorced by Judgment dated November 30, 1974, in Proceeding No. 13, 105 of the Chancery Court of Pearl River County, Mississippi, Court, secondly to Johnny F. Smith, who is deceased, and thirdly to Quentin R. Stumpf, with whom she is presently living and residing

and

THE SUCCESSION OF JOHNNY F. SMITH (U.S. Taxpayer Identification no 72-6199014, permanent mailing address—c/o Gary P. Duplechain & Associates, 757 Gause Boulevard, Slidell, Louisiana 70458) being Proceeding No. 99-30625 C. of the 22nd Judicial District Court in and for the Parish of St. Tammy, State of Louisiana, herein represented by Janice Seal Smith, Independent Executrix pursuant to approval and confirmation in the aforesaid proceeding, a certified copy of which, dated March 8, 2002, is annexed hereto and made a part hereof; the said Janice Seal Smith being herein represented by Chris Jean, her Agent and Attorney-in-Fact, pursuant to Power of Attorney passed before Gary Duplechain, Notary Public, dated February 17, 2003, annexed hereto and made a part hereof.

(hereinafter referred to as “Seller” whether one or more)

who declared that Seller does by these present, grant, bargain, sell convey, transfer, assign, set over, abandon and deliver with all legal warranties and with full substitution and subrogation in and to all the rights and actions of warranty which Seller has or many have against all preceding owners and vendors unto:

VISTA HOLDING, LLC, a Louisiana limited liability company, whose permanent mailing address is 4301 Vista Road, Pasadena, Texas 77504, and whose U.S. taxpayer identification number is 76-0699801

All and singular the following described property (the “Property”), to wit:

ALL THAT CERTAIN LOT OR PARCEL OR LAND, together with all the building and improvement thereon and all of the rights, ways, privileges, servitudes, appurtenances and advantages thereunto belonging or in anywise appertaining, situated in SECTIONS 11 and 12, TOWNSHIP 9 SOUTH RANGE 14 EAST, ST. TAMMANY PARISH, LOUISIANA, and being more fully described as follows, to wit:

From the Northwest corner of the Southeast Quarter of the Southeast Quarter of Section 11 Township 9 South, Rage 14 East, St. Tammany Parish, Louisiana, go South 89 degrees 48 minutes 16 seconds East 695.13 feet to Point of Beginning. From the Point of Beginning, go South 89 degrees 25 minutes 16 seconds East (Title South 89 degrees 48 minutes 16 seconds East) 112.10 feet (Title 111.87 feet); thence South 89 degrees 50 minutes 33 seconds East (Title North 89 degrees 40 minutes 46 seconds East) 511.20 feet (Title 513.0 feet); thence South 65 degrees 01 minutes 05 seconds East (Title South 62 degrees 59 minutes 15 seconds East) 62.08 feet: thence South 18 degrees 00 minutes 30 seconds West (Title South 17 degrees 50 seconds West) 449.50 feet; thence South 89 degrees 53 minutes 59 seconds West (Title South 89 degrees 40 minutes 46 seconds West) 540.61 feet (Title 542.51 feet); thence North 457.18 feet (Title 456.65 feet) back to the Point of Beginning. Said property contains 6.40 acres of land, more or less.

All in accordance with a survey no. 2003 070 by John E. Bonneau & Associates, Inc., John E. Bonneau, Registered Land Surveyor, dated January 30, 2003, print of which is annexed hereto.

Being the same property acquired by Janice Seal, wife of/and, Johnny F. Smith from W. R. Zanes and Company of LA., Inc. as per act passed before Harvey E. Finch, Notary Public, dated April 28, 1995 recorded in the conveyance records of Tammany Parish, on May 2, 1995, at Instrument No. 947631.

To the extent any of the following may be applicable, this act is made and accepted subject to the following:

1. Right of way in favor of CLECO dated October 1, 1962, registered in COB 332, folio 363, St. Tammany Parish, Louisiana.

2. Right of way in favor of AT&T dated September 22, 1927, registered at COB 103, folio 359, St. Tammany Parish, Louisiana.

The parties hereto declare that they do not hereby intend, by the execution of these presents to interrupt, or suspend, the running of any prescription or preemption which has run or may run in connection with the foregoing, nor do the parties intend to revive, establish or initiate any one or more of the foregoing which may not now or hereafter be binding upon the hereinabove described property and/or the parties hereto.

To have and to hold the Property unto the Purchase, and Purchaser’s successors, heirs and assigns forever.

This sale is made and accepted for and in consideration of the price and sum of TWO MILLION ONE HINDERED THOUSAND AND NO/100 ($2,100,000.00) Dollars, cash, which Purchaser has well and truly paid, in ready and current money to Seller, who hereby acknowledges the receipt thereof and grants full acquaintance and discharge therefor.

All taxes up to and including the taxes due and exigible in 2002 are paid as per tax research certificates annexed hereto. Taxes for the current year have been prorated between Seller and Purchaser as of the date hereof, based on 2002 taxes. All future taxes are the responsibility of the Purchaser, at the address listed above.

Seller declares, represent and warrants that there are no judgments, general or particular of record or otherwise against Seller which may affect the Property and there are no liens, privileges, mortgages, pledges or other encumbrance of record or otherwise which may affect or burden the Property.

The parties do hereby waive and dispense with the production of any and all certificates and/or researches required by law and relieve and release me, Notary, and the surety on my natorial bond from any and all liability and/or responsibility for the nonproduction thereof.

THUS DONE AND PASSED, in multiple original, in my office in New Orleans, Louisiana, on the day, month and year herein first above written, in the presence of the undersigned competent witnesses, who hereunto sign their names with the said Appearers and me, Notary.

WITNESSES:
	/s/    illegible	/s/    Chris Jean
		CHRIS JEAN, Agent and Attorney-in-Fact for
		JANICE SEAL SMITH
/s/ Lisa C. Spegale		THE SUCCESSION OF JOHNNY F. SMITH

BY:	/s/    Chris Jean
	CHRIS JEAN, Agent and Attorney-in-Fact for
	JANICE SEAL SMITH, Independent Executrix

EX-10.9

Exhibit 10.9

ASSET PURCHASE AGREEMENT

THIS ASSET PURCHASE AGREEMENT (“Agreement”) is entered into on this 30^th day of June, 2003, by and between TOMASZEK MANAGEMENT, L.L.C., a Texas limited liability company (“Seller”), and VISTA LAND AND EQUIPMENT, L.L.C., a Texas limited liability company (“Buyer”).

W I T N E S S E T H:

WHEREAS, Seller is the owner of certain assets utilized in the planning and development of medical facilities in The Woodlands, Texas, for medical professionals and the health care industry;

WHEREAS, Buyer is in the process of developing the same, or similar type of medical facility in the Woodlands, Texas, to render the same or similar type of medical services as Seller, and Buyer therefore desires to buy and Seller desires to sell substantially all of the assets owned by Seller in order to permit Buyer to acquire the business and goodwill of Seller and its planning and development concepts, studies, plans for building and marketing medical facilities, and control of certain lease space in such facilities (“Assets”);

NOW, THEREFORE, for and in consideration of the mutual premises, agreements, covenants, and conditions contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged and accepted, the parties hereto agree as follows:

1. Sale And Purchase Of The Assets. Seller agrees to sell, assign, transfer, convey, and deliver to Buyer, and Buyer agrees to purchase from Seller, on the terms and subject to the conditions set forth in this Agreement, certain assets (“Assets^”) described in the Assignment, Conveyance And Bill Of Sale attached hereto as Exhibit “A” (“Bill Of Sale”), including without limitation:

1.1 Marketing And Feasibility Studies. All market research prepared in association with the development of a medical facility in the Woodlands area to deliver health care services in the areas of surgery, MRI, and pain management.

1.2 Architectural Plans. All architectural plans developed for the building of the contemplated Woodlands medical facility, including all specialty build out for the MRI/waiting area of the facility.

1.3 Other Current Assets. All miscellaneous assets received in trade, warranty claims, and other prepaid expenses such as deposit for Hitachi MRI, taxes and insurance accrued or held by Seller as of the Closing Date, and as would be so classified in the operating report of Seller as of the Closing Date.

1.4 Residual Assets. The Assets shall also specifically include, but are not limited to, warranties on Assets, customer lists and records, permits, books and records, marketing materials, goodwill, and going concern value, if any, of Seller’s business as of the Closing Date, and all other proprietary rights of Seller in connection therewith.

2. Assets Not Being Sold. Seller shall retain all assets of Seller existing on the Closing Date (as defined herein) not otherwise sold to Buyer pursuant to this Agreement (“Excluded Assets”), including, but not limited to, (i) all cash, including all cash on hand, and cash in bank accounts of Seller; and, (ii) all revenues derived directly or indirectly from sublease tenants under the Master Lease for Riverstone At Vision Park.

3. Purchase Price And Payment. Based solely on Seller’s reliance on Buyer’s representation to Seller that it will be developing a medical facility in The Woodlands, the additional representations and warranties of Buyer contained herein, and on the terms and subject to the conditions set forth herein, Seller agrees to sell and deliver to Buyer the Assets. In reliance upon the representations and warranties of Seller contained herein, and on the terms and subject to the conditions set forth herein, Buyer agrees to purchase the Assets as follows:

3.1 Deposit. Simultaneously with the Buyer’s execution of this Agreement, Buyer will deliver to Seller a Cashier’s Check in the amount of ONE HUNDRED FIFTY THOUSAND AND NO/100 DOLLARS ($150,000.00).

3.2 Payment At Closing. At the Closing (as hereinafter defined), Seller shall execute and deliver to Buyer all titles, bills of sale, deeds, leases, and other instruments of transfer, in form and substance reasonably satisfactory to Buyer and its counsel, as shall be effective to transfer to Buyer the Assets and to vest in Buyer complete, valid, marketable, legal and equitable title to the Assets, free and clear of all mortgages, liens, claims, encumbrances, and security interests. At the Closing, Buyer shall deliver to Seller a cashier^’s or certified check payable to the order of Seller or consummate a wire transfer of funds to a bank account identified by Seller in the amount of One Million Three Hundred Thirteen Thousand And No/100 Dollars ($1,313,000.00), the (“Purchase Price”).

3.3 Allocation Of Purchase Price. Seller and Buyer agree to report in any and all federal income or state income or franchise tax returns the values associated with the Assets and the compensation for Seller’s non-competition covenant as set forth in this Agreement and all attachments, schedules, or annexes hereto. A summary of the values associated with the Assets and the compensation for Seller’s non-competition covenant is set forth in Exhibit “B” attached hereto.

4. Closing. The closing of the purchase and sale of the Assets provided for in this Agreement (“Closing”) shall take place at the offices of Bruce Buckley, 2401 Fountainview, Suite 1000, Houston, Texas 77057 at 10:00 a.m., on or before June 30, 2003, or such other date as may be mutually acceptable to the parties hereto; provided, however, the parties hereto agree that notwithstanding anything to the contrary set forth in this Agreement, in the event the Closing does not occur on or prior to June 30, 2003, this Agreement, and all other agreements referenced herein or contemplated hereby, shall terminate automatically without further action or notice to or by any party. The actual date of the Closing shall be referred to herein as the “Closing Date”.

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5. Seller’s Representations And Warranties. Seller hereby represents and warrants to Buyer as follows:

5.1 Organization And Existence. Seller is a limited liability company duly organized, validly existing, and in good standing under the laws of the State of Texas, and has full company power and authority, and is duly authorized, qualified, and licensed under all applicable requirements, laws, and regulations to carry on its business as now conducted. Seller is not qualified as a foreign entity in any jurisdiction, and Seller is not required to qualify or otherwise be authorized to do business as a foreign entity in any jurisdiction in order to carry on any of its businesses as now conducted or to own, lease, or operate the Assets.

5.2 Authority To Execute Agreement. Seller has, or will have, obtained, prior to Closing, the approval of its Manager and all necessary approvals and consents of its Members to the terms of this Agreement and the authorization, execution and consummation of this Agreement and the transactions contemplated hereby. When executed, this Agreement and all exhibits, appendices, and annexes hereto will constitute legal, valid, and binding obligations of Seller, enforceable against Seller in accordance with their terms. Seller has full company power and authority to make and perform this Agreement, and to consummate the transactions contemplated herein.

5.3 Consent Of Tomaszek Management, L.L.C. Notwithstanding the representations of Seller in Section 5.2 hereof, Seller acknowledges that the sale of the Assets has been authorized and consented to by Tomaszek Management, L.L.C., and that a consent and authorization of Tomaszek Management, L.L.C., with respect to this Agreement will be furnished at the Closing to Buyer in the form which is customary in the circumstances contemplated herein.

5.4 Title To Assets. Seller currently has, and will convey and transfer to Buyer at the Closing, complete, valid, good, marketable, legal and equitable title to the Assets, free and clear of all claims, encumbrances, mortgages, liens, pledges, and security interests of any type except for those liens incurred in the ordinary course of business for taxes not delinquent.

5.5 Warranties. SELLER EXPRESSLY REPRESENTS AND WARRANTS WITH RESPECT TO THE ASSETS THAT SELLER HAS VALID, GOOD, MARKETABLE, LEGAL AND EQUITABLE TITLE TO THE ASSETS BY, THROUGH, AND UNDER SELLER, BUT NOT OTHERWISE.

5.6 No Default Or Conflicts With Agreements And Other Instruments. Seller is not in default in any material respect under the terms of any outstanding contract, agreement, lease, or other commitment which is material to the Assets and there are no events of default or events which with notice, or lapse of time, or both. would constitute a default affecting the Assets, directly or indirectly, under any such contracts, agreements, leases, or other commitment in respect of which Seller has not taken adequate steps to prevent such defaults from occurring. Furthermore, the execution and carrying out of this Agreement and compliance with the provisions hereof by Seller will not conflict with, or result in any breach of any of the terms, conditions, or provisions of, or constitute a default (or an event which with notice or lapse of time, or both, would become a default) under the Articles of Organization or the Regulations And Operating Agreement of

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Seller, or under any indenture, mortgage, lease, agreement, or other instrument to which Seller is a party that could in any manner affect the Assets, or result in any violation of any applicable statute, rule, or regulation of any governmental body or agency having jurisdiction over the Assets or Seller.

5.7 Third Party Consents. Except as contemplated expressly herein, the sale of the Assets is not subject to the approval of, or any filing or notice with, except to the extent to show of record the transfer of title to any of the Assets, any governmental authority, or any other third party.

5.8 Litigation. No litigation, action, investigation, or governmental proceeding is pending or threatened which would prevent or enjoin the sale of the Assets, would result in any lien against or claim upon the Assets, or would result in any material adverse affect with respect to the Assets or the business associated therewith.

5.9 Consignments. None of the Assets are held by third parties under any consignment or similar arrangement.

5.10 Taxes. Seller and its Members are not delinquent with respect to any taxes as a result of which a lien or claim exists, or may exist, with respect to the Assets.

5.11 Fixtures. None of the Assets owned are accessions to property owned or leased by a person other than Seller.

5.12 Insurance. All policies of insurance, if any, held by Seller which cover the operation of the business associated with the Assets, any part of the Assets, or the officers, directors, and employees associated therewith, are in full force and effect, and Seller will continue them in full force and effect at its expense up to and including the Closing Date.

5.13 Intangible Property. The operation and control of the Assets of Seller does not require the use of, or consist of any rights under any patents, inventions, trademarks, tradenames, brand names, service marks or copyrights. Seller owns and has the full and exclusive right to use the Assets. Seller has not transferred, encumbered, or licensed to any person or entity any rights to own, or use any portion of the Assets, or any other intangible property included in the Assets. None of the intangible property included in the Assets knowingly violates or infringes upon any patents, trademarks, tradenames, brand names, or copyrights owned by others.

5.14 No Untrue Statements. The statements, representations, and warranties of Seller set forth in this Agreement, the schedules and exhibits attached hereto, and in all other documents and information furnished to Buyer and its representatives in connection herewith do not include any untrue statement of material fact, or omit to state any material fact necessary to make the statements, representations, and warranties made herein not misleading. To the best knowledge of Seller, there is no fact or matter that is not disclosed to Buyer in this Agreement, or in schedules and exhibits attached hereto, that materially, adversely affects or, so far as Seller can now reasonably foresee, could

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materially, adversely affect the condition, financial or otherwise, of any of the Assets, or the ability of Seller to perform its obligations under this Agreement.

6. Buyer’s Representations And Warranties. Buyer hereby represents and warrants to Seller as follows:

6.1 Organizational Existence. Buyer is a Texas limited liability company duly organized, validly existing, and in good standing under the laws of the State of Texas, and has full power and authority to carry on its business as now conducted, and as proposed to be conducted.

6.2 Authority To Execute Agreement. Buyer’s members have approved the terms of this Agreement and have authorized the execution, delivery and consummation of this Agreement. This Agreement has been duly executed and delivered by Buyer and is a legal, valid, and binding obligation of Buyer, enforceable against Buyer in accordance with its terms, except as rights to indemnification under the Agreement may be limited under applicable law, and subject to any applicable bankruptcy, reorganization, moratorium or other similar laws affecting the enforcement of creditors rights generally, rights of offset and principles of equity. Buyer has full power to make and perform this Agreement, and the remainder of the transactions contemplated herein.

6.3 Conflicts With Agreements And Other Instruments. The execution and carrying out of this Agreement, and compliance with the provisions hereof by Buyer will not conflict with, or result in any breach of any of the terms, conditions, or provisions of, or constitute a default, or events which with notice, or lapse of time, or both, would constitute a default, under the governing documents of Buyer, or under any indenture, mortgage, lease, agreement, or other instrument to which Buyer is a party or result in any violation of any applicable statute, rule, or regulation of any governmental body or agency having jurisdiction over Buyer.

6.4 Litigation. There is no litigation or governmental proceeding pending or threatened against Buyer which, if adversely determined, would materially, adversely affect the financial condition, or results of operations or business of Buyer.

6.5 No Default. Buyer is not in default in any material respect under the terms of any outstanding contract, agreement, lease, or other commitment which is material to its business, operations, properties, or assets, or the condition, financial or otherwise, of Buyer, and there are no events of default, or events which with notice or lapse of time, or both, would constitute a default, under any such contracts, agreements, leases, or other commitments in respect of which Buyer has not taken adequate steps to prevent such defaults from occurring.

6.6 No Untrue Statements. The statements, representations, and warranties of Buyer set forth in this Agreement, the schedules and exhibits attached hereto, and in all other documents and information furnished to Seller and its representatives in connection herewith, do not include any untrue statement of a material fact, or omit to state any

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material fact necessary to make the statements, representations, and warranties made herein not misleading.

7. Covenants Of Seller.

7.1 Access. Prior to the Closing Date, Seller will furnish to Buyer, its officers, agents, attorneys, and accountants, any information which Buyer may reasonably request concerning the Assets and will permit Buyer to have access to, and inspect, the Assets during Seller’s normal business hours.

7.2 Actions Prior To Closing. Seller agrees that prior to the Closing Date, they will maintain the Assets of Seller in substantially the same manner as in the past, and without the prior consent of Buyer, shall not; (i) mortgage, pledge, or subject to lien, charge, security agreement, or any other encumbrance, all or any part of the Assets, or issue, incur, assume or guarantee any such indebtedness; (ii) sell or dispose of any of the Assets or any interest therein; (iii) take any action which would prohibit the Assets from being transferred in good condition; (iv) enter into any transaction other than in the ordinary course of business consistent with good business practice; (v) amend, renew, extend, modify, or terminate any document or any agreement relating to the Assets; (vi) waive any rights of significant value, or allow any material contract to lapse; or, (vii) take any action which would cause or tend to cause any conditions precedent to any obligations hereunder not to be fulfilled. Additionally, Seller shall use its best efforts to preserve the goodwill and reputation of the Seller prior to the Closing Date.

7.3 No Solicitation. Prior to the Closing Date, Seller agrees that it will not, and will instruct their representatives not to, solicit any offer from any third party for the acquisition of any of the membership interests, or all or substantially all, of the Assets of Seller.

8. Conditions Precedent To Buyer’s Obligations Hereunder. The obligations of Buyer hereunder are, at the option of Buyer, subject to the conditions that, on the Closing Date:

8.1 Compliance With Terms. All the terms, covenants, and conditions of this Agreement to be complied with, and performed by, Seller on or before the Closing Date shall have been fully complied with and performed, and the representations and warranties made by Seller herein shall be deemed to have been made again at and as of the Closing Date, and shall as of that date be true and correct in all respects.

8.2 Proper Documentation. All of Seller’s actions, proceedings, instruments, certificates, and documents required to carry out this Agreement, or incidental thereto, shall be in proper form and reasonably acceptable to counsel for Buyer.

8.3 Certificates And Documents. All documents, certificates, or other items required to be furnished to Buyer by Seller at, or prior to, the Closing Date shall have been so provided and approved by Buyer and its counsel.

8.4 Consents. All approvals or consents of public authorities, companies, or private persons required, or advisable, in connection with the consummation of the

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transactions contemplated hereby shall have been obtained on terms satisfactory to Buyer.

8.5 No Material Adverse Change. There shall not have occurred any material adverse change since May 1, 2003 in the business, properties, results of operations, prospects, or financial condition of Seller or any material loss or damage to any of the Assets.

8.6 Payment Of Obligations. All of the obligations retained by Seller and not assumed by Buyer which may in any way affect any of the Assets shall have been paid in full by Seller and satisfactory evidence of said payment or other acceptable arrangement and the release of any lien against the Assets securing payment thereof shall have been provided to Buyer.

8.7 Due Diligence Investigation. Buyer will have been provided the opportunity to conduct and complete a due diligence review of Seller’s business, assets and liabilities against them, if any, and Buyer shall have elected to proceed with the transactions contemplated hereby based upon the results of such due diligence review.

9. Conditions Precedent To Seller’s Obligations Hereunder. The obligations of Seller under this Agreement are, at the option of Seller, subject to the conditions that, on the Closing Date:

9.1 Compliance With Terms. All the terms, covenants, and conditions of this Agreement to be complied with and performed by Buyer on or before the Closing Date shall have been fully complied with and performed, and the representations and warranties made by Buyer herein shall be deemed to have been made again at and as of the Closing Date, and shall as of that date be true and correct in all respects.

9.2 Consents. All consents, authorizations, and approvals necessary for the consummation of the sale of the Assets contemplated by this Agreement shall have been obtained by the Closing Date.

9.3 No Material Change. There shall have been no material adverse change in the condition, financial or otherwise, of Buyer, its business or assets except as disclosed on the date hereof.

10. Brokerage Fees. Buyer has not engaged any agent or broker in connection with this transaction and has done nothing which would give rise to any claim for any fee or other compensation by any person or entity for acting as a broker, finder, or agent. If Seller has engaged any agent or broker in connection with this transaction, or has done anything which would give rise to any claim for any fee or other compensation by any person or entity for acting as a broker, finder, or agent, then Seller shall pay any such fee or claim in full.

11. Post Closing Adjustments And Prorated Items.

11.1 Adjustment Of Costs. Seller shall bear all costs incurred in connection with the utilization of the Assets, including without limitation, utilities, rentals, service

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contracts, employee costs, and maintenance expenses, prior to the Closing Date and Buyer shall bear all such costs thereafter. Each party will forward to the other party any invoices received by a party which are to be paid by the other in accordance with the terms of Section 11.4.

11.2 Adjustments Of Revenues. Seller shall be entitled to all revenues or other use of the Assets prior to the Closing Date. With the exception of all revenues derived from the Master Lease referenced in Section 1.1 hereinabove, Buyer shall be entitled to all such revenues associated with the Assets thereafter.

11.3 Taxes.

(a) Buyer shall be liable for and shall pay all sales, use, transfer, and any other similar taxes assessed, imposed, or levied as a direct result of the sale of the Assets purchased hereby by Buyer, by any governmental authority;

(b) Whichever party is liable hereunder for the payment of a tax shall prepare any necessary renditions and returns, and shall bear all costs incident to the determination and payment thereof. Such party shall further have all available rights to contest the tax;

(c) Seller shall remain responsible for all income, property, real or personal, franchise, or other taxes which may be due and payable by it for revenues earned, or assets owned prior to the Closing Date.

11.4 Payment Of Taxes And Other Expenses. If Buyer or Seller receives an invoice for any tax or other expense which is allocable to the other party in part or in full hereunder, the recipient shall forward a copy of the invoice within five (5) business days of receipt to the other party. If the other party is fully liable for such invoice it shall pay it in full when due; provided, however, that said party may contest any tax in accordance with the provisions of Section 11.3(b) above. If Buyer or Seller receives an invoice for taxes or other expense which is allocable partly to one party and partly to the other, then the party receiving the invoice shall pay such invoice and, provided a copy thereof shall have been received by the other party ten (10) days prior to payment by the receiving party, and the other party shall not have objected thereto, the party receiving the invoice shall then advise the other party that such invoice has been paid and shall request the appropriate reimbursement. To the extent owed, Seller and Buyer shall pay such reimbursement to the other party within ten (10) days_. of the request therefor.

11.5 Receipts. If either party receives a payment from a third party due in whole or in part to the other party, it shall pay over such portion to the other party within ten (10) days after receipt thereof.

11.6 Legal Expenses. Buyer agrees to pay all legal expenses incurred by Buyer in the negotiation of the transactions contemplated herein, and the preparation of all related documents, and Seller agrees to pay all legal expenses incurred by Seller in the

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negotiations of the transactions contemplated herein and the preparation of all related documents.

12. Risk Of Loss.

12.1 Risk Of Loss. Buyer shall bear all risk of loss or damage to the Assets purchased hereby after 11:59 p.m. Central Standard Time on the Closing Date.

12.2 Loss Prior To Closing. If any of the Assets are damaged in excess of $50,000.00, prior to the Closing Date, then (i) Buyer may reduce the Purchase Price by the amount of any damage to the Assets; or, (ii) Buyer can request that Seller replace or repair and restore the damaged Assets to their original condition; or, (iii) if the Assets are damaged in excess of $100,000.00, or are substantially destroyed or otherwise made unusable in Buyer’s sole discretion, Buyer may terminate this Agreement in its sole discretion without any liability to Seller.

13. Competition With Buyer. For a period commencing on the Closing Date and ending five (5) calendar years thereafter (“Restricted Period”), Seller, and all Members of Seller, agree that they will not, without the prior written consent of Buyer, directly or indirectly engage, whether as a creditor, member, stockholder, director, officer, employee, owner, partner, advisor, or otherwise in any new business or venture competing for the same customer base as Buyer within a twenty-five (25) mile radius of The Woodlands, Texas, or to recruit or hire any person who is or was an employee, officer, director, or manager of Buyer.

Seller, and all members of Seller, agree that as a material incentive for Buyer to consummate this transaction, and upon payment of additional consideration by Buyer, the receipt and sufficiency of which is hereby acknowledged and confessed, Seller shall acquire from Riverstone at Vision, Ltd., a restrictive covenant upon the real property (legally described in Exhibit C hereto) for the benefit of Buyer herein, said covenant being set forth in Exhibit D hereto.

In the event of the violation of this Section 13, Buyer shall be entitled to temporary and permanent injunctive relief, it being agreed by Seller and its Members that the remedies at law for breach of this Section 13 are inadequate and that such breach will cause irreparable injury to Buyer. Seller, its Members, and Buyer agree that this Section 13 is an independent promise within this Agreement, and enforceable notwithstanding, and separate and apart from any other provision of this Agreement.

14. Disclaimer Of Representations. Buyer agrees with and represents to Seller that the Assets have been inspected by Buyer and its representatives, and that the Assets are being purchased by Buyer as a result of such inspection and not as a result of any representations made by Seller that are not incorporated in this Agreement.

15. Survival Of Obligations And Liabilities. The respective obligations, representations, warranties, covenants, and liabilities of all parties hereto shall survive the Closing Date.

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16. Termination. Anything contained in this Agreement to the contrary notwithstanding, this Agreement may be terminated and the transactions contemplated herein abandoned at any time prior to the Closing: (i) by mutual written consent signed by each of the parties hereto; (ii) pursuant to the provisions of Section 12.2(iii); (iii) by Buyer, if any condition to its obligations as set forth in this Agreement has not been met or waived, and cannot be so met or waived prior to the Closing Date; or, (iv) by Seller, if any condition to their respective obligations as set forth in this Agreement has not been met or waived, and cannot be so met or waived prior to the Closing Date. In the event of the termination of this Agreement pursuant to the provisions hereof, this Agreement shall immediately become void and have no effect, without any liability on the part of any party hereto, and all expenses relating hereto shall be borne by the party incurring them.

17. Amendment And Modification. This Agreement and all attachments, schedules, or annexes hereto may not be modified or supplemented except by written instrument executed by each of the parties hereto.

18. Prior Agreements Superseded. This Agreement (and all exhibits, schedules, and appendices hereto) constitutes the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior written or oral agreements and understandings, including any letters of intent, by and between Buyer and Seller which Buyer and Seller each acknowledge are rescinded, terminated and replaced hereby.

19. Notices. All notices, requests, demands, and other communications permitted or required hereunder shall be in writing and delivered personally, and by e-mail or facsimile, in which event such communication shall be deemed to be immediately given to the following addresses, or such other addresses as the parties may notify the others of in writing from time to time in the manner set forth in this Section:

(a) If to Seller:

Tomaszek Management, L.L.C.

7439 Teaswood Drive

Conroe, Texas 77804

Attention: David E. Tomaszek

Facsimile: (281) 440-5168

with a copy to:

Buckley, Mathews, White & Howell, L.L.P.

2401 Fountainview, Suite 1000

Houston, Texas 77057

Attention R. Bruce Buckley

E-mail: rbrucebuckley@mindspring.com

Facsimile: 713-789-7703

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(b) If to Buyer:

Vista Land and Equipment, L.L.C.

10304 I-10 East, Suite 369

Houston, Texas 77029

Attention: Mr. Philip Chan

Facsimile: 713-378-3155

with a copy to:

Eric G. Carter & Associates

1314 Texas Avenue, Suite 1110

Houston, Texas 77002

Attention: Eric Carter

E-Mail: carterlawfirm@mindspring.com

Facsimile: (713) 227-7001

20. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. This Agreement shall become effective when one or more counterparts have been signed by each of the parties hereto and delivered to the other parties hereto. In making proof of this document, it shall not be necessary to produce more than one such completed counterpart.

21. Parties Bound. This Agreement shall bind and inure to the benefit of the heirs, personal representatives, successors and assigns of the parties hereto.

22. Waiver. No waiver of any of the provisions hereunder shall be binding upon the parties unless agreed to in writing. The failure of any party at any time to require performance by the other party of any provision hereof shall not affect such party’s right to require such performance at any time thereafter.

23. Governing Law. This Agreement shall be governed, construed, and enforced in accordance with the laws of the State of Texas. Venue for any legal proceedings under this agreement shall be in the state district courts of Harris County, Texas.

24. Assignment. Any assignment of this Agreement by any party hereto without the prior written consent of each of the other parties shall be void.

25. Severability. If any term or other provision of this Agreement is invalid, illegal, or incapable of being enforced by any rule of law or public policy, all other conditions and provisions of this Agreement shall nevertheless be legally binding, and shall remain in full force and effect. Upon the determination that any term or other provision of this Agreement is invalid, illegal, or incapable of being enforced, the parties hereto shall amend this Agreement so as to effect the original intentions of the parties as closely as possible in a legally acceptable manner.

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26. Section Headlines. Section headings are included herein solely for purposes of clarity and are not to be referred to or considered in construing or interpreting this Agreement.

27. Further Assurances. Seller hereby agrees on and after the Closing Date to take any and all actions deemed reasonably necessary by Buyer and Seller in order to more completely transfer title to the Assets to Buyer. All expenses of such actions taken by Seller at the request of Buyer shall be borne solely by Buyer, except as otherwise provided in this Agreement.

28. Costs And Attorneys^’ Fees. In the event that any action, suit, or other proceeding is instituted by any of the parties hereto concerning or arising out of this Agreement, the prevailing party shall recover from the non-prevailing party all of such party’s costs and attorneys’ fees incurred in each and every such action, suit, or other proceeding, including any and all appeals or petitions therefrom. As used herein, “prevailing party” shall mean the party entitled to recover his or its cost of such action, suit, or proceeding, whether or not the suit proceeds to final judgment, and as used herein, “attorneys’ fees” shall mean the full and actual costs of any legal services actually rendered in connection with the matters involved, calculated on the basis of the usual fee charged by the attorneys performing such services, and shall not be limited to “reasonable attorneys^’ fees” as defined by any statute or rule of court.

IN WITNESS WHEREOF, this Agreement has been entered into as of the date first set forth above.

		SELLER:
		TOMASZEK MANAGEMENT, L.L.C.
		By:	/s/    David E. Tomaszek
			David E. Tomaszek, Manager
EXHIBITS: Exhibit “A” – Assignment, Conveyance And Bill of Sale Exhibit “B” – Allocation of Purchase Price Exhibit “C” Real Property Description
Exhibit “D” Restrictive Covenant
		BUYER:
		VISTA LAND AND EQUIPMENT, L.L.C.
	By:	DOCTORS PRACTICE
		MANAGEMENT, INC., Manager
		By:	/s/    Philip Chan
			Philip Chan, President

ASSET PURCHASE AGREEMENT

PAGE 12

ADOPT RATIFIED AND CONFIRMED THIS 30th DAY OF JUNE 2003	ADOPT RATIFIED AND CONFIRMED THIS                      DAY OF JUNE 2003
/s/    illegible	/s/    illegible
Member of Tomaszek Management, L.L.C.	Member of Tomaszek Management, L.L.C.
ADOPT RATIFIED AND CONFIRMED THIS                  DAY OF JUNE 2003	ADOPT RATIFIED AND CONFIRMED THIS                      DAY OF JUNE 2003
/s/    illegible	/s/    illegible
Member of Tomaszek Management, L.L.C.	Member of Tomaszek Management, L.L.C.
ADOPT RATIFIED AND CONFIRMED THIS                  DAY OF JUNE 2003	ADOPT RATIFIED AND CONFIRMED THIS                      DAY OF JUNE 2003
/s/    illegible	/s/    illegible
Member of Tomaszek Management, L.L.C.	Member of Tomaszek Management, L.L.C.
ADOPT RATIFIED AND CONFIRMED THIS                  DAY OF JUNE 2003	ADOPT RATIFIED AND CONFIRMED THIS                      DAY OF JUNE 2003
/s/    illegible	/s/    illegible
Member of Tomaszek Management, L.L.C.	Member of Tomaszek Management, L.L.C.
ADOPT RATIFIED AND CONFIRMED THIS                  DAY OF JUNE 2003	ADOPT RATIFIED AND CONFIRMED THIS                      DAY OF JUNE 2003
/s/    illegible	/s/    illegible
Member of Tomaszek Management, L.L.C.	Member of Tomaszek Management, L.L.C.

ASSET PURCHASE AGREEMENT

PAGE 13

EXHIBIT “A”

ASSIGNMENT CONVEYANCE AND BILL OF SALE

THIS ASSIGNMENT, CONVEYANCE AND BILL OF SALE (“Conveyance”) dated as of June 30th 2003, is from TOMASZEK MANAGEMENT, L.L.C., with its principal offices located in The Woodlands, Texas (hereinafter referred to as “Grantor”), to VISTA LAND AND EQUIPMENT, L.L.C. a Texas registered limited liability partnership, with its principal offices located in Houston, Texas (“Grantee”).

WITNESSETH:

For the sum of TEN AND NO/100 DOLLARS ($10.00) cash, and other good and valuable consideration recited in that certain Asset Purchase Agreement dated June 30th. 2003, between Grantor and Grantee, the receipt and sufficiency of which is hereby acknowledged by Grantor, Grantor does hereby ASSIGN, TRANSFER, CONVEY, AND SELL subject to the provisions herein, the following Property unto Grantee effective as of the date contain hereinabove (the “Effective Date”).

1. All of Grantor’s right, title and interest now owned, or hereinafter acquired in and to Grantor^’s market research prepared in association with the feasibility of developing a medical facility in The Woodlands, Texas, area to deliver health care services in the areas of surgery, MRI, and pain management.

2. All of Grantor^’s right, title and interest now owned, or hereinafter acquired in and to Grantor^’s architectural plans developed for the construction of the contemplated Woodlands medical facility, including all specialty build out for the MRI/waiting area of the facility.

3. All of Grantor^’s right, title and interest now owned, or hereinafter acquired in and to Grantor’s assets received in trade, warranty claims, or other prepaid expenses such as the deposit made for a Hitachi MRI, taxes, and insurance accrued or held by Seller as of the Effective Date.

4. All of Grantor^’s right, title and interest now owned, or hereinafter acquired in and to Grantor’s customer lists and records, permits, books and records, goodwill, and going concern value of Seller’s business as of the Effective Date.

5. Subject to the reservations and exceptions made hereinafter, all other general intangibles, rights, titles, and interest of Grantor, now owned, or hereafter acquired, and attributable to any of Grantor’s rights, titles, or interests in the Property, as defined hereinafter, now owned, or hereafter acquired, in and to, or derived from the Property, including without limitation, all Grantor’s rights under and by virtue of all covenants and warranties pertaining to the Property, express or implied, that have heretofore been made by any or all of Grantor’s manufacturers or predecessors in title; and, together with any and all proceeds and other property of value incident thereto which Grantor might at any time have been,

ASSET PURCHASE AGREEMENT

PAGE 14

and may be, or may hereafter become, entitled to which are attributable to any of the Property.

All of the foregoing rights, title, interests, and other properties identified hereinabove are collectively called “Property”. Concurrent with the transfer and conveyance contemplated herein, the Conveyance Documents shall terminate and be of no further force and effect, it being agreed that only the Property subject thereto as described therein and herein shall be transferred and conveyed hereby.

Grantor represents and warrants to Grantee that Grantor has good and marketable title to the Property, free and clear of all claims, encumbrances, mortgages, liens, security interests, and/or other rights in respect of title arising or created by, through, or under Grantor, but not otherwise, that Grantor has the absolute right and authority to grant, bargain, sell, convey, and assign the Property, and that Grantor has no knowledge of any threatened litigation, proceedings, or claims that would in any way affect the Property of Grantor’s ability to transfer such title to any of the Property.

Grantor represents and warrants that Grantor, its successors and assigns, will forever warrant and defend such title to the Property against the claims, encumbrances, mortgages, liens, security interest, and/or other rights in respect of title of the Property, howsoever and whenever arising, asserted, or created, or any and all persons whomsoever claiming, or who or which may claim any right, title, or interest in or to such title or the Property, or any part thereof, arising, asserted, or created by, through, or under Grantor, but not otherwise.

Grantor represents and warrants to Grantor that it is a limited liability company duly organized, validly existing, and in good standing under the laws of the State of Texas, and is duly licensed or qualified, and in good standing as a limited liability company authorized to do business in the State of Texas.

Grantor represents and warrants to Grantee that the execution and delivery of this Conveyance is within Grantor^’s Company powers, and has been duly authorized by Grantor by all necessary Company action.

Grantor, its successors and assigns, shall indemnify, save, defend, and forever hold Grantee, its successors and assigns, harmless from and against, and to reimburse Grantee with respect to any and all claims, demands, causes of action administrative proceedings, loss, judgments, damages, penalties, fines, liabilities (including sums paid in settlement of claims), interest, costs, and expenses (including reasonable attorneys^’ fees and court costs) of any and every kind or character, known or unknown, fixed or contingent, asserted against or incurred and paid by the Grantee at any time, which is attributable directly to the breach of any representation or warranty of Grantor set forth in this Conveyance which is made by any third party by, through, or under Grantor, but not otherwise.

EXCEPT AS SPECIFICALLY PROVIDED FOR IN THE REPRESENTATIONS AND WARRANTIES SET FORTH HEREINABOVE, GRANTOR AND GRANTEE AGREE THAT THE PROPERTY IS CONVEYED BY GRANTOR, AND ACCEPTED BY GRANTEE, IN ITS “AS IS”, “WHERE IS” CONDITION, “WITH ALL FAULTS”. ABSOLUTELY NO WARRANTIES ARE GIVEN BY GRANTOR WITH RESPECT TO THE PROPERTY,

ASSET PURCHASE AGREEMENT

PAGE 15

INCLUDING WITHOUT LIMITATION, ANY WARRANTY OF SUITABILITY, HABITABILITY, MERCHANTABILITY, OR FITNESS FOR A PARTICULAR PURPOSE.

Grantor herein expressly RESERVES, SAVES, AND EXCEPTS from this conveyance, for its sole use and benefit, the exclusive right to receive all revenue directly or indirectly derived from the Master Lease and lease space conveyed to Grantee in Paragraph No. 1 hereinabove.

It is the intent of this Conveyance that Grantee shall own after the Effective Date, the entirety of the interest owned by Grantor in the Property as of the Effective Date, subject to all matters recited herein.

All of the terms, provisions, covenants and agreements herein contained shall extend to, and be binding upon, the parties hereto, and their respective successors and assigns, and shall be governed and interpreted by the laws of the State of Texas. Venue for any legal proceedings hereunder shall be in the state district courts of Harris County, Texas.

If this Conveyance is executed in multiple counterparts, each shall, for all purposes, be deemed to be an original, and all such counterparts together shall constitute but one and the same instrument. All such counterparts, if any, shall be identical.

This Agreement and all attachments, schedules, or annexes hereto may not be modified or supplemented except by written instrument executed by each of the parties hereto.

Seller hereby agrees on and after the Closing Date to take any and all actions deemed reasonably necessary by Buyer and Seller in order to more completely transfer title to the Assets to Buyer. All expenses of such actions taken by Seller at the request of Buyer shall be borne solely by Buyer, except as otherwise provided in this Agreement.

Executed as of the Effective Date.

TOMASZEK MANAGEMENT, L.L.C.

(“Grantor”)

/s/    David E. Tomaszek        

David E. Tomaszek, M.D., Manager

ASSET PURCHASE AGREEMENT

PAGE 16

STATE OF TEXAS         § §

COUNTY OF HARRIS   §

This instrument was acknowledged before me on the 23rd day of June, 2003, by David E. Tomaszek, M.D., Manager of Tomaszek Management, L.L.C., a Texas limited liability company on behalf of said company.

/s/    Jennifer L. Evans

Notary Public In And For The State Of Texas

ASSET PURCHASE AGREEMENT

PAGE 17

EX-10.10

Exhibit 10.10

ASSET PURCHASE AGREEMENT

THIS ASSET PURCHASE AGREEMENT (this “Agreement”) is made and entered into as of the 31st day of July, 2003, by and between GARLAND PHYSICIANS’ HOSPITAL, LTD., a Texas limited partnership (“Seller”) and VISTA HOSPITAL OF DALLAS, L.P., a Texas limited partnership (“Purchaser”). LELAND MEDICAL CENTERS, INC., a Texas corporation (“Leland”) is the corporate parent of Seller’s general partner and shall receive a direct benefit by consummation of the transactions contemplated by this Agreement and therefore joins in this Agreement for the purposes stated in Sections 1.02(e), 3.09, 6.03, 8.01 and 11.02 hereof and Article IV and Article X hereof.

RECITALS:

A. Seller owns a fully licensed and operational 113-bed acute care general hospital located in Garland, Texas, commonly known as “Leland Medical Plaza,” and a medical office building that is attached thereto, together with its related businesses and properties (collectively referred to as the “Hospital”).

B. Seller desires to sell to Purchaser and Purchaser desires to purchase substantially all of the assets, real estate, equipment, inventory, fixtures and other property which are directly or indirectly related to, necessary for, or used in connection with, the operation of the Hospital (except for the Retained Assets as defined in Section 1.02 hereof), on the terms and conditions set forth in this Agreement.

C. Seller and Leland will derive substantial benefits from the transactions contemplated by this Agreement and in connection therewith are willing to (i) deliver to Purchaser certain agreements not to compete with Purchaser and the business of the Hospital (the “Business”), and (ii) make certain representations, warranties, covenants and agreements set forth herein.

NOW, THEREFORE, for and in consideration of the premises and the agreements, covenants, representations, and warranties hereinafter set forth and other good and valuable consideration, the receipt and adequacy of which are forever acknowledged and confessed, the parties hereto hereby agree as follows:

ARTICLE I

PURCHASE AND SALE OF ASSETS

1.01 Assets to be Purchased. Subject to the terms and conditions hereinafter set forth and except for the Retained Assets, Seller hereby agrees to sell, assign, convey, transfer and deliver to Purchaser, and Purchaser agrees to purchase, accept and acquire from Seller, on the Closing Date (as defined in Section 3.01 hereof), on a going concern basis, all of Sellers’s right, title and interest in and to all of the assets, properties, rights and interests of every kind and

description, real, personal or mixed, tangible or intangible owned or used by Seller and its Affiliates (as hereinafter defined) in connection with the operation of the Business (all of which assets, properties, rights and interests are hereinafter collectively referred to as the “Acquired Assets”), including, without limitation, the following:

(a) all legal, beneficial and equitable title to that certain approximately 23-acre tract of real property located in Garland, Texas and being more particularly described on Exhibit A attached to this Agreement, together with (i) all buildings, fixtures and other improvements located thereon or attached to such real property; (ii) all of Seller’s right, title and interest in and to all leases, subleases, franchises, licenses, permits, rights-of-way and easements, if any, appurtenant to or otherwise benefiting such real property or its buildings, fixtures or improvements, and (iii) all other rights and appurtenances pertaining to such land and its improvements, including strips and gores (collectively, the “Real Property”);

(b) all tangible business and personal property, including, without limitation, all major, minor, medical, surgical or other equipment, vehicles, furniture, furnishings, machinery, data processing and computer hardware, appliances and other tangible personal property of every description and kind and all replacement parts therefore and accessories thereto, including, without limitation, those assets listed on Schedule 1.01(b) to this Agreement (collectively, the “Equipment”);

(c) all supplies, goods and inventory used, useable or useful in respect of the Business existing as of the Closing Date, including, but not limited to, pharmaceuticals and medications, food, janitorial and cleaning materials, disposables, linens, consumables, office supplies and medical supplies, including, without limitation, those assets listed on Schedule 1.01(c) to this Agreement (collectively, the “Inventory”);

(d) all deposits, prepaid taxes and expenses, escrows and other advance payments relating to any expenses of the Business to the extent that the same are assignable or transferable, including, without limitation, those items listed on Schedule 1.01(d) (collectively, the “Prepaid Expenses”);

(e) all financial, patient, medical staff and personnel records and other records relating to the Hospital, whether in hard or any other format (including, without limitation, all clinical records, equipment records, medical administrative libraries, medical records, patient billing records, documents, catalogs, books, records, files, operating manuals, current personnel records and computer software (collectively, the “Documentary Information”));

(f) all rights and benefits of Seller in, to or under those written agreements, contracts, sales commitments, purchase orders, customer commitments, security agreements or instruments and undertakings entered into in the ordinary course of the Business which have been (i) entered into on or before the date hereof and are listed on Schedule 1.01(f) to this Agreement or (ii) are entered into after the date hereof, are related

exclusively to the Business and satisfy the requirements of Section 6.02 hereof (collectively, the “Acquired Contracts”);

(g) all of Seller’s right, title and interest in and to those personal property leases listed on Schedule 1.01(g) to this Agreement (collectively, the “Personal Property Leases”);

(h) all of Seller’s right, title and interest in and to those real property leases with respect to tenants of the medical office building attached to the hospital building, including, without limitation, those leases listed on Schedule 1.01(h) to this Agreement (collectively, the “Real Property Leases”);

(i) all rights and benefits of Seller under any and all manufacturer’s, merchant’s, repairmen’s and other third-party warranties, guaranties and service or replacement programs relating to the Business or any Acquired Asset, including, without limitation, those assets listed on Schedule 1.01(i) to this Agreement (collectively, the “Warranties”);

(j) all of the licenses, permits, approvals, variances, rights, waivers or consents (collectively, the “Licenses”) issued to Seller by any federal, state, county or local governmental entity or municipality or subdivision thereof or any authority, arbitrator, department, commission, board, bureau, body, agency, court or instrumentality thereof (collectively, “Governmental Authorities”) and used by Seller in connection with the operation of the Business to the extent the same are assignable or transferable, including all Hospital Licenses, certificates of occupancy, Drug Enforcement Administration registrations and certifications, authorizations and/or certifications for participation in the Medicare program or any state Medicaid program and including, without limitation, the Licenses listed on Schedule 1.01(j) to this Agreement;

(k) all of the provider, facility and billing numbers used in connection with the operation of the Business to the extent that the same are assignable or transferable, including, without limitation, those numbers listed on Schedule 1.01(k) to this Agreement;

(l) all names, trade names, trademarks and service marks (or variations thereof) associated with the Hospital, including the name “Garland Physicians’ Hospital” and those other names, marks and logos used by the Hospital and, to the extent assignable by Seller, all warranties (express or implied) and rights and claims assertable by (but not against) Seller related to such assets;

(m) all rights of Seller to those telephone, pager and facsimile numbers utilized by Seller in connection with the operation of the Hospital, including, without limitation, those numbers listed on Schedule 1.01(m) to this Agreement;

(n) all goodwill associated with the Hospital and the Acquired Assets; and

(o) all other property, other than the Retained Assets, of every kind, character or description owned by Seller or its Affiliates and used or held for use in the business of the Hospital, wherever located and whether or not similar to the items specifically set forth above.

For purposes of this Agreement the term “Affiliate” shall mean with respect to any party to this Agreement any entity or person that directly or indirectly controls, is controlled by, or under common control with such party. As used in this definition of “Affiliate”, the term “control” means possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of an entity whether through ownership of voting securities, by contract or otherwise.

1.02 Retained Assets. Notwithstanding anything contained in Section 1.01 hereof to the contrary, Seller shall, and hereby does, expressly retain all of Seller’s right, title and interest in and to the following assets, properties, rights and interests, including, without limitation, certain assets related to the Business which are expressly described herein (all of which assets, properties, rights and interests are hereinafter collectively referred to as the “Retained Assets”):

(a) cash, cash equivalents, certificates of deposit and other investments in marketable securities of third-party issuers;

(b) all accounts (including intercompany receivables of Seller with any of Seller’s Affiliates, including WMH Physicians Hospital, L.L.C. and Physicians Metroplex Hospital, L.L.C.), notes, interest and other receivables of Seller, and all claims, rights, interests and proceeds related thereto, including all accounts and other receivables, disproportionate share payments and cost report settlements related thereto, arising from the rendering of services to inpatients and outpatients in connection with the Business, billed and unbilled, recorded and unrecorded, for services provided by Seller prior to the Effective Time whether payable by private pay patients, private insurance, third party payors, Medicare, Medicaid, CHAMPUS, Blue Cross, or by any other source (collectively “Seller Receivables”);

(c) all of Seller’s interest in the two (2) stand alone medical office buildings that are located adjacent to the Hospital and being more particularly described on Schedule 1.02(c) to this Agreement;

(d) all of Seller’s interest in that certain approximately 0.3 acre tract of real property being more particularly described on Exhibit B attached to this Agreement, together with all buildings, fixtures and other improvements located thereon (the “Retained Real Property”);

(e) any and all names, symbols, trademarks or logos used in connection with the Hospital which include the name “Leland,” or any variants thereof (the “Excluded Marks”); provided, however, Seller and Leland, from and after Closing, grant a non-exclusive license to Purchaser and its successors and assigns to use such names in

connection with its use of the personal property contained among the Acquired Assets even though certain items may contain the Excluded Marks, through the useful life of personal property;

(f) the original corporate and tax records of Seller and the general partner thereof;

(g) all documents, records, correspondence, work papers and other documents relating exclusively to the Seller Receivables, the Seller Cost Reports (as defined in Section 7.10 hereof) or Agency Settlements (as defined in Section 7.10 hereof);

(h) all of Seller’s right, title and interest in and to real property and leases relating to the two stand alone medical office buildings described on Schedule 1.02(c);

(i) all of Seller’s or any Affiliate of Seller’s proprietary manuals, marketing materials, policy and procedure manuals, standard operating procedures and marketing brochures, data and studies or analyses set forth on Schedule 1.02(i) to this Agreement;

(j) all of Seller’s interest in GCH Interests, Ltd., a Texas limited partnership;

(k) all current contracts between any Seller and any Affiliate of Seller with respect to the operation of the Hospital set forth on Schedule 1.02(k) to this Agreement;

(l) the portions of Inventory disposed of, expended or canceled, as the case may be, by Seller after the date of this Agreement and on or prior to the Closing Date in the ordinary course of business, and in accordance with Section 6.02 hereof;

(n) all refunds for (i) insurance policies held by Seller prior to the Closing Date, and (ii) the Seller Cost Reports, whether filed or to be filed, with respect to medical services provided by Seller prior to the Effective Time; and

(o) Seller’s Medicare provider number 45S315 and Seller’s Medicaid provider number 1217911-02, which provider numbers were used by Seller solely to bill for psychological services and related products rendered and/or provided at the Hospital.

1.03 Assignability and Consents. To the extent that the assignment of any Acquired Contract, Personal Property Lease, Real Property Lease, Warranty, License, Prepaid Expense, Documentary Information or other Acquired Asset to be assigned to Purchaser as provided herein shall require the consent or waiver of any third party or any Governmental Authority (each a “Required Consent”), Seller shall use its best efforts to obtain the consent or waiver of each such third party or Governmental Authority to such assignment, in each case in form and substance satisfactory to Purchaser, on or prior to the Closing Date. Schedule 1.03 to this Agreement sets forth a list of all of the Required Consents.

1.04 Assumed Liabilities and Obligations. On the Closing Date, Purchaser shall assume and agree to pay, perform and discharge as and when due only the following obligations and liabilities of Seller:

(a) All executory obligations with respect to the Business accruing exclusively, and based upon events occurring, after the Effective Time (as defined in Section 3.02 hereof) under (i) the Acquired Contracts, (ii) the Personal Property Leases, (iii) the Real Property Leases, and (iv) the Licenses.

All of the foregoing to be assumed by Purchaser hereunder are collectively referred to herein as the “Assumed Liabilities”.

1.05 Retained Liabilities and Obligations. Except for the Assumed Liabilities, Purchaser shall not assume and under no circumstances shall Purchaser be obligated to pay or assume, and none of the assets of Purchaser shall be or become liable for or subject to, any liability, indebtedness, commitment, or obligation of Seller or any of its Affiliates, whether known or unknown, fixed or contingent, recorded or unrecorded, currently existing or hereafter arising or otherwise, including, without limitation, the following (collectively, the “Retained Liabilities”):

(a) any debt, obligation, expense or liability of Seller or any of its Affiliates (or any predecessor operator of the Hospital or the Acquired Assets) that is not an Assumed Liability;

(b) claims or potential claims for medical malpractice or general liability arising from events that occurred prior to the Effective Time;

(c) any liabilities associated with or arising out of any of the Retained Assets;

(d) liabilities and obligations in respect of periods prior to the Effective Time arising under the terms of the Medicare, Medicaid, CHAMPUS, Blue Cross, or any other third party payor programs, and any liability arising pursuant to the Medicare, Medicaid, CHAMPUS, Blue Cross, or any other third party payor programs as a result of the consummation of any of the transactions contemplated under this Agreement;

(e) federal, state or local tax liabilities or obligations in respect of periods prior to the Effective Time, including, without limitation, any income tax, any franchise tax, any tax recapture, any sales and/or use tax, and any FICA, FUTA, workers’ compensation, and any and all other taxes or amounts due and payable as a result of the exercise by the employees at the Hospital of such employee’s right to vacation, sick leave, personal leave, bonus time, holiday benefits or such other paid time-off benefits accrued while in the employ of Seller or any of its Affiliates.

(f) liability for any and all claims by or on behalf of Seller’s current or former employees relating to periods prior to the Effective Time, including, without limitation,

liability for any pension, profit sharing, deferred compensation, or any other employee health and welfare benefit plans, liability for any EEOC claim, ADA claim, FMLA claim, wage and hour claim, unemployment compensation claim, or workers’ compensation claim;

(g) any obligation or liability accruing, arising out of, or relating to any federal, state or local investigations or inquiry of, or claims or actions against, Seller or any of its Affiliates or any of their employees, medical staff, agents, vendors or representatives (including but not limited to inquiries of, or claims or actions by, the Office of Inspector General (“OIG”), Federal Bureau of Investigation (“FBI”), the Department of Justice (“DOJ”), Internal Revenue Service (“IRS”), and/or any state agency or private individual acting in the capacity of qui tam relator or qui tam plaintiff), with respect to acts or omissions prior to the Effective Time, including, without limitation, damages, penalties, fines, assessments and attorneys’ fees, as well as any costs associated with or arising from researching, reviewing, providing or copying records and responding to search warrants, civil investigative demands, summons or subpoenas;

(h) any civil or criminal obligation or liability accruing, arising out of, or relating to any acts or omissions of Seller, its Affiliates or their respective partners, directors, officers, employees and agents claimed to violate any constitutional provision, statute, ordinance or other law, rule, regulation, interpretation or order of any governmental entity, including, without limitation, any costs associated with, or arising from: providing or copying records; responding to search warrants, summons, or subpoenas; and providing legal counsel to any employee, officer or director of Purchaser or its Affiliates in connection therewith;

(i) liabilities or obligations arising as a result of any breach by Seller at any time of any contract or commitment that is not assumed by Purchaser;

(j) liabilities or obligations arising out of any breach by Seller prior to the Effective Time of any Acquired Contract, Personal Property Lease or Real Property Lease;

(k) any debt, obligation, expense, or liability arising out of or incurred solely as a result of any transaction of Seller occurring after the Effective Time or arising out of any violation by Seller of any law, regulation, or ordinance at any time (including, without limitation, those pertaining to fraud, environmental, healthcare regulatory and ERISA matters);

(l) all liabilities and obligations relating to any oral agreements, oral contracts or oral understandings with any referral sources including, but not limited to, physicians, unless reduced to writing and expressly assumed as part of the Acquired Contracts; and

(m) liabilities or obligations with respect to the ownership or operation of any assets owned or operated by Seller or any of its Affiliates other than the Acquired Assets.

ARTICLE II

PURCHASE PRICE

2.01 Payment. As full payment for the Acquired Assets and the Noncompetition Agreement (as defined in Section 3.09 hereof), at the Closing Purchaser shall (a) assume the Assumed Liabilities, and (b) shall pay and/or deliver to Seller:

(i) the sum of Six Million Thirty Thousand Dollars ($6,030,000.00), by wire transfer of immediately available funds to such accounts as shall be designated in writing by Seller at least three (3) business days prior to the Closing Date (the “Cash Portion”); and

(ii) the Purchaser’s promissory note in the principal amount of Six Hundred Seventy Thousand Dollars ($670,000.00) and substantially in the form attached hereto as Exhibit C (the “Note”).

The Cash Portion and the original principal amount of the Note are collectively referred to herein as the “Purchase Price.”

2.02 Allocation of Purchase Price. The Purchase Price and the Assumed Liabilities represent the amount agreed upon by the parties to be the value of the Acquired Assets and the Noncompetition Agreement, it being further agreed that the Purchase Price and the Assumed Liabilities shall be allocated among the Acquired Assets and the Noncompetition Agreement in accordance with the allocation set forth on Schedule 2.02. Purchaser and Seller shall report the purchase and sale of the Acquired Assets and the Noncompetition Agreement in their respective federal, state or local tax returns in accordance with the allocation set forth on such Schedule 2.02.

ARTICLE III

CLOSING

3.01 Date, Time and Place of Closing. The closing of the transactions contemplated by this Agreement (the “Closing”) shall take place at the offices of Purchaser’s legal counsel, Hallett & Perrin, P.C., 2001 Bryan Street, Suite 3900, Dallas, Texas 75201, at 10:00 a.m., local Dallas, Texas time, on August 14, 2003, or as promptly as practicable thereafter as soon as the conditions set forth in Article VIII are satisfied, or at such other date, time or place fixed by mutual written consent of Purchaser and Seller, but in no event later than September 3, 2003. All proceedings to take place at the Closing shall take place simultaneously, and no delivery shall be considered to have been made until all such proceedings have been completed (the time and date of such Closing is referred to herein as the “Closing Date”).

3.02 Effective Time. The transactions contemplated by this Agreement shall be deemed effective for tax, accounting and all other purposes as of 12:01 a.m., local Dallas, Texas

time, on the day immediately following the Closing Date (the “Effective Time”), unless otherwise mutually agreed in writing by the parties.

3.03 Conveyance of Assets. At the Closing, Seller shall deliver or cause to be delivered to Purchaser for the purpose of transferring the Acquired Assets to Purchaser such documents, bills of sale, certificates of title, endorsements, assignments and instruments necessary, advisable or desirable to vest in Purchaser good and marketable title to all of the Acquired Assets being transferred by Seller to Purchaser hereunder, including, without limitation, the following (such documents and instruments hereinafter collectively referred to as the “Transfer Documents”):

(a) A Special Warranty Deed fully executed by Seller in recordable form, conveying to Purchaser good and marketable fee simple title and full ownership to the Real Property described in Schedule 1.01(a), subject only to the Permitted Encumbrances (as defined in Section 4.16);

(b) A General Bill of Sale and Assignment, in form satisfactory to Purchaser and fully executed by Seller, conveying to Purchaser good, valid and marketable title and full ownership to all tangible assets which are a part of the Acquired Assets and valid title to all intangible assets which are a part of the Acquired Assets, free and clear of all Liens (as hereinafter defined), other than the Assumed Liabilities;

(c) Certificates of Title to all vehicles which constitute a part of the Acquired Assets endorsed by Seller together with completed originals of any forms required by the State of Texas to transfer the same free and clear of all Liens;

(d) An Assignment of Leases and Contracts, fully executed by Seller, conveying to Purchaser Seller’s interest in the Acquired Contracts, the Personal Property Leases and the Real Property Leases; and

(e) An Owner’s Policy of Title Insurance covering the Real Property, as described in and provided by Section 7.02 hereof.

(f) If requested by Purchaser, written notice from Seller of the conveyance of the Real Property hereunder to each tenant of the Real Property under the Real Property Leases in substantially the form attached hereto as Exhibit H.

(g) The Officer’s Certificate described in Section 8.02(b) hereof.

(h) Originals of the Real Property Leases.

(i) Possession of the Real Property free and clear of all parties in possession except tenants under the Real Property Leases, and (to the extent in Seller’s possession) all keys, codes and other security devices for the Real Property.

All Acquired Assets shall be free and clear of any and all liens, prior assignments, security interests, charges, pledges, claims or encumbrances whatsoever (collectively, “Liens”), except Liens relating to the Assumed Liabilities and with respect to the Real Property, and except the Permitted Encumbrances (as defined in Secion 4.16 hereof).

3.04 Assumption Instrument. At the Closing, Purchaser shall execute and deliver to Seller an assumption agreement with respect to the Assumed Liabilities, in substantially the form attached hereto as Exhibit D (the “Assumption Instrument”).

3.05 Payment of Purchase Price. At the Closing, Purchaser shall pay to Seller the Purchase Price by delivering to Seller the Cash Portion as contemplated by Section 2.01 and the Note.

3.06 Taxes, Charges and Fees.

(a) Sales, Use and Transfer Taxes; Title and Survey Costs. At the Closing, Seller shall pay all transfer taxes, documentary stamp taxes, title search and title insurance fees and costs, survey costs and recording charges and any other taxes imposed by any Governmental Authority or otherwise incurred by either party in connection with the sale and transfer of the Acquired Assets. Seller shall be solely responsible for any and all taxes imposed by any Governmental Authority in connection with the ownership, use, sale or rental of the Acquired Assets on or prior to the Closing Date. In addition, Seller shall have the sole responsibility of representing its position in any future audit by any Governmental Authority with respect to any tax periods during which the Seller owned the Acquired Assets or operated the Business.

(b) Proration of Personal Property Taxes. Personal property taxes associated with the Acquired Assets that are imposed on a periodic basis and are payable for a tax period that includes (but does not end on) the Closing Date shall be prorated as of the Closing Date, and Seller shall bear the proportion, and shall have the sole responsibility of, such taxes (and any payments due on account of such taxes) equal to a fraction, the numerator of which is equal to the number of days which shall have elapsed from the beginning of the applicable tax period to and including the Closing Date and the denominator of which is the number of days in the entire applicable tax period. Purchaser shall have the sole responsibility for the remainder of such taxes (and any payments due on account of such taxes). If the tax statement or appropriate information for such tax period is not in the possession of the Seller on the Closing Date, the tax proration payment shall be made by Seller to Purchaser at Closing based on a reasonable estimate taking into account the prior period’s taxes and any publicly announced tax rate increase or decrease or change in the law governing such taxes, and Purchaser shall pay such taxes for such period when due, and any adjustments shall be made as soon thereafter as the tax statement or appropriate information is received.

(c) Proration of Real Property Taxes. The real property taxes and assessments required to be paid by Seller with respect to the Real Property shall be prorated as of the

Closing Date between Purchaser and Seller in the same manner as described in Section 3.06(b) hereof. If the tax statement or appropriate information for such tax period is not in the possession of the Seller on the Closing Date, the tax proration payment shall be made by Seller to Purchaser at Closing based on a reasonable estimate taking into account the prior period’s taxes and any publicly announced tax rate increase or decrease or change in the law governing such taxes, and Purchaser shall pay such taxes for such period when due, and any adjustments shall be made as soon thereafter as the tax statement or appropriate information is received.

3.07 Proration of Utilities and Assessments. Seller and Purchaser agree that utilities and assessments on the Business and the Acquired Assets shall be prorated on a daily basis between Seller and Purchaser, with Seller responsible for such utilities and assessments through and including the Closing Date. If Purchaser or Seller should subsequently receive any refund of such utilities or assessments, such refund shall be similarly apportioned and the party receiving such refund shall remit to the other party its proportionate part thereof.

3.08 Security Deposits and Proration of Rents. Seller shall credit to Purchaser (and Purchaser shall receive a credit against the Purchase Price) for the security deposits, if any, held under the Real Property Leases. Seller and Purchaser agree that any and all amounts received pursuant to the Real Property Leases, including any and all rental or lease payments, shall be allocated between the Purchaser and Seller on a prorated daily basis with Seller entitled to all amounts earned or accrued through and including the Closing Date. Notwithstanding the foregoing, no proration shall be made for any delinquent rents existing as of the date of Closing; with respect to any such delinquent rents, Purchaser shall make a reasonable attempt to collect the same for Seller’s benefit after Closing in the usual course of operation of the Real Property, and any such collections shall be remitted to Seller promptly upon receipt by Purchaser; provided, however, that nothing contained herein shall operate to require Purchaser to institute any lawsuit or other collection procedure to collect such delinquent rents. The first monies collected from tenants shall be applied to the month of receipt, and any other monies shall be applied to the earliest period for which rents are owing. Seller shall pay all leasing commissions and tenant costs (including, without limitation, tenant improvement costs, moving costs, design costs incurred by the tenant, lease buyout costs and similar tenant inducement costs) in connection with the Real Property Leases; provided, however, that Purchaser shall pay all leasing commissions and tenant costs (including, without limitation, tenant improvement costs, moving costs, design costs incurred by the tenant, lease buyout costs and similar tenant inducement costs) related to any post-Closing renewals, extensions or expansions by the tenants under the Real Property Leases. Where the Real Property Leases contain tenant obligations for taxes, common area expenses, operating expenses or additional charges of any other nature, and where Seller shall have collected any portion thereof in excess of amounts owed by tenants for such items with respect to the period prior to the Closing, then there shall be an adjustment and credit given to Purchaser on the Closing Date for such excess amounts collected, if any. Purchaser shall apply all such excess amounts to the charges owed by Purchaser for such items for the period after the Closing Date.

3.09 Noncompetition Agreement. At the Closing, Seller, Leland and Purchaser shall enter into a Noncompetition Agreement (herein so called) in substantially the form attached hereto as Exhibit E.

3.10 Other Documents. All other documents, certificates, consents, approvals and notations, confirmations and papers required by Article VIII hereof as conditions to Closing, and all appropriate receipts, shall be delivered to Seller and to Purchaser, as the case may be, at the Closing.

3.11 Covenants and Further Assurance. Seller shall, at any time and from time to time after the Closing Date, upon request of Purchaser and without further cost or expense to Purchaser, execute and deliver such instruments of conveyance and assignment and shall take such action as Purchaser may reasonably request to more effectively transfer to and vest in Purchaser, and to put Purchaser in possession of, any and all of the Acquired Assets, free and clear of any and all Liens (other than Liens relating to the Personal Property Leases and the Permitted Encumbrances), or otherwise carry out the transactions contemplated by this Agreement. Purchaser shall, at the time and from time to time after the Closing Date, upon request of Seller and without further cost or expense to Seller, execute and deliver such instruments of assumption and shall take such other action as Seller may reasonably request to more effectively evidence or effect the assumption by Purchaser of the Assumed Liabilities or otherwise carry out the transactions contemplated by this Agreement.

ARTICLE IV

REPRESENTATIONS AND WARRANTIES OF SELLER AND LELAND

In order to induce the Purchaser to enter into this Agreement and to consummate the transactions contemplated hereby, Seller and Leland, jointly and severally, hereby represent and warrant as of the date hereof as follows:

4.01 Existence and Capacity.

(a) Seller is a limited partnership, duly organized and validly existing under the laws of the State of Texas. Seller has the requisite power and authority to enter into this Agreement, to perform its obligations hereunder and to conduct its business as now being conducted. The sole general partner of Seller is LMC GPH, Inc., which is a corporation duly organized, validly existing and in good standing under the laws of the State of Texas (the “General Partner”). The General Partner has the requisite corporate power and authority to execute this Agreement on behalf of Seller, to perform Seller’s obligations hereunder and to conduct its business as now being conducted. The State of Texas is the only jurisdiction in which the operations of Seller make it necessary to be qualified to do business.

(b) Leland is a corporation, duly organized, validly existing and in good standing under the laws of the State of Texas. Leland has the requisite power and authority to enter into

this Agreement, to perform its obligations hereunder and to conduct its business as now being conducted.

4.02 Authorization.

(a) The execution, delivery and performance of this Agreement and all other agreements and instruments executed and delivered by Seller in connection herewith and the consummation of the transactions contemplated hereby and thereby have been duly and validly authorized by all necessary action on the part of Seller. This Agreement has been, and the other agreements and instruments to be executed and delivered by Seller in connection herewith will be, on or prior to the Closing Date, duly executed and delivered by Seller, and constitute, or upon execution and delivery will constitute, the valid, legal and binding obligations of Seller, enforceable against Seller in accordance with their respective terms.

(b) The execution, delivery and performance of this Agreement and all other agreements and instruments executed and delivered by Leland in connection herewith and the consummation of the transactions contemplated hereby and thereby have been duly and validly authorized by all necessary action on the part of Leland. This Agreement has been, and the other agreements and instruments to be executed and delivered by Leland in connection herewith will be, on or prior to the Closing Date, duly executed and delivered by Leland, and constitute, or upon execution and delivery will constitute, the valid, legal and binding obligations of Leland, enforceable against Leland in accordance with their respective terms.

4.03 Conflicts; Defaults. The execution and delivery of this Agreement and the other agreements and instruments executed or to be executed in connection herewith by Seller do not, and the performance by Seller of its obligations hereunder and thereunder and the consummation by Seller of the transactions contemplated hereby or thereby, will not as of the Closing Date (i) violate, conflict with, or constitute a breach or default under any of the terms of Seller’s organizational documents, or except for the Required Consents, any License, patent, trademark, copyright or other intellectual property right of Seller, Warranty, Documentary Information, Acquired Contract, Personal Property Lease or Real Property Lease or any other obligation under or with respect to the Acquired Assets, (ii) result in the creation or imposition of any Liens in favor of any third party upon any of the Acquired Assets or the Business, (iii) violate or require any authorization, approval, consent or other action by, or registration, declaration or filing with or notice to, any Governmental Authority pursuant to any law, statute, judgment, decree, injunction, order, writ, rule or regulation of any Governmental Authority affecting the Business or the Acquired Assets; or (iv) conflict with or result in a breach of, create an event of default (or event that, with the giving of notice or lapse of time or both, would constitute an event of default) under, or give any third party the right to terminate, cancel or accelerate any obligation under, any contract, agreement, note, bond, guarantee, deed of trust, loan agreement, mortgage, license, lease, indenture, instrument, order, arbitration award, judgment or decree to which Seller is a party or by which Seller or any of its assets or properties are bound or affected, including, without limitation, the Acquired Assets. There is no pending or, to the best knowledge of Seller, threatened action, suit, claim, proceeding, inquiry or investigation before or by any Governmental Authority, involving or to restrain or prevent the consummation of the transactions contemplated

by this Agreement or that might reasonably be expected to affect the right of Purchaser to acquire or own the Acquired Assets or the right of Purchaser to operate the Business in substantially the manner in which it currently is operated.

4.04 Absence of Undisclosed Information. Except as otherwise disclosed in any Schedule attached hereto and listed on the List of Schedules made part of this Agreement provided for herein, the Business and the Acquired Assets are not subject to any liabilities or obligations of any nature, fixed or contingent, or any facts that might give rise to any such liabilities or obligations, which would materially adversely affect the business, business prospects, assets, financial condition or results of operations of the Business.

4.05 Financial Statements; Financial Information.

(a) Seller has heretofore delivered to Purchaser true and correct copies of the Seller’s audited balance sheet as at December 31, 2001, and related statements of operations, retained earnings and cash flows for the twelve month period ending December 31, 2001, together with the notes relating thereto (collectively, the “Audited Financial Statements”). The Audited Financial Statements: (A) have been prepared in accordance with the books and records of Seller; (B) have been prepared in accordance with generally accepting accounting principles consistently applied with Seller’s financial statements for its business; (C) reflect and provide adequate reserves and disclosures in respect of all liabilities of the Business, including without limitation, all contingent liabilities, as of December 31, 2001 to the extent required by generally accepted accounting principles consistently applied; and (D) present fairly the financial condition of the Business at such date and the results of operations and cash flows of the Business for the period then ended.

(b) Seller has heretofore delivered to Purchaser true and correct copies of the Seller’s unaudited balance sheet as at April 30, 2003, and related income statement for the four (4) month period ending April 30, 2003.

(c) Seller has heretofore delivered to Purchaser a true and correct, in all material respects, summary of all of Seller’s outstanding liabilities as of July 28, 2003 (the “Summary of Outstanding Liabilities”). The Summary of Outstanding Liabilities (i) has been prepared based on the books and records of the Seller, and (ii) accurately and completely sets forth, in all material respects, all liabilities of Seller as of July 28, 2003.

4.06 Adequacy of Acquired Assets. Seller has good and marketable title to all of the Acquired Assets and the Acquired Assets are, or will be, upon consummation of the transactions contemplated by this Agreement on the Closing Date, free and clear of all Liens (other than Liens relating to the Assumed Liabilities and with respect to the Real Property, and except the Permitted Encumbrances). The Acquired Assets include all assets and properties of Seller of every kind and description, real, personal or mixed, tangible or intangible, the use of which is reasonably necessary to enable Purchaser to conduct the Business as it has been conducted by Seller prior to the date hereof. Except for those liabilities that shall be paid by Seller at Closing, there are no unpaid liabilities, claims or obligations arising from the ownership, use or operation

of the Acquired Assets or the Business which could give rise to any mechanic’s, materialman’s or other statutory lien against the Acquired Assets, or for which Purchaser could be held responsible. Except as expressly set forth in this Article IV, the Acquired Assets transferred to Purchaser will be sold by Seller and purchased by Purchaser in their physical condition on the Closing Date, “AS IS, WHERE IS AND WITH ALL FAULTS” and “WITH NO WARRANTY OF HABITABILITY OR FITNESS FOR HABITATION,” with respect to the Real Property, land, buildings and improvements, and “WITH NO WARRANTIES, INCLUDING, WITHOUT LIMITATION, THE WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE,” with respect to the physical condition of the Equipment and Inventory, any and all of which warranties (both express and implied) Seller hereby disclaims. All of the foregoing real and personal property shall be further subject to normal wear and tear on the land, buildings, improvements and equipment and normal and customary use of the inventory and supplies in the ordinary course of business up to the Closing Date.

4.07 Personal Property Leases. Schedule 1.01(g) to this Agreement sets forth as of the date of this Agreement a list and brief description of each lease or other agreement or right, whether written or oral, under which Seller is lessee of, or holds or operates any machinery, equipment, vehicle or other tangible personal property owned by a third party and used in connection with the Business. All Personal Property Leases to which Seller is a party either as lessor or lessee with respect to the Acquired Assets are valid and enforceable in accordance with their respective terms, and except as disclosed on Schedule 1.01(g) there is not under any of such leases any material breach or default on the part of Seller or, to the knowledge of Seller, on the part of any other party thereto, or any condition or event that, with the giving of notice or lapse of time or both, would constitute such a material breach or default on the part of Seller or, to the knowledge of Seller, on the part of any other party thereto.

4.08 Real Property Leases. The Real Property Leases are valid and existing leases and are in full force and effect and are valid and enforceable against the parties thereto in accordance with their terms and all rental and other payments due under each of the Real Property Leases have been duly paid in accordance with the terms of such Real Property Leases. Except as set forth in Schedule 4.08, there is no breach or event of default on the part of any party to any Real Property Lease and no condition or event that, with the giving of notice or lapse of time or both, would constitute such breach or event of default, has occurred and is continuing. No waiver, indulgence or postponement of any tenant’s obligations under any Real Property Lease has been granted by the Seller. No construction, alteration or other leasehold improvement work with respect to any of the Real Property Leases remains to be paid for or to be performed by Seller.

4.09 Intellectual Property. (a) Schedule 4.09 to this Agreement sets forth a true and accurate description of all intellectual property and all registrations and applications for any of the foregoing owned or used by Seller in connection with the conduct of the Business (the “Intellectual Property”).

(b) Seller is the owner of all right, title and interest in and to the Intellectual Property free and clear of all Liens and without obligation to make any royalty, license or

other payment with respect thereto, including, without limitation, any royalty, license or other payment resulting from any infringement of any third party rights.

(c) There have not been any claims, actions or judicial or other adversary proceedings involving Seller concerning any item of the Intellectual Property; there is no basis for any such action or proceeding; and to the best knowledge of Seller no such action or proceeding is threatened.

4.10 Contracts and Commitments. Except as set forth in Schedule 4.10 to this Agreement, Seller is not, with respect to the Business or the Acquired Assets, a party to any written or oral:

(i) contract not made in the ordinary course of business, other than this Agreement, under which the total outstanding obligation is in excess of Ten Thousand Dollars ($10,000.00);

(ii) consulting agreement or contract for the employment of any employee or other person on a full-time, part-time or consulting basis that is not terminable upon notice of thirty (30) days or less without cost or other liability resulting solely from such termination;

(iii) agreement relating to the lease of any property, real or personal, whether as lessor or lessee that involves future obligations of more than Ten Thousand Dollars ($10,000.00);

(iv) contract for the purchase or sale of real property or capital or fixed assets that involves future obligations of more than Ten Thousand Dollars ($10,000.00); or

(v) contracts and other agreements containing covenants under which the Business may not compete in any line of business or with any person in any geographic area.

Except as set forth in Schedule 4.10 to this Agreement, Seller is not in breach of or in default under and, to Seller’s knowledge, no other party thereto is in breach of or default under, any of the contracts, agreements or arrangements set forth in Schedule 4.10 to this Agreement, and no event has occurred that, with the giving of notice or lapse of time or both, would constitute such a breach or default. True, correct and complete copies of such contracts, agreements or instruments have been delivered to Purchaser.

4.11 Inventory. Except as set forth in Schedule 4.11 to this Agreement, Seller has good title to all Inventory included as part of the Acquired Assets, free and clear of all Liens. The Inventory is adequate for the conduct of the Business and inventory levels are not in excess of the normal operating requirements of the Business in the ordinary course of business consistent with past practices.

4.12 Licenses. The Hospital is duly licensed as a 113-bed general acute care hospital pursuant to the applicable laws of the State of Texas. The pharmacies, laboratories, and all other ancillary departments located at the Hospital or operated for the benefit of the Hospital which are required to be specially licensed are duly licensed by the Department of Health of the State of Texas (“TDH”) or other appropriate licensing agency. Seller has all other licenses, permits, and approvals which are needed or required by law to operate the business related to or affecting the Hospital or any ancillary services related thereto. Seller has delivered to Purchaser an accurate and complete list (Schedule 1.01(j)) of all such Licenses owned or held by Seller relating to the ownership, development, or operation of the Hospital or the Acquired Assets, all of which are now and as of Closing shall be valid, in full force and effect and not subject to meritorious challenge. All applications required to have been filed for the renewal of the Licenses have been duly filed on a timely basis, or with appropriate extensions, each with the appropriate Governmental Authority, and all other filings required to have been made with respect to such Licenses have been duly made on a timely basis, each with the appropriate Governmental Authority.

4.13 Medicare Participation/Accreditation. The Hospital is certified for participation in the Medicare, Medicaid and CHAMPUS programs, has a current and valid provider contract with such programs, is in compliance with the conditions of participation in such programs, and has received all approvals or qualifications necessary for capital reimbursement for the Hospital. The Hospital is duly accredited, with no contingencies by the Joint Commission on Accreditation of Healthcare Organizations (“JCAHO”) for the three (3) year period ending August 24, 2003. A copy of the most recent accreditation letter from JCAHO pertaining to the Hospital has been made available to Purchaser. Neither Seller nor any of its officers, directors, managing employees, or controlling partners are excluded from participation in the Medicare, Medicaid or CHAMPUS programs, nor is any such exclusion threatened. Seller has not received any notice from any of the Medicare, Medicaid or CHAMPUS programs, or any other third party payor programs of any pending or threatened investigations or surveys, and Seller has no reason to believe that any such investigations or surveys are pending, threatened, or imminent. Attached hereto as Schedule 4.13 is a copy of any Statement of Deficiencies and Plan of Correction (Form HCFA-2567) received during the past three (3) years with respect to the Hospital.

4.14 Third Party Payors. In addition to the Medicare, Medicaid and CHAMPUS programs, the Hospital has current and valid provider contracts with those third party payors listed on Schedule 4.14 hereto. True, correct and complete copies of such third party payor contracts have been provided to Purchaser by Seller. Seller is not in breach of or in default under any third party payor contract and no event has occurred that, with the giving of notice or lapse of time or both, would constitute such a breach or default.

4.15 Regulatory Compliance. The Hospital is in compliance with all applicable statutes, rules, regulations, and requirements of all Governmental Authorities having jurisdiction over the Hospital and the Acquired Assets and the operations of the Hospital and the Acquired Assets. Seller has timely filed all reports, data, and other information required to be filed with such Governmental Authorities. The Hospital has received no notice of any violation of federal or state fraud and abuse or self referral laws, nor does Seller have knowledge of any such

violations in connection with the operation of its business. Neither Seller nor any of its employees have committed a violation of federal or state laws regulating health care fraud, including but not limited to the federal Anti-Kickback Law, 42 U.S.C. Section 1320a-7b, the Stark I and II Laws, 42 U.S.C. Section 1395nn, as amended, and the False Claims Act, 31 U.S.C. Section 3729, et seq.

4.16 Real Property. Seller owns good, marketable, fee simple (full ownership) title to the Real Property, together with all buildings, improvements, fixtures and component parts thereon and all easements, servitudes, appurtenances and rights thereto, and except as described in Schedule 4.16, Seller has not created any mortgages, liens, restrictions, agreements, claims, or other encumbrances which cause title to such Real Property to be unmarketable or which will materially interfere with the use by Purchaser of the Acquired Assets in a manner consistent with the current use by Seller. The Real Property will be conveyed to Purchaser subject to (i) current taxes not yet due and payable, (ii) any lease obligation expressly assumed hereunder by Purchaser, and (iii) easements and other restrictions of record as more particularly described in Schedule 4.16 hereto (collectively, the “Permitted Encumbrances”). In respect of the Real Property, Seller represents and warrants that:

(a) If any lien or liens including, without limitation, mortgage liens, mechanics and materialmen’s liens, and/or judgment liens, which are not Permitted Encumbrances or Assumed Liabilities, are asserted against the Real Property, Seller shall promptly obtain the release of such lien(s);

(b) Seller has not received notice of a violation of any applicable ordinance or other law, order, regulation, or requirement and has not received notice of condemnation, lien, assessment, or the like relating to any part of the Real Property or the operation thereof and, to Seller’s knowledge, no such notice is threatened or contemplated;

(c) At Closing, Seller shall convey by special warranty deed to Purchaser good and marketable fee simple (full ownership) title to the Real Property, free and clear of any Lien, except for the Permitted Encumbrances;

(d) The Real Property and its operation are in compliance with all applicable zoning ordinances, and the consummation of the transactions contemplated herein will not result in a violation of any applicable zoning ordinance or the termination of any applicable zoning variance now existing, and if any of the improvements on the Real Property are damaged or destroyed subsequent to Closing, the repair or replacement of same by Purchaser to the condition existing immediately prior to Closing will not violate applicable zoning ordinances (assuming there has been no change in such zoning ordinances);

(e) Except for the Permitted Encumbrances, the Real Property is subject to no easements, servitudes, restrictions, ordinances, or such other limitations on title which make or could make the Real Property, or any part thereof, unusable for its current use or unmarketable;

(f) All utilities serving the Real Property are, and, to the extent within Seller’s control, shall be at Closing, adequate to operate the Real Property in the manner it is currently operated;

(g) Except for those tenants in possession of the Real Property under the Real Property Leases listed on Schedule 1.01(h), there are no parties in possession of, or claiming any possession, adverse or not, to or other interest in, any portion of the Real Property as lessees, tenants at sufferance, trespassers or, to Seller’s knowledge, otherwise. No tenant is entitled to any rebate, concession or free rent, other than as set forth in the lease or contract with such tenant; no commitments have been made to any tenant for repairs or improvements other than for normal repairs and maintenance in the future; and except as will be released by Garland Community Hospital, Ltd. at Closing, no rents due under any Real Property Leases with tenants have been assigned or hypothecated to or encumbered by any person; the copies of the Real Property Leases provided to Purchaser pursuant to Section 6.04(c) hereof are true, correct and complete and are the only leases in effect with respect to the Real Property; such Real Property Leases are in full force and effect; such tenants are the sole tenants at the Real Property and are currently occupying same; except as disclosed in Schedule 4.16(g), such tenants are current in the payment of monthly base rent due under the Real Property Leases and are current in the payment of all other charges due under the Real Property Leases; there are no defaults by Seller or the tenants under the Real Property Leases and no conditions exist which by the giving of notice or with the passage of time would constitute such a default; all brokerage commissions with respect to the Real Property Leases have been paid in full and there will be no brokerage commissions due in respect of any extension or renewal of the Real Property Leases (this representation shall survive the Closing indefinitely notwithstanding the limits on survival set forth in Section 11.01 hereof); Seller has not and shall not in the future collect any installment of rent more than thirty (30) days in advance of its date due; the tenants have has not paid a security deposit or any other deposits to Seller or any prior landlord except as set forth in Schedule 4.16(g) attached hereto;

(h) Except as set forth on Schedule 4.16(h), any division of the Real Property by Seller or its Affiliates, including the division required to exclude the tract described in Section 1.02(d) hereof, has been done in compliance with all applicable subdivision, zoning or other land use laws, regulations, ordinances or requirements.

(i) Seller has not received any written condemnation notice from any Governmental Entity with respect to all or part of the Real Property and to Seller’s acknowledge no condemnation or eminent domain action is threatened or contemplated;

(j) Seller has not (i) commenced a voluntary case, or had entered against it a petition, for relief under any federal bankruptcy act or any similar petition, order or decree under any federal or state law or statute relative to bankruptcy, insolvency or other relief for debtors, (ii) caused, suffered or consented to the appointment of a receiver, trustee, administrator, conservator, liquidator or similar official in any federal, state or foreign

judicial or non-judicial proceedings, to hold, administer and/or liquidate all or substantially all of its property, or (iii) made an assignment for the benefit of creditors;

(k) Seller has not granted any options or rights of first refusal to tenants or any other third parties to purchase or otherwise acquire any interest in the Real Property;

(l) All documents and records delivered or made available to Purchaser will be true, correct and complete copies of the documents and records required to be delivered or made available;

(m) Seller currently has in place the public liability, casualty and other insurance coverage with respect to the Real Property. Such policy is in full force and effect, and all premiums due and payable thereunder have been, and at closing will be, fully paid when due. No notice of cancellation has been received or threatened with respect thereto. No insurance company insuring the Improvements has delivered to Seller oral or written notice (i) that any insurance policy now in effect would not be renewed or (ii) that Seller has failed to comply with insurance requirements or (iii) that defects or inadequacies exist in the Real Property, or in any part thereof, which could adversely affect the insurability thereof or the cost of such insurance. At all times from the date hereof through the date of Closing, Seller shall cause to be maintained in force fire and extended coverage insurance upon the Real Property, and public liability insurance with respect to damage or injury to person or property occurring on the Real Property in at least such amounts as are maintained by Seller on the date hereof;

(n) That, at closing, there will be no unpaid bills, claims, or liens in connection with any construction or repair of the Real Property;

(o) Except as disclosed in the Title Commitment, the Real Property is free and clear of all mechanic’s liens;

(p) Seller has not received written notice of, nor does Seller have actual knowledge or information of, any pending or contemplated change in any regulation, code, ordinance or law, or private restriction applicable to any of the Real Property, or any natural or artificial condition upon or affecting the Real Property, or any part thereof, which would result in any material change in the condition of the Real Property or any part thereof, or would in any way limit or impede the operation of the Real Property;

(q) There are no contracts of construction, maintenance, management, service or supply which would affect the Real Property or operation of the Real Property after Closing except as set forth in Schedule 4.16(q);

(r) Seller has not received any written notice that the Real Property or the current operation thereof is in violation of any laws, regulations, ordinances, rules, orders or other requirements of any governmental authorities having jurisdiction over the Real Property or affecting all or any part thereof or bearing on its construction or operation, or

with any private covenants or restrictions, which violations are uncured as of the date hereof;

(s) Seller has all licenses, permits, easements, rights-of-way, including, without limitation, all building and occupancy permits from all governmental authorities having jurisdiction over the Real Property or from private parties for the normal use, maintenance, occupancy, and operation of the Real Property and to insure unimpeded access, ingress and egress to and from the Real Property as required to permit normal usage of the facilities thereon;

(t) Present zoning regulations permit the use of the Real Property as a hospital, the Real Property complies with all applicable parking and zoning regulations, and there are no governmental or private regulations, orders, agreements or instruments restricting the current use and operation of the Real Property except as may be shown in the Title Commitment;

(u) To the best of Seller’s knowledge, (i) there are no public plans or proposals for changes in road grade, access or other municipal improvements which would affect the Real Property or result in any assessments, (ii) no ordinance authorizing improvements, the cost of which might be assessed against Purchaser or the Real Property is pending, and (iii) no tax proceeding is pending for the reduction or increase of the assessed real estate tax evaluation to the Real Property or any portion thereof; and

(v) Seller has received no written notice of defects, faults or other problems in connection with the soils, subsoils, grading or compaction of the land comprising the Real Property.

4.17 Employee Benefit Plans.

(a) Schedule 4.17 contains a true and complete list of all the following agreements, plans or other arrangements, covering any employee of the Business, which were previously or are presently in effect: (i) employee benefit plans within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) and (ii) any other employee benefit plan, program, policy, or arrangement providing for insurance coverage (including without limitation any self-insured arrangements), workers’ compensation, disability benefits, supplemental unemployment benefits, paid time-off benefits (including without limitation vacation leave, sick leave, personal leave, bonus leave, and leave for civil obligations), retirement benefits, life, health, disability or accident benefits (including without limitation any “voluntary employees’ beneficiary association” as defined in Section 501(c)(9) of the Internal Revenue Code of 1986, as amended (the “Code”) providing for the same or other benefits) or for deferred compensation, profit sharing bonuses, stock options, restricted stock, phantom stock, stock appreciation rights, stock purchases or other forms of incentive compensation or post-retirement insurance, compensation or benefits, whether written or unwritten, formal or informal, which Seller or any of its Affiliates currently sponsors, or to which it has any outstanding present

or future obligation to contribute or other liability, whether voluntary, contingent or otherwise (collectively, the “Benefit Plans”).

(b) The Seller has, with respect to each Benefit Plan listed on Schedule 4.17, delivered to the Purchaser, or shall provide to Purchaser within five (5) days after the date hereof, a true and complete set of copies of (i) all Benefit Plans and related trust agreements, annuity contracts or other funding instruments as in effect immediately prior to the Closing Date, together with all amendments thereto which shall become effective at a later date; (ii) all summary plan descriptions for each Benefit Plan required to prepare, file and distribute summary plan descriptions; and (iii) all summaries furnished or made available to employees, officers and directors of any of Seller or the ERISA Controlled Group of all Benefit Plans for which a summary plan description is not required.

(c) The Acquired Assets are not, and Seller does not expect them to become, subject to a lien imposed under the Code or under Title I or Title IV of ERISA including liens arising by virtue of Seller being considered to be aggregated with another entity pursuant to Section 414 of the Code or ERISA Section 4001(a)(14) (“ERISA Controlled Group”).

(d) Neither Seller nor any member of Seller’s ERISA Controlled Group has sponsored, contributed to, participated or agreed to participate in, or had an “obligation to contribute” (as defined in ERISA Section 4212(a)) to a “multiemployer plan” (as defined in Code Section 414(f) or ERISA Sections 4001(a)(3) or (3)(37)(A)) on behalf of any employee of the Business.

(e) Neither Seller nor any member of Seller’s ERISA Controlled Group has at any time sponsored or contributed to, participated or agreed to participate in, a “single employer plan” (as defined in ERISA Section 4001(a)(15)) to which at least two or more of the “contributing sponsors” (as defined in ERISA Section 4001(a)(13)) are not part of the same ERISA Controlled Group.

(f) There are no actions, liens, suits, audits or claims pending or, to Seller’s knowledge, threatened against Seller, with respect to Seller’s maintenance of the Benefit Plans; any Benefit Plan; or the assets of any Benefit Plan; other than routine claims for benefits and other claims that are not material.

(g) Seller and each member of Seller’s ERISA Controlled Group have, at all times, complied with all requirements of the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended (“COBRA”), ERISA Sections 601 through 608 and Section 4980B of the Code, and all regulatory guidance thereto.

(h) Each Benefit Plan that constitutes an “eligible retirement plan” as defined in Section 402(c)(8)(B) of the Code, and each related trust agreement, annuity contract or other funding instrument, from which assets may be involved in a “direct rollover” (as defined in Section 401(a)(31) of the Code) or other transfer to Purchaser’s retirement plans has complied with the applicable requirements of the Code and, with respect to Benefit Plans that are qualified under Section 401(a) of the Code, each such Benefit Plan has been so determined by the Internal

Revenue Service pursuant to a current favorable determination letter, or application for such determination has been made and is currently pending.

4.18 Litigation. Except as set forth on Schedule 4.18 attached hereto, there is no pending or, to the best knowledge of Seller, threatened litigation, action, suit, proceeding, claim, investigation, or administrative proceeding against or affecting Seller, by or before any Governmental Authority, involving or relating to the Business or the Acquired Assets.

4.19 Taxes.

(a) Seller has, or by the Closing Date will have, (i) timely filed all Tax (as defined in clause (f) of this Section 4.19) returns, schedules and declarations (including any withholding and information returns) required to be filed by any jurisdiction to which it is or has been subject, all of which Tax returns, schedules and declarations are or will, when filed, be true, complete, accurate and correct in all material respects, (ii) paid in full all Taxes due and payable (or claimed to be due and payable by any federal, state, local or foreign Taxing authority), (iii) paid or finally settled all Tax deficiencies asserted or assessed against it, and (iv) made timely payments to the proper Governmental Authorities of the Taxes required to be deducted and withheld from the wages paid to its employees.

(b) Seller (i) is not delinquent in the payment of any Tax, (ii) has not been granted an extension of time to file any Tax return prior to or on the Closing Date which has expired, or will expire, on or before the Closing Date without such return having been filed, and (iii) has not granted to any other person or entity a power of attorney or similar authorization with respect to the settlement of its liability for Taxes.

(c) No deficiencies for any Tax has been claimed, proposed or assessed (whether or not finally or tentatively, orally or in writing), no requests for waivers of the time to assess any deficiency for any Taxes are pending, and there are no pending or threatened Tax audits, investigations or claims for or relating to (i) the assessment or collection of Taxes, or (ii) a claim for refund made with respect to Taxes previously paid. There are no matters under discussion or dispute with any Governmental Authorities with respect to Taxes that may have been raised, nor are there any issues Seller believes will be raised in the future, by any Taxing authority with respect to Taxes accruing on or prior to the Closing Date.

(d) There are, and as of the Closing Date there will be, no Liens for Taxes upon the Acquired Assets except for statutory Liens for Taxes not yet due or delinquent. Purchaser will take title to the Acquired Assets free and clear of any such Liens.

(e) Seller is not a “foreign person” within the meaning of Section 1445(b)(2) of the Code.

(f) As used in this Agreement, “Taxes” (and all derivations thereof) means all federal, state, local and foreign sales, use, property, payroll and other taxes imposed by any

Governmental Authority with respect to the ownership, operation, transfer, or use of the Business or the Acquired Assets, or in any other way relating to the Business or the Acquired Assets.

4.20 Employee Agreements. Schedule 4.20 contains a list of the names and current aggregate annual cash compensation and identifies the other material benefits of each employee of the Business and any employment contracts, confidentiality agreements or non-compete agreements to which Seller is a party. Except as set forth on Schedule 4.20 to this Agreement, no labor organization, collective bargaining representative or group represents or claims to represent any of the employees currently engaged in the Business.

4.21 Environmental Laws.

(a) Except as set forth on Schedule 4.21 (i) neither Seller nor the Real Property is subject to any environmental hazards, risks, or liabilities, and (ii) neither Seller nor the Real Property is in violation of any federal, state or local statutes, regulations, laws or orders pertaining to environmental matters, including, without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”), as supplemented and amended, the Environmental Cleanup Responsibility Act (“ECRA”), the Resource Conservation and Recovery Act, as amended (“RCRA”), 42 U.S.C. Section 6901, et seq.; the Federal Clean Air Act, 42 U.S.C. Section 7401, et seq.; the Federal Water Pollution Control Act, Federal Clean Water Act of 1977, 33 U.S.C. Section 1251, et seq.; Federal Hazardous Materials Transportation Act, 48 U.S.C. Section 1801, et seq.; Federal Toxic Substances Control Act, 15 U.S.C. Section 2601, et seq.; and the Federal Safe Drinking Water Act, 42 U.S.C. Section 300f, et seq. No Hazardous Substances (which for purposes of this Section 4.21 shall mean and include any hazardous or toxic substances, pollutants, contaminants, materials or wastes, including but not limited to those substances, pollutants, contaminants, materials and wastes listed in the United States Department of Transportation Table (49 CFR 172.101) or by the Environmental Protection Agency as hazardous substances pursuant to 40 CFR Part 302, or such substances, materials and wastes which are regulated under any federal environmental law or any applicable local or state environmental law, including, but not limited to, CERCLA, ECRA, RCRA; toxic substances as defined under the Toxic Substance Control Act, 15 U.S.C. 2601, et seq.; or any of the following: hydrocarbons, petroleum and petroleum products, asbestos, polychlorinated biphenyls, formaldehyde, radioactive substances, flammables and explosives) have been and through the Closing Date will be, disposed of or released or discharged from or onto (including groundwater contamination) the Real Property by Seller in violation of any applicable environmental statute, regulation, or ordinance. Neither Seller, nor to Seller’s knowledge, any prior owners, operators or occupants of the Real Property, have allowed any Hazardous Substances to be discharged, possessed, managed, processed, or otherwise handled on the Real Property in a manner which is in violation of applicable law, and Seller has complied with all environmental laws applicable to any part of the Real Property. Seller shall immediately notify Purchaser, in writing, should Seller become aware of any lien, notice, litigation, or threat of litigation relating to any alleged unauthorized release of any Hazardous Substance or the existence of any Hazardous Substance with respect to any part of the Real Property; and shall promptly furnish the Purchaser with copies of any correspondence, notices, or legal pleadings in connection therewith.

(b) Except as disclosed on Schedule 4.21:

(i) Neither Seller, its Affiliates nor its agents have received any communication (written or oral) that alleges that Seller is not in compliance with all applicable environmental laws;

(ii) Seller has obtained all environmental permits necessary for the operation of the Hospital and related activities, all such permits are in good standing and Seller is in compliance with all terms and conditions of its environmental permits; and

(iii) No portion of the Real Property has ever been used as a landfill, garbage or refuse dump site, waste disposal facility, transfer station or other type of facility for the processing, treatment or disposal of waste materials.

4.22 Employee Relations. Except as set forth on Schedule 4.22, all employees of the Hospital are employees of Seller or LMC LES, Inc., a Texas corporation, which is an Affiliate of Leland. The employee relations of Seller are good. There is no threatened employee strike, work stoppage, or labor dispute pertaining to the Hospital. No union representation question exists respecting any employees of Seller. No collective bargaining agreement, labor contract, letter of understanding, contract or any other arrangement, formal or informal, with any labor union or organization exists or is currently being negotiated by Seller, no demand has been made for recognition by a labor organization by or with respect to any employees of Seller, no union organizing activities by or with respect to any employees of Seller are, to the best knowledge of Seller, taking place, and none of the employees of Seller are represented by any labor union or organization. There is no unfair practice claim against Seller before the National Labor Relations Board, nor any strike, dispute, slowdown, or stoppage pending or threatened against or involving the Hospital, and none has occurred. Seller is in compliance with all federal and state laws respecting employment and employment practices, terms and conditions of employment, and wages and hours. Seller is not engaged in any unfair labor practices. Seller has complied with all requirements of the Immigration Reform and Control Act of 1986. Except as set forth on Schedule 4.22, there are no pending or, to the best knowledge of Seller, threatened EEOC or DFEH claims, OSHA complaints, DOL complaints, union grievances, wage and hour claims, unemployment compensation claims, workers, compensation claims or the like. There are on the date hereof, and there shall be at all times through the Closing Date, fewer than 100 full-time and part-time employees of the Business. During the ninety (90) day period immediately preceding the Closing Date, no more than fifty (50) full-time and part-time employees of the Business shall have had their employment terminated.

4.23 Third Party Payor Cost Reports. Seller has duly filed on a timely basis all required cost reports with respect to the Hospital for all the fiscal years through and including the fiscal year ended December 31, 2002. All of such cost reports accurately reflect the information to be included thereon and such cost reports do not claim and neither the Hospital nor Seller has received payment or reimbursement in any amount in excess of the amounts provided by law or any applicable agreement that has not been either repaid by Seller or subject to an accepted deferred payment plan. Seller has provided Purchaser with complete and accurate copies of all

third party payor cost reports and related forms filed during the past three (3) years by or on behalf of Seller with respect to the Business. Schedule 4.23 indicates which of such cost reports have not been audited and finally settled and a brief description of any and all notices of program reimbursement, proposed or pending audit adjustments, disallowances, appeals of disallowances, and any and all other unresolved claims or disputes in respect of such cost reports.

4.24 Medical Staff. Seller has previously delivered to Purchaser a true, correct and complete copy of medical staff privilege and membership application forms, a description of medical staff privileges, all current medical staff bylaws, rules and regulations and amendments thereto, all credentials and appeals procedures not incorporated therein, the name of each current member of the medical staff of the Hospital, the age of each medical staff member, the specialty, if any, of each medical staff member, and all contracts with physicians, physician groups or other members of the medical staff of the Hospital. There are no pending or, to Seller’s knowledge, threatened appeals, challenges, disciplinary or corrective actions or disputes involving applicants, staff members or health professionals.

4.25 Hill-Burton And Other Liens. Neither Seller, nor to Seller’s knowledge, its predecessors, have received any loans, grants or loan guarantees pursuant to the Hill-Burton Act program, the Health Professions Educational Assistance Act, the Nurse Training Act, the National Health Planning and Resources Development Act, and the Community Mental Health Centers Act, as amended, or similar laws or acts relating to health care facilities.

4.26 Insurance. Schedule 4.26 summarizes the professional and general liability insurance policies covering the operations of the Hospital and the property insurance policies covering the Acquired Assets, including the policies’ numbers, terms, identity of insurers, amounts and coverage. All such insurance policies are in full force and effect and shall remain in full force and effect through the Closing Date. Seller does not provide and is not obligated to provide professional liability coverage for any physician or other health care provider.

4.27 Conflicts Of Interest. Except as set forth on Schedule 4.27, no Affiliate of Seller, nor, to Seller’s knowledge, any Hospital employee: (i) is a supplier of goods or services to Seller, (ii) directly or indirectly controls or is a director, trustee, member, officer, controlling shareholder, employee or agent of any corporation, firm, association, partnership or other business entity which is a supplier of goods or services to Seller, or (iii) is a party to any contract or other agreement with Seller.

4.28 Brokers, Finders and Agents. Neither Seller nor Leland is directly or indirectly obligated to anyone as a broker, finder, agent or in any other similar capacity in connection with this Agreement or the transactions contemplated hereby.

4.29 Other Information. The information provided and to be provided by Seller to Purchaser in this Agreement or in Exhibits or the Schedules or in any other writing pursuant hereto (including, without limitation, the representations and warranties contained in this Article IV) does not and will not contain any untrue statement of a material fact and does not and will not omit to state a material fact required to be stated herein or therein or necessary to make the

statements contained herein or therein, in light of the circumstances in which they are made, not false or misleading. Copies of all financial statements, reports, documents and other materials heretofore or hereafter delivered or made available to Purchaser pursuant hereto and thereto were or will be at the time of their delivery to Purchaser true, complete and accurate copies of such financial statements, reports, documents and other materials.

ARTICLE V

REPRESENTATIONS AND WARRANTIES OF PURCHASER

In order to induce Seller and Leland to enter into this Agreement and to consummate the transactions contemplated hereby, the Purchaser hereby represents and warrants as of the date hereof as follows:

5.01 Organization and Good Standing: Power and Authority. Purchaser is a limited liability company duly organized, validly existing and in good standing under the laws of the State of Texas. Purchaser has full power and authority to execute and deliver this Agreement, and to perform Purchaser’s obligations hereunder and to consummate the transactions contemplated hereby. Purchaser is qualified to do business and is in good standing in each jurisdiction in which the failure to so qualify would have a material adverse affect upon Purchaser.

5.02 Corporate Authorization. The execution, delivery and performance of this Agreement and all other agreements and instruments executed and delivered by Purchaser in connection herewith and the consummation of the transactions contemplated hereby and thereby have been duly and validly authorized by all necessary action on the part of Purchaser. This Agreement has been, and the other agreements and instruments to be executed and delivered by Purchaser in connection herewith will be, on or prior to the Closing Date, duly executed and delivered by Purchaser, and constitute, or upon execution and delivery will constitute, the valid, legal and binding obligations of Purchaser, enforceable against Purchaser in accordance with their respective terms.

5.03 Conflicts; Defaults. The execution and delivery of this Agreement and the other agreements and instruments executed or to be executed in connection herewith by Purchaser do not, and the performance by Purchaser of its obligations hereunder and thereunder and the consummation by Purchaser of the transactions contemplated hereby or thereby, will not (i) violate, conflict with, or constitute a breach or default under any of the terms of Purchaser’s Articles of Organization or Regulations; (ii) violate or require any authorization, approval, consent or other action by, or registration, declaration or filing with or notice to, any Governmental Authority pursuant to any law, statute, judgment, decree, injunction, order, writ, rule or regulation of any Governmental Authority; or (iii) conflict with or result in a breach of, create an event of default (or event that, with the giving of notice or lapse of time or both, would constitute an event of default) under, or give any third party the right to terminate, cancel or accelerate any obligation under, any contract, agreement, note, bond, guarantee, deed of trust, loan agreement, mortgage, license, lease, indenture, instrument, order, arbitration award, judgment or decree to which Purchaser is a party or by which Purchaser or any of its assets or

properties are bound or affected. There is no pending or, to the best knowledge of Purchaser, threatened action, suit, claim, proceeding, inquiry or investigation before or by any Governmental Authorities, involving or to restrain or prevent the consummation of the transactions contemplated by this Agreement or that might reasonably be expected to affect the right of Purchaser to purchase the Acquired Assets.

5.04 Brokers, Finders and Agents. Purchaser is not directly or indirectly obligated to anyone as a broker, finder, agent or in any other similar capacity in connection with this Agreement or the transactions contemplated hereby.

ARTICLE VI

COVENANTS OF SELLER

Seller hereby covenants to Purchaser that:

6.01 Access and Information. Seller shall afford to Purchaser and Purchaser’s accountants, counsel and other representatives full and reasonable access from time to time during normal business hours throughout the period from the date hereof until the Closing Date to Seller’s properties, books, contracts, commitments, personnel and records relating to the Business and the Acquired Assets, and, during such period, Seller will (or will cause its representatives to) furnish to Purchaser and Purchaser’s accountants, counsel and other representatives copies of such documents and all such other information concerning the Acquired Assets, the Retained Assets, the Assumed Liabilities, the Retained Liabilities and the business, properties and personnel of the Business as Purchaser may reasonably request.

6.02 Conduct of the Business Pending Closing. Prior to the earlier of the Closing or termination of this Agreement:

(a) Ordinary Course of Business. Seller shall use all reasonable efforts to preserve the business organization of the Business intact, to keep available to the Business the services of all current employees and to preserve for Purchaser the goodwill of the third party payors, physicians, suppliers, patients, employees and others having business relations with the Business.

(b) Operation of Business. Except as otherwise permitted by this Agreement or consented to in writing by Purchaser, Seller shall continue the operation of the Business in the ordinary course and consistent with past practices, and maintain the assets, properties and rights of the Business (including, without limitation, the Acquired Assets) in at least as good order and condition as exists on the date hereof, subject to ordinary wear and tear.

(c) Material Contracts. Seller shall not enter into any contract, purchase order or other commitment directly or indirectly affecting the Acquired Assets or the Business, except contracts and commitments entered into the ordinary course of business consistent

with past practices that are terminable on no more than thirty (30) days notice without penalty or obligation, and that do not call for aggregate payments by, or have an estimated cost of performance to Seller in excess of Five Thousand Dollars ($5,000.00) under any single contract or series of related contracts or in the aggregate of Fifteen Thousand Dollars ($15,000.00) without the prior written consent of Purchaser.

(d) Material Adverse Change. Seller shall give prompt written notice (but not later than five (5) days after the occurrence thereof) to Purchaser of any (i) material adverse change in the business, business prospects, assets, financial condition or results of operation of the Business; and (ii) change that would render any representation or warranty made by Seller hereunder untrue or incomplete in any material respect as of the date of such change.

(e) Compliance with Representations and Warranties. Without limiting the foregoing, except as otherwise expressly provided in this Agreement, Seller shall not take any action or permit to occur any event, directly or indirectly within the control of Seller, that would cause any representation or warranty contained herein to be inaccurate or untrue on or before the Closing Date.

(f) Continued Maintenance. From the date of execution of this Agreement through the Closing Date, Seller shall continue to maintain the Real Property in the ordinary course of business.

(g) No Lease Modifications. From the date of execution of this Agreement through the Closing Date, Seller shall not enter into new leases, terminate or modify or renew any of the Real Property Leases, apply any security deposits or institute any legal action with respect to any default by a tenant of the Real Property, without the prior written consent of Purchaser. From the date of execution of this Agreement through the date of Closing, Seller will comply with the requirements of the “landlord” under the Real Property Leases.

(h) No Zoning Changes. From the date of execution of this Agreement through the Closing Date, Seller will not allow or consent to any zoning change affecting the Real Property.

(i) No Removal of Items from Real Property. From the date of execution of this Agreement through the Closing Date, Seller shall not remove any fixtures, equipment, furnishings or other personal property from the Real Property.

6.03 Exclusivity. From and after the date hereof to and including the Closing Date, neither Seller nor Leland nor any of their respective Affiliates, partners, shareholders, officers, directors, employees, or agents, shall, directly or indirectly, solicit, initiate or engage in or continue (including without limitation, furnishing any information concerning the Acquired Assets or the Business) discussions, inquiries or proposals, or enter into any negotiations for the

purpose or with the intention of leading to any proposal, concerning the acquisition or purchase by any other party of the Seller, the Business or any part thereof or any Acquired Asset.

6.04 Due Diligence Items. Within ten (10) business days after the execution of this Agreement Seller shall furnish to Purchaser, at Seller’s sole cost and expense each of the following (collectively, the “Due Diligence Items”):

(a) The most current “as built” survey of the Real Property in Seller’s possession;

(b) A copy of Seller’s title policy with respect to the Real Property, together with all documents constituting exceptions to Seller’s title as reflected in the title policy;

(c) True, correct and complete copies of the Real Property Leases (including all amendments relating thereto);

(d) Copies of all licenses, permits, certificates of occupancy, governmental approvals and other entitlements in the possession of Seller relating to the Real Property;

(e) All environmental reports, structural inspection reports and engineering reports relating to the Real Property in the possession of Seller;

(f) All site plans, plans and specifications or construction drawings for the construction of the Real Property, including change orders, in the possession of Seller; and

(g) A current rent roll, reflecting, by tenant space, the tenant’s name, designation of tenant space, term, the amount of monthly rentals, prepaid or delinquent rentals, if any, that remain outstanding with respect to such tenant or tenant space, if any, and deposits paid by tenants under the Real Property Leases.

6.05 Inspection Period. Purchaser and its advisors, at Purchaser’s sole expense, shall have the right to conduct feasibility, environmental, engineering and physical studies of the Real Property, to inspect the Real Property and to evaluate all matters as are deemed relevant to Purchaser in its sole discretion, for a period of time commencing on the date hereof and expiring on the day preceding the Closing Date. Upon reasonable advance notice to Seller, Purchaser and Purchaser’s duly authorized agents or representatives shall be permitted to enter upon the Real Property at all reasonable times in order to conduct environmental studies, engineering studies, soil tests and any other inspections and/or tests that Purchaser may deem necessary or advisable; provided, however, that no drilling or other ground penetrations or physical sampling in any building shall be done without Seller’s prior written consent, and Purchaser agrees to conduct such inspections so as to cause the least possible interference or inconvenience to Seller’s and its tenants’ business operations. Purchaser agrees to indemnify and hold Seller harmless from and against any and all costs, liabilities, claims, liens, encumbrances and causes of action (including without limitation reasonable attorneys’ fees) arising out of Purchaser’s actions taken on the Real Property in conjunction with exercising Purchaser’s rights under this

Section 6.05 and such indemnification obligations shall survive the Closing Date or any termination of this Agreement. Seller agrees to cooperate with Purchaser, at no cost to Seller, in having Seller’s existing inspection reports (i.e., its current environmental reports) re-dated and re-certified in favor of Purchaser.

6.06 Estoppel Certificates. Seller shall use its best efforts to deliver to Purchaser at or prior to Closing an Estoppel Certificate in the form of Exhibit G attached hereto, signed by each of the tenants under the Real Property Leases, dated not more than twenty (20) days prior to Closing.

ARTICLE VII

ADDITIONAL AGREEMENTS OF SELLER AND PURCHASER

7.01 Employee Matters.

(a) Employment. Seller agrees to cooperate with Purchaser and give Purchaser access to employee information and assistance with employee communications in connection with Purchaser’s potential employment of the current employees of the Business. Seller will also cooperate and assist Purchaser in connection with any pre-employment screening, interviewing, physicals or drug testing, with respect to Seller’s employees, that Purchaser desires to conduct, as well as distribution of communication materials and enrollment forms for Purchaser’s employee benefit plans. However, Purchaser shall be under no obligation to (i) hire any employees of the Business; (ii) maintain any of Seller’s employees which it does hire at the same position, title, or level or responsibility that they had with Seller; (iii) grant seniority or service credit or recognize paid time-off benefits (including without limitation accrued vacation, holidays or sick leave time, or leave for civic obligations) to any such employee; or (iv) pay any specified level of compensation or benefits to any such employee.

(b) Employment Liabilities. Purchaser does not assume, and Seller hereby retains, at its own expense, any and all employment related costs, obligations, and liabilities of the Business incurred on or prior to Closing or which relate to events, occurrences, conditions, actions, or inactions which took place or were in effect on or prior to Closing (whether or not reported, filed, billed, or paid for on or prior to Closing), including, without limitation, costs, obligations and liabilities relating to severance rights of employees of the Business, employment discrimination, unfair labor practices, wage and hour laws, health and safety, workers compensation, wrongful discharge, compensation, fringe benefits, insurance, employee benefit plans, pensions, retiree medical, severance pay, vacations, torts, accidents, disabilities, injuries, sickness, exposure to harmful conditions, breach of oral or written employment contracts or collective bargaining agreements, or breach of law, statute, judgment, decree, injunction, order, writ, rule or regulation of any Governmental Authority, without regard to the employment by Purchaser of any of the employees of the Business after Closing. The entire liability for continuing acts or conditions (such as exposure to harmful conditions or continuing discrimination) shall be retained and assumed by Seller if any material portion of the act or condition occurred on or prior to Closing.

(c) COBRA. Purchaser does not assume, and Seller agrees to be solely responsible for, any and all liabilities and obligations whatsoever relating to health care continuation coverage under the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended (“COBRA”) which arise prior to, or which relate to, or arise out of or in connection with, this transaction or the events contemplated by this Agreement. Seller shall indemnify and hold harmless Purchaser from and against any and all COBRA liabilities or obligations accrued with respect to employees of the Business, or arising under or pursuant to or in connection with the Benefit Plans. Purchaser may provide such benefits to employees of the Business who transfer employment to the Purchaser on or after Closing as Purchaser shall determine, in its sole and absolute discretion.

7.02 Title Commitment. Seller shall cause to be furnished to Purchaser within fifteen (15) days after the date of this Agreement, at Seller’s sole cost and expense, a current title commitment (the “Title Commitment”) issued by Stewart Title Guaranty Company—Commercial Division, 1980 Post Oak Boulevard, Suite 110, Houston, Texas 77056, or such other nationally recognized title insurance company reasonably acceptable to both parties (the “Title Company”), together with legible copies of all exceptions to title referenced therein. The Title Commitment shall set forth the state of title to the Real Property, together with all exceptions or conditions to such title, including, without limitation, all easements, restrictions, rights-of-way, covenants, reservations, and all other encumbrances affecting the Real Property which would appear in an owners’ title policy, if issued. The Title Commitment shall contain the express commitment of the Title Company to issue an owners, title policy (the “Title Policy”) to Purchaser in an amount equal to that portion of the Purchase Price allocated to the Real Property as improved, insuring good, indefeasible fee simple (full ownership) title to the Real Property. The Title Commitment shall provide that the Title Policy when issued shall have all Standard and General Exceptions deleted so as to afford full “extended form coverage,” except for the standard exception as to taxes which shall be limited to taxes for the current and subsequent years “not yet due and payable,” and shall contain such endorsements or other affirmative coverage that the Purchaser reasonably require. At Closing, the Seller shall cause the Title Commitment to be later-dated and the so-called “gap” exception to be deleted to cover the Closing and the recording of the deeds to be delivered at Closing and shall cause the Title Company to deliver to Purchaser a marked Title Commitment or pro forma Title Policy, with endorsements, as directed by Purchaser. The Title Policy shall show that the Real Property is free from all Liens, liabilities and defects in title other than the Permitted Encumbrances. In the event Purchaser requests, and at Purchaser’s expense, the Title Company shall issue a mortgage title policy in an amount up to the Purchase Price which is allocated to the Real Property as improved, at simultaneous issue rates. Seller shall execute such certificates and affidavits as may be reasonably required in connection with the issuance of the Title Policy and any endorsements.

7.03 Survey. Seller shall cause, at Seller’s sole cost and expense, a current ALTA/ASCM “as-built” survey of the Real Property (the “Survey”) to be furnished to Purchaser and the Title Company within 30 days after the date of this Agreement prepared by a registered land surveyor or engineer, licensed in the State of Texas. The Survey shall be acceptable to the Title Company for purposes of deleting standard survey exceptions as provided in Section 7.02 and shall reflect the location and dimension of all improvements visible on the grounds and all

dominant and servient easements or servitudes or, rights of way, means of ingress or egress, the physical location of all utilities (to the extent ascertainable by on-site observation or by records provided by Seller, utility companies or other appropriate sources), the location of all streets, highways, alleys and public ways crossing or abutting the Real Property, all encroachments and drainage ditches, whether abutting or interior, of record or on the grounds and such other matters as Purchaser may reasonably require. The Survey shall reflect whether and to the extent any portion of the Real Property lies within the 100-year flood plain. The Survey shall be certified to the Title Company, Purchaser and Purchaser’s lender, if any, in conformance with the current Minimum Standard Detail Requirements for ALTA/ASCM Land Title Surveys for “urban surveys” and as otherwise directed by Purchaser. The Survey shall reflect that it is a true, correct and accurate representation of the Real Property. The Survey shall reflect such other matters as are necessary for the Title Company to issue the Title Policy free from any survey objection or exceptions whatsoever, other than an exception not objected to or waived by Purchaser and the standard exception for calculation of acreage.

7.04 Casualty. If, prior to the Closing, the Hospital or any other Acquired Asset sustains damage or destruction by fire or other casualty that Seller does not completely repair prior to Closing, the following provisions shall apply:

(a) If (i) such damage or destruction results in any portion of the Hospital being unusable for its current purpose, or (ii) the aggregate cost to repair such damage or destruction, or to replace such damaged or destroyed portion of the Hospital or other Acquired Asset (collectively, the “Cost to Repair”), is greater than One Hundred Thousand Dollars ($100,000) and Seller does not have insurance coverage therefor, Purchaser may elect to either (1) terminate this Agreement as provided in Section 9.01(b) by providing written notice thereof to Seller and, except as set forth in Section 11.02 hereof, all obligations of the parties hereunder shall terminate, or (2) consummate the transactions contemplated by this Agreement and receive a credit against the Cash Portion of the Purchase Price equal to the amount of such Cost to Repair, and thereafter Seller shall have no obligations to repair such damage or destruction.

(b) If the provisions of subsection (a) do not apply, then (i) if Seller has insurance coverage for the Cost to Repair any such damage or destruction, Purchaser may elect either to (1) receive from Seller all of the proceeds of such insurance paid or payable and then pay to Seller the full amount of the Purchase Price, or (2) allow Seller to retain all such insurance proceeds subject to a reduction of the Cash Portion of the Purchase Price equal to the amount of the Cost to Repair; and (ii) if, and to the extent that, the Cost to Repair any such damage or destruction is not covered by insurance, including, without limitation, costs that are subject to a deductible or self-insured retention, the Cash Portion of the Purchase Price shall be reduced by an amount equal to that portion of the Cost to Repair such damage or destruction that is not covered by insurance.

7.05 Condemnation. If, prior to Closing, any part of the Real Property is condemned, or becomes subject to any pending or threatened condemnation by any Governmental Authority, Purchaser may, in its sole discretion, either:

(a) Close the transactions contemplated by this Agreement, in which event all of the condemnation proceeds shall be payable to Purchaser, and Seller shall assign all claims therefor and all right, title and interest therein to Purchaser; or

(b) Elect to terminate this Agreement pursuant to 9.01(b) hereof by providing written notice thereof to Seller within five (5) days after Purchaser receives written notification of such condemnation or threatened condemnation.

7.06 Insurance Ratings. Seller shall take all action reasonably requested by Purchaser to enable Purchaser to succeed to the Workmen’s Compensation and Unemployment Insurance ratings, insurance policies, deposits and other interests of the Seller with respect to the operation of the Hospital and other ratings for insurance or other purposes established by the Seller. Purchaser shall not be obligated to succeed to any such rating, insurance policy, deposit or other interest, except as it may elect to do so.

7.07 Platting. Seller shall cooperate with Purchaser in all respects, both before and after Closing to plat the Real Property and Retained Real Property and receive approval of such plats by the Planning Commission of the City of Garland, Texas, and Seller shall perform all other actions, and prepare and file all other documents as required by law to subdivide the tract of land containing the Real Property and the Retained Real Property.

7.08 Completion and Updating of Schedules.

(a) Seller shall prepare and deliver to Purchaser true, correct and complete copies of all Schedules contemplated by this Agreement as soon as practicable, but not later than the date that this Agreement is executed by the parties.

(b) Between the date that this Agreement is executed by the parties and the Closing Date, Seller shall provide Purchaser with written notice of the occurrence of any event that would result in or constitute a supplement, change or amendment, including without limitation, an addition or deletion, to any Schedule to this Agreement. Within four (4) days of Purchaser’s receipt of such notice, Purchaser shall, by written notice to Seller either (i) accept the proposed supplement, change or amendment as submitted by Seller, or (ii) elect to terminate this Agreement in accordance with the provisions of Section 9.01(b) in the event that the proposed supplement, change or amendment, in Purchaser’s sole and complete discretion, is unacceptable. Upon Purchaser’s written acceptance, the proposed supplemented, changed or amended Schedule shall become for all purposes the Schedule attached to and incorporated into this Agreement.

7.09 Reasonable Efforts. Seller and Purchaser agree that prior to the Closing they will each use all reasonable efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable to consummate and make effective the transactions contemplated by this Agreement.

7.10 Cost Report Matters. Seller shall prepare and timely file all cost reports relating to the periods ending on or prior to the Closing Date or required as a result of the consummation of the transactions described herein, including, without limitation, those relating to Medicare, Medicaid, Blue Cross and other third party payors which settle on a cost report basis (the “Seller Cost Reports”). Purchaser shall forward to Seller any and all correspondence relating exclusively to the Seller Receivables, the Seller Cost Reports or rights to settlements and retroactive adjustments on the Seller Cost Reports (“Agency Settlements”) within ten (10) business days of receipt by Purchaser. Purchaser shall not reply to any such correspondence without Seller’s written approval which shall not be unreasonably withheld. Purchaser shall remit any receipts relating to the Seller Receivables, the Seller Cost Reports or the Agency Settlements within ten (10) business days after receipt by Purchaser, and will forward any demand for payments within ten (10) business days. Seller shall retain all rights to the Seller Cost Reports and to the Seller Receivables including, without limitation, any payables resulting therefrom or receivables relating thereto and the right to appeal any Medicare determinations relating to the Agency Settlements and the Seller Cost Reports; provided, that, Purchaser shall have the right to participate in any appeal of a Medicare determination that affects Purchaser. Seller will furnish copies of the Seller Receivables records to Purchaser upon request and allow Purchaser and its representatives reasonable access to such documents.

7.11 Access to Records and Cooperation. Upon reasonable notice and during normal business office hours, Purchaser will cooperate with Seller in regard to (i) the preparation, filing, handling, and appeals of the Seller Cost Reports and Agency Settlements, (ii) any cost report disputes and/or other claim adjudication matters relative to governmental program reimbursement, (iii) any litigation, claim, arbitration or administrative action involving Seller, Leland or their Affiliates, and (iv) (preparing final billings with respect to patients in the Hospital at the Effective Time. Such cooperation shall include the providing of statistics and obtaining files at the Hospital, if any, the coordination with Seller pursuant to adequate notice of Medicare and Medicaid exit conferences or meetings. Purchaser will, upon reasonable notice, during normal business office hours and at the sole cost and expense of Seller, and subject to applicable law regarding confidentiality of patient records, provide Seller reasonable access to any and all records of the Hospital within Purchaser’s possession and will allow Seller and its representatives to copy any such documents.

7.12 Remit Payments. Purchaser shall within ten (10) business days of receipt by it of any payment of any Seller Receivable or other amount that is a Retained Asset, deliver such amount to Seller.

7.13 Inventory. Purchaser shall have the right to conduct an inventory of the Equipment, personal property and Inventory of the Hospital prior to Closing. Seller shall provide all cooperation to Purchaser necessary to complete such inventory.

7.14 Transfer of Hospital Patients. Purchaser has advised Seller, and Seller has acknowledged that Purchaser does not intend to offer or provide, directly or indirectly, the psychological services and/or related products that are currently being offered and/or provided at the Hospital by Seller. Accordingly, on or prior to the Closing Date, Seller shall take any and all

action necessary or appropriate to transfer any patients then receiving psychological services and/or related products at the Hospital to another suitable healthcare facility so that patient care shall not be adversely affected. Any and all transfers of patients by Seller shall be performed in accordance with all applicable laws.

ARTICLE VIII

CONDITIONS OF CLOSING

8.01 Obligation of Purchaser. The obligation of Purchaser to consummate the purchase contemplated by the provisions of this Agreement shall be subject to the fulfillment on or prior to the Closing Date of the following conditions (any of which may be waived in writing, in whole or in part, by Purchaser):

(a) Representations and Warranties; Performance. The representations and warranties of Seller and Leland set forth in this Agreement shall be true, correct and complete as of the Closing Date (as though such representations and warranties were made anew at and as of such date) except with respect to the effect of transactions specifically permitted by the provisions of this Agreement, and Seller and Leland shall have duly performed in all material respects all agreements and covenants herein required to be performed by Seller and/or Leland on or before the Closing Date.

(b) Officer’s Certificates. Seller shall have furnished Purchaser with a certificate, executed on behalf of Seller by one of the executive officers of its general partner and dated the Closing Date, confirming the matters expressed in Section 8.01(a) hereof with respect to Seller. Leland shall have furnished Purchaser with a certificate, executed on behalf of Leland by one of its executive officers and dated on the Closing Date, confirming the matters expressed in Section 8.01(a) hereof with respect to Leland.

(c) Certificate of Authorities. Seller shall have furnished to Purchaser (i) certificates of the Secretary of State of Texas, dated as of a date nor more than five (5) business days prior to the Closing Date, attesting to the organization and existence of Seller and the organization and good standing of the General Partner, (ii) a copy certified by the Secretary of State of Texas, as of a date not more, than five (5) business days prior to the Closing Date, of the General Partner’s Articles of Incorporation and all amendments thereto and Seller’s Certificate of Limited Partnership and all amendments thereto, (iii) a copy, certified by the Secretary of the General Partner, of the Bylaws of General Partner, as amended and in effect as of the Closing Date, (iv) a copy, certified by the Secretary of the General Partner, of resolutions duly adopted by the Board of Directors of the General Partner duly authorizing the transactions contemplated in this Agreement, (v) a copy, certified by an executive officer of the General Partner, of Seller’s Agreement of Limited Partnership, including all amendments thereto, and (vi) a copy, certified by an executive officer of the General Partner, of the resolutions duly adopted by Seller’s partners authorizing the transactions contemplated by this Agreement.

(d) Consents and Approvals. All material consents, approvals and novations, on terms satisfactory to Purchaser, of third parties and Governmental Authorities (including, without limitation, the Required Consents) that shall be (i) required to consummate the transactions contemplated hereby or (ii) reasonably necessary to permit Purchaser to operate the Business, shall have been obtained.

(e) Transfer Documents. Purchaser shall have received the Transfer Documents as contemplated in Section 3.03 hereof.

(f) Taxes, Charges, and Fees. Purchaser shall have received verification from Seller, in form and substance satisfactory to Purchaser, that Seller has paid or caused to be paid, any taxes, charges and fees required to be paid by Seller pursuant to Section 3.06 hereof.

(g) Receipt of Opinion of Counsel. Purchaser shall have received an opinion, dated as of the Closing Date, of counsel to Seller and Leland, in substantially the form attached hereto as Exhibit F.

(h) Noncompetition Agreement. Purchaser shall have received the Noncompetition Agreement executed by Seller and Leland.

(i) Title Insurance. Purchaser shall have received the Title Policy contemplated by Section 7.02 hereof. Purchaser acknowledges and agrees that the Title Policy may be actually delivered at a reasonable time following the Closing so long as Purchaser has received at Closing current and binding Title Commitment obligating the Title Company to deliver the Title Policy.

(j) Survey. Purchaser shall have received the Survey contemplated by Section 7.03 hereof and there shall be no changes in the matters reflected in the Survey, and there shall not exist any easement, right-of-way, encroachment, waterway, pond, flood plain, conflict or protrusion with respect to the Real Property not shown on the Survey.

(k) Certificate of Non-Foreign Status. Seller shall have duly executed and delivered Purchaser a Certificate of Non-Foreign Status sufficient in form and substance to relieve Purchaser of all withholding obligations under Section 1445 of the Code.

(l) Environmental Survey. Purchaser shall have determined, in its sole discretion, that any potential environmental liabilities relating to the Real Property or the Business are acceptable to Purchaser.

(m) MAI Appraisal. Seller shall have furnished Purchaser with a copy of an MAI appraisal dated January 29, 2002, with respect to the Real Property, indicating that the Real Property has an appraised fair market value of not less than Ten Million Dollars ($10,000,000.00).

(n) Personal Property Valuation. Seller shall have furnished Purchaser with evidence, satisfactory in both form and substance to Purchaser, that as of the Closing Date the Equipment and the Inventory have an aggregate book value of not less than Three Million Dollars ($3,000,000.00). For purposes of calculating the book value of the Equipment, any Equipment subject to a Personal Property Lease shall be included and any pre-paid rent under any such Personal Property Lease shall also be included.

(o) Insolvency. Neither Seller nor Leland shall (i) be in receivership or dissolution, (ii) have made any assignment for the benefit of creditors, (iii) have admitted in writing their inability to pay their respective debts as they mature, (iv) have been adjudicated a bankrupt, (v) have filed a petition in voluntary bankruptcy, a petition or answer seeking bankruptcy, or an arrangement with creditors under the federal bankruptcy law or other similar law or statute of the United States or any state, nor shall have any such petition have been filed against Seller or Leland.

(p) Approval of Dynacq. The Board of Directors of Dynacq International, Inc., a Nevada corporation and indirect parent corporation of Purchaser, shall have approved this Agreement and the transactions contemplated hereby.

(q) No Changes to Title Commitment. There shall be no change in the matters reflected in the Title Commitment, and there shall not exist any encumbrance or title defect affecting the Real Property not described in the Title Commitment except for the Permitted Exceptions.

(r) No Violation of Law. There shall be no violation of law against the Real Property imposed or threatened in writing.

(s) No Litigation or Condemnation. There shall be no litigation or condemnation commenced or threatened that affects any of the Real Property.

(t) Transfer of Hospital Patients. All patients at the Hospital shall have been transferred to another suitable healthcare facility as contemplated by Section 7.14 hereof.

At Closing, Seller shall certify to Purchaser as part of the Officer’s Certificate pursuant to Section 8.02(b) that to its actual knowledge none of the items listed above shall have occurred; provided that if Seller shall obtain knowledge of any matter that would cause a violation of any of the above prior to the Closing, Seller agrees to promptly notify Purchaser in writing of such matter and Seller shall disclose such violation in the Officer’s Certificate. If any of conditions (a) through (t) above are not fully satisfied by Closing, Purchaser’s sole remedy shall be either (a) to terminate this Agreement by written notice to Seller, whereupon this Agreement shall be cancelled and, thereafter neither Seller nor Purchaser shall have any continuing obligations one unto the other (except for the obligations that expressly survive termination), or (b) proceed with Closing of the transaction hereunder notwithstanding such condition.

8.02 Obligation of Seller. The obligation of Seller to consummate the sale contemplated by the provisions of this Agreement shall be subject to the fulfillment on or prior to the Closing Date of the following conditions (any of which may be waived in writing, in whole or in part, by Seller):

(a) Representations and Warranties; Performance. The representations and warranties of Purchaser set forth in this Agreement shall be true, correct and complete as of the Closing Date (as though such representations and warranties were made anew at and as of such date) except with respect to the effect of transactions specifically permitted by the provisions of this Agreement, and Purchaser shall have duly performed in all material respects all agreements and covenants herein required to be performed by Purchaser on or before the Closing Date.

(b) Officer’s Certificates. Purchaser shall have furnished Seller with a certificate, executed on behalf of Purchaser by one of the executive officers of its general partner and dated the Closing Date, confirming the matters expressed in Section 8.02(a) hereof.

(c) Certificate of Authorities. Purchaser shall have furnished to Seller (i) certificates of the Secretary of State of Texas, dated as of a date nor more than five (5) business days prior to the Closing Date, attesting to the organization and good standing of Purchaser and the organization and good standing of its general partner, (ii) a copy certified by the Secretary of State of Texas, as of a date not more than five (5) business days prior to the Closing Date, of the Articles of Organization and all amendments thereto of Purchaser’s general partner, (iii) a copy certified by the Secretary of the general partner of Purchaser, of the Regulations of Purchaser’s general partner, as amended and in effect as of the Closing Date, (iv) a copy, certified by the Secretary of Purchaser’s general partner, of resolutions duly adopted by the sole manager of such general partner duly authorizing the transactions contemplated in this Agreement, (v) a copy, certified by an executive officer of Purchaser’s general partner, of Purchaser’s Agreement of Limited Partnership, including all amendments thereto, and (vi) a copy, certified by an executive officer of Purchaser’s general partner, of the resolutions adopted by Purchaser’s partners authorizing the transaction contemplated by this Agreement.

(d) Consents and Approvals. All material consents, approvals and novations, on terms satisfactory to Seller, of third parties and Governmental Authorities (including, without limitation, the Required Consents) that shall be (i) required to consummate the transactions contemplated hereby or (ii) reasonably necessary to permit Purchaser to operate the Business, shall have been obtained.

(e) Assumption Instrument. Seller shall have received from Purchaser the Assumption Instrument as contemplated by Section 3.04 hereof.

ARTICLE IX

TERMINATION OF AGREEMENT

9.01 Termination of Agreement. This Agreement and the transactions contemplated hereby may be terminated and abandoned at any time on or prior to the Closing as follows:

(a) by the written consent of Purchaser and Seller;

(b) by Purchaser, (i) if there is or occurs an inaccuracy in any material respect in the representations and warranties of Seller or Leland set forth in this Agreement, which inaccuracy is not capable of being cured by August 29, 2003, (ii) if there has been a breach in any material respect of a covenant of Seller or Leland, or a failure in any material respect on the part of Seller or Leland to comply with their respective obligations hereunder, and such breach or failure is not capable of being cured by August 29, 2003, (iii) if there occurs any casualty with respect to the Hospital or any Acquired Asset and the terms and conditions of Section 7.04 hereof are satisfied, (iv) if any portion of the Real Property is condemned or threatened to be condemned by any Governmental Authority and the terms and conditions of Section 7.05 hereof are satisfied, (v) if any proposed supplement, change or amendment to any Schedule submitted by Seller to Purchaser is unacceptable to Purchaser and the terms and conditions of Section 7.08 hereof are satisfied, or (vi) if any of the conditions set forth in Section 8.01 hereof are not satisfied on or before August 29, 2003;

(c) by Seller, (i) if there is or occurs an inaccuracy in any material respect in the representations and warranties of Purchaser set forth in this Agreement, which inaccuracy is not capable of being cured by August 29, 2003, (ii) if there has been a breach in any material respect on the part of Purchaser to comply with its obligations hereunder, and such breach or failure is not capable of being cured by August 29, 2003, or (iii) if any of the conditions set forth in Section 8.02 hereof are not satisfied on or before August 29, 2003; or

(d) by Purchaser or Seller if the Closing Date shall not have occurred before September 3, 2003, for any reason other than the failure of the party seeking to terminate this Agreement to perform in any material respect its obligations hereunder or the breach or inaccuracy in any material respect of a representation or warranty made by such party; provided, that, any such failure, breach or inaccuracy by Leland shall be deemed a failure, breach or inaccuracy by Seller for purposes of this subsection (d).

9.02 Obligations Upon Termination. Except for obligations provided in Section 11.02 hereof, in the event that this Agreement is terminated pursuant to the provisions of Section 9.01(a) or (d) hereof, Seller shall have no obligation to Purchaser and Purchaser shall have no obligation to Seller. In the event that Seller or Purchaser shall terminate this Agreement pursuant to Section 9.01(b) or (c) hereof, respectively, the right of Purchaser or Seller, as the case may be, to pursue any and all rights it may have at law or equity or hereunder shall survive unimpaired.

ARTICLE X

INDEMNIFICATION

10.01 Indemnification by Purchaser. From and after the Closing Date, Purchaser shall indemnify, defend and hold Seller and Leland harmless from and against and reimburse Seller for any and all claims, losses, liabilities, damages, costs and expenses (including, without limitation, reasonable attorneys’ fees) (collectively, “Liabilities”) that may be incurred by, imposed upon or asserted against Seller arising from: (i) any failure of Purchaser to assume, pay, perform and discharge the Assumed Liabilities; (ii) any action, claim, judicial or other proceeding asserted by any third party against Seller with respect to any of the Assumed Liabilities; and (iii) any inaccuracy in or breach of any representation, warranty, covenant, obligation or agreement of Purchaser contained herein or in any document or instrument delivered pursuant hereto.

10.02 Indemnification by Seller and Leland. From and after the Closing Date, Seller and Leland shall indemnify, defend and hold Purchaser harmless from and against and reimburse Purchaser for any and all Liabilities that may be incurred by, imposed upon or asserted against Purchaser arising from or relating to: (i) any failure of Seller to assume, pay, perform and discharge the Retained Liabilities; (ii) any action, claim, judicial or other proceeding asserted by any third party against Purchaser with respect to any of the Retained Liabilities; (iii) any inaccuracy in or breach of any representation, warranty, covenant, obligation or agreement of Seller or Leland contained herein, or in any document or instrument delivered pursuant hereto; and (iv) the operation of the Business or the ownership, use or sale of the Acquired Assets by Seller prior to the Effective Time (including, without limitation, any contractual, tax, product, warranty, tort or other Liability whatsoever). Purchaser may withhold from Seller any payment otherwise due to Seller pursuant to the Note and offset the full amount of such claim for indemnification against the amount due to Seller pursuant to the Note in accordance with Section 10.05 hereof.

10.03 Notification of Claim. Each indemnified party under this Article X will promptly, and within ten (10) days after notice to such indemnified party of any claim as to which it asserts a claim for indemnification, notify the indemnifying party of such claim and the amount thereof; provided, however, that the failure to give such notification shall not relieve the indemnifying party from any liability which it may have pursuant to the provisions of this Article X as long as the failure to give such notice within such time is not prejudicial to the indemnifying party. Notice to an indemnified party for the purpose of the preceding sentence shall mean the filing of any legal action, receipt of any claim in writing or similar form of actual notice.

10.04 Defense of Claim. If any claim for indemnification by any indemnified party arises out of a claim by a person other than such indemnified party, the indemnifying party may, by written notice to the indemnified party, undertake to conduct any proceedings or negotiations in connection therewith or necessary to defend the indemnified party and take all other steps or proceedings to settle or contest such claim, including, but not limited to, the employment of

counsel; provided, however, that the indemnifying party shall reasonably consider the advice of the indemnified party as to the defense and settlement of such claim and the indemnified party shall have the right to participate, at its own expense, in such defense, but control of such litigation and settlement shall remain with the indemnifying party. The indemnified party shall provide all reasonable cooperation in connection with any such defense by the indemnifying party. Counsel and auditor fees, filing fees and court fees of all proceedings, contests or lawsuits with respect to any such claim shall be borne by the indemnifying party. If any such claim is made hereunder and the indemnifying party elects not to undertake the defense thereof by written notice to the indemnified party, the indemnified party shall be entitled to indemnification with respect thereto pursuant to the terms of this Article X. To the extent that the indemnifying party undertakes the defense of such claim by written notice to the indemnified party and diligently pursues such defense at its expense, the indemnified party shall be entitled to indemnification hereunder only to the extent that such defense is unsuccessful as determined by a final judgment of a court of competent jurisdiction, or by written acknowledgment of the parties. If any claim for indemnification by Purchaser arises out of a claim by Purchaser, then Purchaser shall be entitled to immediate indemnification hereunder pursuant to Section 10.05 hereof.

10.05 Offset. In the event that Purchaser shall exercise its right to offset provided in Section 10.02 any such offset shall be collected by reducing the amount owed by Purchaser to Seller in the following manner (i) first, to the extent of the principal amount outstanding on the Note, then (ii) to the extent of any accrued interest on the Note. Purchaser shall provide Seller with written notice of any proposed offset, including a reasonably detailed description of the basis for such offset, not less than ten (10) days prior to the effectiveness of such offset.

10.06 Subrogation. Following indemnification as provided for hereunder, the indemnifying party shall be subrogated to all rights of the indemnified party with respect to all persons or entities relating to the matter for which indemnification has been made.

ARTICLE XI

MISCELLANEOUS

11.01 Survival of Representations and Warranties. All representations and warranties contained in this Agreement, any Exhibit or Schedule hereto or any certificate, agreement or document delivered in connection with the transactions contemplated hereby shall survive the consummation of the transactions contemplated by this Agreement and any investigation on the part of the parties hereto and shall continue in full force and effect after the Closing for a period of one (1) year from the Closing Date at which time they shall expire and no party shall any longer be liable with respect thereto, except as to claims made in respect thereof in writing by any other party or any other indemnitee on or before the expiration of such one-year period; provided, however, that the representations and warranties contained in Sections 4.01, 4.02, 4.03, 4.06, 4.13, 4.15, 4.17, 4.19, 4.21, 4.23, 5.01, 5.02 and 5.03 shall survive indefinitely. The covenants and agreements of the parties hereto set forth in this Agreement shall not be affected by the expiration of any representation or warranty pursuant to this Section 11.01 and shall survive indefinitely.

11.02 Expenses. Regardless of whether the transactions contemplated by this Agreement are consummated, each of the parties hereto shall pay the fees and expenses of its own counsel, accountants or other experts, and all expenses incurred by such party incident to the negotiation, preparation, execution, consummation, and performance of this Agreement and the transactions contemplated hereby.

11.03 Notices. All notices, requests and other communications under this Agreement shall be in writing (including a writing delivered by facsimile transmission) and shall be deemed to have been duly given if delivered personally, or sent by either certified or registered mail, return receipt requested, postage prepaid, by overnight courier guaranteeing next day delivery, or by facsimile, addressed as follows:

(a) If to Seller or Leland:

Garland Physicians’ Hospital, Ltd.

c/o Leland Medical Centers, Inc.

5800 Granite Parkway, Suite 850

Plano, Texas 75024

Attn: Charles L. Simons

Facsimile No.: (972) 731-8042

With a required copy to:

Wayne M. Whitaker, General Counsel

5800 Granite Parkway, Suite 850

Plano, Texas 75024

Facsimilie No. (972) 731-8042

or at such other address or facsimile number as Seller or Leland may have advised Purchaser in writing; and

(b) If to Purchaser:

Vista Hospital of Dallas, L.P.

c/o Dynacq International, Inc.

4301 Vista Road

Pasadena, Texas 77504

Attn: Philip S. Chan

Facsimile No.: (713) 378-1966

With a required copy to:

Hallett & Perrin, P.C.

2001 Bryan Street

Suite 3900

Dallas, Texas 75201

Attn: William W. Meier, III, Esq.

Facsimile No.: (214) 922-4170

or at such other address or facsimile number as Purchaser may have advised Seller and Leland in writing.

All such notices, requests and other communications shall be deemed to have been received on the date of delivery thereof, if delivered by hand, on the fifth day after the mailing thereof, if mailed, on the next day after the sending thereof, if by overnight courier, and when receipt is acknowledged, if faxed.

11.04 Waivers and Amendments. No amendment or waiver of any provision of this Agreement, nor consent to any departure therefrom, shall be effective unless the same be in writing and signed by each party hereto, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No failure on the part of any party hereto to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right hereunder preclude any other or further exercise thereof or the exercise of any other right. The remedies provided in this Agreement are cumulative and not exclusive of any remedies provided by law.

11.05 Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. No party hereto shall assign any of its rights hereunder or any interest herein without the prior written consent of the other parties hereto.

11.06 Exhibits and Schedules. The Exhibits and Schedules attached hereto or referred to herein are incorporated herein and made a part hereof for all purposes. As used herein, the expression “this Agreement” means this document and such Exhibits and Schedules.

11.07 Governing Law. THIS AGREEMENT, AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HERETO, SHALL BE GOVERNED BY AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH THE SUBSTANTIVE LAWS OF THE STATE OF TEXAS, WITHOUT REGARD TO ITS PRINCIPLES OF CONFLICT OF LAWS.

11.08 Jurisdiction and Venue. Any judicial proceeding brought by or against any of the parties to this Agreement on any dispute arising out of this Agreement or any matter related hereto shall be brought in any Federal or State court sitting in Dallas County, State of Texas, and, by execution and delivery of this Agreement, each of the parties to this Agreement accepts for itself the exclusive jurisdiction and venue of the aforesaid courts as trial courts, expressly waives any objection which such party may have now or hereafter to the laying of the venue or to the

jurisdiction of any such suit, action or proceeding, and irrevocably agrees to be bound by any final non-appealable judgment rendered in connection witthis Agreement.

11.09 Number and Gender. Whenever herein the singular number is used, the same shall include the plural where appropriate, and words of any gender shall include each other gender where appropriate.

11.10 Captions. The captions, headings and arrangements used in this Agreement are for convenience only and do not in any way affect, limit or amplify the provisions hereof.

11.11 Invalid Provisions. If any provision of this Agreement is held to be illegal, invalid or unenforceable under present or future laws effective during the term hereof, such provision shall be fully severable; this Agreement shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof; and the remaining provisions of this Agreement shall remain in full force and effect and shall not be affected by the illegal, invalid or unenforceable provision of its severance from this Agreement.

11.12 Entirety. This Agreement contains the agreement and understanding among the parties with respect to the matters addressed herein and supersedes all prior representations, inducements, promises or agreements, oral or otherwise, which are not embodied herein.

11.13 Publicity. Except as otherwise required by law, until the existence of this Agreement is publicly disclosed, no party hereto shall issue any press release or make any other public statement, in either case relating to or connected with or arising out of this Agreement or the matters contained herein, without obtaining the prior written approval of the other parties to the contents and the manner of presentation and publication thereof, which approval shall not be unreasonably withheld.

11.14 Attorneys’ Fees. In the event that any action or proceeding is commenced by any party hereto for the purpose of enforcing any provision of this Agreement, the party to such action or proceeding may receive as part of any award, judgment, decision or other resolution of such action or proceeding its costs and attorneys’ fees as determined by the person or body making such award, judgment, decision or resolution. Should any claim hereunder be settled short of the commencement of any such action or proceeding, the parties in such settlement shall be entitled to include as part of the damages alleged to have been incurred reasonable costs of attorneys or other professionals in investigation or counseling on such claim.

11.15 Third Party Beneficiaries. Nothing contained herein, express or implied, is intended to confer upon any person or entity other than the parties hereto and their successors in interest and permitted assigns any rights or remedies under or by reason of this Agreement.

11.16 Counterparts. This Agreement may be executed in multiple counterparts, each of which shall be deemed an original for all purposes and all of which shall be deemed collectively to be one agreement.

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first written above.

PURCHASER:	VISTA HOSPITAL OF DALLAS, L.P.
	By: Vista Dallas, L.L.C., its General Partner
	By:	/s/    PHILIP S. CHAN
	Printed Name:	Philip S. Chan
	Title:	Manager
SELLER:	GARLAND PHYSICIANS’ HOSPITAL, LTD.
	By: LMC GPH, Inc., its General Partner
	By:	/s/    CHARLES L. SIMONS
	Printed Name:	Charles L. Simons
	Title:	Chairman
LELAND:	LELAND MEDICAL CENTERS, INC.
	By:	/s/    CHARLES L. SIMONS
	Printed Name:	Charles L. Simons
	Title:	President

EX-10.11

Exhibit 10.11

BILL OF SALE

THIS BILL OF SALE is made as of this 29^th day of August, 2003, by NPF-LL, Inc., an Ohio corporation (“Lessor”), in favor of Vista Land & Equipment, LLC, a Texas limited liability company (“Purchaser”), the designee of Garland Physicians’ Hospital, Ltd., a Texas limited partnership (“Lessee”), under the following circumstances:

A. Lessor and Lessee entered into an Equipment Lease Agreement dated December 17, 2001 (the “Lease”), which Lease was thereafter assigned to The Provident Bank (“Provident”).

B. Lessor is delivering this Bill of Sale and Provident is consenting to this transaction and delivering this Bill of Sale to the extent of its interest in the Assets, pursuant to a Settlement Agreement between Lessor, Lessee and Provident of even date herewith (the “Settlement Agreement”).

NOW, THEREFORE, in consideration of One Million Six Hundred Fifty Thousand Dollars ($1,650,000), the receipt and sufficiency of which is hereby acknowledged, Lessor and Provident do hereby transfer, assign, convey and deliver to Purchaser, as the designee of Lessee, its successors and assigns, all right, title and interest, legal or equitable, in or with respect to the equipment subject to the Lease (the “Assets”) in accordance with the Bankruptcy Court Order approving the Settlement Agreement. Provident consents to this transfer and releases any and all rights and interests in and with respect to the Assets.

NEITHER LESSOR NOR PROVIDENT MAKES ANY WARRANTY, EXPRESS OR IMPLIED WITH RESPECT TO THE ASSETS AND THE ASSETS ARE CONVEYED TO PURCHASER “AS IS”, “WHERE IS”, AND “WITH ALL FAULTS”. LESSOR AND PROVIDENT EXPRESSLY DISCLAIM ANY AND ALL IMPLIED OR EXPRESS WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTY OF TITLE, MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, CONDITION OR ANY OTHER WARRANTY IMPLIED UNDER THE UNIFORM COMMERCIAL CODE.

On or after the date of this Bill of Sale, Lessor and/or Provident will execute such further documents and instruments and perform such further acts as may be necessary for it to transfer, convey, assign and deliver the Assets to Purchaser on the terms and conditions contained herein and in the Settlement Agreement and to evidence or record the transfer and assignment of the Assets.

IN WITNESS WHEREOF, Lessor and Provident have executed this Bill of Sale as of the date first written above.

NPF-LL, Inc.		The Provident Bank
By:	David J. Colet	By:
Name:	David J. Colet	Name:
Title:	Secretary	Title:

Lessee hereby acknowledges that Purchaser is its designee and hereby assigns all rights and interests it has under the Lease or the Settlement Agreement in and with respect to the Assets to Purchaser.

Garland Physicians’ Hospital, Ltd.
By:	LMC GPH, Inc.
Its General Partner
By:	/s/    Charles L. Simons
Name:	Charles L. Simons
Title:	Chairman

Purchaser acknowledges receipt of the Assets and accepts the assets in accordance with all of the terms and conditions of the foregoing Bill of Sale. Purchaser, on behalf of itself, and each of its present and former partners, directors, officers, employees, agents, representatives, advisors, predecessors, successors, affiliates, and assigns, hereby unconditionally and irrevocably releases and forever discharges Lessor and Provident and each of their respective present and former directors, officers, employees, agents, representatives, advisors, affiliates and assigns from any and all costs, expenses, claims, demands, actions, causes of action, liabilities or suits of whatever kind or nature, known or unknown, accrued or unaccrued, liquidated or unliquidated, fixed or contingent, which may have arisen at any time prior to the date of this Bill of Sale, including but not limited to, any such claims arising out of or relating to the Assets acquired under the this Bill of Sale; provided, that Purchaser does not release Lessor or Provident from any costs, expenses, claims, demands, actions, causes of action, liabilities or suits arising out of any breach of the Settlement Agreement or this Bill of Sale by Lessor or Provident.

Vista Land & Equipment, LLC

By:

Name:

Title:

2

EX-10.12

Exhibit 10.12

MANAGEMENT SUPPORT AND MARKETING AGREEMENT

This MANAGEMENT SUPPORT AND MARKETING AGREEMENT (“Agreement,”) entered into and effective as of the 1st day of September, 2002 (notwithstanding the date of actual execution) by and between DOCTORS PRACTICE MANAGEMENT, INC., A Texas business corporation (“DPM”), and MEDICAL MULTIMEDIA ADVERTISING, INC. (“MMA”).

WITNESSETH:

WHEREAS, MMA is a duly and validly existing Texas corporation that has been organized for the purpose of providing investment opportunities and management support and marketing services for medical and related healthcare providers (“Healthcare Services”) to the general public in the Greater Houston, Texas area;

WHEREAS, DPM is experienced in providing management and related items and services to physicians, professional associations, and other professional healthcare entities and individuals and has been engaged as manager by VISTA COMMUNITY MEDICAL CENTER, L.L.C., (“VISTA”) a Texas business corporation organized for the purpose of operating an outpatient surgical and diagnostic clinic and providing medical and related healthcare services (“Healthcare Services”) in the Greater Houston, Texas area;

WHEREAS, DPM desires and intends to obtain such management, administrative, and business services necessary and appropriate for VISTA’S business operations and the provision of Healthcare Services by VISTA, and MMA is capable of assisting DPM in providing, all such management, administrative, and business services; and

WHEREAS, DPM and MMA mutually desire an arrangement that:

(1) ensures consistency of service, quality of care, and safety of VISTA’S patients;

(2) facilitates effective utilization of Healthcare Services;

(3) ensures consistent and customary patterns for the provision of Healthcare Services;

(4) facilitate the establishment and maintenance of a public image of excellence and high quality for VISTA, all for the benefit of those persons seeking Healthcare Services as patients of VISTA.

NOW, THEREFORE, for and in consideration of the mutual covenants set forth herein, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged and confessed, the parties agree as follows:

Covenants and Conditions Regarding Management and Advertising:

1.1 MMA agrees that it has the primary responsibility for the marketing of the facilities, including but not limited to the following:

(a) recruitment of physicians as tenants in the professional building;

(b) recruitment of physicians to use and otherwise employ the services of the hospital;

(c) general efforts to improve the reputation and market the benefits of VISTA; and

(d) create and publish multi-media advertising (subject to advance DPM approval).

1.2 DPM agrees to pay Two Hundred Thousand Dollars ($200,000.00) a month to be used for advertising and to pay fees and expenses of MMA. MMA and DPM agree that these funds will be deposited in an account to be managed and controlled solely by MMA. From these funds, MMA agrees to expend at least $165,000.00 monthly, directly on advertising and the general marketing of VISTA, and the associated services of the Vista Medical Center at 1401 and 1401A Vista, Pasadena, Texas. Further, MMA will provide to DPM a written report and verification of these expenditures quarterly, with said report being due not later than thirty (30) days after the end of each respective quarter.

1.3 Management and Clerical Personnel. MMA shall employ or otherwise retain, and shall be responsible for selecting, training, supervising, scheduling, and terminating, all management and clerical personnel as MMA deems reasonably necessary and appropriate in the performance of its duties and obligations under this Agreement. MMA shall have sole responsibility for determining the salaries, wages, and fringe benefits of all such management and clerical personnel, for paying such salaries and wages, and for providing such fringe benefits, and for withholding as required by law, any sums for income tax, unemployment insurance, social security, or any other withholding required by applicable law or governmental requirement.

1.4 Insurance. Throughout the Term, MMA shall, at MMA’s expense, obtain and maintain with commercial carriers, through captive insurance companies, through self-insurance, or some combination thereof, professional, casualty, and comprehensive general liability insurance covering MMA, its personnel, and all of its equipment in such amounts, on such basis, and upon such terms and conditions as DPM deems appropriate.

1.5 Indemnification by MMA. MMA shall indemnify and hold DPM harmless from and against any and all liability losses, damages, claims, causes of action, and expenses, including, without limitation, reasonable attorney’s fees and associated costs, associated with or resulting, directly or indirectly, from any act or omission of MMA, its employees, agents, or independent contractors in or about the Facility during the Term. To be entitled to such indemnification, DPM shall give MMA prompt written

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notice of the assertion by a third party of any claim with respect to which DPM might bring a claim for indemnification hereunder, and in all events must provide such written notice to MMA within the applicable period for defense of such claim by MMA. MMA shall, at its own expense, have the right to defend and litigate any such third-party claim.

2.1 Organization and Existence. DPM is a Texas corporation duly organized, validly existing and in good standing under the laws of the State of Texas and has all requisite legal and corporate power to carry on its business as now conducted and to enter into and perform this Agreement.

2.2 Compliance with Laws. DPM is in compliance in all material respects with all applicable foreign, federal, state, municipal and other political subdivision or governmental agency statutes, ordinances and regulations, including, without limitation, those imposing taxes, in every applicable jurisdiction in respect of the ownership of DPM properties and conduct of DPM’s business.

2.3 Brokers. DPM in not a party to or in any way obligated under any contract or other agreement for, and there are no outstanding claims against DPM for the payment of any broker’s or finder’s fee in connection with the origin, negotiation, execution or performance of this Agreement.

2.4 DPM’s Authority Relative to this Agreement. The execution, delivery and performance of this Agreement by DPM has been duly authorized and approved by the Board of Directors and no further corporate action is necessary on the part of DPM to make this Agreement valid and binding upon DPM in accordance with its terms. Neither the execution, delivery nor performance of this Agreement by DPM will result in a violation or breach of any term or provision under the Articles of Incorporation or Bylaws of DPM or constitute a default or breach of, or accelerate the performance required under, any indenture, mortgage, deed of trust or other contract or agreement to which DPM is a party or by which it or any of its respective assets are bound, or, violate any order, writ, injunction or decree of any court, administrative agency or governmental body.

3.1 Organization and Existence. MMA is a Texas corporation duly organized pursuant to the laws of Texas and in good standing, and has all requisite legal power to enter into and perform this Agreement.

3.2 Authority Relative to this Agreement. The execution, delivery and performance of this Agreement has been duly authorized, and no further action is necessary on the part of MMA to make this Agreement valid and binding upon MMA in accordance of its terms. Neither the execution, delivery nor performance of this Agreement by MMA will result in a violation or breach of any term or provision or constitute a default or breach of, or accelerate the performance required under any other contract or agreement to which MMA is a party or by which it or its properties are bound, or violate any order, writ, injunction or decree of any court, administrative agency or governmental body.

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3.3 Brokers. MMA is not a party to or in any way obligated under any contract or agreement for, and there are no outstanding claims against MMA for the payment of any broker’s or finder’s fee in connection with the origin, negotiation, execution, or performance of this agreement.

4.1 Confidential Information. MMA acknowledges that in the course of the performance of this Agreement, it has had and will continue to have access to certain know-how, formulae, processes, data, proprietary information, supplier and patient records and information and other confidential knowledge and trade secrets of DPM’s and VISTA’s business and operations. MMA understands that all such information is confidential and has been or will be conceived or learned by MMA in confidence, and agrees not to reveal any such information to any third person for any reason or under any circumstances. MMA further agrees that it will at no time use any such information for the purpose of competing with or assisting others in competing with the business of DPM or VISTA, or for any purpose which may be harmful or detrimental to the business or interests of DPM or VISTA. The restrictions in this section shall not apply and shall not prohibit the use or disclosure of such confidential information (i) to the extent required by law or court order, or other administrative order in any litigation, arbitration, or similar proceeding; (ii) to the extent such information becomes publicly available other than through a breach of this section; or (iii) to the extent such information would become necessary to support any claim arising between the parties; or (iv) with the written agreement of DPM and VISTA. The parties agrees that any remedy at law for actual or threatened breach of the provisions of this section would be inadequate and that DPM or VISTA shall be entitled to specific performance thereof or injunctive relief by temporary or permanent injunction or such other appropriate judicial remedy, writ or order as may be entered by a court of competent jurisdiction. Any such remedy shall be in addition to any damages which DPM or VISTA may be legally entitled to recover as a result of any breach by the other party of the provisions of this section, and MMA hereby waives any requirement for the securing or posting of any bond in connection with obtaining any such injunctive or other equitable relief.

5.1 Initial and Renewal Terms. The term of this Agreement will be for three (3) years commencing as of October 15, 2003, and expiring as of October 15 2006, unless and until terminated as provided hereinafter (“the Term”). DPM is hereby granted and shall, if not at the time in default under this Agreement, have at its sole discretion, an option to extend the term of this Agreement for two (2) years under the same terms contained herein. This option shall be exercised only by DPM’s delivering to MMA before the termination of the original Term written notice of DPM’s election to extend the Term of this Agreement as provided herein.

5.2 Termination by DPM. DPM may terminate this Agreement upon thirty (30) days written notice to MMA.

5.3 Termination by MMA. MMA may terminate this Agreement upon the occurrence of the dissolution of DPM, or if DPM fails to pay MMA the advertising dollars as provided for in sec. 1.3 of this Agreement within thirty (30) days of the date such amounts are due.

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5.4 Termination by Agreement. In the event MMA and DPM shall mutually agree in writing, this Agreement may be terminated on the date specified in such written agreement.

5.5 Bankruptcy. In the event that either party become insolvent, or if any petition under federal or state law pertaining to bankruptcy or insolvency or for a reorganization or arrangement or other relief from creditors shall be filed by or against either party, or if any assignment, trust, mortgage, or other transfer shall be made of all or a substantial part of the property of either party, or if either party shall make or offer a composition in its debts with its creditors, or if a receiver, trustee, or similar officer or creditor’s committee shall be appointed to take charge of any property of or to operate or wind up the affairs of either party, then the other party may, by written notice, as specified herein, immediately terminate this Agreement.

5.6 Default. In the event either party shall give written notice to the other that such other party has substantially defaulted in the performance of any material duty or material obligation imposed upon it by this Agreement, and such default shall not have been cured within thirty (30) days following the giving of such written notice, the party giving such written notice shall have the right to immediately terminate this Agreement unless the defaulting party shall, within said thirty (30) day period, have made a good faith effort to initiate corrective action and it is contemplated that such corrective action will be completed within the following thirty (30) day period.

5.7 Effects of Termination. Upon termination of this Agreement, as hereinabove provided, neither party shall have any further obligations hereunder except for (i) obligations accruing prior to the date of termination, and (ii) obligations, promises, or covenants set forth herein that are expressly made to extend beyond the Term, including, without limitation, indemnities, and payment of accrued advertising dollars, if any.

6.1 Independent Relationship. It is mutually understood and agreed that MMA and DPM, in performing their respective duties and obligations under this Agreement, are at all times acting and performing as independent contractors with respect to each other, and nothing in this Agreement is intended nor shall be construed to create an employer/employee relationship or a joint venture relationship, or to allow DPM to exercise control or direction of any nature, kind, or description over the manner or method by which MMA performs its duties.

6.2. MMA Representative. Except as may be herein more specifically provided, MMA shall act with respect to all matters hereunder through its managers.

6.3 DPM Representative. Except as may be herein more specifically provided, DPM shall act with respect to all matters hereunder through its President.

6.4 Notices. Any notice, demand, or communication required, permitted, or desired to be given hereunder shall be deemed effectively given when personally

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delivered or mailed by prepaid certified mail, return receipt requested, addressed as follows:

If to MMA:	Kevin Bailey 1314 Texas Ave suite 1110 Houston, Texas 77002 Telephone: (713) 227-0042 Telefax: (713) 227-7001
If to DPM:	Philip Chan 4301A Vista Pasadena, Texas 77504 Telephone: (713) 947-0891 Telefax: (713) 944-3334

or to such other address, or to the attention of such other person or officer, as either party may by written notice designate.

6.5 Governing Law. This Agreement has been executed and delivered in, and shall be governed by, and construed and enforced in accordance with, the laws of the State of Texas. Venue for any legal actions hereunder shall be in the State district courts of Harris County, Texas.

6.6 Assignment. This Agreement may not be assigned by any party hereto.

6.7 Waiver of Breach. The waiver by either party of any condition or covenant, or of any breach or violation of any provision of this Agreement shall not operate as, or to be construed to constitute, a waiver of any subsequent breach of the same or another provision hereof.

6.8 Enforcement. In the event either party resort to legal action to enforce or interpret any provision of this Agreement, the prevailing party shall be entitled to recover costs of such action so incurred, including, without limitation, reasonable attorney’s fees.

6.9 Gender and Number. Whenever the context of this Agreement requires, the gender of all words herein shall include the masculine, feminine, and neuter, and the number of all words herein shall include the singular and plural.

6.10 Additional Assurance. Except as may be herein specifically provided to the contrary, the provisions of this Agreement shall be self-operative and shall not require further agreement by the parties; provided, however, at the request of either party, the other party shall execute such additional instruments and take such additional acts as are reasonable and as the requesting party may deem necessary to effectuate this Agreement.

6.11 Consents, Approvals, and Exercise of Discretion. Except as may be herein specifically provided to the contrary, whenever this Agreement requires any consent or approval to be given by either party, or either party must or may exercise

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discretion, the parties agree that such consent or approval shall not be unreasonably withheld or delayed, and such discretion shall be reasonably exercised.

6.12 Force Majeure. Neither party shall be liable or deemed to be in default for any delay or failure in performance under this Agreement or other interruption of service deemed to result, directly or indirectly, from acts of God, civil or military authority, acts of public enemy, war, accidents, fires, explosions, earthquakes, floods, failure of transportation, strikes or other work interruptions by either party’s employees, or any other similar cause beyond the reasonable control of either party.

6.13 Severability. In the event any provision of this Agreement is held to be invalid, illegal, or unenforceable for any reason and in any respect, such invalidity, illegality, or unenforceability shall not affect the remainder of this agreement, which shall be and remain in full force and effect, enforceable in accordance with its terms.

6.14 Divisions and Readings. The division of this Agreement into articles, sections, and subsections and the use of captions and headings in connection therewith are solely for convenience and shall not affect in any way the meaning or interpretation of this Agreement.

6.15 Amendments and Agreement Execution. This Agreement and amendments hereto shall be in writing and executed in multiple copies by the duly authorized officers of VISTA and Manager. Each multiple copy shall be deemed an original, but all multiple copies together shall constitute one and the same instrument.

6.16 Entire Agreement. This Agreement supersedes all previous contracts and amendments and constitutes the entire agreement between the parties with respect to the subject matter of this Agreement. Neither party shall be entitled to benefits other than those specified herein. No oral statements or prior written material not specifically incorporated herein shall be of any force and effect, and no changes in or additions to this Agreement shall be recognized unless incorporated herein by amendment as provided herein, such amendment(s) to become effective on the date stipulated in such amendment(s). The parties specifically acknowledged that, in entering into and executing this Agreement, the parties rely solely upon the representations and agreements contained in this Agreement and no others.

6.17 Specific Performance. Each party acknowledges that a remedy at law for any breach or attempted breach of the provisions of this Agreement will be inadequate, and agrees that each party shall be entitled to specific performance and injunctive or other equitable relief in case of any such breach or attempted breach.

6.18 Successors Bound. Subject to the provisions of Section 7.5, this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, personal legal representatives, and assigns.

6.19 Section and Paragraph Headings. The section and paragraph headings in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. The word “this Agreement,” “this

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instrument,” “herein,” “hereto,” “hereunder,” and words of similar import refer to this Agreement as a whole and not to a particular article, section, paragraph, or other subdivision of this Agreement. Whenever the context requires, the gender of all words used in this Agreement shall include the masculine, feminine, and neuter, and the number of all words shall include the singular and the plural.

6.20 Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which shall constitute the same instrument.

6.21 Public Disclosure. The parties hereto agree that any disclosure or press release about the transactions contemplated by this Agreement may only be made in the manner and at the time mutually determined by the Purchaser and the Seller.

6.22 Time. Time is of the essence hereof. If the time for performance of any obligations set forth in this Agreement falls on Saturday, Sunday, or legal holiday, compliance with such obligation on the next business day following such Saturday, Sunday or legal holiday shall be deemed acceptable. For purposes of this Agreement, a “business day” is any day other than a Saturday, Sunday, or legal holiday in Texas.

6.23 Attorney’s Fees. In the event of any action at law or in equity between the parties hereto to enforce any provision or right hereunder or in any way related hereto or arising herefrom, the unsuccessful party in such litigation covenants and agrees to pay to the successful party all costs and expenses, including reasonable attorney’s fees, incurred therein by such successful party. If such successful party shall recover judgment in any such action or proceeding, such costs and expenses shall be included as part of such judgment.

6.24 Language. The language of this Agreement shall be construed as a whole and in accordance with the fair meaning of the language used. The language of this Agreement shall not be strictly construed for or against either of the parties hereto based upon who drafted or was principally responsible for drafting the Agreement or any specific term or condition hereof. This Agreement shall be deemed to have been drafted by each party hereto, and no party may urge otherwise.

6.25 Knowledge. Any representation, warranty or covenant herein which is limited to a party’s “knowledge” is made with the understanding that such party has examined whatever sources of information that are reasonably accessible to such party in order to verify the truth and accuracy of such representation, warranty or covenant.

6.26 Other Documents. The parties agree to execute all other documents or instruments necessary to effect the transfers of property set forth herein and otherwise to implement the provisions of this Agreement.

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IN WITNESS WHEREOF, MMA and DPM have executed this Agreement in multiple originals this 15th day of October, 2003.

MMA:	Medical Multimedia Advertising, Inc.
	By:	/s/    Kevin Bailey
		Kevin Bailey, President

DPM:	Doctors Practice Management, Inc.
	By:	/s/    Philip Chan
		Philip Chan, President

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ADDENDUM

MANAGEMENT SUPPORT AND MARKETING AGREEMENT

The addendum to the MANAGEMENT SUPPORT AND MARKETING AGREEMENT (“Agreement”) entered into and effective as of the 15^th day of October, 2003 by and between DOCTORS PRACTICE MANAGEMENT, INC., a Texas business corporation (“DPM”) and MEDICAL MULTIMEDIA ADVERTISING, INC. (“MMA”) is offered to correct the reference effective date from the erroneous date of September 1, 2002 to the correct date of October 15, 2003.

All other recitations contained in the Agreement are correct and remain in full force and effect.

IN WITNESS WHEREOF, MMA and DPM have executed the Agreement in multiple originals this 28th day of July, 2004

MMA:	Medical Multimedia Advertising, Inc.
	/s/    Kevin Bailey
	Kevin Bailey, President
DPM:	Doctors Practice Management, Inc.
	/s/    Philip Chan
	Philip Chan, President

EX-10.13

Exhibit 10.13

CASH SALE BY VISTA HOLDINGS, L.L.C.

TO HEALTHGROUP PARTNERS, LLC

BE IT KNOWN THAT, on the dates hereinafter set forth, before the undersigned Notaries Public, duly commissioned and qualified in and for the States and Parishes or Counties hereinafter set forth, and in the presence of the undersigned competent witnesses,

PERSONALLY CAME AND APPEARED:

VISTA HOLDINGS, L.L.C., a Louisiana limited liability company, whose permanent mailing address is 4301 Vista Road, Pasadena, Texas 77504, and whose U.S. taxpayer identification number is 76-0699801, represented herein by Philip S. Chan, its duly authorized representative, pursuant to Resolution of the members of Vista Holdings, L.L.C., a copy of which is attached hereto

(hereinafter referred to as Seller)

who declared that Seller does by these presents, grant, bargain, sell, convey, transfer, assign, set over, abandon and deliver with all legal warranties of title, but with no warranty as to condition, and with full substitution and subrogation in and to all the rights and actions of warranty which Seller has or may have against all preceding owners and vendors unto:

HEALTHGROUP PARTNERS, LLC, a Nevada limited liability company, whose permanent mailing address is c/o Gwynne E. Old, Esq., Three Riverway, Suite 1800, Houston, Texas 77056-1969, and whose U. S. taxpayer identification number is                     , herein represented by David J. Felt, its duly authorized representative, pursuant to Resolution of the members of Healthgroup Partners, LLC, a copy of which is attached hereto

(hereinafter referred to as Purchaser)

here present, accepting, and purchasing for Purchaser, Purchaser’s successors, heirs and assigns, and acknowledging due delivery and possession thereof, all and singular the following described property (the Property), to-wit:

ALL THAT CERTAIN LOT OR PARCEL OF LAND, together with all the buildings and improvements thereon and all of the rights, ways, privileges, servitudes, appurtenances and advantages thereunto belonging or in anywise appertaining, situated in SECTIONS 11 and 12, TOWNSHIP 9 SOUTH, RANGE 14 EAST, ST. TAMMANY PARISH, LOUISIANA, and being more fully described as follows, to-wit:

From the Northwest corner of the Southeast Quarter of the Southeast Quarter of Section 11, Township 9 South, Range 14 East, St. Tammany Parish, Louisiana, go South 89 degrees 48 minutes 16 seconds East 695.13 feet to the Point of Beginning. From the Point of Beginning, go South 89 degrees 25 minutes 16 seconds East (Title South 89 degrees 48 minutes 16 seconds East) 112.10 feet (Title 111.87 feet); thence South 89 degrees 50 minutes 33 seconds East (Title North 89 degrees 40 minutes 46 seconds East) 511.20 feet (Title 513.0 feet); thence South 65 degrees 01 minutes 05 seconds East (Title South 62

degrees 59 minutes 15 seconds East) 62.08 feet; thence South 18 degrees 00 minutes 30 seconds West (Title South 17 degrees 50 seconds West) 449.50 feet; thence South 89 degrees 53 minutes 59 seconds West (Title South 89 degrees 40 minutes 46 seconds West) 540.61 feet (Title 542.51 feet); thence North 457.18 feet (Title 456.65 feet) back to the Point of Beginning. Said property contains 6.40 acres of land, more or less.

All in accordance with a survey no. 2003 070 by John E. Bonneau & Associates, Inc., John E. Bonneau, Registered Land Surveyor, dated January 30, 2003, print of which is annexed to act passed before Roy E. Blossman, dated February 21, 2003, recorded at Conveyance Instrument No. 1351066.

Being the same property acquired by Vista Holdings, L.L.C. from Janice Seal Smith and the Succession of Johnny F. Smith as per act passed before Roy E. Blossman, Notary Public, dated February 21, 2003, recorded in the conveyance records of St. Tammany Parish, on February 26, 2003, at Instrument No. 1351066.

To the extent any of the following may be applicable, this act is made and accepted subject to the following:

1. Right-of-way in favor of CLECO dated October 1, 1962, registered in COB 332, folio 363, St. Tammany Parish, Louisiana.

2. Right-of-way in favor of AT&T dated September 22, 1927, registered at COB 103, folio 359, St. Tammany Parish, Louisiana.

3. Apparent servitude for gravel road and electric line as shown on survey by John E. Bonneau & Associates, dated January 30, 2003.

The parties hereto declare that they do not hereby intend, by the execution of these presents, to interrupt, or suspend, the running of any prescription or preemption which has run or may run in connection with the foregoing, nor do the parties intend to revive, establish or initiate any one or more of the foregoing which may not now or hereafter be binding upon the hereinabove described property and/or the parties hereto.

To have and to hold the Property unto the Purchaser, and Purchaser’s successors, heirs and assigns forever.

PURCHASER ACKNOWLEDGES AND AGREES THAT THE TRANSFER OF THE PROPERTY, INCLUDING ANY BUILDINGS AND IMPROVEMENTS LOCATED ON THE PROPERTY, IS SOLD BY SELLER AND ACCEPTED BY PURCHASER IN ITS PRESENT “AS-IS, WHERE-IS” CONDITION WITH ALL FAULTS AND WITHOUT ANY WARRANTIES WHATSOEVER.

AS A MATERIAL AND INTEGRAL CONSIDERATION FOR THE EXECUTION OF THIS ACT OF SALE BY SELLER, PURCHASER WAIVES AND RELEASES SELLER FROM ANY AND ALL CLAIMS OR CAUSES OF ACTION TO WHICH PURCHASER MAY HAVE OR HEREAFTER MAY OTHERWISE BE ENTITLED, BASED ON VICES OR DEFECTS IN THE PROPERTY HEREIN

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SOLD, OR ANY IMPROVEMENTS OR COMPONENT PARTS THEREOF, WHETHER IN THE NATURE OF IMPLIED WARRANTY OF FITNESS OR MERCHANTABILITY, REDUCTION OF THE PURCHASE PRICE, CONCEALMENT, OR ANY OTHER THEORY OF LAW. THE PURCHASER FURTHER ASSUMES THE RISK OF ALL VICES AND DEFECTS IN THE PROPERTY, AND ALL IMPROVEMENTS AND COMPONENT PARTS THEREOF, WHETHER THOSE VICES OR DEFECTS ARE LATENT OR NOT DISCOVERABLE UPON SIMPLE INSPECTION, AND INCLUDING THOSE VICES OR DEFECTS, KNOWLEDGE OF WHICH WOULD DETER PURCHASER FROM MAKING THIS PURCHASE.

PURCHASER FURTHER ACKNOWLEDGES THAT PURCHASER (A) HAD AMPLE OPPORTUNITY TO FULLY INSPECT THE PROPERTY, INCLUDING, BUT NOT LIMITED TO THE ENVIRONMENTAL CONDITION OF THE PROPERTY, (B) HAS INSPECTED THE PROPERTY TO THE EXTENT PURCHASER DEEMED NECESSARY, (C) DOES HEREBY PURCHASE THE PROPERTY IN ITS PRESENT CONDITION, AND (D) DOES HEREBY PURCHASE THE PROPERTY SUBJECT TO ANY PHYSICAL ENCROACHMENTS ON THE PROPERTY AND ANY PHYSICAL ENCROACHMENTS ONTO ADJACENT PROPERTY BY IMPROVEMENTS LOCATED ON THE PROPERTY.

PURCHASER ACKNOWLEDGES THAT THE PROPERTY, OR A PORTION THEREOF, IS CONTAINED IN THE AREA DESIGNATED BY THE STATE OF LOUISIANA FOR CONSTRUCTION OF A HIGHWAY AND RELATED IMPROVEMENTS AND, ACCORDINGLY, THE STATE OF LOUISIANA MAY EXPROPRIATE THE PROPERTY, OR A PORTION THEREOF, FOR HIGHWAY PURPOSES.

PURCHASER FURTHER ACKNOWLEDGES THAT ALL OF THE FOREGOING EXCLUSIONS, WAIVERS AND AGREEMENTS BY PURCHASER HAVE BEEN BROUGHT TO PURCHASER’S ATTENTION AND READ AND EXPLAINED TO PURCHASER AND THAT THEY ARE A MATERIAL AND INTEGRAL CONSIDERATION FOR THIS ACT OF SALE.

This sale is made and accepted for and in consideration of the price and sum of TWO MILLION FIVE HUNDRED THOUSAND AND NO/100 ($2,500,000.00) Dollars, cash, which Purchaser has well and truly paid, in ready and current money to Seller, who hereby acknowledges the receipt thereof and grants full acquittance and discharge therefor.

All taxes up to and including the taxes due and eligible in 2003 are paid. Taxes for the current year have been prorated between Seller and Purchaser as of the date hereof, based on 2003 taxes.

Seller declares, represents and warrants that there are no judgments, general or particular, of record or otherwise against Seller, which may affect the Property, and there are no liens,

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privileges, mortgages, pledges or other encumbrances of record or otherwise which may affect or burden the Property.

This Cash Sale may be executed by the parties thereto in several counterparts, each of which when so executed shall be deemed to be an original, but all such counterparts shall together constitute but one and the same instrument.

[INTENTIONALLY LEFT BLANK]

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THUS DONE AND PASSED in multiple originals, in Houston Parish/County of Harris, State of Texas, on the 23^rd day of January, 2004, in the presence of the undersigned competent witnesses who have signed their names, together with appearers and me, Notary.

WITNESSES:		VISTA HOLDINGS, L.L.C.
	David Farley	BY:	Philip S. Chan
			PHILIP S. CHAN
	/s/    Laurie Knape		Its: Duly Authorized Representative, Pursuant to Resolution Attached hereto

/s/    Sulema Alanis
NOTARY PUBLIC	(SEAL)
My Commission expires: 10/25/06

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THUS DONE AND PASSED in multiple originals, in Houston County of Harris, State of Texas, on the 23^rd day of January, 2004, in the presence of the undersigned competent witnesses who have signed their names, together with appearers and me, Notary.

WITNESSES:		HEALTHGROUP PARTNERS, LLC
	/s/    Ruth Greenhart	BY:	/s/    David J. Felt
			DAVID J. FELT
	/s/    Vanessa Reeves		Its: Duly Authorized Representative, Pursuant to Resolution Attached hereto

/s/    Patty R. Barnes
NOTARY PUBLIC	(SEAL)
My Commission expires: 2/28/04

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EX-10.14

Exhibit 10.14

CONSULTING AGREEMENT

THIS CONSULTING AGREEMENT (“Agreement”) effective as of February 1, 2004, between SARAH C. GARVIN, of Seabrook, Harris County, Texas (“Garvin”), DYNACQ HEALTHCARE, INC., a Delaware corporation (“Dynacq”) (formerly, Dynacq International, Inc., a Nevada corporation (“Dynacq–Nevada”)), and DOCTORS PRACTICE MANAGEMENT, INC., a Texas corporation and a wholly-owned subsidiary of Dynacq (“DPM”).

RECITALS:

WHEREAS, Garvin entered into that Employment Agreement (the “Original Employment Agreement”), effective December 6, 2000, between Garvin, as an employee, and Dynacq–Nevada, as the employer, and in connection with the Original Employment Agreement Dynacq–Nevada made an incentive stock option grant to Garvin of options (the “Stock Options”) to purchase 100,000 shares (subsequently, 200,000 shares after a 2-for-1 stock split) of Dynacq’s common stock, $.001 par value (“Stock”) pursuant to that Incentive Stock Option Agreement (Pursuant to Dynacq International, Inc. Year-2000 Stock Incentive Plan) (the “Stock Option Agreement”); and

WHEREAS, under the terms of the Stock Option Agreement all Stock Options have vested and have been exercised by Garvin, with the exception of Stock Options covering the remaining 80,000 shares of Stock which vested and became exercisable on December 5, 2003 but have not yet been exercised; and

WHEREAS, Dynacq–Nevada changed its name to Dynacq Healthcare, Inc. and became reincorporated in the State of Delaware; and

WHEREAS, after the expiration of the 3-year term of the Original Employment Agreement, Garvin entered into a new employment arrangement pursuant to that Employment Agreement, dated December 19, 2003 (the “Second Employment Agreement”), between Garvin, as employee, and DPM, as employer; and

WHEREAS, Garvin, DPM and Dynacq are agreeable to changing Garvin’s status as an employee under the Second Employment Agreement to that of consultant under the terms and provisions of this Agreement, to terminating the Second Employment Agreement, all to be effective as of February 1, 2004.

NOW THEREFORE, in consideration of Five Dollars ($5.00) cash in hand paid by each party hereto to the other, the premises, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Garvin, DPM and Dynacq hereby agree as follows:

1. Consulting Services; Location; Other Activities or Employment.

A. Effective February 1, 2004, Garvin shall hold herself available to provide consulting services to DPM, as may be requested by DPM from time to time during the term of this Agreement, involving the field of Garvin’s expertise in the acquisition, leasing and operation

of surgical hospitals, including but not limited to the referral, as Garvin may determine in her sole discretion, of any acquisition and leasing leads to DPM and Dynacq for their consideration, and assistance with feasibility studies related to such leads as may be requested by DPM and/or Dynacq, and holding herself available for providing information or assistance regarding current hospital operations and strategic models for DPM. Garvin shall provide the consulting services provided hereunder at such times and upon such schedules as shall be determined by her in her sole discretion, except as may be otherwise mutually agreed upon in connection with a particular consulting assignment.

B. Garvin may render the consulting services pursuant to this Agreement from an office situated in any location of her own choosing, within or outside of the State of Texas, including but not limited to the State of Georgia; and the reasonable expenses of any travel away from such office incurred by Garvin in connection with consulting services rendered hereunder shall be reimbursed by DPM in accordance with the usual and customary practices of DPM, provided that such expenses are reimbursable only to the extent that they are incurred due to a specific request by Dynacq and/or DPM and the amounts thereof are approved in advance by Dynacq and/or DPM.

C. Garvin shall not be expressly or impliedly restricted or prohibited by virtue of this Agreement or the relationship created hereby from engaging in other activities or business ventures of any kind or character whatsoever. Garvin shall have the right to be employed by, to conduct, or to possess a direct or indirect ownership interest in, activities and business ventures of every type and description, including activities and business ventures in direct competition with DPM or Dynacq, provided, however, that, except as otherwise provided in this Agreement, Garvin shall not compete, directly or indirectly, with Dynacq, DPM, and/or any of its subsidiaries or affiliates in the ownership or operation of, or consulting for, ambulatory surgery centers and/or hospitals of any type (individually, a “Project”) within a twenty-five (25) mile radius of any location where the Company or any of its affiliates currently operates or currently intends to operate, namely, Vista Community Medical Center, LLP, Vista Surgical Center West, LLC, Vista Hospital of Dallas, L.P., Vista Hospital of Baton Rouge, LLC, Georgia Baptist Meriwether Hospital and Nursing Home, and/or Riverstone Hospital Partners, L.L.P., for the period of duration of the consulting relationship under this Agreement, but no longer (this proviso concerning non-competition is sometimes hereinafter referred to as the “Noncompetition Clause”). In the event that within the period of twelve (12) months after the effective date of this Agreement, the Company or any of its affiliates should give written notice to Garvin that it does not intend to further pursue development of any one of the Projects named in the preceding Noncompetition Clause which it does not presently operate but currently intends to operate, each such Project shall thereafter be deleted from and shall not be included in the list of Projects in the Noncompetition Clause Garvin shall not be obligated by virtue of this Agreement to present any particular business opportunity to DPM or Dynacq even if such opportunity is of a character that, if presented to DPM or Dynacq, could be taken, pursued or developed by either of DPM or Dynacq. Garvin shall have the right to take, pursue and develop any such opportunity for her own account (individually or as a partner, member, shareholder, fiduciary or otherwise) or to present or recommend it to any third party, except as otherwise prohibited by this paragraph. Should Garvin violate the terms of this Noncompetition Clause, as determined pursuant to the terms and provisions of Paragraph 11 of this Agreement, the consulting relationship of Garvin hereunder shall be terminated effective as of such determination, and Dynacq shall be entitled to

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exercise all appropriate legal remedies. In such event, DPM and/or Dynacq shall have no further obligation to make any further payments to Garvin; and Garvin’s obligations under the Noncompetition Clause shall terminate.

2. Term. The term of Garvin’s engagement as a consultant under this Agreement shall be for a period of thirty (30) months commencing February 1, 2004 and ending August 31, 2006, unless such engagement is sooner terminated as provided in this Agreement.

3. Compensation; Expenses; Termination of Consulting Relationship.

A. As compensation for her consulting services and for holding herself available to render her consulting services hereunder, Garvin shall receive a fee (the “Consulting Fee”) in the aggregate sum of (i) One Hundred Eighty-Nine Thousand and No/100 ($189,000.00) for the first eighteen (18) months of the term of this Agreement, payable in the amount of Ten Thousand Five Hundred and No/100 Dollars ($10,500.00) per month, plus (ii) One Hundred Twenty Thousand and No/100 ($120,000.00) for the remaining twelve (12) months of the term of this Agreement, payable in the amount of Ten Thousand and No/100 Dollars ($10,000.00) per month. The monthly payments of the Consulting Fee shall be payable on the fifteenth day of each month, commencing on February 15, 2004. Additionally, Garvin shall be reimbursed for all travel, entertainment and other business expenses incurred in connection with her consulting services hereunder, provided that such expenses are reimbursable only to the extent that they are incurred due to a specific request by Dynacq and/or DPM and the amounts thereof are approved in advance by Dynacq and/or DPM.

B. DPM shall have the right at any time during the term of this Agreement to terminate the consulting relationship with Garvin hereunder; provided, however, that in such event DPM and Dynacq shall jointly and severally have the obligation to pay to Garvin the amount of the remaining unpaid balance of the Consulting Fee in full within thirty (30) days after such termination unless such termination results from Garvin’s violation of the Noncompetition Clause contained in sub-Paragraph 1.C. DPM and Dynacq, jointly and severally, shall have the obligation to pay to Garvin the full amount of the Consulting Fee provided in the foregoing sub-Paragraph 3.A. under any and all circumstances, regardless of her incapacity or other inability during the term of this Agreement to perform her obligations hereunder, unless the termination is due to the death of Garvin or results from Garvin’s violation of the Noncompetition Clause contained in sub-Paragraph 1.C.

C. Excluding termination resulting from a violation of the Noncompetition Clause contained in sub-Paragraph 1.C, in the event that any installment of the Consulting Fee should not be received by Garvin thirty (30) days after it is due and payable, then DPM shall be deemed to have terminated the consulting relationship with Garvin hereunder effective as of the date such installment was due and payable, and DPM and Dynacq shall jointly and severally be obligated to pay to Garvin the amount of the remaining unpaid balance of the Consulting Fee in full within an additional thirty (30) days. If the termination does result from a violation of the Noncompetition Clause contained in sub-Paragraph 1.C, DPM and/or Dynacq shall have no further obligation to pay any sum to Garvin.

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D. Excluding termination resulting from a violation of the Noncompetition Clause contained in sub Paragraph 1.C, under which circumstances DPM and/or Dynacq would have no further obligation to pay any sum to Garvin, in the event that the remaining unpaid balance of the Consulting Fee should not be received by Garvin thirty (30) days after termination of the consulting relationship with Garvin pursuant to sub-Paragraphs 3.B, or 3.C hereunder, (i.e., in the case of sub-Paragraph 3.C, sixty (60) days after the delinquent installment was due), then both (i) the Noncompetition Clause contained in the second sentence of sub-Paragraph 1.C herein, and (ii) the provisions of the General Release by Garvin provided in sub-Paragraph 8.B herein, shall each terminate in their entirety and cease to be of any further force or effect. Also, in such an event, the provisions of the General Release by Dynacq and DPM provided in sub-Paragraph 8.A herein, shall also terminate in their entirety and cease to be of any further force or effect.

4. Termination of Second Employment Agreement.

A. Effective February 1, 2004, the Second Employment Agreement, and all terms and provisions and the employment relationship thereunder, will terminate and cease to be of any further force or effect, with the exception of Paragraph 5 styled “Confidential, Proprietary & Trade Secret Information”, Paragraph 6 styled “Release From Covenant Not To Compete Contained in the Original Employment Agreement”, and Paragraph 7 styled “Continuation of Indemnity Agreement”. From and after February 1, 2004, neither Garvin, Dynacq nor DPM shall have any further obligations or duties to the other pursuant the Second Employment Agreement, except as may be otherwise provided in this Agreement.

B. Effective February 1, 2004, Garvin shall cease to hold or occupy all positions as an officer of, or to hold any other positions or relationships with respect to Dynacq and of DPM, which might cause Garvin to be deemed an “affiliate” or an “officer” of Dynacq respectively under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, or any rules or regulations promulgated with respect to such laws, and shall hereafter be strictly a consultant under this Agreement and not an employee of either Dynacq or DPM.

C. For purposes of Garvin’s Stock Option Agreement, the change in Garvin’s status as an employee under the Second Employment Agreement to that of consultant under the terms and provisions of this Agreement shall be deemed a termination of Garvin’s employment “without cause”, and therefore Garvin shall have three (3) months from the effective date hereof to exercise her vested options thereunder.

5. Confidential, Proprietary, and Trade Secret Information. Garvin and DPM hereby agree that Garvin shall have a continuing duty to not disclose any confidential, proprietary, or trade secret information regarding Dynacq Healthcare, Inc. f/k/a Dynacq International, Inc., or any of its affiliates or subsidiaries obtained during the term of her employment under the Original Employment Agreement, under the Second Employment Agreement dated December 19, 2003, and/or during the term of this Consulting Agreement. Such information includes, but is not limited to, the operating results of individual healthcare facilities, employees’ compensation or other information, regulatory or legal issues, accounting and reporting matters and other information related to such companies’ operations and development plans.

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Information shall be excluded from the term “confidential, proprietary, or trade secret information” that (i) has been published or is otherwise in the public domain at the time of the disclosure; (ii) becomes public through no fault of Garvin or of the party receiving such information; (iii) was already in the possession of Garvin prior to employment or engagement as a consultant hereunder or the party receiving such information is rightfully in possession thereof without knowledge of, or a breach of, any applicable confidentiality requirements or other restrictions; (iv) is obtained from a third party who is lawfully in possession of said information and is not subject to a contractual or fiduciary relationship to the party receiving or providing such information or any other person; or (v) is disclosed pursuant to a mandatory requirement of a governmental agency or by operation of law.

6. Release from Covenant Not To Compete Provisions Contained in the Original Employment Agreement. Except as otherwise provided herein, Dynacq and DPM agree that Garvin is hereby, and shall be, released from the terms and provisions of Section 15, styled “Covenant Not to Compete”, contained in the Original Employment Agreement, and all duties and obligations thereunder.

7. Continuation of Indemnity Agreement. From and after December 6, 2003, that Indemnification Agreement dated as of January 24, 2002, between Dynacq — Nevada and Garvin is hereby ratified and confirmed by Dynacq and DPM and shall continue to be in full force and effect and applicable to any and all matters arising prior to February 1, 2004.

8. General Releases.

A. Except as may be otherwise provided in sub-Paragraph 3.D hereunder, in consideration for Five and No/100 Dollars ($5.00) cash in hand, and other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, Dynacq and DPM, each on behalf of itself and its respective predecessors, employees, agents, officers, directors, shareholders, representatives, attorneys, successors, insurers and assigns, and on behalf of any other persons claiming by, through or under Dynacq’s or DPM’s name, do each hereby waive, release, and relinquish their rights to and discharge, release and acquit Garvin, her agents, attorneys, successors, insurers and assigns, from any and all causes of action, claims, demands, debts, liabilities, expenses or costs of any kind and every character and nature whatsoever arising and accruing prior to February 1, 2004, including but not limited to any claims or rights, for known past events or acts, contingent or fixed, either in or arising out of the law of contracts, torts or property rights, whether arising under statutory law or common law, at law or in equity, with respect to her Original Employment Agreement and/or her Second Employment Agreement dated December 19, 2003, and Garvin’s employment relationship thereunder, and Garvin’s positions as an officer of Dynacq and/or DPM. Furthermore, except as may be otherwise provided in sub-Paragraph 3.D hereunder,_ Dynacq and DPM each jointly and severally agree to Indemnify and hold harmless Garvin, and all other persons or entities released by Dynacq and DPM above against the full amount of any liability, loss, claim, damage, or expense (including attorneys’ fees and any judgment required to be paid) in connection with any of the matters it has released in the event any person should assert against such released person or entity a claim under assignment or title derivative from Dynacq or DPM.

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B. Except as may be otherwise provided in sub-Paragraph 3.D hereunder, in consideration for Five and No/100 Dollars ($5.00) cash in hand, and other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, Garvin, on behalf of herself and her agents, attorneys, successors, insurers and assigns, and on behalf of any other persons claiming by, through or under Garvin’s name, do each hereby waive, release, and relinquish its rights to and discharge, release and acquit Dynacq Healthcare, Inc., f/k/a Dynacq International, Inc. (“Dynacq”), its subsidiaries, affiliates and parents and their independent contractors, agents, officers, directors, shareholders, representatives, attorneys, successors, insurers and assigns, from any and all causes of action, claims, demands, debts, liabilities, expenses or costs of any kind and every character and nature whatsoever arising and accruing prior to February 1, 2004, including but not limited to any claims or rights, whether known or unknown, contingent or fixed, either in or arising out of the law of contracts, torts or property rights, whether arising under statutory law or common law, at law or in equity. Furthermore, except as may be otherwise provided in sub-Paragraph 3.D hereunder, Garvin agrees to Indemnify and hold harmless Dynacq and its subsidiaries, affiliates and parents and all other persons or entities released by Garvin above against the full amount of any liability, loss, claim, damage, or expense (including attorneys’ fees and any judgment required to be paid) in connection with any of the matters Garvin has released in the event any person should assert against such released person or entity a claim under assignment or title derivative from Garvin.

9. Survivability of Certain Provisions. The terms and provisions of Sections 3, 5, 6, 7, 8, and 9 of this Agreement shall survive, for an indefinite period, the termination of Garvin’s consulting engagement hereunder and the term of this Agreement.

10. Notice. Any notice provided or permitted to be given under this Agreement shall be in writing, and may be served by personal delivery or by depositing same in the mail, addressed to the party to be notified, postage prepaid, and registered or certified, with a return receipt requested. Notice deposited in the mail in the manner hereinabove described shall be deemed to have been given and received five (5) days after deposit in the mail as provided in the preceding sentence. Notice served in any other manner shall be deemed to have been given and received only if and when actually received by the addressee. For purposes of notice the addresses of the parties shall be as follows:

If to DPM or Dynacq:	Doctors Practice Management, Inc. c/o Dynacq Healthcare, Inc. 10304 Interstate 10 East, Suite 369 Houston, Texas 77029 Attention: Philip Chan, President
If to Garvin:	Sarah C. Garvin 4010 Beechwood Drive Atlanta, Georgia 30327

Each party shall have the right, upon giving ten (10) days prior notice to the other in the manner hereinabove provided, to change its address for purposes of notice. Failure of or delay in

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delivery of any copy of a notice shall not impair the effectiveness of any notice given to either DPM/Dynacq or Garvin.

11. Violation of Noncompetition Clause. The parties hereto agree that, in the event of a claim by DPM that Garvin has violated the Noncompetition Clause hereunder, and as a prerequisite to exercising its rights under this Agreement with respect to such violation, DPM must (i) immediately notify Garvin in writing, stating the specific factual allegations giving rise to the claim of such violation (for purposes of this Paragraph, the “Claim”), AND (ii) permit Garvin forty-five (45) days to either cure or disprove the breach. If Garvin shall not have cured or disproved the breach to the satisfaction of DPM and Dynacq within forty-five (45) days, DPM may terminate this Agreement. If Garvin does cure or disprove the breach within forty-five (45) days, this Agreement shall remain in force. All parties are required to exercise good faith in the performance, interpretation, and enforcement of the Noncompetition Agreement.

12. Miscellaneous.

(a) This Agreement sets forth the entire agreement of the parties hereto with respect to the consulting services and the other matters addressed herein and supersedes all previous agreements, understandings or negotiations with respect to the consulting services and the other matters addressed herein.

(b) The rights and obligations set forth in this Agreement may be amended, modified or supplemented only by a writing signed by each party hereto.

(c) A party hereto may waive a right under this Agreement only by a written waiver signed by the party. No failure to exercise or delay in exercising a right under this Agreement will constitute a waiver of that right.

(d) If any provision of this Agreement is found invalid, illegal or unenforceable, and the basis of the bargain between the parties is not thereby destroyed, the provision will be ineffective only to the extent of the invalidity, illegality or unenforceability, and the other provisions of this Agreement will remain in full force and effect.

(e) A party hereto may not assign its rights, and a party hereto may not delegate its obligations, under this Agreement unless it first obtains the written consent of the other parties. Any party, in its discretion, may withhold consent to any such assignment or delegation.

(f) Except as permitted under the foregoing Subsection (e), this Agreement will not inure to the benefit of any person other than the parties hereto.

(g) This Agreement will be governed by and construed and enforced in accordance with the internal laws of the State of Texas without reference to the principles of conflicts of laws thereof; and exclusive jurisdiction and venue of any dispute arising hereunder shall lie in Harris County, Texas.

(h) This Agreement may be executed in multiple counterparts, each copy of which shall constitute an original document.

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(i) Time is of the essence under this Agreement.

(Signature page follows)

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EXECUTED this 6th day of February 2004, but effective as of the effective date first mentioned above.

DYNACQ:
DYNACQ HEALTHCARE, INC.
By:	/s/    Philip Chan
	Philip Chan, Vice President & Chief Financial Officer
DPM:
DOCTORS PRACTICE MANAGEMENT, INC.
By:	/s/    Philip Chan
	Philip Chan, President

GARVIN:

/s/    Sarah C. Garvin        

Sarah C. Garvin

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EX-10.15

Exhibit 10.15

EMPLOYMENT AGREEMENT

THIS AGREEMENT is entered into on August 1, 2003, by and between Doctors Practice Management, Inc., a Texas corporation (the “Company”) and James Baxter (the “Employee”).

1. EMPLOYMENT: The Company hereby agrees to employ the Employee and Employee hereby accepts employment as an Executive Vice President. The Employees duties shall include investor relations, financing transactions and special projects and other duties as assigned by the CEO. The Employee shall report directly to the Chief Executive Officer of the Company.

2. TERM: Unless terminated earlier pursuant to paragraph 4, the term of employment shall be for a period of 3 years.

3. COMPENSATION & OTHER BENEFITS: As compensation, Employee shall receive the following:

• An annual salary of $160,000 per year plus an auto allowance of $20,000 per year.

• A stock option for the purchase of up to One Hundred Thousand (100,000) shares of the common stock of Dynacq International, Inc. Said options may be exercised at the average price per share on the date of the execution of this agreement. In the event the Employee’s employment is terminated, vested options may be exercised for 90 days after the termination of employment and shall thereafter lapse. Said options shall vest as follows:

i. On July 31, 2004: 30,000 options;

ii. On July 31, 2005: 30,000 options

iii. On July 31, 2006: 40,000 options

• Relocation Expenses in the amount of $10,000.

• One country club membership to include initiation fee and dues.

• The right to participate in any Medical benefit plan, company incentive bonus, 401K, and/or pension plan offered by the Company to officers and senior management.

4. TERMINATION OF EMPLOYMENT

• The Company may terminate this Agreement for Cause. “Cause” is defined as: (i) the Employee has knowingly committed a serious act, such as fraud, embezzlement or theft, against the Company, intending to enrich himself at the expense of the Company; (ii) the Employee is knowingly involved in a transaction in connection with the performance of his duties that is adverse to the interests of the Company and is engaged in for personal profit; (iii) the Employee has engaged in conduct that causes a material injury to the Company; (iv) the Employee is convicted of a felony involving moral turpitude; (v) the Employee is guilty of neglect or misconduct in carrying out his duties; (vi) the Employee has breached (as determined by the written legal advice or opinion of independent outside counsel appointed by the Compensation Committee) any legal duty owed to the Company, including, but not limited to, breach of the duty of loyalty, receiving improper benefits, not disclosing material conflicts of interest or an act or omission for which the liability of an officer or director is expressly provided for by statute.

1

• If Employee’s employment is terminated without cause, employee shall be entitled to receive six (6) months severance pay and shall have three (3) months after the termination of employment to exercise any options which would have been exercisable under the incentive stock option agreement in year one, year two or year three from the vesting date based upon the applicable vesting percentage for that year determined by multiplying the fraction the numerator of which is the total number of days of employment in the applicable year of termination (whether year one, year two or year three from the vesting date) divided by 365 days, multiplied by 30,000 option shares in year one or year two or, if year three, by 40,000 option shares.

• The Employee may voluntarily terminate his employment under this Agreement at any time by providing written notice to the Company.

5. AMENDMENT: This Agreement may not be amended, modified, waived except by a written instrument signed by the party against whom enforcement of any such modification, amendment or waiver is sought.

6. VENUE AND JURISDICTION: Venue and jurisdiction for any action arising hereunder shall be exclusively in the federal and state courts of Harris County, Texas.

7. SUPERSEDES PRIOR AGREEMENT: This Incentive Option Agreement shall supersede and replace all prior oral agreements and understandings, and any written agreements or understandings.

/s/    James Baxter
James Baxter
Doctors Practice Management, Inc.
By:	/s/    Philip Chan
Name:	Mr. Philip Chan
Title:	President

2

EX-10.16

Exhibit 10.16

EMPLOYMENT AGREEMENT

DATED April 15, 2002

BY AND BETWEEN

DYANCQ INTERNATIONAL, INC.

a Nevada corporation

(“Company”)

AND

Richard Valentine

(“Employee”)

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT (the “Agreement”) is entered into effective April 15, 2002 (the “Effective Date”) between DYNACQ INTERNATIONAL, INC., a Nevada corporation (the “Company”), and Richard Valentine (“Employee”). The Company by this Agreement employs Employee and Employee accepts employment on the terms and conditions that follow:

1. POSITION; DUTIES; PRINCIPAL OFFICE. Employee will be employed with the titles, positions, and responsibilities (the “Duties”) of Vice President-Operations and Marketing for the Company. Employee shall report directly to the Company’s Chief Operating Officer.

2. SALARY. Employee will be paid an annual salary (the “Base Salary”) of $175,000, payable in accordance with the normal payroll practices of the Company.

3. TERM. The term of employment under this Agreement shall be a period of five (5) years commencing on the Effective Date of this Agreement, and ending on the fifth anniversary of such date, unless earlier terminated as provided in this Agreement, or extended by mutual agreement of the Company and Employee. Notwithstanding the foregoing, for a period of ninety (90) days following the date of this Agreement (the “Probationary Period”), either party may terminate the agreement with or without cause and Employee shall be entitled to receive only his Base Salary on a pro rata basis to the date of termination. In the event of a termination during the Probationary Period, any uvested Options, as defined below, shall immediately terminate and the covenant not to compete in Section 15 hereof shall immediately cease.

4. EXPENSES. Employee will be reimbursed for all reasonable expenses incurred in the performance of Employee’s Duties.

5. EMPLOYEE BENEFITS AND VACATION. Employee will be entitled to participate in the Company’s health plan and in any other benefit plans provided by the Company to its employees, subject to Employee’s qualification to participate on the same basis as other employees (length of service, health status, etc.). In addition, Employee shall be entitled to a minimum three (3) weeks of paid vacation per year, and additional time if needed and agreed to by the CEO.

6. EXECUTIVE BENEFITS. Employee will be provided an automobile allowance of $750.00 per month to purchase and/or lease an automobile of recent make that befits his professional and business status with the Company and shall be eligible to participate in the Company’s executive bonus plans or programs which may be adopted from time-to-time by the Company on the same or a similar basis with the other executive officers of his level and productivity, subject to the final determination and approval of the Compensation Committee of the Board of Directors in its sole discretion in view of Employee’s existing benefits, bonus participation, salary, stock options and other remuneration, all of which shall be considered. A Bonus Plan will be established that will allow employee to receive an annual bonus of 50% of his annual salary based on objective performance parameters. After the end of the fiscal year, the Company’s board of directors shall determine, in their sole discretion, which performance parameters have been met by Employee and the Employee’s bonus shall be payable on or before

March 31 following such fiscal year. In the event Employee is entitled to a bonus payment for service during a partial year, such bonus payment shall be calculated on a pro rata basis for the months served during such year.

7. INCENTIVE STOCK OPTION GRANT - UPON EMPLOYMENT. Employee is hereby granted an incentive stock option grant (the “Option”) pursuant to the ISO Agreement referred to below under the Dynacq International, Inc. Year-2002 Stock Incentive Plan (the “Stock Plan”) a copy of which has been provided to Employee, and is attached hereto as Exhibit “A,” to purchase 100,000 shares of the Company’s common stock, $.001 par value (the “Common Stock”) at an exercise price equal to the Fair Market Value as defined in Section 2.22 of the Stock Plan ($6.07 per share) which represents the closing sales price per share on the date the Company and Employee agreed to the material Employment Agreement terms and material Option terms, including the number thereof, the expiration date for vesting and exercise, the exercise price, and other terms and conditions on February 4, 2002, The right to purchase Common Stock issuable pursuant to the Option will vest over a five-year period with: (i) 20% vesting the first year, (ii) 20% vesting the second year, (iii) 20% vesting the third year, (iv) 20% vesting the forth year, and (v) 20% vesting the fifth year, per full year of employment. Notwithstanding anything in this Agreement to the contrary, with respect to the grant of the Option, the terms thereof, the rights and obligations of Employee with respect thereto or any ambiguity, conflict, interpretive question or matter not specifically addressed and answered herein which rise out of this Employment Agreement, the ISO Agreement or the Stock Plan (the “ISO Issues”) the terms of the Stock Plan shall first control, secondly the terms of the ISO Agreement shall control subject to the terms of the Stock Plan and lastly the terms of this Employment Agreement shall control. If ISO Issues remain after reviewing the foregoing agreements the Employee and Company agree that the Compensation Committee (the “Committee”) shall be entitled to resolve any ISO Issues as provided for in Section 3 of the Stock Plan and elsewhere therein. In addition, the Company shall cause its Compensation Committee to provide Employee with evidence of its separate and formal approval acting in its official capacity of the ISO Agreement and this Agreement.

8. TERMINATION OF EMPLOYMENT – WITHOUT CAUSE. If Employee is terminated without cause, all of Employee’s Options outstanding under the ISO Agreement (but only to the, extent specifically provided for therein) and/or the Stock Plan (if not previously forfeited and/or vested and subject to the terms of the ISO Agreement) on the date of such termination shall immediately vest and become immediately and fully exercisable for a period of three (3) months from the date of termination, and Employee will receive six months severance pay (based on Employee’s base salary during the year of termination) within 30 days of such termination. In addition, Employee’s Non-Compete Covenant, set forth in Section 15 hereof shall immediately terminate.

9. CHANGE OF CONTROL - In the event of a “Change in Control,” as defined in the Stock Plan (“Change in Control”), all of Employee’s outstanding incentive stock options will immediately vest and become immediately and fully exercisable, as provided herein or in any stock option or incentive agreement or in the Stock Plan, whichever shall provide the greatest benefit to Employee as Employee may elect, and if Employee is terminated within six (6) months following the Change-in-Control (and the Company shall use its best efforts to require the corporation acquiring control to assume the terms of this Agreement) other than for cause, death

or disability, Employee will receive six (6) months severance pay In addition to the consideration provided for in Section 15 below for Employee’s Non-Compete Covenant, if the covenant is not waived by the Company or its legal successor in interest in its sole and absolute discretion.

10. EMPLOYMENT AGREEMENT. At such time as the Company enters into employment and/or incentive agreements with its key employees, Employee shall have the opportunity to negotiate for substantially equivalent terms with the Company and the Company shall negotiate in good faith with Employee to achieve a result in the best interests of the Company and its shareholders; provided, however, the terms of this Employment Agreement shall not be changed unless Employee and the Company (through the Compensation Committee) enter into a new written agreement, duly executed by both parties, in form and substance satisfactory to each in their sole and absolute discretion,

11. DIRECTORS AND OFFICERS INSURANCE. The Company and Employee shall negotiate an Indemnification Agreement providing Employee with the maximum indemnification provided by Nevada or other applicable law and such other permissible benefits, including the advancement of expenses to Employee to cover reasonable defense fees and costs, to the maximum extent permitted by applicable laws.

12. PROPRIETARY INFORMATION.

(a) In connection with the performance of the Duties, the Employee acknowledges that he will acquire Proprietary Information (as defined below) from the Company and/or its affiliates (collectively the “Company Group”). The use of the word Company in this Agreement shall also include when referring to the rights or obligations of the Company or Employee hereunder shall include the Company Group as appropriate or applicable in the context used. Accordingly, the Employee agrees that all Proprietary Information acquired by him hereunder shall be safeguarded with the same degree of control and care as a reasonably prudent person would exercise with respect to his or her own similar information, and that the same shall be returned to the owner of such Proprietary Information upon the owner’s request.

(b) The Employee agrees (i) to treat in strict confidence any proprietary or other confidential information received from the Company Group (whether tangible or intangible), including, without limitation, client lists, lists of referral sources, business prospects, pricing and cost information, operating results of individual healthcare facilities, employees’ names, compensation and other information, regulatory and legal issues, accounting and reporting matters, trade secrets, patents, copyrights, concepts, inventions, processes, formulas, know-how, data and information, whether such information is of a technical or a business nature, and all copies of any of the foregoing whether or not in writing or in any electronic or computer storage medium (“Proprietary Information”), (ii) that he will not disclose any Proprietary Information to third parties, except as specifically permitted herein, and (iii) that he will not use any

Proprietary Information for any purpose not contemplated by this Agreement without the written permission of the Company, including any use for personal gain or benefit whether directly or indirectly.

(c) Information that is to be excluded from the term “Proprietary Information” is any intonation that:

(i) has been published or is otherwise in the public domain at the time of the disclosure;

(ii) becomes public through no fault of Employee or of the party receiving such information;

(iii) was already in the possession of Employee prior to employment or the party receiving such information is rightfully in possession thereof without knowledge of, or a breach of, any applicable confidentiality requirements or other restrictions;

(iv) is obtained from a third party who is lawfully in possession of said information and is not subject to a contractual or fiduciary relationship to the party receiving or providing such information or any other person; or

(v) is disclosed pursuant to a mandatory requirement of a governmental agency or by operation of law.

(d) The provisions of this Section 12 shall apply for so long as Employee provides services to the Company Group in any capacity, whether or not pursuant to this Agreement, and shall survive the termination of this Agreement for so long as the information remains Proprietary Information,

13. INTELLECTUAL PROPERTY RIGHTS. Except for Proprietary Information owned by the Employee which is designated in writing to the Company prior to the execution hereof as Exhibit “B” hereto, the Employee agrees that all ideas, proposals, valuation processes, Ambulatory Surgical Centers (“A&S”) and Surgical Hospital economic models, profiles or operating processes or architectural designs, insights, knowledge, writing, drawings, inventions, designs, parts, machines or processes developed as a result of, or in the course of, the Duties rendered to the Company Group or by the Employee during the term of this Agreement, whether or not patentable or subject to copyright, shall be the property of the Company Group. Subject to the foregoing exception, the Employee herewith assigns all rights in the foregoing intellectual property to the Company Group and shall supply all assistance, both while an Employee of the Company and after leaving the Company, reasonably requested in securing for the Company Group’s benefit any patent, copyright, trademark, service mark, license, right or other evidence of ownership of any such intellectual property, and shall provide full information regarding any such item and execute all appropriate documentation prepared by the Company Group in applying or otherwise registering, in the name of the appropriate entity comprising part of the Company Group, all rights, to any such item. The Employee shall prominently mark all written

information with an appropriate legend that the material contained therein is the property of the Company and that the information is confidential and proprietary and not to be reproduced or used by other parties. The Company Group shall have the right to sell, or grant licenses to use, any of such intellectual property to others, including, without limitation, any such intellectual property derived from any business practices journal prepared in connection with the Duties provided. If the Employee’s assistance is required after the departure of the Employee from the Company, the Company will reimburse Employee for any out-of-pocket expenses incurred in the performance of the needed assistance.

14. TERMINATION OF EMPLOYMENT.

(a) FOR CAUSE. Nothing herein shall prevent the Company from terminating the Employee, without prior notice, for “Cause” (as hereinafter defined), in which event the Employee shall be entitled to receive his Base Salary on a pro rata basis to the date of termination. In the event of such termination for Cause, all other rights and benefits the Employee may have under any employee benefit, bonus and stock option plans and programs of the Company shall be determined in accordance with the terms and conditions of Section 15 of this Agreement and any loans, advances or undocumented expenses (not previously included by the Company in a W-2 or Form 1099) shall be immediately due and payable. The term “Cause” shall mean (i) the Employee has committed a willful serious act, such as fraud, embezzlement or theft, against the Company, intending to enrich himself at the expense of the Company, (ii) the Employee has been convicted of a felony (or entered a plea of nolo contendere to a felony charge), (iii) the Employee has engaged in conduct that has caused material injury, monetary or otherwise, to the Company, including the violation of any material law or regulation applicable to the Company, (iv) the Employee, in carrying out his Duties hereunder, has been guilty of gross neglect or gross misconduct, or any act or omission involving intentional misconduct or a knowing violation of law, (v) the Employee has refused to carry out his Duties as they now exist or as changed from time-to-time or to follow the reasonable written direction of the Board of Directors of the Company or any senior officer and, after receiving written notice to such effect from the Compensation Committee, and the Employee fails to cure the existing problem within fifteen (15) days, with notice not being required if it is determined the problem is not curable, (vi) the Employee has materially breached this Agreement and has not remedied such breach within fifteen (15) days after receipt of written notice from the Compensation Committee that a breach of this Agreement has occurred (written notice being required only if the breach can be remedied or cured), or (vii) the Employee has breached (as determined by legal advice of independent outside counsel appointed by the Compensation Committee) any legal duties to the Company provided by the laws of its state of incorporation, whether Nevada or any other state (if reincorporated by merger or otherwise to another state), including, primarily, those applicable to officers and directors including, but not

limited to, breach of the duty of loyalty, receiving improper benefits, not disclosing material conflicts of interest or an act or omission for which the liability of an officer or director is expressly provided for by statute.

(b) DEATH. If the Employee dies, this Agreement shall terminate on the date of death. In the event of such termination due to death, all other rights and benefits the Employee (or his estate) may have under the employee benefit, bonus and/or stock option plans and programs of the Company, generally, shall be determined in accordance with the terms and conditions of such plans and programs.

(c) DISABILITY. In the event the Employee suffers a “disability” (as hereinafter defined), this Agreement shalt terminate on the date on which the Disability occurs and the Employee shall be entitled to his Base Salary for six (6) months offset by any disability pay under the Company’s disability insurance program or any applicable disability policy even if the policy is net maintained by the Company. In the event of such termination due to Disability, all other rights and benefits the Employee may have under the employee benefit, bonus and/or stock option plans and programs of the Company shall be determined in accordance with the terms and conditions of such plans and programs. For purpose of this Agreement, “Disability” shall mean the inability or incapacity (by reason of a medically determinable physical or mental impairment) of the Employee to perform the duties and responsibilities related to the job or position with the Company described in Section 1 for a period that can be reasonably expected to last more than ninety (90) days. Such inability or incapacity shall be documented to the reasonable satisfaction of the Company by appropriate correspondence from registered physicians reasonably satisfactory to the Company. Nothing in this Section 14 or in this Agreement shall be deemed to require or permit the Company to take an illegal or wrongful act under the Americans with Disabilities Act or any other applicable law or regulation.

(d) CESSATION OF OPERATIONS. In the event the Board of Directors determines that the Company should cease operations, whether through dissolution and liquidation or otherwise, this Agreement shall terminate thirty (30) days following the date of such determination or at such earlier time as the parties may agree. In such event: (i) Employee shall be entitled to receive his Base Salary for six (6) months after termination of his employment hereunder, as liquidated damages under this Agreement, (ii) the Company shall be deemed to have performed all of its obligations under this Agreement, (iii) all rights and benefits the Employee may have under any employee benefit, bonus and/or stock option plans of the Company shall be determined in accordance with the terms and conditions of such plans and programs, and (iv) the Non-Compete provision in Section 15 hereof shall immediately cease.

(e) VOLUNTARY TERMINATION. The Employee may voluntarily terminate his employment under this Agreement at any time by providing at least ninety (90) days’ prior written notice to the Company, provided, however, the notice requirement and the remaining employment period may be waived or reduced, respectively, by the Company in whole or in part. In such event, the Employee shall be entitled to receive his Base Salary until the date his employment terminates, and all other benefits the Employee may have under any employee benefit, bonus and/or stock option plans and programs of the Company shall be determined in accordance with the terms and conditions of such plans and programs. Voluntary Termination shall not include “Resignation For Good Reason” defined as follows;

(i) the assignment to the Employee of any lesser duties inconsistent with the Employee’s executive position (including status, offices, titles or reporting relationships), authority, duties or responsibilities as contemplated by Section 1 hereof, that results in a long-term material diminution in such position, authority, duties or responsibilities, but excluding for these purposes (i) any isolated and insubstantial action not taken in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by Employee; or (ii) the hiring of additional senior officers whose rank may exceed Employees or changes in, or the assignment of, additional duties which are required as part of the Company’s business needs but do not result in a substantial and material diminution of Employee’s position and responsibilities as a senior officer;

(ii) any material failure by the Company to honor its material obligations under this Agreement but only after Employee provides the Company thirty (30) days written notice and an opportunity to cure such failure within such period;

(iii) any failure by the Company to obtain an assumption of this Agreement by a successor corporation as required under Subsection 14(f) hereof;

(iv) any purported termination by the Company of the Employee’s employment otherwise than as expressly permitted by this Agreement; or

(v) a material reduction in salary, bonus, benefits or overall remuneration unrelated to the performance of Employee’s Duties, or as a result of the Company’s financial condition, in which case the compensatory and benefit reductions shall be on a basis not materially inconsistent with those of other executive officers.

(f) TERMINATION IN THE EVENT OF A CHANGE OF CONTROL. In the event of a. Change of Control (as defined in the Stock Plan) of the Company in which subsection (d) above does not apply, either Company or Employee may terminate this Agreement upon written notice at any time after such Change of Control occurs (but in any event not later than six (6) months after the Change of Control). In the event of the termination of this Agreement by either party under this subsection, (i) all of Employee’s outstanding incentive stock options or other awards granted under the Stock Plan will immediately vest and become immediately and fully exercisable and any restrictions or requirements with respect to any prior grants of Restricted Stock or, Performance Shares as defined in the Stock Plan or other awards thereunder will be deemed waived or met, and (ii) the Company or its successor shall be obligated (Y) to pay Employee the consideration provided in Section 9 above and in Section 15 below (unless the Non-Compete Covenant is waived or not enforced by the Company or its successors and assigns), and (Z) to continue the Employee under the Company’s health plan and to pay the premiums therefore to the extent such plan remains in effect and Employee remains eligible to participate in same, in lieu of any other rights, claims or benefits created or receivable under this Agreement,

15. COVENANT NOT TO COMPETE. It was a mandatory and material condition imposed by the Company for Employee to enter into this Agreement and grant the Company the Non-Compete Covenant contained herein, and in consideration provided for therein and herein Employee agrees with the Company that during the period of his employment and for a period of two (2) years (the “Restricted Period”) following his termination of employment for any reason, whether by resignation (with or without good reason), termination by the Company for cause or without cause, or any other reason whatsoever, except for Employee’s association with Houston Community Hospital, Inc., Employee will not compete, whether directly or indirectly as an owner, partner, shareholder, member, sole proprietor, consultant, manager, officer, director or in any other capacity except as a passive investor without managerial responsibilities, in the ownership or operation of ASC’s or hospitals in (i) Houston, Texas, Harris County, Texas, and in all contiguous counties and (ii) in such other counties (including all contiguous counties) where the Company or its affiliates own and/or operate, whether directly or indirectly, any ASC or hospital in the State of Texas or any other of the forty-nine (49) states of the United States of America. In the event Employee voluntarily terminates his employment, he shall not be entitled to severance pay or any other additional payments of consideration for this covenant not to compete, In the event Employee’s employment is terminated without cause, he shall be entitled to the consideration provided for in Section 8 and he shall be additionally entitled to his full Base Salary in effect as of the date of termination, payable in monthly installments commencing in month seven (7) following his termination of employment through the final month of this covenant not to compete. If Employee’s employment is terminated for cause or if Employee resigns without good reason, Employee shall not be entitled to any severance benefits, and Employee’s outstanding incentive stock options under the Stock Plan or any other benefits provided for thereunder including but not limited to restricted stock, stock appreciation rights, performance shares or cash bonus programs which are not then vested, exercised and paid or performed in full will terminate and Employee shall receive no additional consideration for Employee’s covenant not to compete. The Company or its legal successors or permitted assigns

may waive its rights under this Section 15 and in that event Employee shall not be entitled to the consideration for this covenant not to compete specified in this Section 15 and may compete with the Company in any area or in any legal manner; provided, however, the provisions and restrictions relating to the use or disclosure of Proprietary Information shall continue to apply.

16. SOLICITATION. Employee hereby agrees that during the Restricted Period, he will not directly or indirectly, solicit or participate as employee, agent, consultant, stockholder, director, partner or in other individual or representative capacity in any business which solicits, business from any person, firm, corporation or other entity which is or was a customer, supplier or business associate of the Company, or from any successor in interest to any such person, firm, corporation or other entity for the purpose of securing business, contacts, or developing a hospital or ASC. Further, Employee hereby agrees that he will not directly or indirectly, entice, encourage, ask or otherwise promote employees of the Company to terminate their employment with the Company

17. NOTICES. Any notices required or permitted hereunder shall be sufficient if in writing and sent by certified mail, return receipt requested with postage prepaid to the other party at the appropriate address set forth below, or to such other address as may be designated by written notice similarly given by either party to the other. All notices shall also be effective if in writing, when received, with confirmation thereof, by mail as provided above, fax, personal delivery, courier service or electronic transmission if proof of delivery is obtained, and if sent via e-mail, proof of sending and the opening of the e-mail is required, followed by written notification in any manner provided above.

(I) If to the Company:

Dynacq International, Inc.

4301 A Vista

Pasadena, Texas 77504 Attn:

Chairman and CEO

Cc: Philip Chan, CFO

cc: Eric Carter, General Counsel

If to the Employee:

Richard Valentine

18. GOVERNING LAW, JURISDICTION, VENUE, AND ATTORNEYS’ FEES. THIS AGREEMENT SHALL BE GOVERNED BY THE LAWS OF THE STATE OF TEXAS WITHOUT REGARD TO THE CONFLICT OF LAWS PRINCIPLES THEREOF. IN THE EVENT OF ANY CONFLICT RELATING TO OR ARISING OUT OF THIS AGREEMENT, IN WHOLE OR IN PART, THE PARTIES AGREE TO THE EXCLUSIVE JURISDICTION OF THE STATE OR FEDERAL DISTRICT COURTS IN HOUSTON, HARRIS COUNTY, TEXAS AND AGREE TO EXCLUSIVE VENUE IN SUCH COURTS. IN THE EVENT OF LEGAL PROCEEDINGS HEREUNDER, THE PARTY SUBSTANTIALLY PREVAILING ON THE MERITS SHALL BE ENTITLED TO AN AWARD OF ATTORNEYS’ FEES AND COSTS. ANY PARTY MAY REQUEST AND OBTAIN A NON-BINDING MEDIATION

HEARING AFTER FILING A LAWSUIT HEREUNDER IN HOUSTON, TEXAS, WITH COSTS TO BE SHARED EQUALLY, AND THE MEDIATOR SHALL BE APPOINTED BY THE COURT IF THE PARTIES CANNOT AGREE TO A MEDIATOR.

19. ENTIRE AGREEMENTS AND AMENDMENTS. This Agreement contains the entire agreement of the Employee and the Company relating to the matters contained herein (except with respect to “Options” or “Awards” as defined in the Stock Plan, whether referred to herein or hereafter arising, the terms of the Stock Plan and/or the later agreement relating to any Stock Plan Award or Option shall control) and this Agreement supersedes all prior agreements and understandings, oral or written, between the Employee and the Company with respect to the subject matter hereof; this Agreement may not be amended or modified except by an agreement in writing signed by the party against whom enforcement of any waiver or modification is sought. In the event of any conflict, ambiguity, inconsistency, or outright differences between the parties’ rights under the Merger Documentation, the agreement that addresses the matter with the greatest specificity shall control.

20. HEADINGS. The headings of Sections and subsections hereof are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement.

21. SEPARABILITY. If any provisions of this Agreement are rendered or declared illegal, invalid, or unenforceable by reason of any existing or subsequently enacted legislation or by the final judgment of any court of competent jurisdiction, the Employee and the Company shall promptly meet and negotiate substitute provisions for those rendered or declared illegal or unenforceable to preserve the original intent of this Agreement to the extent legally possible, but all other provisions of this Agreement shall remain in full force and effect.

22. ASSIGNMENTS. The Company may assign this Agreement to any person or entity succeeding to all or substantially all the business interests of the Company by merger or otherwise. The rights and obligations of the Employee under this Agreement are personal to him, and no such rights, benefits or obligations shall be subject to voluntary or involuntary alienation, assignment or transfer, except to a successor in interest to substantially all of the assets or business interests or ownership of the Company or the Company Group, whether directly or indirectly, as provided above.

23. COUNTERPARTS. This Agreement may be executed in one or more counterparts and by facsimile, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.

24. SURVIVAL OF CERTAIN TERMS. The terms contained in Sections 12,13,14,15 and 16 shall survive the termination of this Agreement for any reason, whether terminated by Company or Employee.

25. CONSTRUCTION OF AGREEMENT. The parties hereto acknowledge, stipulate and agree that this Agreement was jointly prepared, negotiated and drafted by the parties and their respective counsel, and agree that the presumption of a favorable interpretation for the nondrafting party in the event of ambiguity or any other matter of interpretation shall not apply.

26. BREACH OF EMPLOYEE’S COVENANTS. If Employee breaches or threatens to breach Sections 12, 13, 15 or 16 hereof, Employee specifically acknowledges that such breach or breaches shall be conclusively presumed to cause irreparable harm to the Company or Company Group entitling it to all equitable relief available at law or in equity including but not limited to a temporary restraining order, a temporary injunction and a permanent injunction and Employee stipulates and acknowledges that monetary recovery shall not be sufficient alone to compensate the Company in such events and waives proof thereof and the necessity for the Company to post a bond, except for the minimum amount permitted by law.

IN WITNESS WHEREOF, the parties hereto have executed this Agreement effective as of the date stated in the initial paragraph above.

EMPLOYEE:
/s/    Richard Valentine
Richard Valentine
EMPLOYER:
Dynacq International, Inc.
By:	/s/    Sarah C. Garvin
	Sarah C. Garvin, COO

EX-10.17

Exhibit 10.17

EMPLOYMENT AGREEMENT

THIS AGREEMENT is entered into on August 1, 2003, by and between Doctors Practice Management, Inc., a Texas corporation. (the “Company”) and Tammy Danberg-Farney (the “Employee”).

1. EMPLOYMENT. The Company hereby agrees to employ the Employee and Employee hereby accepts employment as in-house corporate counsel. The Employee shall report directly and exclusively to the Chief Executive Officer of the Company.

2. TERM. Unless terminated earlier pursuant to paragraph 4, the term of employment shall be for a period of 2 years and thereafter shall automatically renew for like periods of time unless written notice is given by either party 30 days prior to the termination of the primary term or prior to the expiration of any subsequent primary term.

3. COMPENSATION & OTHER BENEFITS. As compensation, Employee shall receive the following:

• An annual salary of $120,000 for the first 90 days of employment, after the expiration of such 90-day period the annual salary shall increase to $150,000.

• Fifteen (15) working days of paid vacation.

• A stock option for the purchase of up to One Hundred Thousand (100,000) shares of the common stock of Dynacq International, Inc. Said options shall vest in increments of 20,000 shares on each anniversary date of her employment and may be exercised at the average price per share on the date of the execution of this agreement. Such shares shall be unrestricted and may be exercised through a cashless exchange. In the event the Employee’s employment is terminated, vested options may be exercised for 90 days after the termination of employment and shall thereafter lapse.

• The right to participate in any Medical benefit plan, company incentive bonus, 401K, and/or pension plan offered by the Company to officers and senior management.

• A separate office with a window and the right to her own personal competent secretary/paralegal.

• A monthly expense check in the amount of $2,500.00 which Employee will place into an expense account to be used for miscellaneous legal department expenses and accounted for on a monthly basis.

4. TERMINATION OF EMPLOYMENT

• The Company may only terminate this Agreement for Cause. “Cause” is defined as: (i) the Employee has knowingly committed a serious act, such as fraud, embezzlement or theft, against the Company, intending to enrich herself at the expense of the Company; (ii) the Employee is knowingly involved in a transaction in connection with the performance of her duties that is adverse to the interests of the Company and is engaged in for personal profit; or (iii) the Employee has knowingly caused material injury to the Company.

• The Employee may voluntarily terminate her employment under this Agreement at any time by providing written notice to the Company.

/s/    TAMMY DANBERG-FARNEY        

Tammy Danberg-Farney

Doctors Practice Management, Inc.
By:	/s/    PHILIP CHAN
Name:	Mr.Philip Chan
Title:	Vice President

EX-10.18

Exhibit 10.18

Merrill Lynch WCMA^® REDUCING REVOLVER – LOAN AND SECURITY AGREEMENT

WCMA REDUCING REVOLVER^® LOAN AND SECURITY AGREEMENT NO. 582-07L53 (“Loan Agreement”) dated as of May 18, 2001, between DYNACQ INTERNATIONAL, INC., a corporation organized and existing under the laws of the State of Nevada having its principal office at 10304 Interstate 10 East, Suite 369, Houston, Texas 77029 (“Customer”), and MERRILL LYNCH BUSINESS FINANCIAL SERVICES INC., a corporation organized and existing under the laws of the State of Delaware having its principal office at 222 North LaSalle Street, Chicago, IL 60601 (“MLBFS”).

In accordance with that certain WORKING CAPITAL MANAGEMENT^® ACCOUNT AGREEMENT NO. 582-07L53 (“WCMA Agreement”) between Customer and MLBFS’ affiliate, MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED (“MLPF&S”), Customer has subscribed to the WCMA Program described in the WCMA Agreement. The WCMA Agreement is by this reference incorporated as a part hereof. In conjunction therewith, Customer has requested that MLBFS make a WCMA Reducing Revolver Loan (a “Reducing Revolver”) to Customer in the amount and upon the terms hereafter specified, and, subject to the terms and conditions hereafter set forth, MLBFS has agreed to provide a Reducing Revolver for Customer.

A Reducing Revolver is a term credit facility, similar to a conventional term loan, but funded out of a line of credit under the WCMA Program (“WCMA Line of Credit”) in the amount of the initial loan. With a Reducing Revolver (i) interest will generally be charged each month to Customer’s WCMA account, and, so long as the WCMA Line of Credit is in effect, paid with an additional loan under the WCMA Line of Credit (i.e., added to the loan balance), (ii) the maximum WCMA Line of Credit will be reduced each month by the amount that would be payable on account of principal if the Reducing Revolver were a conventional term loan amortized over the same term and in the same manner as the Reducing Revolver, and (iii) Customer will be required to make sufficient payments on account of the Reducing Revolver to assure that the outstanding balance of the Reducing Revolver does not at any time exceed the Maximum WCMA Line of Credit, as reduced each month.

Absent a prepayment by Customer, this structure results in required monthly payments for the Reducing Revolver that are substantially the same as the required monthly payments for a conventional term loan with the same term and amortization. However, unlike most conventional term loans, because is funded out of a line of credit, the Reducing Revolver permits both a prepayment in whole or in part at any time, and, subject to certain conditions, the reborrowing on a revolving basis of any such prepaid amounts up to the Maximum WCMA Line of Credit, as reduced each month. The structure therefore will enable Customer at its option to use any excess or temporary cash balances that it may have from time to time to prepay the Reducing Revolver and thereby effectively reduce interest expense on the Reducing Revolver without impairing its working capital.

Accordingly, and in consideration of the premises and of the mutual covenants of the parties hereto, Customer and MLBFS hereby agree as follows.

Article I.

DEFINITIONS

1.1 Specific Terms. In addition to terms defined elsewhere in this Loan Agreement, when used herein the following terms shall have the following meanings:

(a) “Account Debtor” shall mean any party who is or may become obligated with respect to an Account or Chattel Paper.

(b) “Additional Agreements” shall mean all agreements, instruments, documents and opinions other than this Loan Agreement, whether with or from Customer or any other party, which are contemplated hereby or otherwise reasonably required by MLBFS in connection herewith, or which evidence the creation, guaranty or collateralization of any of the Obligations or the granting or perfection of liens or security interests upon the Collateral or any other collateral for the Obligations.

(c) “Bankruptcy Event” shall mean any of the following (i) a proceeding under any bankruptcy, reorganization, arrangement, insolvency, readjustment of debt or receivership law or statute shall be filed or consented to by Customer or any Guarantor, or (ii) any such proceeding shall be filed against Customer or any Guarantor and shall not be dismissed or withdrawn within sixty (60) days after filing, or (iii) Customer or any Guarantor shall make a general assignment for the benefit of creditors, or (iv) Customer or any Guarantor shall generally fail to pay or admit in writing its inability to pay its debts as they become due, or (v) Customer or any Guarantor shall be adjudicated a bankrupt or insolvent.

(d) “Business Day” shall mean any day other than a Saturday, Sunday, federal holiday or other day on which the New York Stock Exchange is regularly closed.

(e) “Closing Date” shall mean the date upon which all conditions precedent to MLBFS’ obligation to make the Loan shall have been met to the satisfaction of MLBFS.

(f) “Collateral” shall mean all Equipment, Fixtures, Investment Property and Financial Assets of Customer, howsoever arising, whether now owned or existing or hereafter acquired or arising, and wherever located, together with all parts thereof (including spare parts), all accessories and accessions thereto, all books and records (including computer records) directly related thereto, all proceeds thereof (including, without limitation, proceeds in the form of Accounts and insurance proceeds), and the additional collateral described in Section 4.6(b) hereof.

(g) “Commitment Expiration Date” shall mean June 18, 2001.

(h) “Commitment Fee” shall mean a fee of $53,000.00 due to MLBFS in connection with this Loan Agreement.

(i) “Default” shall mean either an “Event of Default” as defined in Section 4.5 hereof, or an event which with the giving of notice, passage of time, or both, would constitute such an Event of Default.

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(j) “General Funding Conditions” shall mean each of the following conditions precedent to the obligation of MLBFS to make the Loan or any Subsequent WCMA Loan hereunder (i) Customer shall have validly subscribed to and continued to maintain the WCMA Account with MLPF&S, and the WCMA Account shall then be reflected as an active “Commercial” WCMA Account (i.e., one with line of credit capabilities) on MLPF&S’ WCMA computer system, (ii) no Default shall have occurred and be continuing or would result from the making of the Loan or such Subsequent WCMA Loan by MLBFS, (iii) there shall not have occurred and be continuing any material adverse change in the business or financial condition of Customer or any Guarantor, (iv) all representations and warranties of Customer or any Guarantor herein or in any Additional Agreements shall then be true and correct in all material respects, (v) MLBFS shall have received this Loan Agreement and all Additional Agreements (including, without limitation, each of the Additional Agreements described in the definition of “Real Property Funding Condition”), duly executed and filed or recorded where applicable, all of which shall be in form and substance reasonably satisfactory to MLBFS, (vi) the Commitment Fee shall have been paid in full, (vii) MLBFS shall have received, as and to the extent applicable, copies of invoices, bills of sale, loan payoff letters and/or other evidence reasonably satisfactory to it that the proceeds of the Loan will satisfy the Loan Purpose; (viii) MLBFS shall have received evidence reasonably satisfactory to it as to the ownership of the Collateral and the perfection and priority of MLBFS’ liens and security interests thereon, as well as the ownership of and the perfection and priority of MLBFS’ liens and security interests on any other collateral for the Obligations furnished pursuant to any of the Additional Agreements, (ix) MLBFS shall have received evidence reasonably satisfactory to it of the insurance required hereby or by any of the Additional Agreements, and (x) any additional conditions specified in the “WCMA Reducing Revolver Loan Approval” letter executed by MLBFS with respect to the transactions contemplated hereby shall have been met to the reasonable satisfaction of MLBFS.

(k) “Guarantor” shall mean a person or entity who has either guaranteed or provided collateral for any or all of the Obligations, and “Business Guarantor” shall mean any such Guarantor that is a corporation, partnership, proprietorship, limited liability company or other entity regularly engaged in a business activity.

(l) “Interest Due Date” shall mean the last Business Day of each calendar month during the term hereof (or, if Customer makes special arrangements with MLPF&S, on the last Friday of each calendar month during the term hereof).

(m) “Interest Rate” shall mean a variable per annum rate equal to the sum of (i) 2.30% per annum, and (ii) the interest rate from time to time published in the “Money Rates” section of The Wall Street Journal as the “Dealer Commercial Paper” rate for 30-day high-grade unsecured notes sold through dealers by major corporations (the “30-day Dealer Commercial Paper Rate”). The Interest Rate will change as of the date of publication in The Wall Street Journal of a 30-day Dealer Commercial Paper Rate that is different from that published on the preceding Business Day. In the event that The Wall Street Journal shall, for any reason, fail or cease to publish the 30-day Dealer Commercial Paper Rate, MLBFS will choose a reasonably comparable index or source to use as the basis for the Interest Rate.

(n) “Loan” shall mean the specific Reducing Revolver by MLBFS to Customer pursuant to this Agreement for the Loan Purpose and in the Loan Amount.

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(o) “Loan Amount’” shall mean an amount equal to the lesser of (i) 80% of the fair market value of the Real Property, as determined by the appraisal required to be furnished by Customer to MLBFS pursuant hereto, (ii) the aggregate amount which Customer shall request be advanced by MLBFS on account of the Loan Purpose on the Closing Date, or (ii) $8,000,000.00.

(p) “Loan Purpose” shall mean the purpose for which the proceeds of the Loan will be used, to wit to refinance an existing mortgage loan with G E Capital and the remaining proceeds will be used for expansion and acquisition of additional ambulatory surgery centers.

(q) “Location of Tangible Collateral” shall mean the address of Customer set forth at the beginning of this Loan Agreement, together with any other address or addresses set forth on an exhibit hereto as being a Location of Tangible Collateral.

(r) “Maximum WCMA Line of Credit” shall mean the maximum aggregate line of credit which MLBFS will extend to Customer subject to the terms and conditions hereof, as the same shall be reduced each month in accordance with the terms hereof. On the Closing Date, the Maximum WCMA Line of Credit will equal the Loan Amount.

(s) “Obligations” shall mean all liabilities, indebtedness and other obligations of Customer to MLBFS, howsoever created, arising or evidenced, whether now existing or hereafter arising, whether direct or indirect, absolute or contingent, due or to become due, primary or secondary or joint or several, and, without limiting the foregoing, shall include interest accruing after the filing of any petition in bankruptcy, and all present and future liabilities, indebtedness and obligations of Customer under this Loan Agreement.

(t) “Permitted Liens” shall mean with respect to the Collateral (i) liens for current taxes not delinquent, other non-consensual liens arising in the ordinary course of business for sums not due, and, if MLBFS’ rights to and interest in the Collateral are not materially and adversely affected thereby, any such liens for taxes or other non-consensual liens arising in the ordinary course of business being contested in good faith by appropriate proceedings, (ii) liens in favor of MLBFS, (iii) liens which will be discharged with the proceeds of the initial WCMA Loan, (iv) existing liens, if any, upon Accounts, Chattel Paper, Contract Rights, and Inventory of Customer, together with any future purchase money liens upon Inventory of Customer, and (v) any other liens expressly permitted in writing by MLBFS.

(u) “Real Properties” shall mean the real properties and improvements thereon commonly known as 4301 Vista Road, 4301A Vista Road and 4301B Vista Road, Pasadena, Texas 77504.

(v) “Real Property Funding Condition” shall mean that Customer, at Customer’s expense, shall have furnished or caused to be furnished to MLBFS all of the following, in form and substance reasonably satisfactory to MLBFS (i) a first mortgage or deed of trust upon each of the Real Properties in favor of MLBFS (including an assignment of rents and a security agreement granting to MLBFS a first security interest upon all fixtures now or hereafter located upon each of the Real Properties), (ii) if any of the Real Properties are over 25 years old, a Property Condition Report prepared by an engineer selected by MLBFS setting forth any deferred maintenance on each of the Real Properties and capital improvements required to

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maintain each of the Real Properties during the term of the credit facility being provided by MLBFS, (iii) a Phase 1 Environmental Audit Report on each of the Real Properties, prepared by an environmental specialist selected by MLBFS, disclosing no conditions that are reasonably unacceptable to MLBFS, (iv) an appraisal of each of the Real Properties prepared by an MAI appraiser selected by MLBFS demonstrating an aggregate fair market value of not less than $10,000,000.00, and (v) such other agreements, documents and instruments in connection with the Real Properties or MLBFS’ lien thereon as MLBFS or the title insurance company may reasonably require.

(w) “Subsequent WCMA Loan” shall mean each WCMA Loan other than the Loan, including, without limitation, each WCMA Loan to pay accrued interest.

(x) “Termination Date” shall mean the first to occur of (i) the last Business Day of the one hundred twentieth (120th) full calendar month following the Closing Date, or (ii) if earlier, the date of termination of the WCMA Line of Credit pursuant to the terms hereof.

(y) “WCMA Account” shall mean and refer to the Working Capital Management Account of Customer with MLPF&S identified as WCMA Account No. 582-07L53 and any successor Working Capital Management Account of Customer with MLPF&S.

(z) “WCMA Loan” shall mean each advance made by MLBFS pursuant to the WCMA Line of Credit, including the Loan and each Subsequent WCMA Loan.

(aa) “WCMA Loan Balance” shall mean an amount equal to the aggregate unpaid principal balance of all WCMA Loans.

1.2 Other Terms. Except as otherwise defined herein, (i) all terms used in this Loan Agreement which are defined in the Uniform Commercial Code of Illinois (“UCC”) shall have the meanings set forth in the UCC, and (ii) capitalized terms used herein which are defined in the WCMA Agreement (including, without limitation, “Money Accounts”, “Minimum Money Accounts Balance”, “WCMA Directed Reserve Program” and “WCMA Program”) shall have the meanings set forth in the WCMA Agreement.

Article II.

THE LOAN

2.1 Commitment. Subject to the terms and conditions hereof, MLBFS hereby agrees to make the Loan to Customer, and Customer hereby agrees to borrow the Loan from MLBFS. Except as otherwise provided in Section 3.1 hereof, the entire proceeds of the Loan will be disbursed by MLBFS out of the WCMA Line of Credit either directly to the applicable third party or parties on account of the Loan Purpose or to reimburse Customer for amounts directly expended by it for the Loan Purpose, all as directed by Customer in a Closing Certificate to be executed and delivered to MLBFS prior to the date of funding.

2.2 Conditions of MLBFS’ Obligation. The Closing Date and MLBFS’ obligations to activate the WCMA Line of Credit, as hereafter set forth, and make the Loan on the Closing Date are subject to the prior fulfillment of each of the following conditions: (a) not less than two Business Days prior to any requested funding date, MLBFS shall have received a Closing

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Certificate, duly executed by Customer, setting forth, among other things, the amount of the Loan and the method of payment and payee(s) of the proceeds thereof, (b) after giving effect to the Loan, the WCMA Loan Balance will not exceed either the Maximum WCMA Line of Credit or the Loan Amount. (c) the Commitment Expiration Date shall not then have occurred, and (d) each of the General Funding Conditions and the Real Property Funding Condition shall then have been met or satisfied to the reasonable satisfaction of MLBFS.

2.3 Commitment Fee. In consideration of the agreement by MLBFS to extend the Loan and any Subsequent WCMA Loans to Customer in accordance with and subject to the terms hereof, Customer has paid or shall, on or before the Closing Date pay, the Commitment Fee to MLBFS. Customer acknowledges and agrees that the Commitment Fee has been fully earned by MLBFS, and that it will not under any circumstances be refundable.

2.4 Use of Loan Proceeds. Unless otherwise agreed by MLBFS in writing, the proceeds of the Loan shall be used solely for the Loan Purpose. The Proceeds of each Subsequent WCMA Loan initiated by Customer shall be used by Customer solely for working capital in the ordinary course of its business, or, with the prior written consent of MLBFS, for other lawful business purposes of Customer not prohibited hereby. Customer agrees that under no circumstances will the proceeds of the Loan or any Subsequent WCMA Loan be used: (i) for personal, family or household purposes of any person whatsoever, or (ii) to purchase, carry or trade in securities, or repay debt incurred to purchase, carry or trade in securities, whether in or in connection with the WCMA Account, another account of Customer with MLPF&S or an account of Customer at any other broker or dealer in securities, or (iii) unless otherwise consented to in writing by MLBFS, to pay any amount to Merrill Lynch and Co., Inc., or any of its subsidiaries, other than Merrill Lynch Bank USA, Merrill Lynch Bank & Trust Co. or any subsidiary of either of them (including MLBFS and Merrill Lynch Credit Corporation).

Article III.

THE WCMA LINE OF CREDIT

3.1 Activation of the WCMA Line of Credit. Subject to the terms and conditions hereof, on the Closing Date MLBFS will activate a WCMA Line of Credit for Customer in the Loan Amount. The Loan will be funded out of the WCMA Line of Credit immediately after such activation (or, if and to the extent otherwise expressly contemplated in the definition of Loan Purpose or otherwise directed in the Closing Certificate and hereafter expressly agreed by MLBFS, all or part of the Loan may be made available as a WCMA Line of Credit and funded by Customer).

3.2 Subsequent WCMA Loans. Subject to the terms and conditions hereof, during the period from and after the Closing Date to the Termination Date: (a) Customer may repay the WCMA Loan Balance in whole or in part at any time without premium or penalty, and request a re-borrowing of amounts repaid on a revolving basis, and (b) in addition to Subsequent WCMA Loans made automatically to pay accrued interest, as hereafter provided, MLBFS will make such Subsequent WCMA Loans as Customer may from time to time request or be deemed to have requested in accordance with the terms hereof. Customer may request Subsequent WCMA Loans by use of WCMA Checks, FTS, Visa^® charges, wire transfers, or such other means of

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access to the WCMA Line of Credit as may be permitted by MLBFS from time to time, it being understood that so long as the WCMA Line of Credit shall be in effect, any charge or debit to the WCMA Account which but for the WCMA Line of Credit would under the terms of the WCMA Agreement result in an overdraft, shall be deemed a request by Customer for a Subsequent WCMA Loan.

3.3 Conditions of Subsequent WCMA Loans. Notwithstanding the foregoing, MLBFS shall not be obligated to make any Subsequent WCMA Loan, and may without notice refuse to honor any such request by Customer, if at the time of receipt by MLBFS of Customer’s request (a) the making of such Subsequent WCMA Loan would cause the Maximum WCMA Line of Credit, as reduced pursuant to the provisions of Section 3.6 hereof, to be exceeded, or (b) the Termination Date shall have occurred, or (c) an event shall have occurred and be continuing which shall have caused any of the General Funding Conditions to not then be met or satisfied to the reasonable satisfaction of MLBFS. The making by MLBFS of any Subsequent WCMA Loan (including, without limitation, the making of a Subsequent WCMA Loan to pay accrued interest or late charges, as hereafter provided) at a time when any one or more of said conditions shall not have been met shall not in any event be construed as a waiver of said condition or conditions or of any Default, and shall not prevent MLBFS at any time thereafter while any condition shall not have been met from refusing to honor any request by Customer for a Subsequent WCMA Loan.

3.4 WCMA Note. Customer hereby promises to pay to the order of MLBFS, at the times and in the manner set forth in this Loan Agreement, or in such other manner and at such place as MLBFS may hereafter designate in writing (a) the WCMA Loan Balance, (b) interest at the Interest Rate on the outstanding WCMA Loan Balance (computed for the actual number of days elapsed on the basis of a year consisting of 360 days), from and including the date on which the Loan is made until the date of payment of all WCMA Loans in full, and (c) on demand, all other sums payable pursuant to this Loan Agreement, including, but not limited to, any late charges. Except as otherwise expressly set forth herein, Customer hereby waives presentment, demand for payment, protest and notice of protest, notice of dishonor, notice of acceleration, notice of intent to accelerate and all other notices and formalities in connection with this WCMA Note and this Loan Agreement.

3.5 Interest. (a) An amount equal to accrued interest on the WCMA Loan Balance shall be payable by Customer monthly on each Interest Due Date, commencing with the Interest Due Date occurring in the calendar month in which the Closing Date shall occur. Unless otherwise hereafter directed in writing by MLBFS on or after the Termination Date, such interest will be automatically charged to the WCMA Account on the applicable Interest Due Date, and, to the extent not paid with free credit balances or the proceeds of sales of any Money Accounts then in the WCMA Account, as hereafter provided, such interest will be paid by a Subsequent WCMA Loan and added to the WCMA Loan Balance. All interest shall be computed for the actual number of days elapsed on the basis of a year consisting of 360 days.

(b) Notwithstanding any provision to the contrary in this Agreement or any of the Additional Agreements, no provision of this Agreement or any of the Additional Agreements shall require the payment or permit the collection of any amount in excess of the maximum amount of interest permitted to be charged by law (“Excess Interest”) if any Excess Interest is

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provided for, or is adjudicated as being provided for, in this Agreement or any of the Additional Agreements, then. (i) Customer shall not be obligated to pay any Excess Interest, and (ii) any Excess Interest that MLBFS may have received hereunder or under any of the Additional Agreements shall, at the option of MLBFS, be either applied as a credit against the then WCMA Loan Balance, or refunded to the payer thereof.

3.6 Periodic Reduction of Maximum WCMA Line of Credit. Commencing on the last Business Day of the first full calendar month following the Closing Date, and continuing on the last Business Day of each calendar month thereafter to and including the last Business Day of the one hundred nineteenth (119th) such calendar month, the Maximum WCMA Line of Credit shall be reduced by an amount equal to one-one hundred eightieth (1/180th) of the Loan Amount per month. Unless the WCMA Line of Credit shall have been earlier terminated pursuant to the terms hereof, on the last Business Day of the one hundred twentieth (120th) such calendar month, the WCMA Line of Credit shall, without further action of either of the parties hereto, be terminated, Customer shall pay to MLBFS the entire WCMA Loan Balance, if any, and all other Obligations, and the WCMA Account, at the option of Customer, will either be converted to a WCMA Cash Account (subject to any requirements of MLPF&S) or terminated. No failure or delay on the part of MLBFS in entering into the WCMA computer system any scheduled reduction in the Maximum WCMA Line of Credit pursuant to this Section shall have the effect of preventing or delaying such reduction.

3.7 Mandatory Payments. CUSTOMER AGREES THAT IT WILL, WITHOUT DEMAND, INVOICING OR THE REQUEST OF MLBFS, FROM TIME TO TIME MAKE SUFFICIENT PAYMENTS ON ACCOUNT OF THE WCMA LOAN BALANCE TO ASSURE THAT THE WCMA LOAN BALANCE WILL NOT AT ANY TIME EXCEED THE MAXIMUM WCMA LINE OF CREDIT, AS REDUCED EACH MONTH PURSUANT TO SECTION 3.6 HEREOF.

3.8 Method of Making Payments. All payments required or permitted to be made pursuant to this Loan Agreement shall be made in lawful money of the United States. Unless otherwise hereafter directed by MLBFS, such payments may be made by the delivery of checks (other than WCMA Checks), or by means of FTS or wire transfer of funds (other than funds from the WCMA Line of Credit) to MLPF&S for credit to the WCMA Account. Payments to MLBFS from funds in the WCMA Account shall be deemed to be made by Customer upon the same basis and schedule as funds are made available for investment in the Money Accounts in accordance with the terms of the WCMA Agreement. The acceptance by or on behalf of MLBFS of a check or other payment for a lesser amount than shall be due from Customer, regardless of any endorsement or statement thereon or transmitted therewith, shall not be deemed an accord and satisfaction or anything other than a payment on account, and MLBFS or anyone acting on behalf of MLBFS may accept such check or other payment without prejudice to the rights of MLBFS to recover the balance actually due or to pursue any other remedy under this Loan Agreement or applicable law for such balance. All checks accepted by or on behalf of MLBFS in connection with this Loan Agreement are subject to final collection.

3.9 Irrevocable Instructions to MLPF&S. In order to minimize the WCMA Loan Balance, Customer hereby irrevocably authorizes and directs MLPF&S, effective on the Closing Date and continuing thereafter so long as this Agreement shall be in effect: (a) to immediately

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and prior to application for any other purpose pay to MLBFS to the extent of any WCMA Loan Balance or other amounts payable by Customer hereunder all available free credit balances from time to time in the WCMA Account, and (b) if such available free credit balances are insufficient to pay the WCMA Loan Balance and such other amounts, and there are in the WCMA Account at any time any investments in Money Accounts (other than any investments constituting any Minimum Money Accounts Balance under the WCMA Directed Reserve Program), to immediately liquidate such investments and pay to MLBFS to the extent of any WCMA Loan Balance and such other amounts the available proceeds from the liquidation of any such Money Accounts.

3.10 Late Charge. Any payment or deposit required to be made by Customer pursuant to this Loan Agreement or any of the Additional Agreements not paid or made within ten (10) days of the applicable due date shall be subject to a late charge in an amount equal to the lesser of (a) 5% of the overdue amount, or (b) the maximum amount permitted by applicable law. Such late charge shall be payable on demand, or, without demand, may in the sole discretion of MLBFS be paid by a Subsequent WCMA Loan and added to the WCMA Loan Balance in the same manner as provided herein for accrued interest with respect to the WCMA Line of Credit.

3.11 Prepayment. Customer may prepay the Loan and any Subsequent WCMA Loan at any time in whole or in part without premium or penalty.

3.12 Option of Customer to Terminate. Customer will have the option to terminate the WCMA Line of Credit at any time upon written notice to MLBFS. Concurrently with any such termination, Customer shall pay to MLBFS the entire WCMA Loan Balance and all other Obligations.

3.13 Limitation of Liability. MLBFS shall not be responsible, and shall have no liability to Customer or any other party, for any delay or failure of MLBFS to honor any request of Customer for a WCMA Loan or any other act or omission of MLBFS, MLPF&S or any of their affiliates due to or resulting from any system failure, error or delay in posting or other clerical error, loss of power, fire, Act of God or other cause beyond the reasonable control of MLBFS, MLPF&S or any of their affiliates unless directly arising out of the willful wrongful act or active gross negligence of MLBFS. In no event shall MLBFS be liable to Customer or any other party for any incidental or consequential damages arising from any act or omission by MLBFS, MLPF&S or any of their affiliates in connection with the WCMA Line of Credit or this Loan Agreement.

3.14 Statements. MLPF&S will include in each monthly statement it issues under the WCMA Program information with respect to WCMA Loans and the WCMA Loan Balance. Any questions that Customer may have with respect to such information or the Loan should be directed to MLBFS; and any questions with respect to any other matter in such statements or about or affecting the WCMA Program should be directed to MLPF&S.

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Article IV.

GENERAL PROVISIONS

4.1 Representations and Warranties.

Customer represents and warrants to MLBFS that:

(a) Organization and Existence. Customer is a corporation, duly organized and validly existing in good standing under the laws of the State of Nevada and is qualified to do business and in good standing in each other state where the nature of its business or the property owned by it make such qualification necessary, and, where applicable, each Business Guarantor is duly organized, validly existing and in good standing under the laws of the state of its formation and is qualified to do business and in good standing in each other state where the nature of its business or the property owned by it make such qualification necessary.

(b) Execution, Delivery and Performance. The execution, delivery and performance by Customer of this Loan Agreement and by Customer and each Guarantor of such of the Additional Agreements to which it is a party (i) have been duly authorized by all requisite action, (ii) do not and will not violate or conflict with any law or other governmental requirement, or any of the agreements, instruments or documents which formed or govern Customer or any such Guarantor, and (iii) do not and will not breach or violate any of the provisions of, and will not result in a default by Customer or any such Guarantor under, any other agreement, instrument or document to which it is a party or by which it or its properties are bound.

(c) Notices and Approvals. Except as may have been given or obtained, no notice to or consent or approval of any governmental body or authority or other third party whatsoever (including, without limitation, any other creditor) is required in connection with the execution, delivery or performance by Customer or any Guarantor of such of this Loan Agreement and the Additional Agreements to which it is a party.

(d) Enforceability. This Loan Agreement and such of the Additional Agreements to which Customer or any Guarantor is a party are the respective legal, valid and binding obligations of Customer and such Guarantor, enforceable against it or them, as the case may be, in accordance with their respective terms, except as enforceability may be limited by bankruptcy and other similar laws affecting the rights of creditors generally or by general principles of equity.

(e) Collateral. Except for any Permitted Liens (i) Customer has good and marketable title to the Collateral, (ii) none of the Collateral is subject to any lien, encumbrance or security interest, and (iii) upon the filing of all Uniform Commercial Code financing statements executed by Customer with respect to the Collateral in the appropriate jurisdiction(s) and/or the completion of any other action required by applicable law to perfect its liens and security interests, MLBFS will have valid and perfected first liens and security interests upon all of the Collateral.

(f) Financial Statements. Except as expressly set forth in Customer’s or any Business Guarantor’s financial statements, all financial statements of Customer and each

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Business Guarantor furnished to MLBFS have been prepared in conformity with generally accepted accounting principles, consistently applied, are true and correct in all material respects, and fairly present the financial condition of it as at such dates and the results of its operations for the periods then ended (subject, in the case of interim unaudited financial statements, to normal year-end adjustments), and since the most recent date covered by such financial statements, there has been no material adverse change in any such financial condition or operation. All financial statements furnished to MLBFS of any Guarantor other than a Business Guarantor are true and correct in all material respects and fairly represent such Guarantor’s financial condition as of the date of such financial statements, and since the most recent date of such financial statements, there has been no material adverse change in such financial condition.

(g) Litigation. No litigation, arbitration, administrative or governmental proceedings are pending or, to the knowledge of Customer, threatened against Customer or any Guarantor, which would, if adversely determined, materially and adversely affect the liens and security interests of MLBFS hereunder or under any of the Additional Agreements, the financial condition of Customer or any such Guarantor or the continued operations of Customer or any Business Guarantor.

(h) Tax Returns. All federal, state and local tax returns, reports and statements required to be filed by Customer and each Guarantor have been filed with the appropriate governmental agencies and all taxes due and payable by Customer and each Guarantor have been timely paid (except to the extent that any such failure to file or pay will not materially and adversely affect either the liens and security interests of MLBFS hereunder or under any of the Additional Agreements, the financial condition of Customer or any Guarantor, or the continued operations of Customer or any Business Guarantor).

(i) Collateral Location. All of the tangible Collateral is located at a Location of Tangible Collateral.

(j) No Outside Broker. Except for employees of MLBFS, MLPF&S or one of their affiliates, Customer has not in connection with the transactions contemplated hereby directly or indirectly engaged or dealt with, and was not introduced or referred to MLBFS by, any broker or other loan arranger.

(k) Owner-Occupied. Not less than 35% of the Real Property is regularly occupied for use in a business operated by Customer or one or more entities which are either (i) more than 50% owned and controlled by Customer or a Guarantor, or (ii) if Customer is an entity, which own and control more than 50% of Customer.

Each of the foregoing representations and warranties (i) has been and will be relied upon as an inducement to MLBFS to make the Loan and each Subsequent WCMA Loan, and (ii) is continuing and shall be deemed remade by Customer on the Closing Date, and concurrently with each request by Customer for a Subsequent WCMA Loan.

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4.2 Financial and Other Information.

(a) Customer shall furnish or cause to be furnished to MLBFS during the term of this Loan Agreement all of the following:

(i) Annual Financial Statements. Within 120 days after the close of each fiscal year of Customer, a copy of the annual audited and consolidated financial statements of Customer and the annual audited and consolidated financial statements of each Business Guarantor, including, in each case, in reasonable detail, a balance sheet and statement of retained earnings as at the close of such fiscal year and statements of profit and loss and cash flow for such fiscal year,

(ii) Interim Financial Statements. Within 45 days after the close of each fiscal quarter of Customer, a copy of the interim consolidated financial statements of Customer and each Business Guarantor for such fiscal quarter (including in reasonable detail both a balance sheet as of the close of such fiscal period, and statement of profit and loss for the applicable fiscal period),

(iii) Paid Tax Bills. A copy of each real estate tax bill on or issued in connection with the Real Property, together with evidence of payment of such tax bill, and

(iv) Other Information. Such other information as MLBFS may from time to time reasonably request relating to Customer, any Guarantor or the Collateral.

(b) General Agreements With Respect to Financial Information. Customer agrees that except as otherwise specified herein or otherwise agreed to in writing by MLBFS (i) all annual financial statements required to be furnished by Customer to MLBFS hereunder will be prepared by either the current independent accountants for Customer or other independent accountants reasonably acceptable to MLBFS, and (ii) all other financial information required to be furnished by Customer to MLBFS hereunder will be certified as correct in all material respects by the party who has prepared such information, and, in the case of internally prepared information with respect to Customer or any Business Guarantor, certified as correct by their respective chief financial officer.

4.3 Other Covenants. Customer further covenants and agrees during the term of this Loan Agreement that:

(a) Financial Records; Inspection. Customer and each Business Guarantor will (i) maintain at its principal place of business complete and accurate books and records, and maintain all of its financial records in a manner consistent with the financial statements heretofore furnished to MLBFS, or prepared on such other basis as may be approved in writing by MLBFS, and (ii) permit MLBFS or its duly authorized representatives, upon reasonable notice and at reasonable times, to inspect its properties (both real and personal), operations, books and records.

(b) Taxes. Customer and each Guarantor will pay when due all taxes, assessments and other governmental charges, howsoever designated, and all other liabilities and obligations, except to the extent that any such failure to pay will not materially and adversely affect either the liens and security interests of MLBFS hereunder or under any of the Additional Agreements, the financial condition of Customer or any Guarantor or the continued operations of Customer or any Business Guarantor.

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(c) Compliance With Laws and Agreements. Neither Customer nor any Guarantor will violate any law, regulation or other governmental requirement, any judgment or order of any court or governmental agency or authority, or any agreement, instrument or document to which it is a party or by which it is bound, if any such violation will materially and adversely affect either the liens and security interests of MLBFS hereunder or under any of the Additional Agreements, the financial condition of Customer or any Guarantor, or the continued operations of Customer or any Business Guarantor.

(d) No Use of Merrill Lynch Name. Neither Customer nor any Guarantor will directly or indirectly publish, disclose or otherwise use in any advertising or promotional material, or press release or interview, the name, logo or any trademark of MLBFS, MLPF&S, Merrill Lynch and Co. Incorporated or any of their affiliates.

(e) Notification By Customer. Customer shall provide MLBFS with prompt written notification of (i) any Default, (ii) any materially adverse change in the business, financial condition or operations of Customer or any Business Guarantor, (iii) any information which indicates that any financial statements of Customer or any Guarantor fail in any material respect to present fairly the financial condition and results of operations purported to be presented in such statements, and (iv) any change in Customers outside accounts. Each notification by Customer pursuant hereto shall specify the event or information causing such notification, and, to the extent applicable, shall specify the steps being taken to rectify or remedy such event or information.

(f) Notice of Change. Customer shall give MLBFS not less than 30 days prior written notice of any change in the name (including any fictitious name) or principal place of business or residence of Customer or any Guarantor.

(g) Real Estate Expense Deposit. On or before the date of execution hereof by Customer, Customer shall pay to MLBFS a “Real Estate Expense Deposit” in the amount of $7,000.00. Said deposit, which shall not bear interest and which need not be segregated from other funds of MLBFS, shall be applied by MLBFS on account of the out-of-pocket expenses to third parties incurred in fulfilling the Real Property Funding Condition. On the final Closing Date, or if this Loan Agreement and any commitment of MLBFS to make the Loan shall for any reason be terminated without a funding of any portion of the Loans, then promptly after the date of such termination, any unused portion of the Real Estate Expense Deposit shall be refunded to Customer. Nothing herein shall alter the primary liability of Customer to pay or reimburse MLBFS for all of the out-of-pocket expenses to third parties incurred in fulfilling the Real Property Funding Condition, whether or not the Loan is funded.

(h) Continuity. Except upon the prior written consent of MLBFS, which consent will not be unreasonably withheld (i) neither Customer nor any Business Guarantor shall be a party to any merger or consolidation with, or purchase or otherwise acquire all or substantially all of the assets of, or any material stock, partnership, joint venture or other equity interest in, any person or entity, or sell, transfer or lease all or any substantial part of its assets, if any such action would result in either: (A) a material change in the principal business, ownership or control of Customer or such Business Guarantor, or (B) a material adverse change in the financial condition or operations of Customer or such Business Guarantor, (ii) Customer and

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each Business Guarantor shall preserve their respective existence and good standing in the jurisdiction(s) of establishment and operation, (iii) neither Customer nor any Business Guarantor shall engage in any material business substantially different from their respective business in effect as of the date of application by Customer for credit from MLBFS, or cease operating any such material business, (iv) nether Customer nor any Business Guarantor shall cause or permit any other person or entity to assume or succeed to any material business or operations of Customer or such Business Guarantor, and (v) neither Customer nor any Business Guarantor shall cause or permit any material change in its controlling ownership.

(i) Minimum Tangible Net Worth. Customer’s and Business Guarantors’ (on a consolidated basis) “tangible net worth” shall at all times exceed $15,000,000.00. For the purposes hereof, the term “tangible net worth” shall mean Customer’s and Business Guarantors’ (on a consolidated basis) net worth as shown on Customer’s and Business Guarantors’ regular consolidated financial statements prepared in a manner consistent with the terms hereof, but excluding an amount equal to (i) any assets which are ordinarily classified as “intangible” in accordance with generally accepted accounting principles, and (ii) any amounts now or hereafter directly or indirectly owing to Customer or Business Guarantors by officers, shareholders or affiliates of Customer and Business Guarantors.

(j) Minimum Net Cash Flow. The “Net Cash Flow” of Customer and Business Guarantors (on a consolidated basis) as of the end of each of its fiscal years shall not be less than $1,600,000.00. As used herein, “Net Cash Flow” shall mean the (i) the sum of Customer’s and Business Guarantors’ (on a consolidated basis) annual net after-tax income, any non-recurring expenses, and depredation and similar non-cash charges, less (ii) the sum of the current portion of Customer’s and Business Guarantors’ (on a consolidated basis) long term debt, any non-recurring income, and any dividends or other distributions to its owners, all as set forth on Customer’s and Business Guarantors’ regular annual consolidated financial statements prepared in a manner consistent with the terms hereof.

4.4 Collateral.

(a) Pledge of Collateral. To secure payment and performance of the Obligations, Customer hereby pledges, assigns, transfers and sets over to MLBFS, and grants to MLBFS first liens and security interests in and upon all of the Collateral, subject only to Permitted Liens.

(b) Liens. Except upon the prior written consent of MLBFS, Customer shall not create or permit to exist any lien, encumbrance or security interest upon or with respect to any Collateral now owned or hereafter acquired other than Permitted Liens.

(c) Performance of Obligations. Customer shall perform all of its obligations owing on account of or with respect to the Collateral, it being understood that nothing herein, and no action or inaction by MLBFS, under this Loan Agreement or otherwise, shall be deemed an assumption by MLBFS of any of Customer’s said obligations.

(d) Sales and Collections. So long as no Event of Default shall have occurred and be continuing, Customer may in the ordinary course of its business (i) sell any Inventory normally held by Customer for sale, (ii) use or consume any materials and supplies normally held by

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Customer for use or consumption, and (iii) collect all of its Accounts Customer shall take such action with respect to protection of its Inventory and the other Collateral and the collection of its Accounts as MLBFS may from time to time reasonably request.

(e) Account Schedules. Upon the request of MLBFS, made now or at any reasonable time or times hereafter, Customer shall deliver to MLBFS, in addition to the other information required hereunder, a schedule identifying, for each Account and all Chattel Paper subject to MLBFS’ security interests hereunder, each Account Debtor by name and address and amount, invoice or contract number and date of each invoice or contract Customer shall furnish to MLBFS such additional information with respect to the Collateral, and amounts received by Customer as proceeds of any of the Collateral, as MLBFS may from time to time reasonably request.

(f) Alterations and Maintenance. Except upon the prior written consent of MLBFS, Customer shall not make or permit any material alterations to any tangible Collateral which might materially reduce or impair its market value or utility. Customer shall at all times keep the tangible Collateral in good condition and repair, reasonable wear and tear excepted, and shall pay or cause to be paid all obligations arising from the repair and maintenance of such Collateral, as well as all obligations with respect to each Location of Tangible Collateral, except for any such obligations being contested by Customer in good faith by appropriate proceedings.

(g) Location. Except for movements required in the ordinary course of Customer’s business, Customer shall give MLBFS 30 days’ prior written notice of the placing at or movement of any tangible Collateral to any location other than a Location of Tangible Collateral. In no event shall Customer cause or permit any material tangible Collateral to be removed from the United States without the express prior written consent of MLBFS.

(h) Insurance. Customer shall insure all of the tangible Collateral under a policy or policies of physical damage insurance providing that losses will be payable to MLBFS as its interests may appear pursuant to a Lender’s Loss Payable Endorsement and containing such other provisions as may be reasonably required by MLBFS. Customer shall further provide and maintain a policy or policies of comprehensive public liability insurance naming MLBFS as an additional party insured. Customer and each Business Guarantor shall maintain such other insurance as may be required by law or is customarily maintained by companies in a similar business or otherwise reasonably required by MLBFS. All such insurance policies shall provide that MLBFS will receive not less than 10 days prior written notice of any cancellation, and shall otherwise be in form and amount and with an insurer or Insurers reasonably acceptable to MLBFS. Customer shall furnish MLBFS with a copy or certificate of each such policy or policies and, prior to any expiration or cancellation, each renewal or replacement thereof.

(i) Event of Loss. Customer shall at its expense promptly repair all repairable damage to any tangible Collateral. In the event that any tangible Collateral is damaged beyond repair, lost, totally destroyed or confiscated (an “Event of Loss”) and such Collateral had a value prior to such Event of Loss of $25,000.00 or more, then, on or before the first to occur of (i) 90 days after the occurrence of such Event of Loss, or (ii) 10 Business Days after the date on which either Customer or MLBFS shall receive any proceeds of insurance on account of such Event of Loss, or any underwriter of insurance on such Collateral shall advise either Customer or MLBFS

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that it disclaims liability in respect of such Event of Loss, Customer shall, at Customers option, either replace the Collateral subject to such Event of Loss with comparable Collateral free of all liens other than Permitted Liens (in which event Customer shall be entitled to utilize the proceeds of insurance on account of such Event of Loss for such purpose, and may retain any excess proceeds of such insurance), or permanently prepay the Loan by an amount equal to the actual cash value of such Collateral as determined by either the insurance company’s payment (plus any applicable deductible) or, in absence of insurance company payment, as reasonably determined by MLBFS, it bang further understood that any such permanent prepayment shall be accompanied by a like permanent reduction in the Maximum WCMA Line of Credit. Notwithstanding the foregoing, if at the time of occurrence of such Event of Loss or any time thereafter prior to replacement or line reduction, as aforesaid, an Event of Default shall have occurred and be continuing hereunder, then MLBFS may at its sole option, exercisable at any time while such Event of Default shall be continuing, require Customer to either replace such Collateral or prepay the Loan and reduce the Maximum WCMA Line of Credit, as aforesaid.

(j) Notice of Certain Events. Customer shall give MLBFS immediate notice of any attachment, lien, judicial process, encumbrance or claim affecting or involving $25,000.00 or more of the Collateral.

(k) Indemnification. Customer shall indemnify, defend and save MLBFS harmless from and against any and all claims, liabilities, losses, costs and expenses (including, without limitation, reasonable attorneys’ fees and expenses) of any nature whatsoever which may be asserted against or incurred by MLBFS arising out of or in any manner occasioned by (i) the ownership, collection, possession, use or operation of any Collateral, or (ii) any failure by Customer to perform any of its obligations hereunder, excluding, however, from said indemnity any such claims, liabilities, etc. arising directly out of the willful wrongful act or active gross negligence of MLBFS. This indemnity shall survive the expiration or termination of this Loan Agreement as to all matters arising or accruing prior to such expiration or termination.

4.5 Events of Default. The occurrence of any of the following events shall constitute an “Event of Default” under this Loan Agreement.

(a) Failure to Pay. (i) Customer shall fail to deposit into the WCMA Account an amount sufficient to assure that the WCMA Loan Balance does not exceed the Maximum WCMA Line of Credit, as reduced in accordance with the provisions hereof, or (ii) Customer shall fail to pay to MLBFS or deposit into the WCMA Account when due any other amount owing or required to be paid or deposited by Customer under this Loan Agreement, or (iii) Customer shall fail to pay when due any other Obligations, and any such failure shall continue for more than five (5) Business Days after written notice thereof shall have been given by MLBFS to Customer.

(b) Failure to Perform. Customer or any Guarantor shall default in the performance or observance of any covenant or agreement on its part to be performed or observed under this Loan Agreement or any of the Additional Agreements (not constituting an Event of Default under any other clause of this Section), and such default shall continue unremedied for ten (10) Business Days after written notice thereof shall have been given by MLBFS to Customer.

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(c) Breach of Warranty. Any representation or warranty made by Customer or any Guarantor contained in this Loan Agreement or any of the other Additional Agreements shall at any time prove to have been incorrect in any material respect when made.

(d) Default Under Other Agreement. A default or Event of Default by Customer or any Guarantor shall occur under the terms of any other agreement, instrument or document with or intended for the benefit of MLBFS, MLPF&S or any of their affiliates, and any required notice shall have been given and required passage of time shall have elapsed.

(e) Bankruptcy Event. Any Bankruptcy Event shall occur.

(f) Material Impairment. Any event shall occur which shall reasonably cause MLBFS to in good faith believe that the prospect of full payment or performance by Customer or any Guarantor of any of their respective liabilities or obligations under this Loan Agreement or any of the Additional Agreements to which Customer or such Guarantor is a party has been materially impaired. The existence of such a material impairment shall be determined in a manner consistent with the intent of Section 1-208 of the UCC.

(g) Acceleration of Debt to Other Creditors. Any event shall occur which results in the acceleration of the maturity of any indebtedness of $100,000.00 or more of Customer or any Guarantor to another creditor under any indenture, agreement, undertaking, or otherwise.

(h) Seizure or Abuse of Collateral. The Collateral, or any material part thereof, shall be or become subject to any material abuse or misuse, or any levy, attachment, seizure or confiscation which is not released within ten (10) Business Days.

4.6 Remedies.

(a) Remedies Upon Default. Upon the occurrence and during the continuance of any Event of Default, MLBFS may at its sole option do any one or more or all of the following, at such time and in such order as MLBFS may in its sole discretion choose.

(i) Termination. MLBFS may without notice terminate its obligation to make the Loan (if the Loan has not then been funded), terminate the WCMA Line of Credit, and terminate any obligation to make any Subsequent WCMA Loan (including, without limitation, any Subsequent WCMA Loan to pay accrued interest) or otherwise extend any credit to or for the benefit of Customer (it being understood that upon the occurrence of any Bankruptcy Event the WCMA Line of Credit and all such obligations shall automatically terminate without any action on the part of MLBFS), and upon any such termination MLBFS shall be relieved of all such obligations.

(ii) Acceleration. MLBFS may declare the WCMA Loan Balance and all other Obligations to be forthwith due and payable, whereupon all such amounts shall be immediately due and payable, without presentment, demand for payment, protest and notice of protest, notice of dishonor, notice of acceleration, notice of intent to accelerate or other notice or formality of any kind, all of which are hereby expressly waived, provided, however, that upon the occurrence of any Bankruptcy Event the WCMA Loan

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Balance and other Obligations shall automatically become due and payable without any action on the part of MLBFS.

(iii) Exercise Other Rights. MLBFS may exercise any or all of the remedies of a secured party under applicable law, including, but not limited to, the UCC, and any or all of its other rights and remedies under this Loan Agreement and the Additional Agreements.

(iv) Possession. MLBFS may require Customer to make the Collateral and the records pertaining to the Collateral available to MLBFS at a place designated by MLBFS which is reasonably convenient to Customer, or may take possession of the Collateral and the records pertaining to the Collateral without the use of any judicial process and without any prior notice to Customer.

(v) Sale. MLBFS may sell any or all of the Collateral at public or private sale upon such terms and conditions as MLBFS may reasonably deem proper. MLBFS may purchase any Collateral at any such public sale. The net proceeds of any such public or private sale and all other amounts actually collected or received by MLBFS pursuant hereto, after deducting all costs and expenses incurred at any time in the collection of the Obligations and in the protection, collection and sale of the Collateral, will be applied to the payment of the Obligations, with any remaining proceeds paid to Customer or whoever else may be entitled thereto, and with Customer and each Guarantor remaining jointly and severally liable for any amount remaining unpaid alter such application.

(vi) Delivery of Cash, Checks, Etc. MLBFS may require Customer to forthwith upon receipt, transmit and deliver to MLBFS in the form received, all cash, checks, drafts and other instruments for the payment of money (property endorsed, where required, so that such items may be collected by MLBFS) which may be received by Customer at any time in full or partial payment of any Collateral, and require that Customer not commingle any such items which may be so received by Customer with any other of its funds or property but instead hold them separate and apart and in trust for MLBFS until delivery is made to MLBFS.

(vii) Notification of Account. Debtors MLBFS may notify any Account Debtor that its Account or Chattel Paper has been assigned to MLBFS and direct such Account Debtor to make payment directly to MLBFS of all amounts due or becoming due with respect to such Account or Chattel Paper, and MLBFS may enforce payment and collect, by legal proceedings or otherwise, such Account or Chattel Paper.

(viii) Control of Collateral. MLBFS may otherwise take control in any lawful manner of any cash or non-cash items of payment or proceeds of Collateral and of any rejected, returned, stopped in transit or repossessed goods included in the Collateral and endorse Customer’s name on any item of payment on or proceeds of the Collateral.

(b) Set-Off. MLBFS shall have the further right upon the occurrence and during the continuance of an Event of Default to set-off, appropriate and apply toward payment of any of

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the Obligations, in such order of application as MLBFS may from time to time and at any time elect, any cash, credit, deposits, accounts, financial assets, investment property, securities and any other property of Customer which is in transit to or in the possession, custody or control of MLBFS, MLPF&S or any agent, bailee, or affiliate of MLBFS or MLPF&S. Customer hereby collaterally assigns and grants to MLBFS a continuing security interest in all such property as additional Collateral.

(c) Power of Attorney. Effective upon the occurrence and during the continuance of an Event of Default, Customer hereby irrevocably appoints MLBFS as its attorney-in-fact, with full power of substitution, in its place and stead and in its name or in the name of MLBFS, to from time to time in MLBFS’ sole discretion lake any action and to execute any instrument which MLBFS may deem necessary or advisable to accomplish the purposes of this Loan Agreement, including, but not limited to, to receive, endorse and collect all checks, drafts and other instruments for the payment of money made payable to Customer included in the Collateral.

(d) Remedies are Severable and Cumulative. All rights and remedies of MLBFS herein are severable and cumulative and in addition to all other rights and remedies available in the Additional Agreements, at law or in equity, and any one or more of such rights and remedies may be exercised simultaneously or successively.

(i) Notices. To the fullest extent permitted by applicable law, Customer hereby irrevocably waives and releases MLBFS of and from any and all liabilities and penalties for failure of MLBFS to comply with any statutory or other requirement imposed upon MLBFS relating to notices of sale, holding of sale or reporting of any sale, and Customer waives all rights of redemption or reinstatement from any such sale. Any notices required under applicable law shall be reasonably and property given to Customer if given by any of the methods provided herein at least 5 Business Days prior to taking action MLBFS shall have the right to postpone or adjourn any sale or other disposition of Collateral at any time without giving notice of any such postponed or adjourned date. In the event MLBFS seeks to take possession of any or all of the Collateral by court process, Customer further irrevocably waives to the fullest extent permitted by law any bonds and any surety or security relating thereto required by any statute, court rule or otherwise as an incident to such possession, and any demand for possession prior to the commencement of any suit or action.

4.7 Miscellaneous.

(a) Non-Waiver. No failure or delay on the part of MLBFS in exercising any right, power or remedy pursuant to this Loan Agreement or any of the Additional Agreements shall operate as a waiver thereof, and no single or partial exercise of any such right, power or remedy shall preclude any other or further exercise thereof, or the exercise of any other right, power or remedy. Neither any waiver of any provision of this Loan Agreement or any of the Additional Agreements, nor any consent to any departure by Customer therefrom, shall be effective unless the same shall be in writing and signed by MLBFS. Any waiver of any provision of this Loan Agreement or any of the Additional Agreements and any consent to any departure by Customer from the terms thereof shall be effective only in the specific instance and for the specific purpose

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for which given. Except as otherwise expressly provided herein, no notice to or demand on Customer shall in any case entitle Customer to any other or further notice or demand in similar or other circumstances.

(b) Disclosure. Customer hereby irrevocably authorizes MLBFS and each of its affiliates, including without limitation MLPF&S, to at any time (whether or not an Event of Default shall have occurred) obtain from and disclose to each other any and all financial and other information about Customer.

(c) Communications. All notices and other communications required or permitted hereunder or in connection with any of the Additional Agreements shall be in writing, and shall be either delivered personally, mailed by postage prepaid certified mail or sent by express overnight courier or by facsimile. Such notices and communications shall be deemed to be given on the date of personal delivery, facsimile transmission or actual delivery of certified mail, or one Business Day after delivery to an express overnight courier. Unless otherwise specified in a notice sent or delivered in accordance with the terms hereof, notices and other communications in writing shall be given to the parties hereto at their respective addresses set forth at the beginning of this Loan Agreement, or, in the case of facsimile transmission, to the parties at their respective regular facsimile telephone number.

(d) Fees, Expenses and Taxes. Customer shall pay or reimburse MLBFS for (i) all Uniform Commercial Code filing and search fees and expenses incurred by MLBFS in connection with the verification, perfection or preservation of MLBFS’ rights hereunder or in the Collateral or any other collateral for the Obligations, (ii) any and all stamp, transfer and other taxes and fees payable or determined to be payable in connection with the execution, delivery and/or recording of this Loan Agreement or any of the Additional Agreements, (iii) any and all reasonable fees and out-of-pocket expenses to third parties incurred by MLBFS in connection with the title insurance, environmental audit, appraisal, survey and other instruments or documents referred to in the definition of Real Property Funding Condition; and (iv) all reasonable fees and out-of-pocket expenses (including, but not limited to, reasonable fees and expenses of outside counsel) incurred by MLBFS in connection with the collection of any sum payable hereunder or under any of the Additional Agreements not paid when due, the enforcement of this Loan Agreement or any of the Additional Agreements and the protection of MLBFS’ rights hereunder or thereunder, excluding, however, salaries and normal overhead attributable to MLBFS’ employees. Customer hereby authorizes MLBFS, at its option, to either cause any and all such fees, expenses and taxes to be paid with a WCMA Loan, or invoice Customer therefor (in which event Customer shall pay all such fees, expenses and taxes within 5 Business Days after receipt of such invoice). The obligations of Customer under this paragraph shall survive the expiration or termination of this Loan Agreement and the discharge of the other Obligations.

(e) Right to Perform Obligations. If Customer shall fail to do any act or thing which it has covenanted to do under this Loan Agreement or any representation or warranty on the part of Customer contained in this Loan Agreement shall be breached, MLBFS may, in its sole discretion, after 5 Business Days written notice is sent to Customer (or such lesser notice, including no notice, as is reasonable under the circumstances), do the same or cause it to be done or remedy any such breach, and may expend its funds for such purpose. Any and all reasonable

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amounts so expended by MLBFS shall be repayable to MLBFS by Customer upon demand, with interest at the Interest Rate during the period from and including the date funds are so expended by MLBFS to the date of repayment, and all such amounts shall be additional Obligations. The payment or performance by MLBFS of any of Customers obligations hereunder shall not relieve Customer of said obligations or of the consequences of having failed to pay or perform the same, and shall not waive or be deemed a cure of any Default.

(f) Further Assurances. Customer agrees to do such further acts and things and to execute and deliver to MLBFS such additional agreements, instruments and documents as MLBFS may reasonably require or deem advisable to effectuate the purposes of this Loan Agreement or any of the Additional Agreements, or to establish, perfect and maintain MLBFS’ security interests and liens upon the Collateral, including, but not limited to (i) executing financing statements or amendments thereto when and as reasonably requested by MLBFS, and (ii) if in the reasonable judgment of MLBFS it is required by local law, causing the owners and/or mortgagees of the real property on which any Collateral may be located to execute and deliver to MLBFS waivers or subordinations reasonably satisfactory to MLBFS with respect to any rights in such Collateral.

(g) Binding Effect. This Loan Agreement and the Additional Agreements shall be binding upon, and shall inure to the benefit of MLBFS, Customer and their respective successors and assigns. Customer shall not assign any of its rights or delegate any of its obligations under this Loan Agreement or any of the Additional Agreements without the prior written consent of MLBFS. Unless otherwise expressly agreed to in a writing signed by MLBFS, no such consent shall in any event relieve Customer of any of its obligations under this Loan Agreement or any of the Additional Agreements.

(h) Headings. Captions and section and paragraph headings in this Loan Agreement are inserted only as a matter of convenience, and shall not affect the interpretation hereof.

(i) Governing Law. This Loan Agreement and, unless otherwise expressly provided therein, each of the Additional Agreements, shall be governed in all respects by the laws of the State of Illinois.

(j) Severability of Provisions. Whenever possible, each provision of this Loan Agreement and the Additional Agreements shall be interpreted in such manner as to be effective and valid under applicable law. Any provision of this Loan Agreement or any of the Additional Agreements which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective only to the extent of such prohibition or unenforceability without invalidating the remaining provisions of this Loan Agreement and the Additional Agreements or affecting the validity or enforceability of such provision in any other jurisdiction.

(k) Term. This Loan Agreement shall become effective on the date accepted by MLBFS at its office in Chicago, Illinois, and, subject to the terms hereof, shall continue in effect so long thereafter as (i) MLBFS shall be obligated to make the Loan, (ii) the WCMA Line of Credit shall be in effect, (iii) there shall be any moneys outstanding under this Loan Agreement, or (iv) there shall be any other Obligations outstanding.

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(l) Counterparts. This Loan Agreement may be executed in one or more counterparts which, when taken together, constitute one and the same agreement.

(m) Jurisdiction; Waiver. CUSTOMER ACKNOWLEDGES THAT THIS LOAN AGREEMENT IS BEING ACCEPTED BY MLBFS IN PARTIAL CONSIDERATION OF MLBFS’ RIGHT AND OPTION, IN ITS SOLE DISCRETION, TO ENFORCE THIS LOAN AGREEMENT AND THE ADDITIONAL AGREEMENTS IN EITHER THE STATE OF ILLINOIS OR IN ANY OTHER JURISDICTION WHERE CUSTOMER OR ANY COLLATERAL FOR THE OBLIGATIONS MAY BE LOCATED. CUSTOMER IRREVOCABLY SUBMITS ITSELF TO JURISDICTION IN THE STATE OF ILLINOIS AND VENUE IN ANY STATE OR FEDERAL COURT IN THE COUNTY OF COOK FOR SUCH PURPOSES, AND CUSTOMER WAIVES ANY AND ALL RIGHTS TO CONTEST SAID JURISDICTION AND VENUE AND THE CONVENIENCE OF ANY SUCH FORUM, AND ANY AND ALL RIGHTS TO REMOVE SUCH ACTION FROM STATE TO FEDERAL COURT. CUSTOMER FURTHER WAIVES ANY RIGHTS TO COMMENCE ANY ACTION AGAINST MLBFS IN ANY JURISDICTION EXCEPT IN THE COUNTY OF COOK AND STATE OF ILLINOIS. MLBFS AND CUSTOMER HEREBY EACH EXPRESSLY WAIVE ANY AND ALL RIGHTS TO A TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM BROUGHT BY EITHER OF THE PARTIES AGAINST THE OTHER PARTY WITH RESPECT TO ANY MATTER RELATING TO, ARISING OUT OF OR IN ANY WAY CONNECTED WITH THE LOAN, THIS LOAN AGREEMENT, ANY ADDITIONAL AGREEMENTS AND/OR ANY OF THE TRANSACTIONS WHICH ARE THE SUBJECT MATTER OF THIS LOAN AGREEMENT. CUSTOMER FURTHER WAIVES THE RIGHT TO BRING ANY NON-COMPULSORY COUNTERCLAIMS.

(n) Integration. THIS LOAN AGREEMENT, TOGETHER WITH THE ADDITIONAL AGREEMENTS, CONSTITUTES THE ENTIRE UNDERSTANDING AND REPRESENTS THE FULL AND FINAL AGREEMENT BETWEEN THE PARTIES WITH RESPECT TO THE SUBJECT MATTER HEREOF, AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR WRITTEN AGREEMENTS OR PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS OF THE PARTIES. WITHOUT LIMITING THE FOREGOING, CUSTOMER ACKNOWLEDGES THAT: (I) NO PROMISE OR COMMITMENT HAS BEEN MADE TO IT BY MLBFS, MLPF&S OR ANY OF THEIR RESPECTIVE EMPLOYEES, AGENTS OR REPRESENTATIVES TO MAKE THE LOAN OR ANY SUBSEQUENT WCMA LOAN ON ANY TERMS OTHER THAN AS EXPRESSLY SET FORTH HEREIN, OR TO MAKE ANY OTHER LOAN OR OTHERWISE EXTEND ANY OTHER CREDIT TO CUSTOMER OR ANY OTHER PARTY; AND (II) EXCEPT AS OTHERWISE EXPRESSLY PROVIDED HEREIN, THIS LOAN AGREEMENT SUPERSEDES AND REPLACES ANY AND ALL PROPOSALS, LETTERS OF INTENT AND APPROVAL AND COMMITMENT LETTERS FROM MLBFS TO CUSTOMER, NONE OF WHICH SHALL BE CONSIDERED AN ADDITIONAL AGREEMENT. NO AMENDMENT OR MODIFICATION OF THIS AGREEMENT OR ANY OF THE ADDITIONAL

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AGREEMENTS TO WHICH CUSTOMER IS A PARTY SHALL BE EFFECTIVE UNLESS IN A WRITING SIGNED BY BOTH MLBFS AND CUSTOMER.

IN WITNESS WHEREOF, this Loan Agreement has been executed as of the day and year first above written

DYNACQ INTERNATIONAL, INC.
By:	/s/ Philip Chan
	Philip Chan, Vice President
Accepted at Chicago, Illinois
MERRILL LYNCH BUSINESS FINANCIAL SERVICES INC.
By:	/s/ Beth Afensen, VP
	Beth Afensen, VP

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EX-14.1

Exhibit 14.1

DYNACQ HEALTHCARE, INC.

Code of Ethics for Principal Executive and Senior Financial Officers

I. Introduction and Purpose

This Code of Ethics for Principal Executive and Senior Financial Officers (hereinafter referred to as the “Code”) helps maintain Dynacq Healthcare, Inc.’s (hereinafter referred to as the “Company”) standards of business conduct and ensures compliance with legal requirements, specifically, but not limited to, Section 406 of the Sarbanes-Oxley Act of 2002 and SEC rules promulgated thereunder.

In addition to securing compliance with legal requirements, the purpose of the Code is to deter wrongdoing and promote ethical conduct, and full, fair, accurate, timely, and understandable disclosure of financial information in the periodic reports of the Company. The matters covered in this Code are of the utmost importance to the Company, our stockholders and our business partners, and are essential to our ability to conduct our business in accordance with our stated values.

Financial executives hold an important and elevated role in corporate governance and are uniquely capable and empowered to ensure that stockholders’ interests are appropriately balanced, protected and preserved. Accordingly, this Code provides principles to which financial executives are expected to adhere and advocate. This Code embodies rules regarding individual and peer responsibilities, as well as responsibilities to the company, the public and others.

II. Application

This Code is applicable to the following persons (hereinafter referred to as the “Officers”):

1. The Company’s principal executive officer;

2. The Company’s principal financial officers;

3. The Company’s principal accounting officer or controller; and

4. Persons performing similar functions.

III. Code of Ethics:

Each Officer shall adhere to and advocate the following principles and responsibilities governing professional and ethical conduct:

1. Act with honesty and integrity, avoiding actual or apparent conflicts of interest in personal and professional relationships.

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2. Provide information that is full, fair, accurate, complete, objective, relevant, timely, and understandable to the Company’s Board of Directors, the Securities and Exchange Commission, the Company’s stockholders, and the public.

3. Comply with applicable governmental laws, rules, and regulations of federal, state and local governments.

4. Act in good faith, responsibly, with due care, competence and diligence, without misrepresenting material facts or allowing your independent judgment to be subordinated.

5. Take all reasonable measures to protect the confidentiality of non-public information about the Company acquired in the course of your work except when authorized or otherwise legally obligated to disclose such information and to not use such confidential information for personal advantage.

6. Proactively promote ethical behavior in the work environment and community.

7. Assure responsible use of and control over all assets and resources employed or entrusted to you.

8. Promptly report to the General Counsel or to the Chairman of the Audit Committee:

a. any information you may have regarding any violation of this Code;

b. any actual or apparent conflict of interest between personal and/or professional relationships involving management or any other employee with a role in financial reporting disclosures or internal controls;

c. any information you might have concerning evidence of a material violation of the securities or other laws, rules or regulations applicable to the Company and its operations;

d. significant deficiencies in the design or operation of internal controls that could adversely affect the Company’s ability to record, process, summarize or report financial data; or

e. any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s financial reporting, disclosures or internal controls.

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IV. Reporting Procedure and Process

As discussed above, Officers shall promptly report any violation of this Code to the Company’s General Counsel or to the Chairman of the Company’s audit Committee.

Reports of violations under this Code received by the General Counsel shall be handled in accordance with the Complaint Procedures as adopted by the Audit Committee. Reports of violations received by or referred to the Chairman of Audit Committee shall be investigated by the Audit Committee. If the Audit Committee finds a violation of this Code, it shall refer the matter to the full Board of Directors.

In the event of a finding that a violation of this Code has occurred, appropriate action shall be taken that is reasonably designed to deter wrongdoing and to promote accountability for adherence to this Code, and may include written notices to the individual involved of the determination that there has been a violation, censure by the Board, demotion or re-assignment of the individual involved, suspension with or without pay or benefits, and up to and including, if appropriate, termination of the individual’s employment. In determining what action is appropriate in a particular case, the Board of Directors (or the independent directors of the Board as the case may be) shall take into account all relevant information, including the nature and severity of the violation, whether the violation was a single occurrence or repeated occurrences, whether the violation appears to have been intentional or inadvertent, whether the individuals in question had been advised prior to the violation as to the proper course of action and whether or not the individual in question had committed other violations in the past.

V. Anonymous Reporting

Any violation of this Code and any violation by the Company or its directors or officers of the securities laws, rules, or regulations, or other laws, rules, or regulations applicable to the Company may be reported to the General Counsel or Chairman of the Audit Committee anonymously.

VI. No Retaliation

It is against the Company’s policy to retaliate in any way against an Officer for good faith reporting of violations of this Code.

VII. Waiver and Amendment

The Company is committed to continuously reviewing and updating its policies and procedures. Therefore, this Code is subject to modification. Any amendment or waiver of any provision of this Code must be approved in writing by the Company’s Board of Directors and promptly disclosed pursuant to applicable laws and regulations.

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VIII. Acknowledgment Of Receipt Of Code Of Ethics For Principal Executive And Senior Financial Officers

I have received and read the Company’s Code of Ethics for Principal Executive and Senior Financial Officers (the “Code”). I understand the standards and policies contained in the Code and understand that there may be additional policies or laws applicable to my job. I agree to comply with the Code in all respects.

If I have questions concerning the meaning or application of the Code, any Company policies, or the legal and regulatory requirements applicable to my job, I know that I can consult with the Company’s General Counsel or the Chairman of the Audit Committee, knowing that my questions or reports will remain confidential to the fullest extent possible.

I understand that my agreement to comply with this Code does not constitute a contract of employment.

Officer Name

Signature

Date

Please sign and return this form to the Company’s General Counsel.

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EX-21.1

EXHIBIT 21.1

SUBSIDIARIES OF THE REGISTRANT

The registrant has the following subsidiaries, which except as indicated, do business under their legal names:

NAME	PLACE OF INCORPORATION/ORGANIZATION
DOCTORS PRACTICE MANAGEMENT, INC.	TEXAS
VISTA HEALTHCARE, INC.	TEXAS
VISTA LAND AND EQUIPMENT, L.L.C.	TEXAS
VISTA REDSTONE, INC.	NEVADA
PASADENA NEVADA, INC.	NEVADA
DPM II, INC.	TEXAS
DALLAS NEVADA, INC.	NEVADA
VISTA DALLAS, L.L.C.	TEXAS
VISTA HOSPITAL OF BATON ROUGE, L.L.C. d/b/a VISTA SURGICAL HOSPITAL OF BATON ROUGE	LOUISIANA
VISTA HOLDINGS, L.L.C.	LOUISIANA
AMBULATORY INFUSION THERAPY SPECIALIST, INC.	TEXAS
VISTA MEDICAL MANAGEMENT, L.L.C.	LOUISIANA
VISTA HOSPITAL OF DALLAS, L.P. d/b/a VISTA HOSPITAL OF DALLAS	TEXAS
VISTA SURGICAL CENTER WEST, L.L.C.	TEXAS
VISTA RIVERSTONE HOSPITAL, L.P. d/b/a RIVERSTONE HOSPITAL	TEXAS
VISTA COMMUNITY MEDICAL CENTER, L.L.P. d/b/a VISTA MEDICAL CENTER HOSPITAL	TEXAS

EX-23.1

EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statement No. 333-72756 of Dynacq Healthcare, Inc. of our report dated June 18, 2004, with respect to the consolidated financial statements and schedule of Dynacq Healthcare, Inc. included in this Annual Report (Form 10-K) for the year ended August 31, 2003.

/s/ Killman, Murrell & Co., P.C.

Killman, Murrell & Co., P.C.

Houston, Texas

July 30, 2004

EX-31.1

EXHIBIT 31.1

CERTIFICATION

I, Chiu M. Chan, certify that:

1. I have reviewed this Annual Report on Form 10-K of Dynacq Healthcare, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: July 30, 2004

	/s/    CHIU M. CHAN
Name:	Chiu M. Chan
Title:	President (Chief Executive Officer)

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Philip S. Chan, certify that:

1. I have reviewed this Annual Report on Form 10-K of Dynacq Healthcare, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: July 30, 2004

/s/ Philip S. Chan
Name:	Philip S. Chan
Title:	Vice President – Finance, CFO and Treasurer

EX-32.1

Exhibit 32.1

Certification Pursuant to

18 U.S.C. Section 1350,

As Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Annual Report of Dynacq Healthcare, Inc. (the “Company”) on Form 10-K for the period ending August 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Chiu M. Chan, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Dated: July 30, 2004

/s/    CHIU M. CHAN        

Chiu M. Chan

President and Chief Executive Officer

Dynacq Healthcare, Inc.

EX-32.2

Exhibit 32.2

Certification Pursuant to

18 U.S.C. Section 1350,

As Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Annual Report of Dynacq Healthcare, Inc. (the “Company”) on Form 10-K for the period ending August 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Philip S. Chan, Vice President – Finance and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Dated: July 30, 2004

/s/    PHILIP S. CHAN        

Philip S. Chan

Vice President - Finance and Chief Financial Officer

Dynacq Healthcare, Inc.

EX-99.1

Exhibit 99.1

AUDIT COMMITTEE CHARTER

OF

DYNACQ HEALTHCARE, INC.

(as amended, restated, and adopted by the Board of Directors

on January 9, 2004)

I. Composition of the Committee:

The Audit Committee (the “Committee”) of the Board of Directors (the “Board”) of Dynacq Healthcare, Inc. (hereinafter referred to as the “Company”) shall be comprised of at least three directors, each of whom is (i) “independent” under the rules of the Nasdaq Stock Market, Inc. and the Sarbanes-Oxley Act of 2002 (the “2002 Act”), (ii) does not accept any consulting, advisory or other compensatory fee from the issuer other than in his or her capacity as a member of the Board or any committee of the Board, (iii) is not an “affiliate” of the Company or any subsidiary of the Company, as such term is defined by the Securities and Exchange Commission (the “SEC”) in its rules pursuant to Section 301 of the 2002 Act, and (iv) does not own or control 20% or more of the Company’s voting securities, or such lower measurement as may be established by the SEC. All members of the Committee must be able to read and understand fundamental financial statements, including a company’s balance sheet, income statement, and cash flow statement, and within the time period set forth by Nasdaq, the Committee shall have at least one member who has past employment experience in finance or accounting, requisite professional certification in accounting, or other comparable experience or background which results in the member’s financial sophistication.

No director may serve as a member of the Committee if such director serves on the audit committees of more than two other public companies unless the Board of Directors determines that such simultaneous service would not impair the ability of such director to effectively serve on the Committee, and discloses this determination in the Company’s annual proxy statement. No member of the Committee may receive, directly or indirectly, any consulting, advisory, or other compensatory fee from the Company other than (i) director’s fees; (ii) a pension or other deferred compensation for prior service that is not contingent on future service; and (iii) any other regular benefits that other directors receive.

Members shall be appointed by the Board and shall serve at the pleasure of the Board and for such term or terms as the Board may determine.

The Audit Committee shall designate one member of the Audit Committee as its chairperson. In the event of a tie vote on any issue, the chairperson’s vote shall decide the issue.

II Purposes of the Committee:

The purposes of the Committee are to:

1. Assist Board oversight of (i) the integrity of the Company’s financial statements, (ii) the Company’s compliance with legal and regulatory requirements, (iii) the independent auditors’ qualifications and independence, and (iv) the performance of the independent auditors and the Company’s internal audit function;

2. prepare the report required to be prepared by the Committee pursuant to the rules of the SEC for inclusion in the Company’s annual proxy statement; and

3. oversee the accounting and financial reporting processes of the Company and the audits of the financial statements of the Company.

The function of the Committee is oversight. The management of the Company is responsible for the preparation, presentation and integrity of the Company’s financial statements. Management and the internal auditing department are responsible for maintaining appropriate accounting and financial reporting principles and policies and internal controls and procedures that provide for compliance with accounting standards and applicable laws and regulations. The independent auditors are responsible for planning and carrying out a proper audit of the Company’s annual financial statements, reviews of the Company’s quarterly financial statements prior to the filing of each quarterly report on Form 10-Q, and other procedures. In fulfilling their responsibilities hereunder, it is recognized that members of the Committee are not full-time employees of the Company and are not, and do not represent themselves to be, performing the functions of auditors or accountants. As such, it is not the duty or responsibility of the Committee or its members to conduct “field work” or other types of auditing or accounting reviews or procedures or to set auditor independence standards.

The independent auditors for the Company are accountable to the Committee, as representatives of the stockholders. The Committee is directly responsible for the appointment, compensation and oversight of the work of the independent auditors (including resolving disagreements between management and the independent auditors regarding financial reporting). The Committee has the authority and responsibility to appoint, retain and terminate the Company’s independent auditors subject, to stockholder ratification. The Company’s independent auditors shall report directly to the Committee.

The independent auditors shall submit to the Committee annually a formal written statement (the “Auditors’ Statement”) describing: the auditors’ internal quality-control procedures; any material issues raised by the most recent internal quality-control review or peer review of the auditors, or by any inquiry or investigation by governmental or professional authorities, within the preceding five years, respecting one or more independent audits carried out by the auditors, and any steps taken to deal with any such issues; and (to assess the auditors’ independence) all relationships between the independent auditors and the Company, including each non-audit service provided to the Company and at least the matters set forth in Independence Standards Board No. 1.

The independent auditors shall submit to the Committee annually a formal written statement of the fees billed in each of the last two fiscal years for each of the following categories of services rendered by the independent auditors: (i) the audit of the Company’s annual financial statements and the reviews of the financial statements included in the Company’s Quarterly Reports on Form 10-Q or services that are normally provided by the independent auditors in connection with statutory and regulatory filings or engagements; (ii) assurance and related services, not included in clause (i) that are reasonably related to the performance of the audit or review of the Company’s financial statements, in the aggregate and by each service; (iii) tax compliance, tax advice and tax planning services, in the aggregate and by each service; and (iv) all other products and services rendered by the independent auditors, in the aggregate and by each service.

III. Meetings of the Committee:

The Committee shall meet once every fiscal quarter, or more frequently if circumstances dictate, to discuss with management the annual audited financial statements and quarterly financial statements, as applicable. The Committee should meet separately at least quarterly with management, the director of the internal auditing department and the independent auditors to discuss any matters that the Committee or any of these persons or firms believe should be discussed privately. The Committee may request any officer or employee of the Company or the Company’s outside counsel or independent auditors to attend a meeting of the Committee or to meet with any members of, or consultants to, the Committee. The Committee shall meet in executive session at least twice a year, and more frequently as necessary or appropriate, in conjunction with regularly scheduled meetings of the Board at regularly scheduled times and places determined by the Committee chairperson. Members of the Committee may participate in a meeting of the Committee by means of conference call or similar communications equipment by means of which all persons participating in the meeting can hear each other.

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IV. Duties and Powers of the Committee:

To carry out its purposes, the Committee shall have the following duties and powers:

1. with respect to the independent auditors,

(i) to appoint, retain and terminate the independent auditors, subject to stockholder ratification, including sole authority to approve all audit engagement fees and terms;

(ii) to pre-approve, or to adopt appropriate procedures to pre-approve, all audit and non-audit services to be provided by the independent auditors, and to consider whether the outside auditors’ provision of non-audit services to the Company is compatible with maintaining the independence of the outside auditors;

(iii) to ensure that the independent auditors prepare and deliver annually an Auditors’ Statement (it being understood that the independent auditors are responsible for the accuracy and completeness of this Statement), and to discuss with the independent auditors any relationships or services disclosed in this Statement that may impact the quality of audit services or the objectivity and independence of the Company’s independent auditors;

(iv) to obtain from the independent auditors in connection with any audit, prior to the filing of the Company’s audit report with the SEC, a report relating to the Company’s annual audited financial statements describing all critical accounting policies and practices used, all alternative treatments of financial information within generally accepted accounting principles for policies and practices related to material items that have been discussed with management, ramifications of the use of such alternative disclosures and treatments, and the treatment preferred by the independent auditors, and any material written communications between the independent auditors and management, such as any “management” letter or schedule of unadjusted differences;

(v) to review and evaluate the qualifications, performance and independence of the lead partner of the independent auditors;

(vi) to discuss with management the timing and process for implementing the rotation of the lead audit partner, the concurring partner and any other active audit engagement team partner and consider whether there should be a regular rotation of the audit firm itself;

(vii) to take into account the opinions of management and the Company’s internal auditors in assessing the independent auditors’ qualifications, performance and independence;

(viii) to instruct the independent auditors that the independent auditors are ultimately accountable to the Committee, as representatives of the stockholders; and

(ix) to review and approve all related party transactions of the Company.

2. with respect to the internal auditing department,

(i) to review the appointment and replacement of the director of the internal auditing department; and

(ii) to advise the director of the internal auditing department that he or she is expected to provide to the Committee summaries of and, as appropriate, the significant reports to management prepared by the internal auditing department and management’s responses thereto;

3. with respect to financial reporting principles and policies and internal audit controls and procedures,

(i) to advise management, the internal auditing department and the independent auditors that they are expected to provide to the Committee a timely analysis of significant financial reporting issues and practices;

(ii) to consider any reports or communications (and management’s and/or the internal audit department’s responses thereto) submitted to the Committee by the independent auditors required by or referred to in SAS 61 (as codified by AU Section 380), as it may be modified or supplemented, including reports and communications related to:

• deficiencies noted in the audit in the design or operation of internal controls;

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• consideration of fraud in a financial statement audit;

• detection of illegal acts;

• the independent auditors’ responsibility under generally accepted auditing standards;

• any restriction on audit scope;

• significant accounting policies;

• significant issues discussed with the national office respecting auditing or accounting issues presented by the engagement;

• management judgments and accounting estimates;

• any accounting adjustments arising from the audit that were noted or proposed by the auditors but were passed (as immaterial or otherwise);

• the responsibility of the independent auditors for other information in documents containing audited financial statements;

• disagreements with management;

• consultation by management with other accountants;

• major issues discussed with management prior to retention of the independent auditors;

• difficulties encountered with management in performing the audit;

• the independent auditors’ judgments about the quality of the entity’s accounting principles;

• reviews of interim financial information conducted by the independent auditors; and

• the responsibilities, budget and staffing of the Company’s internal audit function;

(iii) to meet with management, the independent auditors and, if appropriate, the director of the internal auditing department:

• to discuss the scope of the annual audit;

• to discuss the annual audited financial statements and quarterly financial statements, including the Company’s disclosures under “Management’s Discussion and Analysis of Financial Condition and Results of Operations”;

• to discuss any significant matters arising from any audit, including any audit problems or difficulties, whether raised by management, the internal auditing department or the independent auditors, relating to the Company’s financial statements;

• to discuss any difficulties the independent auditors encountered in the course of the audit, including any restrictions on their activities or access to requested information and any significant disagreements with management;

• to discuss any “management” or “internal control” letter issued, or proposed to be issued, by the independent auditors to the Company;

• to review the form of opinion the independent auditors propose to render to the Board of Directors and stockholders; and

• to discuss, as appropriate: (a) any major issues regarding accounting principles and financial statement presentations, including any significant changes in the Company’s selection or application of accounting principles, and major issues as to the adequacy of the Company’s internal controls and any special audit steps adopted in light of material control deficiencies; (b) analyses prepared by management and/or the independent auditors setting forth significant financial reporting issues and judgments made in connection with the preparation of the financial statements, including analyses of the effects of alternative GAAP methods on the financial statements; and (c) the effect of

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regulatory and accounting initiatives, as well as off-balance sheet structures, on the financial statements of the Company;

(iv) to inquire of the Company’s chief executive officer and chief financial officer as to the existence of any significant deficiencies in the design or operation of internal controls that could adversely affect the Company’s ability to record, process, summarize and report financial data, any material weaknesses in internal controls, and any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internal controls;

(v) to discuss guidelines and policies governing the process by which senior management of the Company and the relevant departments of the Company assess and manage the Company’s exposure to risk, and to discuss the Company’s major financial risk exposures and the steps management has taken to monitor and control such exposures;

(vi) to obtain from the independent auditors assurance that the audit was conducted in a manner consistent with Section 10A of the Securities Exchange Act of 1934, as amended, which sets forth certain procedures to be followed in any audit of financial statements required under the Securities Exchange Act of 1934;

(vii) to discuss with the Company’s General Counsel any significant legal, compliance or regulatory matters that may have a material effect on the financial statements or the Company’s business, financial statements or compliance policies, including material notices to or inquiries received from governmental agencies;

(viii) to discuss earnings press releases;

(ix) to discuss the types of financial information and earnings guidance provided, and the types of presentations made, to analysts and rating agencies;

(x) to establish procedures for the receipt, retention and treatment of complaints received by the Company regarding accounting, internal accounting controls or auditing matters, and for the confidential, anonymous submission by Company employees of concerns regarding questionable accounting or auditing matters;

(xi) to establish hiring policies for employees or former employees of the independent auditors; and

(xii) to review and approve related party transactions of the Company where appropriate.

4. with respect to reporting and recommendations,

(i) to prepare any report or other disclosures, including any recommendation of the Committee, required by the rules of the SEC to be included in the Company’s annual proxy statement;

(ii) to review and reassess the adequacy of this Charter at least annually and recommend any changes to the full Board;

(iii) to report its activities to the full Board on a regular basis and to make such recommendations with respect to the above and other matters as the Committee may deem necessary or appropriate; and

(iv) to prepare and review with the Board an annual performance evaluation of the Committee, which evaluation must compare the performance of the Committee with the requirements of this charter. The performance evaluation by the Committee shall be conducted in such manner as the Committee deems appropriate. The report to the Board may take the form of an oral report by the chairperson of the Committee or any other member of the Committee designated by the Committee to make this report.

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V. Delegation to Subcommittee:

The Committee may, in its discretion, delegate all or a portion of its duties and responsibilities to a subcommittee of the Committee. The Committee may, in its discretion, delegate to one or more of its members the authority to pre-approve any audit or non-audit services to be performed by the independent auditors, provided that any such approvals are presented to the Committee at its next scheduled meeting.

VI. Resources and Authority of the Committee:

The Committee shall have the resources and authority appropriate to discharge its duties and responsibilities, including the authority to select, retain, terminate, and approve the fees and other retention terms of special or independent counsel, accountants or other experts and advisors, as it deems necessary or appropriate, without seeking approval of the Board or management.

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