10-K

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

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

For the fiscal year ended August 31, 2008

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

For the transition period from                      to                     

Commission file number: 000-21574

DYNACQ HEALTHCARE, INC.

(Exact name of registrant as specified in its charter)

Nevada	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 Offices)	(Zip Code)

Registrant’s telephone number, including area code: (713) 378-2000

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

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

Title of each class	Name of each exchange on which registered
Common Stock, $0.001 Par Value	NASDAQ

Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements 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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. (Check One):

Large accelerated filer  ¨  Accelerated filer  ¨  Non-accelerated filer  ¨  Smaller reporting company  x

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

The aggregate market value of voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of February 29, 2008 was $34,775,202. As of October 31, 2008, the registrant had 15,555,731 shares of common stock outstanding.

TABLE OF CONTENTS

		Page
PART I
Item 1.	Business.	1
Item 1A.	Risk Factors.	15
Item 1B.	Unresolved Staff Comments	20
Item 2.	Properties.	20
Item 3.	Legal Proceedings.	21
Item 4.	Submission of Matters to a Vote of Security Holders.	21
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	21
Item 6.	Selected Financial Data.	22
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	22
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk.	32
Item 8.	Financial Statements and Supplementary Data.	32
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	58
Item 9A(T).	Controls and Procedures.	58
Item 9B.	Other Information.	59
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	59
Item 11.	Executive Compensation.	59
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.	59
Item 13.	Certain Relationships and Related Transactions and Director Independence	59
Item 14.	Principal Accounting Fees and Services.	59
PART IV
Item 15.	Exhibits, Financial Statement Schedules.	59

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PART I

This annual report on Form 10-K contains forward-looking statements regarding future events and our future financial performance. Words such as “expects,” “intends,” “forecasts,” “projects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” and similar expressions identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act. All forward-looking statements are based on our current beliefs as well as assumptions made by and information currently available to us. These statements reflect our current views with respect to future events. Important factors that could cause actual results to materially differ from our current expectations include the risks and uncertainties described in Item 1A. Risk Factors below. Please read the following discussion of the results of our business and our operations and financial condition and the risk factors along with our consolidated financial statements, including the notes, included in this annual report on Form 10-K.

Item 1. Business.

General

Dynacq Healthcare, Inc., a Nevada corporation, is a holding company that through its subsidiaries develops and manages general acute care hospitals that principally provide specialized surgeries. We are composed of two divisions, based on our geographic area of operations – U.S. and China.

U.S. Division

The Company’s business strategy is to develop and operate general acute care hospitals designed to handle specialized surgeries such as bariatric, orthopedic and neuro-spine surgeries. Certain of the Company’s facilities also provide plastic surgery, podiatry, gynecology, spine, sleep laboratory and pain management services, as well as minor emergency treatment services. The Company’s hospitals include operating rooms, pre- and post-operative space, intensive care units, nursing units and diagnostic facilities, as well as adjacent medical office buildings that lease space to physicians and other healthcare providers. These hospitals are the Surgery Specialty Hospitals of America – Southeast Houston Campus (formerly Vista Medical Center Hospital) in Pasadena, Texas, near Houston (the “Pasadena facility”); Vista Hospital of Dallas (the “Garland facility”); and Vista Surgical Hospital of Baton Rouge (the “Baton Rouge facility”). During the fiscal year ended August 31, 2008 the Company sold the Baton Rouge facility and in 2007 the Company sold its outpatient surgery center, Vista Surgical Center West (the “West Houston facility”).

Except for emergency room patients, surgeries at our facilities are typically pre-certified or pre-authorized 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. The Company participates in a small number of managed care contracts.

The Company, through its affiliates, owns or leases 100% of the real estate for and equipment in its facilities. The Company maintains a majority ownership and controlling interest in all of its operating entities. As of August 31, 2008, the Company owned the following percentages of its operating entities:

Pasadena facility	99.9	%
Garland facility	100	%

China Division

The Company has sought to expand its operations into China not only to achieve geographic diversity but also to allow the Company to improve its profitability by taking advantage of a high growth market in the provision of healthcare services in that country. Foreign participation in the provision of healthcare services in China is relatively new, and Dynacq believes it is uniquely qualified to become a significant player in that area. Currently many areas of China lack the level of acute care provided by many hospitals in the U.S. Dynacq believes its experience managing U.S. hospitals will enable it to improve the management of existing primary care hospitals in China as well as develop specialized facilities offering advanced levels of treatment, while achieving an attractive

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return on its investment.

Many hospitals in China are government owned, but may be managed by nongovernmental entities with the consent of the local healthcare governmental authority. In a typical management contract, Dynacq would assume responsibility for the operations of the hospital and receive any profits earned or losses incurred from its operations. Although many local hospitals in China are currently not profitable, the Company believes that its experience in providing quality healthcare management and its ability to implement internal controls in healthcare administration will enable it to be profitable in its management of hospitals in China. The management arrangement also allows Dynacq to minimize its expenditure of capital to purchase assets, but still have the potential for an attractive return in its efficient management of the hospital facility.

The Company currently owns 100% of Dynacq Huai Bei Healthcare, Inc. (“Dynacq-Huai Bei”), a Chinese corporation formed to provide healthcare management services in China. On May 30, 2008, Dynacq-Huai Bei entered into a Management Agreement with the Rui An City Department of Health to manage the Rui An Hospital in Rui An, China upon completion of its construction in October 2009. The Company is currently overseeing the construction of this hospital.

For financial information for each of our segments, including information regarding revenues and total assets, see “Note 15—Industry Segments and Geographic Information” contained in the Notes to Consolidated Financial Statements.

The Company was incorporated in Nevada in February 1992. In November 2003, the Company reincorporated in Delaware and changed its name from Dynacq International, Inc. to Dynacq Healthcare, Inc. In August, 2007, the Company reincorporated back in Nevada. The terms “Company,” “Dynacq,” “our” or “we” are used herein to 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 general or limited partners or members.

Recent Developments

Texas Workers’ Compensation Cases

A significant amount of our net revenue results from Texas workers’ compensation claims, which are governed by the rules and regulations of the Texas Department of Workers’ Compensation (“TDWC”) and the workers’ compensation healthcare networks. If one of our hospitals chooses to participate in a network, the amount of revenue that will be generated from workers’ compensation claims will be governed by the network contract.

For claims arising prior to the implementation of workers’ compensation networks and out of network claims, inpatient and outpatient surgical services are either reimbursed pursuant to the Acute Care In-Patient Hospital Fee Guideline or at a “fair and reasonable” rate for services in which the fee guideline is not applicable. Starting March 1, 2008, the Texas Workers’ Compensation 2008 Acute Care Hospital Outpatient and Inpatient Facility Fee Guidelines (the “Guidelines”) became effective. Under these Guidelines, the reimbursement amounts are determined by applying the most recently adopted and effective Medicare reimbursement formula and factors; however, if the maximum allowable reimbursement for the procedure performed cannot be calculated using these Guidelines, then reimbursement is determined on a fair and reasonable basis.

Based on these new Guidelines, the reimbursement due the Company for workers’ compensation cases is lower than we previously experienced. The Company has continued accepting Texas workers’ compensation cases, and has not made any substantial changes in its focus towards such cases. Our net patient service revenue for Texas workers’ compensation cases as a percentage of gross billings has decreased primarily as a result of lower reimbursement rates for workers’ compensation procedures still being performed.

Should our facility disagree with the amount of reimbursement provided by a third-party payer, we are required to pursue the MDR process at the TDWC to request proper reimbursement for services. The Company has recently been successful in its pursuit of collections regarding the stop-loss cases pending before the State Office of Administrative Hearings (“SOAH”), receiving positive rulings in over 90% of its claims presented for administrative

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determination. The 2007 district court decision upholding our interpretation of the statute as applied to the stop-loss claims was recently appealed by certain insurance carriers, and the Third Court of Appeals determined that in order for a hospital to be reimbursed at 75% of its usual and customary audited charges for an inpatient admission, the hospital must not only bill at least $40,000, but also show that the admission involved unusually costly and unusually extensive services. Procedurally, the decision means that each case where a carrier raised an issue regarding whether the services provided were unusually costly or unusually extensive would be remanded to either SOAH or Medical Dispute Resolution (“MDR”) for a case-by-case determination of whether the services provided meet these standards, once the definitions of those standards are determined. We plan to appeal the Third Court of Appeals decision and anticipate further, lengthy litigation at the Travis County District Courts and the Texas Courts of Appeals to establish the legal definition for these standards. Because of this lengthy process and the uncertainty of recovery in these cases, collection of a material amount of funds in these pending stop-loss cases is not anticipated during the 2009 fiscal year.

To date, insurance carriers have voluntarily paid the awards in the decisions and orders issued by SOAH, plus interest, in approximately 180 cases, involving approximately $11 million. In most of these cases, the carriers have requested refunds of the payments made in the event that the SOAH decisions and orders are reversed on appeal. We believe the Company’s ultimate obligation to refund the payments is remote. Our request that the TDWC Commissioner enforce the awards which have not been voluntarily paid by the carriers has been refused in approximately 130 cases.

Claims regarding payment for hospital outpatient services remain pending at the TDWC. It is expected that these claims will be adjudicated at SOAH and ultimately in the Texas district and appellate courts. The basis for reimbursement for these services made the subject of these pending cases is the determination of “fair and reasonable” charges. In 2007, we received unfavorable rulings from SOAH in all of our appeals of unfavorable decisions related to services provided in 2001 and 2002. The 179 cases which have been appealed to the Travis County district courts challenge the constitutionality of the relevant statutory language. A lead case has been selected and is scheduled to be heard on January 14, 2009. Although we would appeal any negative ruling handed down in this lead case, such ruling will impact cases in which a fee guideline was not applicable, specifically all pending cases involving ambulatory surgical services provided in 2001 and 2002 as well as all pending cases involving hospital outpatient services provided prior to March 1, 2008. Successful collection of material amounts in these cases is unlikely.

We are currently pursuing claims against two healthcare agents relating to contracts with certain of our facilities which set out reimbursement guidelines by several workers’ compensation carriers at a minimum of 70% of the facility’s charges. Discovery is continuing on these claims to determine which carriers are involved and the amount of reimbursement due to us.

Due to the uncertainties regarding the accounts receivable in the MDR process, the recent Third Court of Appeals’ opinion and our legal counsel’s advice that settlements with insurance carriers have virtually stopped, the Company has fully reserved all accounts receivable related to the MDR process as of August 31, 2008.

Transactions in China

The DeAn Joint Venture (“DeAn”), which was formed for the purpose of constructing, owning and operating a hospital in Shanghai, China, had entered into land use agreements with the Chinese government under which it leased, for a term of 50 years, approximately 28.88 acres of government-owned land on which the hospital would be constructed. After protracted negotiations with the Chinese government for, among other matters, the payment by the government of the amounts due by it under the Joint Venture Agreement which it had not funded, the sale by the government of its interest in DeAn to a third party, and the extension of the dates for completion of construction of the hospital, the Company agreed to sell its interest in the property owned by DeAn for the construction of the hospital for approximately $4.3 million U.S., net of commissions. Proceeds of the sale were received on July 14, 2008. The Company expects to dissolve DeAn.

Dynacq-Huai Bei was organized to provide healthcare management services in China and is a party to the Management Agreement for the Rui An Hospital. It is currently overseeing the construction of the new hospital to open in October 2009. Upon completion of the new hospital, Dynacq-Huai Bei will manage the facility, and all

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profits, liabilities, operating deficits, and legal disputes of the hospital will be assumed by Dynacq-Huai Bei. Dynacq-Huai Bei has agreed to assume and discharge within ten years $883,000 of existing liabilities, of which $736,000 has already been paid in fiscal year ended August 31, 2008, and to loan to Rui An $2.1 million for the construction costs of the hospital building and up to $730,000 for equipment purchases. At the expiration of the 15 year term, Dynacq-Huai Bei will be compensated for the increase in value of the hospital assets and for the purchase at fair value of all equipment and medical supplies bought by it costing less than $7,267 each. As of the date of this filing, Dynacq has funded Dynacq-Huai Bei with approximately $14 million U.S.

The Company has also organized Sino Bond Inc. Limited, a Hong Kong corporation (“Sino Bond”), through which it has made approximately $23 million in various investments in Hong Kong. Sino Bond has no operations to date but has entered into a marketing contract for the provision of healthcare services by Dynacq subsidiaries in China and Southeast Asia.

Sale of Properties

The Company sold its land in The Woodlands, Texas, its Baton Rouge facility and its interest in the property owned by DeAn for the construction of a hospital in China in the fiscal year ended August 31, 2008.

Industry Background

U.S. Division

The development of proprietary general acute care hospital networks occurred during the 1970’s. During the past 20 years, freestanding outpatient surgery centers were developed to compete with these general hospitals for outpatient procedures. Freestanding outpatient surgery centers have allowed physicians to perform outpatient procedures in specialized facilities designed to improve efficiency and enhance patient care. The Company believes that its operational model allows physicians to perform inpatient and outpatient procedures at facilities that provide similar efficiencies as those provided at freestanding outpatient surgery centers.

General acute care 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 efficiency available through block time/scheduling. Given the opportunity to utilize multiple operating rooms for pre-determined periods of time, the physicians are able to schedule their time more efficiently and, therefore, increase the number of procedures 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 physicians prefer to perform procedures 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.

At August 31, 2008, the Company owned, through its subsidiaries, a 99.9% partnership interest in the Pasadena facility operating entity. The Pasadena facility’s areas of practice include orthopedic and general surgery, such as spine and bariatric surgeries, various pain management modalities and other services. The Pasadena facility represented approximately 39% and 38% of the Company’s net patient revenues in fiscal years 2008 and 2007, respectively. 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 hospital operating entity.

As of August 31, 2008, the Company owned, through its subsidiaries, 100% of the partnership interests in the Garland facility operating entity. The areas of practice performed at this facility are orthopedic surgery, bariatric surgery, general surgery, plastic surgery, podiatry, gynecology, spine and pain management procedures. The Garland facility represented approximately 61% and 62% of the Company’s net patient revenues in fiscal years 2008 and 2007, respectively. 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 hospital operating entity.

The facility located in Baton Rouge, Louisiana was 100% owned by the Company until its sale in December 2007. The West Houston facility was sold during the fiscal year 2007.

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China Division

DeAn, which was formed for the purpose of constructing, owning and operating a hospital in Shanghai, China, had entered into land use agreements with the Chinese government under which it leased, for a term of 50 years, approximately 28.88 acres of government-owned land on which the hospital would be constructed. After protracted negotiations with the Chinese government for, among other matters, the payment by the government of the amounts due by it under the Joint Venture Agreement which it had not funded, the sale by the government of its interest in DeAn to a third party, and the extension of the dates for completion of construction of the hospital, the Company agreed to sell its interest in the property owned by DeAn for the construction of the hospital for approximately $4.3 million U.S., net of commissions. Proceeds of the sale were received on July 14, 2008, and the Company intends to dissolve DeAn.

On May 30, 2008, Dynacq-Huai Bei entered into a Management Agreement with the Rui An City Department of Health to manage the Rui An Hospital in Rui An, China upon completion of its construction in October 2009. The Company is currently overseeing the construction of this hospital.

As of the date of this filing, Dynacq has funded the China Division with approximately $37 million.

Business Growth Strategy

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

• Creating and maintaining relationships with quality physicians;

• Attracting and retaining key management, marketing and operating personnel;

• 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 for its current surgical mix as well as additional types of services;

• Adding new capabilities to its existing hospital campuses; and

• Developing the China Division.

Creating and Maintaining Relationships with Quality Physicians

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 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, as well as to expand the surgical case mix. 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 qualified physicians. Attracting and retaining the appropriate personnel at all levels within the organization, including senior executives at the corporate level, are also important goals of management and essential in expanding our operations.

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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 focus attention on providing physicians with quality facilities designed to improve the physicians’ and their patients’ satisfaction.

Adding 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 surgical equipment. The Company continues to explore the possibility of adding other types of surgical procedures that fit into our business model.

Developing the China Division

In China, gaining the confidence of the current hospital administrators and members of the local healthcare governing authority will be key to acquiring new management agreements on hospitals. We intend to create and maintain quality relationships with such personnel to expand our operations in that country. We believe the employee we have hired to head our China Division is uniquely positioned to enter into additional management agreements with local healthcare governing authorities in China similar to our arrangement with the Rui An Hospital.

Marketing

U.S. Division

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 orthopedic and/or bariatric patients in areas serviced by the Pasadena and/or Garland facilities. These facilities receive orthopedic and bariatric referrals from other sources, and such organizations also refer clients to other area hospitals.

In addition to our arrangements with outside organizations regarding marketing, new bariatric or weight control programs were implemented at the Pasadena facility in the first quarter of fiscal 2006 and at the Garland facility in the second quarter of fiscal 2006, to replace the former bariatric programs at those facilities and to reduce costs associated with outside vendor programs. Our programs provide or contract for marketing, pre-authorization and follow up support services to prospective bariatric patients in areas serviced by the Pasadena or Garland facilities. Each of our Pasadena and Garland facilities was designated as a Bariatric Center of Excellence by the American Society for Bariatric Surgery (ASBS) in June 2007 and August 2008, respectively. The ASBS Center of Excellence designation recognizes surgical programs and surgeons who have demonstrated a track record of favorable short and long-term outcomes in bariatric surgery and have the resources to perform safe bariatric surgeries.

China Division

A three-year management support and marketing agreement was executed effective October 1, 2008 between Sino Bond, Inc. Ltd., the Company’s Hong Kong subsidiary and Otto Regent Ltd., a Hong Kong marketing company to develop strategies to lead the Company’s marketing activities in China including but not limited to recruitment of physicians, multi-media advertising and enhancing the reputation of the Company’s healthcare services.

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Competition

U.S. Division

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

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, reputation, relationships with physicians and other medical providers, as well as 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 compete successfully in these markets.

China Division

Most hospitals in China are owned and operated by the local governments subject to the oversight by the central government. The Company’s strategy is to minimize its capital investment by entering into long term mutually beneficial relationships by utilizing space from existing government hospitals and providing specialty medical treatment therapies that the government owned hospitals are lacking and are in high demand. There currently exist joint venture arrangements between foreign healthcare providers and government owned hospitals, principally in major cities such as Shanghai and Beijing. Some of these competitors have greater financial and other resources than the Company in China. The Company has no prior experience of operating hospitals and can provide no assurance that it will be able to compete successfully in China.

Government Regulation

U.S. Division

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, as well as patient confidentiality requirements. There are also extensive regulations governing a hospital’s participation in government programs and payment for services provided to program beneficiaries. These laws and regulations are extremely complex and, in many instances, the industry does not have the benefit of significant regulatory or judicial interpretation. Some of the laws applicable to us are subject to limited or evolving interpretations; therefore, a review of our operations by a court or law enforcement or regulatory authority may result in a determination that could have a material adverse effect on us. Furthermore, the laws applicable to us may be amended or interpreted in a manner that could have a material adverse effect on us.

We believe that our facilities are in substantial compliance with current applicable federal, state and local regulations and standards. 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 facilities 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

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facilities, equipment, personnel and services so that our facilities remain licensed and qualified to participate in these programs. One or more of these outcomes could be material to our operations.

Texas Workers’ Compensation Systems

A significant amount of our net revenue results from Texas workers’ compensation claims. As such, we are subject to the rules and regulations of the TDWC. See discussion above under Recent Developments.

Licensure, Certification and Accreditation

Our healthcare facilities are subject to state and local licensing regulations ranging from the adequacy of medical care to compliance with building codes and environmental protection laws. The failure to comply with these regulations could result in the suspension or revocation of a healthcare facility’s license. To assure continued compliance with these regulations, our facilities are subject to periodic inspection by governmental and other authorities. 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 (“DHHS”) 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. 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.

We believe that our hospitals are in substantial compliance with current applicable federal, state and local regulations and standards. However, the requirements for licensure and certification are subject to change. Effective August 2008, the Texas licensing rules for hospitals underwent significant revisions. Consequently, in order for our hospitals to remain licensed and certified, it may be necessary from time to time for us to make material changes in our facilities, equipment, personnel and/or services. Additionally, the revisions to the Texas hospital licensing rules may have an impact on any future expansions or renovations to our healthcare facilities in that state.

Professional Licensure

Healthcare professionals at our facilities 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 with their respective licensing agency. We believe that our employees and agents as well as all independent physicians on staff comply with all applicable state licensure laws.

Corporate Practice of Medicine and Fee-splitting

Some states, such as 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 structured 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 the 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 also may be interpreted by courts in a manner inconsistent with our interpretations. The Texas legislature is currently holding committee hearings to identify possible changes to the state’s corporate practice of medicine laws.

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Medicare Reimbursement

On August 22, 2007, the Centers for Medicare and Medicaid Services (“CMS”) posted its final rule of inpatient hospital payment reforms which excluded payment for several hospital-acquired conditions (“HACs”) if any of them occurred during a Medicare beneficiary’s inpatient stay. These initial HACs were discussed, revised and ultimately finalized in the August 19, 2008, final rule for the 2009 Inpatient Prospective Payment System (“IPPS”) payment year. These exclusions were effective for discharges beginning on October 1, 2008. Under the rule, CMS no longer reimburses hospitals for the treatment of certain “conditions that could reasonably have been prevented.” The conditions for which CMS no longer reimburses hospitals for treatment include falls; mediastinitis, an infection that can develop after heart surgery; urinary tract infections that result from improper use of catheters; pressure ulcers; and vascular infections that result from improper use of catheters. Additionally, the conditions include the following three “never events”: objects left in the body during surgery, air embolisms and blood incompatibility. Various insurance companies have also announced plans to stop paying for “serious preventable errors.” The new CMS and insurance company policies could affect not only reimbursement but evidence in malpractice suits and potential claims under the False Claims Act. However, given the recent enactment of these changes, it is not possible to accurately assess what effect, if any, they might have on our operations.

Federal Anti-kickback Statute

The Medicaid/Medicare 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. A violation of the Anti-kickback Statute constitutes a felony and 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 DHHS (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. 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 determination as to compliance with the Anti-kickback statute outside of a safe harbor rests on the particular facts and circumstances and on the parties’ intent in entering into the transaction or arrangement.

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 when certain criteria are met. Two significant criteria for this safe harbor are (1) that no more than 40% of the value of the investment interests of each class of investments may be held in the previous fiscal year or previous twelve-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, and (2) that no more than 40% of the gross revenue of the entity in the previous fiscal year or previous twelve-month period may come from referrals or business otherwise generated from investors. In addition to promulgating safe harbor regulations, to further assist providers, the OIG has established a process to enable healthcare providers to request advisory opinions on whether individual transactions might violate the Anti-kickback and certain other statutes. The OIG also provides insight into its views on the application of the Anti-kickback

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Statute through various documents including Special Fraud Alerts, Special Advisory Bulletins, Medicare Fraud Alerts and Medicare Advisory Bulletins.

We have a variety of financial relationships with physicians who refer patients to our hospitals. Physicians may 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. Exclusion from these programs could result in significant reductions in revenue and could have a material adverse effect on our business.

Stark Law

The federal physician self-referral statute is commonly known as the Stark law. This law prohibits physicians from referring Medicare and Medicaid patients who need “designated health services” (“DHS”) to entities with which the physician or an immediate family member has a financial relationship and prohibits the entities from billing Medicare or Medicaid for services ordered pursuant to a prohibited referral. Stark does, however, have a number of exceptions that permit financial relationships between physicians and entities providing DHS. Sanctions for violating the Stark law include denial of payment, refunding amounts received for services provided pursuant to 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.

On September 5, 2007, CMS completed the third and final installment in its rulemaking process under the Stark law in an effort to provide the healthcare industry additional interpretation and modification of previously promulgated exceptions to the Stark law’s general prohibition on referrals. The new final rule is referred to as “Phase III” and addresses the entire Stark law regulatory scheme. The new regulations were effective December 4, 2007. Additionally, effective October 2, 2007, CMS issued a final rule to update the hospital IPPS for fiscal year 2008. Included in the final rule were two important disclosure provisions that apply to many hospitals. These two disclosure requirements relate to (1) disclosure of physician ownership of hospitals to all patients at the beginning of their hospital stay or outpatient visit, and (2) whether physicians are on site at the hospital 24 hours a day, 7 days a week. This rule also contains provisions for CMS to require 500 hospitals to furnish information concerning their financial relationships with their physicians on the Disclosure of Financial Relationship Report. Other provisions of the IPPS rule significantly modify the Stark regulations and some of these modifications will require physicians, hospitals, and other healthcare providers to unwind or restructure their arrangements. Most of these new Stark regulations are not effective until October 1, 2009, in order to give parties time to unwind or restructure arrangements which are impacted by the changes. There are several other significant rulemaking proposals, and pending legislation, any and all of which may lead to more changes to the Stark regulations and may have a profound impact on the healthcare industry in general and the operation of our healthcare facilities in particular.

One of the exceptions utilized to exempt hospital-provided DHS from the ownership proscription is commonly referred to as the “whole hospital exception.” This exception permits a physician with an ownership interest in a hospital to make referrals to that hospital provided that: (1) the referring physician is authorized to perform services at the hospital; and (2) the physician’s ownership or investment interest is in the entire hospital and not merely in a distinct part or department of the hospital. We believe we have structured our financial arrangements with physicians to comply with the whole hospital exception. However, in the recent past, legislation has been introduced that would have essentially eliminated the “whole hospital exceptions” under the Stark law and would have severely limited the ability of physicians to have ownership interests in hospitals. While the legislation was unsuccessful this time, we cannot predict whether other similar legislation will ever be adopted or enacted into law and how such legislation, if passed, would affect our healthcare facilities. However, it is possible that such legislation could require us to restructure our ownership arrangements with physician investors.

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The Stark law may 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 could 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 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 facilities are located.

Other Fraud and Abuse Provisions

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 lead to the recovery of at least $100 of Medicare funds. 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.

The Social Security Act also imposes criminal and civil penalties for making false claims and statements to Medicare and Medicaid programs. 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

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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. In its 2007 session, the Texas Legislature made numerous revisions to the state’s laws which make it easier and potentially more profitable for a whistleblower to maintain a “qui tam” action.

The regulations governing reimbursement under the Medicare and Medicaid programs are very complex. Third-party payers may also have complicated requirements that must be adhered to by healthcare providers. These rules are not always clear and may be subject to interpretation. It is necessary to ensure that claims submitted for reimbursement are accurately coded and completed. Failure to comply with these services and coding requirements can result in denials of payments or the recoupment of payments already received.

Health Information Security and Privacy Practices

The Administrative Simplification provisions of HIPAA require certain organizations, including us, to implement very significant business and operational systems designed to protect each patient’s individual healthcare information. Among the standards that the DHHS adopted pursuant to HIPAA are standards for the following:

• electronic transactions and code sets;

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

• security and electronic signatures;

• privacy; and

• enforcement.

Pursuant to HIPAA, we are obligated to appoint and have appointed privacy and security officers, analyzed our existing patient record confidentiality system, developed systems to meet the increased confidentiality requirements in the areas of both privacy and security, drafted and implemented policies and procedures to maintain those systems, trained all relevant personnel in the policies and procedures, monitored the systems on an on-going and continuous basis, notified every new and existing patient of our confidentiality practices and contracted with certain vendors to assure they adhere to the same strict confidentiality and security standards.

In addition, 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 invoices. On August 21, 2008, DHHS proposed a rule that would adopt updated versions of the standards for electronic transactions under the authority of HIPAA. The updated standards would replace the current standards. We believe we are in substantial compliance with the standards that have been implemented to date by DHHS.

The imposition of HIPAA privacy, security and transactional code set standards on healthcare providers, among others, is a substantial step by the federal government toward requiring that individual health and medical records are developed, maintained and billed for in electronic format. The rules continue to be amended and, as such, we will continue to modify our systems in order to maintain compliance with the standards.

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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. In 2006, the DHHS adopted final rules 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. The final rule amended the existing rules relating to the investigation of noncompliance to make them apply to all of the HIPAA Administrative Simplification rules, rather than exclusively to the privacy standards. It also amended the existing rules relating to the process for imposition of civil money penalties. Among other matters, the final rule clarified and elaborates upon the investigation process, bases for liability, determination of the penalty amount, grounds for waiver, conduct of the hearing and the appeal process. The act also provides for criminal penalties for violations. We have established a plan and committed the resources necessary to comply with HIPAA. At this time, we anticipate that we will be able to maintain compliance with HIPAA regulations that have been issued. Based on the existing regulations and anticipated additions and amendments to the regulation, we believe that the cost of our compliance with HIPAA will not have a material adverse effect on our results of operations.

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 dedicated emergency department for treatment and, if the patient is suffering from an emergency medical condition, either to stabilize that condition or to make an appropriate transfer of the patient to a facility that can stabilize the condition. The obligation to screen and stabilize emergency medical conditions exists regardless of a patient’s ability to pay for treatment. CMS has issued final regulations and interpretive guidelines clarifying various requirements under EMTALA. 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 our emergency care practices are in compliance with EMTALA requirements, we cannot assure that CMS or others will not assert that our facilities are in violation or predict any modifications that CMS will implement in the future. On May 13, 2004, CMS issued revised interpretive guidelines for surveyors investigating EMTALA complaints that require, in addition to other changes, that hospitals have call coverage that “meets the needs of hospital patients.” On August 19, 2008, CMS adopted a final rule containing significant changes to EMTALA. These revisions were effective October 1, 2008. In summary, CMS made the following changes: (1) rather than expand the obligations of hospitals with specialized capability with regard to the transfer on an inpatient with an emergency medical condition, CMS confirmed its 2003 position regarding inpatients, (2) hospitals may satisfy their on-call coverage obligations by participating in an acceptable formal community/regional call coverage program that meets various requirements. We cannot predict whether we will be in compliance with any new requirements or interpretive guidelines.

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. Particularly given the recent Presidential and Congressional elections results, we cannot predict the course of future healthcare legislation or other changes in the administration or interpretation of governmental healthcare programs or the effect that any legislation, interpretation or change may have on us.

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

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. 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.

Environmental Regulation

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

China Division

There are environmental laws, rules and regulations governing hospitals in China including but not limited to medical waste, medical radioactive agents, and pollution. We cannot predict whether the cost of such compliance will have a material effect on our future earnings, competitiveness, and expansion in China.

Insurance

The Company maintains various insurance policies that cover each of its facilities. Specifically, the Company has occurrence medical malpractice coverage for its Pasadena and Garland facilities. 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, including flood coverage. The Company 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. Coverage is maintained in amounts management deems adequate.

Because hospitals in China are owned by the government, lawsuits against hospitals are generally prohibited. As a result, Dynacq-Huai Bei does not intend to obtain insurance coverage for its operations in China beyond the minimum required for its operations, if any.

Employees

As of October 25, 2008, the Company employed approximately 199 full-time employees and 73 part-time employees, which represents approximately 231 full-time equivalent employees.

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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 100 F Street, N.E., 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.

Item 1A. Risk Factors

The value of an investment in Dynacq Healthcare, Inc. is subject to significant risks, certain of which are specific to our Company, others are inherent in our business and the industry in which we operate, and still others are market related. If any of the matters described in the risk factors listed below were to occur, our business and financial results could be materially adversely affected. The Risk Factors described below apply to the current operations and market for the common stock of the Company, and do not address risks that may arise in the future.

Risks Related to our Business

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

For the fiscal year ended August 31, 2008, approximately 87% of our gross revenues were generated from 23 surgeons, primarily in our Garland facility. For the fiscal year ended August 31, 2007, approximately 81% of our gross revenues were generated from 15 surgeons, primarily in our Garland facility. The loss of physicians who provide significant net patient revenues for the Company may adversely affect our results of operations.

Because foreign participation in hospitals in China is relatively new and unproven, our efforts to obtain management contracts in that country may not be successful, and the management of Rui An Hospital and any other hospitals we may manage may not be profitable.

We have invested a substantial amount of funds and management resources into the development of our China Division. There is no reliable history of foreign participation in the operation of hospitals in China on which to base our prospects for success. The agreement under which Dynacq-Huai Bei will manage Rui An Hospital currently provides for substantial investment of funds in capital expenditures for that hospital, the repayment of liabilities, and the loan of certain amounts to Rui An Hospital. Since May 30, 2008, Dynacq-Huai Bei has incurred, and will continue to incur, substantial costs in managing the construction of the new hospital to be completed in October 2009, before it can begin to realize the profits from the operations of that hospital. Although management agreements on additional hospitals may vary in their terms, there can be no assurances that additional management agreements will be undertaken.

Our lack of success in obtaining necessary local government participation for the DeAn Joint Venture to construct, own and operate a hospital in Shanghai may be indicative of the difficulties involved in foreign investment in China.

DeAn was formed for the purpose of constructing, owning and operating a hospital in Shanghai, China and on May 16, 2005 entered into land use agreements with the Chinese government under which it leased, for a term of 50 years, approximately 28.88 acres of government-owned land on which the hospital would be constructed. The Company was engaged in protracted negotiations for several years for, among other matters, the payment by the local government of the unfunded amounts due by it under the Joint Venture Agreement, the sale by the local government of its interest in DeAn to a third party, and the extension of the dates for construction of the hospital, none of which proved successful. As a result, the Company sold its interest in the property owned by DeAn for the construction of the Shanghai hospital. Although management believes Dynacq Huai-Bei, as a 100% foreign owned domestic corporation, will have certain advantages in operating in China which were not available to DeAn which

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was only 70% owned by Dynacq, there can be no assurances that those advantages will be realized or that Dynacq-Huai Bei will be able to own, operate or manage additional hospitals in China. Dynacq may only be able to obtain certain hospital management arrangements in China by entering into joint ventures with the local government. As a result, we will not have total control over the joint venture, and there can be no assurances that the local government will be able to fulfill its commitments to our joint venture arrangements.

Our expansion into international operations could be harmed by economic, political, regulatory and other risks associated with doing business in foreign countries.

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. International expansion will also 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. There can be no assurances that we will be able to successfully manage the hospital in Rui An or other hospitals that we may enter into contracts to manage. The failure to do so, including the failure to attract patients and to recruit qualified physicians to those facilities, could have a material adverse effect on our business, financial condition and results of operations.

Our credit facility was terminated on October 10, 2008 due to technical defaults in reporting and the Company’s investment in China, so we no longer have access to a credit facility were we to need one.

Our credit facility originally obtained through Merrill Lynch Capital for up to $10 million was transferred to General Electric Commercial Finance in February 2008. General Electric Commercial Finance informed us in September 2008 of certain technical defaults in the credit facility and cited them as reasons to terminate that facility. Because the Company has sufficient cash on hand and cash flow from operations, it has no present need for the credit facility. In the event we were to identify a need for cash in excess of that available to us, however, we may have difficulty arranging a new credit facility on favorable terms in view of the generally tight credit market.

We are subject to substantial uninsured liabilities for which we have incurred, and may continue to incur, significant expenses.

In January 2007, Dynacq settled a class action lawsuit filed by shareholders against it, its directors and officers for allegedly publishing materially misleading financial statements, making materially false or misleading statements or omissions regarding its financial condition, and engaging in a fraudulent schedule to inflate the value of its stock. This case, in addition to the legal actions alleging malpractice, product liability or related legal theories that are common in our industry, have involved significant costs and a major drain on management’s time and resources.

Although 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, our insurance coverage may not be sufficient or continue to be available at a cost allowing us to maintain adequate levels of insurance. Our professional malpractice liability insurance has covered the majority of malpractice and related legal claims to date; however, the cost of defending the shareholder derivative suits and any damages awarded as a result of those suits, are paid by the Company. In addition, the large monetary claims and significant defense costs involved in many of the malpractice claims may exceed the limits of our insurance coverage. 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 employ any of the physicians who conduct procedures at our hospitals, and the governing documents of each of our hospitals require physicians who conduct procedures at our hospitals to maintain stated amounts of insurance.

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We indemnify our directors and officers against certain liabilities and do not presently carry director and officer liability insurance.

As permitted under Nevada law and pursuant to our governing documents and indemnification agreements with certain of our officers and directors, we indemnify our directors against monetary damages for breach of a director’s fiduciary duty and advance expenses to the full extent permitted by Nevada law. As a result, shareholders’ rights to recover against directors for breach of fiduciary duty are limited. We do not carry director and officer liability insurance, so 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. 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.

We are dependent on certain key personnel.

The Company is dependent upon a limited number of key management, technical and professional personnel. The Company’s future success will depend, in part, upon its ability to attract and retain highly qualified personnel. The Company faces competition for such personnel from other companies and organizations, and there can be no assurance that the Company will be successful in hiring or retaining qualified personnel. The Company does not have written employment agreements with any of its officers providing for specific terms of employment, and officers and other key personnel could leave the Company’s employment with little or no prior notice. The Company’s loss of key personnel, especially if the loss is without advance notice, or the Company’s inability to hire or retain key personnel, could have a material adverse effect on the Company’s business, financial condition or results of operations. The Company does not carry any key man life insurance.

Risks Associated with our Industry

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.

The healthcare industry is highly regulated and must comply with extensive government regulation at the federal, state and local levels. Hospitals must meet requirements for licensure, certification to participate in government programs and accreditation. In addition, there are regulatory requirements related to areas such as adequacy and quality of medical care, relationships with physicians and other referral sources (Anti-kickback Statute and Stark law, for example), qualifications of medical and support personnel, billing for services, confidentiality of medical records, emergency care and compliance with building codes. While we believe that we are in substantial compliance with these extensive government laws and regulations, if we fail to comply with any of the laws or regulations we could be subject to criminal penalties and civil sanctions, and our facilities could lose their licenses and their ability to participate in federal and state healthcare programs. In addition, government laws and regulations, or the interpretation of such laws and regulations, may change. In that case, we may have to make changes in our facilities, equipment, personnel, services or business structures so that our facilities may remain licensed and qualified to participate in federal and state programs. If the rules governing reimbursement are revised or interpreted in a different manner or if a determination is made that we did not comply with these requirements, we could be subject to denials of payment or recoupment of payments already received for services provided to patients.

Specifically, the federal Anti-kickback Statute and the Stark law are very broad in scope, and many of their provisions have not been uniformly or definitively interpreted. See Business – Government Regulation for an in- depth description of those statutes. If the ownership distributions paid to physicians by our hospitals are found to constitute prohibited payments made to physicians under the Anti-kickback Statute, physician self-referral or other fraud and abuse laws, our business may be adversely affected. Other companies within the healthcare industry continue to be the subject of federal and state investigations that could increase the risk that we may become subject to similar investigations in the future.

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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 or may 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. A government agency charged with enforcement of these laws, or a private party, might assert that our arrangements with physicians and physician group practices do not comply with applicable corporate practice of medicine laws. 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.

Recent changes to the Fee Guidelines for Texas workers’ compensation cases have resulted in lower reimbursement and may result in a decrease in the number of those type of procedures performed.

The Texas Workers’ Compensation 2008 Acute Care Hospital Outpatient and Inpatient Facility Fee Guidelines which became effective March 1, 2008 establish reimbursement amounts for workers’ compensation procedures performed at our facilities. Those amounts are determined by applying the most recently adopted and effective Medicare reimbursement formula and factors as published annually in the Federal Register, including identifying the appropriate Ambulatory Payment Classification for outpatient services provided, or Diagnosis Related Group for inpatient services provided. The applicable classification or group is used to determine the maximum allowable reimbursement for the procedures performed unless not calculable using Guidelines, in which case reimbursement will be determined on a fair and reasonable basis. Based on these new Guidelines, the reimbursement due the Company for workers’ compensation cases is lower than we previously experienced. Our net patient service revenues attributable to Texas workers’ compensation cases as a percentage of gross billings have decreased and may continue to decrease as a result of both the decreased number of procedures and the lower reimbursement rates for workers’ compensation procedures still being performed.

Our revenues may not increase due to a reduction in payments from third-party payers, a shift in the surgical mix and/or other circumstances over which we have no control.

We are dependent upon private and governmental third-party sources of payment for the services provided to patients in our healthcare facilities. The amount of payment our facilities receive for their services may be adversely affected by market and cost factors as well as other factors over which we have no control, including federal and state regulations and the cost containment and utilization decisions of third-party payers. The Company’s decision to participate in certain managed care contracts may not result in an increase in patient revenues if we are unable to obtain favorable managed care contracts, we are excluded from participation in a managed care contract, or the reimbursement rate for the procedure performed is too low.

Further, complicated reimbursement rules that are subject to interpretation may subject us to denials of payment for services provided or to recoupments of payments already received. We have no control over the number of patients that are referred to our facilities annually or whether such patients will be admitted as inpatients that typically have a higher reimbursement rate per procedure, or outpatients. Fixed fee schedules, capitation payment arrangements, exclusion from participation in managed care programs or other factors affecting payments for healthcare services over which we do not have control could also cause a reduction in our revenues.

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, Dynacq has been the subject of negative publicity in news reports focusing on its Pasadena facility, which has harmed its business and reputation. As the patient-physician relationship involves inherent trust and confidence, any negative publicity

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adversely affecting the reputation of our physicians or our facilities would likely adversely affect our results of operations.

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 our physicians. We compete with other healthcare providers in recruiting and retaining qualified management and medical support personnel responsible for the day-to-day operations of each of our hospitals. In 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.

Market Risks Related to Our Stock

A single stockholder controls a majority of our outstanding shares.

Our chairman and chief executive officer beneficially owns an aggregate of approximately 54% of our issued and outstanding common stock as of August 31, 2008. As a majority stockholder, he is able to control 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, he is in a position to control the management of our business and the appointment of executive officers as well as all management personnel. 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. 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 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 Nasdaq Global Markets. There is only limited trading activity in our securities. We 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 that further increase market volatility. The volatility of the market for our common stock could have a materially adverse effect

19

on our business, results of operations and financial condition. Accordingly, investors must be able to bear the financial risk of losing their entire investment in our common stock.

Future issuance of additional shares of our stock could cause dilution of ownership interests and adversely affect our stock price.

We issued 889,143 shares of the Company’s common stock in a private placement in fiscal year 2006 at a price per share equal to 70% of the current market price. We may in the future issue more of our authorized and unissued securities at less than market price, resulting in the dilution of the ownership interests of current shareholders. In addition to approximately 84 million shares of common stock we have that are authorized to issue but are unissued, our board may issue up to 5 million shares of preferred stock which may have greater rights than our common stock, without seeking approval from holders of our common stock. In addition, we are obligated to issue an aggregate of approximately 1.6 million shares of common stock upon the exercise of options outstanding under our 2000 Incentive Plan, and an additional 1 million shares may be earned under a performance award agreement granted under that Plan. Of that aggregate number, options to purchase approximately 1.1 million shares have an exercise price which is lower than the market price at August 31, 2008, and the 1 million share performance award is at a price which is lower than the market price at August 31, 2008. The shares subject to outstanding options and the performance award represent approximately 16% of our currently outstanding shares of common stock. Additional shares are subject to options not yet granted under the plan, and we may grant additional options or warrants in the future to purchase shares of our common stock not under the plan. The exercise price of each option granted under our option plan is equal to the fair market value of the shares on the date of grant, although that price may be substantially less than the value per share on the date of exercise.

We have not paid cash dividends on our common stock and do not expect to do so in the foreseeable future.

It has been our policy to use all available funds from operations to improve and expand our current facilities and to acquire new facilities. For that reason, we have never paid cash dividends on our common stock and have no present intention to pay dividends in the foreseeable future. Therefore an investor in our common stock should not expect to obtain any economic benefit from owning our common stock prior to a sale of those shares, if then.

Item 1B. Unresolved Staff Comments

Not required.

Item 2. Properties.

The Company or its subsidiaries own or lease the following 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.

• 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 Company leases 7,250 square feet of office space for its executive offices through September 1, 2011 for $6,525 per month. 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.

• The Company leases, on a short term 6-month renewable basis, an apartment for approximately $19,000 per month in Hong Kong for the Chief Executive Officer, who is making efforts to develop the China Division operations.

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Item 3. Legal Proceedings.

The Company is routinely involved in litigation and administrative proceedings that are incidental to its business. Specifically, all judicial review of unsatisfactory determinations of reimbursement amounts due us for our facility’s fees must be made in the district courts of Travis County, Texas in what can often be a lengthy procedure. Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations – Revenue Recognition for a detailed description of the MDR process and our accounts receivable. The Company cannot predict whether any litigation or administrative proceeding 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.

None.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The Company’s common stock was listed on the Nasdaq Capital Market System until February 28, 2008, when it began to be listed on the Nasdaq Global Market. The trading symbol for the Company’s common stock continues to be “DYII”.

The following table sets forth the high and low bid prices of the common stock for the period from September 1, 2006 to August 31, 2008. These over-the-counter prices reflect inter-dealer prices, without retail mark-ups, mark-down or commissions, and may not necessarily represent actual transactions.

	Highs		Lows
FISCAL YEAR 2008
Fourth Quarter	$	8.73	$	3.56
Third Quarter		6.27		3.32
Second Quarter		6.70		4.21
First Quarter		7.30		3.50
FISCAL YEAR 2007
Fourth Quarter	$	9.39	$	1.73
Third Quarter		2.09		1.13
Second Quarter		1.94		1.30
First Quarter		3.50		1.50

At October 31, 2008, there were approximately 341 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 has not declared any cash dividends on its common stock for the two most recent fiscal years. 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.

Purchases of Equity Securities by the Company

Of the 500,000 shares authorized to be repurchased in January 2002, the Company purchased 10,000 shares in December 2007 at an average cost of $3.80 per share. Prior to that the Company had bought back 450,676 shares of

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its common stock during in fiscal years 2002 - 2004 at an average cost of $14.08 per share, for a total purchase price of $6,345,680. The Company is no longer purchasing its shares under this program.

On February 29, 2008 the Company’s Board of Directors authorized a program of repurchasing up to 2 million of its outstanding securities from time to time in open market transactions at prevailing prices on NASDAQ. The Company has repurchased 445,193 shares at an average cost of $5.10 per share during fiscal year 2008. Shares repurchased during the fourth quarter of 2008 pursuant to our repurchase program are as follows:

Period	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Average Price per Share		Maximum Number of Shares that May Yet be Purchased Under the Publicly Announced Plans or Programs
June 1 - 30, 2008	24,806	$	6.11	1,731,729
July 1 - 31, 2008	121,352		4.32	1,610,377
August 1 - 31, 2008	55,570		4.45	1,554,807
Total	201,728	$	4.58	1,554,807

Item 6. Selected Financial Data.

Not required.

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

Our Management’s Discussion and Analysis includes forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from the statements we make in this section due to a number of factors that are discussed in Item 1A – Risk Factors.

Our operating results for all periods presented reflect our Baton Rouge and West Houston facilities as discontinued operations.

Critical Accounting Policies and Estimates

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

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amount of revenue to recognize in connection with the Company’s services is subject to significant judgments and estimates, which are discussed below.

Revenue Recognition 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 are based on estimated or historical cash collections as discussed below and may not represent amounts ultimately collected. At such time as the Company can determine that ultimate collections have exceeded or have been less than the revenue recorded on a group of accounts, additional revenue or reduction in revenue is recorded as a change in estimate during the current period. The Company does adjust current period revenue for actual differences in estimated revenue recorded in prior periods and actual cash collections. As the Company is able to identify specific closed blocks of business, the Company compares the actual cash collections on gross billed charges to the estimated collections that were recorded in revenue. The Company records additional revenue or a reduction in revenue in the current period equal to the difference in the estimate recorded and the actual cash collected.

In the last two fiscal years, the Company has recorded additional revenue as follows:

1. The Company has recorded additional revenue of $8,217,000 during the fiscal year ended August 31, 2008 related to amounts collected on MDR accounts receivable. The Company settled various MDR claims for our Pasadena and Garland facilities and collected a total of $26,713,000 for dates of service ranging from 2001 to 2005. This amount represents payments received initially at the time of filing of the claim, additional monies received upon filing the MDR claim and the settlement amount. On these closed MDR accounts receivable, the Company had recognized approximately $18,496,000 as net revenue during the relevant fiscal years when the service was performed. Gross billings on this block of receivables were $35,807,000. Since the Company actually collected $8,217,000 more on this block of receivables than was booked, additional revenue of $682,000, $3,835,000, $1,324,000 and $2,376,000 was recorded in the first, second, third and fourth quarters of the fiscal year ended August 31, 2008, respectively. We do not believe that the amount of additional revenues from MDR settlements reached in this fiscal year is indicative of the amounts that will be obtained from settlements reached in the next twelve months, since insurance companies who have not yet settled may be more likely to appeal their cases, which could delay settlement or a final judgment.

2. The Company collected $42,596,000 on a block of business generated at our Garland facility between September 2003 and February 2008. The accounts included in this block of business were not related to workers’ compensation. Gross billings on this block of receivables were $78,781,000. The contractual allowance booked on this block of receivables was $41,485,000, or approximately 52.7%, generating net revenue of $37,296,000. Since the Company actually collected $5,300,000 more than revenue booked on this block of receivables, additional revenue in the amount of $5,300,000 was recorded in the fourth quarter of the fiscal year ended August 31, 2008.

3. The Company collected $28,572,000 on a block of business generated at our Pasadena facility between September 2005 and February 2008. The accounts included in this block of business were not related to workers’ compensation. Gross billings on this block of receivables were $60,715,000. The contractual allowance booked on this block of receivables was $36,643,000, or approximately 60.4%, generating net revenue of $24,072,000. Since the Company actually collected $4,500,000 more than revenue booked on this block of receivables, additional revenue in the amount of $4,500,000 was recorded in the fourth quarter of the fiscal year ended August 31, 2008.

4. Due to the uncertainties regarding the accounts receivable in the MDR process, the recent Third Court of Appeals’ opinion and outside counsel’s advice that settlements with insurance carriers have virtually stopped, the Company has fully reserved all accounts receivable related to the MDR process as of August 31, 2008, and written-off $8.7 million and $9.8 million of MDR accounts receivable in the fourth quarter of the fiscal year ended August 31, 2008, at our Garland and Pasadena facilities, respectively.

The net write down in net patient service revenue was $6.3 million in the fourth quarter of the fiscal year ended August 31, 2008, or $4.1 million net of income tax expense, or $0.25 per diluted share.

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The table below sets forth the percentage of our gross patient service revenue by financial class for the fiscal years 2008 and 2007:

	2008	2007
Workers’ Compensation	37%	47%
Commercial	41%	38%
Medicare	10%	9%
Medicaid	—%	1%
Self-Pay	10%	3%
Other	2%	2%

Contractual Allowance

Starting March 1, 2008, the Company computes its contractual allowance based on the estimated collections on its gross billed charges. The Company computes its estimate by taking into account collections received for the services performed and also estimating amounts collectible within the next six months and after six months by considering historical collections ratio. Prior to March 1, 2008, the contractual allowance was calculated based on the ratio of the Company’s historical cash collections during the trailing twelve months on a case-by-case basis by operating facility. This ratio of cash collections to billed services was then applied to the gross billed services by operating facility. The following table shows gross revenues and contractual allowances for fiscal years 2008 and 2007:

	2008		2007
Gross billed charges	$	145,763,332	$	96,215,520
Contractual allowance		85,489,385		53,369,699
Net revenue	$	60,273,947	$	42,845,821
Contractual allowance percentage		59%		55%

A significant amount of our net revenue results from Texas workers’ compensation claims, which are governed by the rules and regulations of the TDWC and the workers’ compensation healthcare networks. If one of our hospitals chooses to participate in a network, the amount of revenue that will be generated from workers’ compensation claims will be governed by the network contract.

For claims arising prior to the implementation of workers’ compensation networks and out of network claims, inpatient and outpatient surgical services are either reimbursed pursuant to the Acute Care In-Patient Hospital Fee Guideline or at a “fair and reasonable” rate for services in which the fee guideline is not applicable. Starting March 1, 2008, the Guidelines became effective. Under these Guidelines, the reimbursement amounts are determined by applying the most recently adopted and effective Medicare reimbursement formula and factors; however, if the maximum allowable reimbursement for the procedure performed cannot be calculated using these Guidelines, then reimbursement is determined on a fair and reasonable basis.

Based on these new Guidelines, the reimbursement due the Company for workers’ compensation cases is lower than we previously experienced. The Company has continued accepting Texas workers’ compensation cases, and has not made any substantial changes in its focus towards such cases. Our net patient service revenue for Texas workers’ compensation cases as a percentage of gross billings has decreased primarily as a result of lower reimbursement rates for workers’ compensation procedures still being performed.

Should our facility disagree with the amount of reimbursement provided by a third-party payer, we are required to pursue the MDR process at the TDWC to request proper reimbursement for services. The Company has recently been successful in its pursuit of collections regarding the stop-loss cases pending before SOAH, receiving positive rulings in over 90% of its claims presented for administrative determination. The 2007 district court decision upholding our interpretation of the statute as applied to the stop-loss claims was recently appealed by certain insurance carriers, and the Third Court of Appeals determined that in order for a hospital to be reimbursed at 75% of its usual and customary audited charges for an inpatient admission, the hospital must not only bill at least $40,000, but also show that the admission involved unusually costly and unusually extensive services. Procedurally, the

24

decision means that each case where a carrier raised an issue regarding whether the services provided were unusually costly or unusually extensive would be remanded to either SOAH or MDR for a case-by-case determination of whether the services provided meet these standards, once the definitions of those standards are determined. We plan to appeal the Third Court of Appeals decision and anticipate further, lengthy litigation at the Travis County District Courts and the Texas Courts of Appeals to establish the legal definition for these standards. Because of this lengthy process and the uncertainty of recovery in these cases, collection of a material amount of funds in these pending stop-loss cases is not anticipated during the 2009 fiscal year.

To date, insurance carriers have voluntarily paid the awards in the decisions and orders issued by SOAH, plus interest, in approximately 180 cases, involving approximately $11 million. In most of these cases, the carriers have requested refunds of the payments made in the event that the SOAH decisions and orders are reversed on appeal. We believe the Company’s ultimate obligation to refund the payments is remote. Our request that the TDWC Commissioner enforce the awards which have not been voluntarily paid by the carriers has been refused in approximately 130 cases.

Claims regarding payment for hospital outpatient services remain pending at the TDWC. It is expected that these claims will be adjudicated at SOAH and ultimately in the Texas district and appellate courts. The basis for reimbursement for these services made the subject of these pending cases is the determination of “fair and reasonable” charges. In 2007, we received unfavorable rulings from SOAH in all of our appeals of unfavorable decisions related to services provided in 2001 and 2002. The 179 cases which have been appealed to the Travis County district courts challenge the constitutionality of the relevant statutory language. A lead case has been selected and is scheduled to be heard on January 14, 2009. Although we would appeal any negative ruling handed down in this lead case, such ruling will impact cases in which a fee guideline was not applicable, specifically all pending cases involving ambulatory surgical services provided in 2001 and 2002 as well as all pending cases involving hospital outpatient services provided prior to March 1, 2008. Successful collection of material amounts in these cases is unlikely.

We are currently pursuing claims against two healthcare agents relating to contracts with certain of our facilities which set out reimbursement guidelines by several workers’ compensation carriers at a minimum of 70% of the facility’s charges. Discovery is continuing on these claims to determine which carriers are involved and the amount of reimbursement due to us.

Due to the uncertainties regarding the accounts receivable in the MDR process, the recent Third Court of Appeals’ opinion and our legal counsel’s advice that settlements with insurance carriers have virtually stopped, the Company has fully reserved all accounts receivable related to the MDR process as of August 31, 2008. Any monies collected for these MDR accounts receivable will be recorded as current period’s net patient service revenues.

Accounts Receivable

Accounts receivable represent net receivables for services provided by the Company. Due to reasons discussed above for writing down all MDR accounts receivable, the Company does not have any long term receivables as at August 31, 2008, and expects to collect the net receivables within twelve months. At each balance sheet date management reviews the accounts receivable for collectibility.

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 partial 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 an individual receivable are recognized.

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

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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 has tended 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. The Company has been participating in managed care contracts since the first quarter of fiscal 2006 and anticipates entering into additional contracts in the future. So far these contracts have not resulted in any meaningful patient revenues. Increased participation in managed care contracts and programs may decrease the per-procedure reimbursement that the Company collects in the future for similar services.

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, with the exception of Medicare, Medicaid and self-pay surgeries. 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. In cases where a commercial insurance payers’ pre-approval is not approved subsequently, those accounts receivable may be classified to self-pay. Historically, such classifications have not been significant.

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.

Deferred income taxes are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted rates in effect during the year in which the differences are expected to reverse. Realization of deferred tax assets is dependent upon generating sufficient taxable income. Valuation allowances are established for the deferred tax assets that we believe do not meet the “more likely than not” criteria established by SFAS No. 109. Judgments regarding future taxable income may be revised due to changes in market conditions, tax laws, or other factors. If our assumptions and estimates change in the future, then the valuation allowances established may be increased, resulting in increased income tax expense. Conversely, if we are ultimately able to use all or a portion of the deferred tax assets for which a valuation allowance has been established, then the related portion of the valuation allowance will be released to income as a credit to income tax expense. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities.

Stock-Based Compensation

Effective at the beginning of our fiscal year 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123 “Share-Based Payment” (“SFAS No. 123(R)”) to account for stock-based compensation. Under SFAS No. 123(R), we estimate the fair value of stock options granted using the Black-Scholes option pricing model. The fair value for awards that are expected to vest is then amortized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. The amount of expense attributed is based on an estimated forfeiture rate, which is updated as appropriate. This option pricing model requires the input of highly subjective assumptions, including the expected volatility of our common stock, pre-

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vesting forfeiture rate and an option’s expected life. The financial statements include amounts that are based on our best estimates and judgments.

Results of Operations

	Year Ended August 31,
	2008					2007
Net patient service revenue	$	60,273,947		100	%	$	42,845,821		100	%
Costs and expenses:
Compensation and benefits		16,983,322		28			12,061,185		28
Medical services and supplies		14,108,723		23			8,984,593		21
Other operating expenses		18,640,685		31			15,790,052		37
Depreciation and amortization		2,115,267		4			2,334,012		5
Total costs and expenses		51,847,997		86			39,169,842		91
Operating income		8,425,950		14			3,675,979		9
Other income (expense):
Rent and other income		889,178		1			257,022		1
Interest income		402,205		1			34,878		—
Interest expense		(132,370	)	—			(455,008	)	(1	)
Total other income (expense), net		1,159,013		2			(163,108	)	—
Minority interest in earnings		(185,958	)	—			(121,563	)	—
Income before income taxes		9,399,005		16			3,391,308		8
(Provision) benefit for income taxes		(4,056,653	)	(7	)		445,490		1
Income from continuing operations		5,342,352		9			3,836,798		9
Discontinued operations, net of income taxes		(26,763	)	—			303,540		1
Gain (loss) on disposal of discontinued operations assets, net of income taxes		3,084,673		5			(14,702	)
Extraordinary gain, net of income taxes		39,436		—			29,844		—
Net income	$	8,439,698		14	%	$	4,155,480		10	%
Operational statistics (Number of procedures):
Inpatient:
Bariatrics		847					334
Orthopedics		279					279
Other		242					65
Total inpatient procedures		1,368					678
Outpatient:
Orthopedics		620					411
Other		1,300					1,553
Total outpatient procedures		1,920					1,964
Total procedures		3,288					2,642
	2008					2007
Revenues
U.S. Division	$	60,273,947				$	42,845,821
China Division		—					—
Operating income (loss)
U.S. Division	$	10,906,475				$	4,424,664
China Division		(2,480,525	)				(748,685	)
Income (loss) before taxes, discontinued operations and extraordinary gain
U.S. Division	$	11,304,946				$	4,136,103
China Division		(1,905,941	)				(744,795	)

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Comparison of the Fiscal Years Ended August 31, 2008 and August 31, 2007

Since the China Division has had no revenues in fiscal years ended August 31, 2008 and 2007, all net patient service revenue of the Company for these years is from the U.S. Division. The China Division incurred costs and expenses during these years, which are discussed below.

Net patient service revenue increased by $17,428,126, or 41%, from $42,845,821 to $60,273,947, and total surgical cases increased by 24% from 2,642 cases in fiscal year 2007 to 3,288 cases in fiscal year 2008. Following are the percentage changes in net patient service revenues and number of cases at the hospital facilities:

	Percentage increase from 2007 to 2008
Facility	Net patient revenue	Cases
Pasadena	44%	5%
Garland	39	42
Overall	41	24

The increase in net patient service revenues is due to following reasons:

Increase in bariatric and orthopedic cases at Garland and Pasadena facilities

The Garland facility had an increase in both bariatric and orthopedic cases due to recruitment of additional physicians in previous years. The increase in net patient service revenue is primarily due to an increase in overall number of cases and also due to a 113% increase in number of inpatient cases at our Garland facility, which typically have a higher average reimbursement per case. Due to recruitment of additional physicians at our Pasadena facility, we had an increase primarily in bariatric cases, as well as in orthopedic cases.

The utilization rate of our hospitals varies widely among physicians on our medical staffs and among specializations, so an increase in the number of physicians on our medical staffs does not, in itself, result in an increase in patient referrals or revenues. While we attempt to continue to attract and retain additional physicians, the potential loss of physicians who provide significant net patient revenues for the Company may adversely affect our results of operations.

Increase in average net patient service revenue per case

Even though the number of cases increased 24% overall in 2008 compared to 2007, the net patient service revenue increased by 41%. Backing out the additional revenues booked discussed above, the net patient service revenue increased 42%, due to an increase of cases by 24% coupled with an increase of 14% in average net patient service revenue per case. Excluding the above-mentioned additional revenues, net patient service revenue per case increased by $2,262 or 14%, from $16,217 in 2007 to $18,479 in 2008.

Starting March 1, 2008, the Company estimates the contractual allowance for Texas workers’ compensation cases based on the new fee Guidelines, and for the other cases based on management’s estimate of collection percentage of gross billed charges. The historical collection for non-Texas workers’ compensation cases is primarily used as a guideline to estimate contractual allowance. Prior to March 1, 2008, the contractual allowance was calculated based on the ratio of the Company’s historical cash collections during the trailing twelve months on a case-by-case basis by operating facility. In compliance with this revenue recognition policy, the Company’s contractual allowance as a percentage of gross patient revenue increased from 55% in 2007 to 59% in 2008.

28

Net reduction in revenues due to closed books of business and write-off of MDR accounts receivable

In terms of the Company’s revenue recognition policy, net patient service revenues are based on estimated or historical cash collections and may not represent amounts ultimately collected. At such time as the Company determines that ultimate collections have exceeded the revenue recorded on a group of accounts, additional revenue or reduction in revenue is recorded as a change in estimate during the current period. The Company analyzed various blocks of business for MDRs and commercial payers, for both the Garland and Pasadena facilities, and recognized additional revenues of approximately $6.5 million and $11.5 million, respectively, for amounts collected in excess of revenue recognized in prior years.

Due to the uncertainties regarding the accounts receivable in the MDR process, the recent Third Court of Appeals’ opinion and our legal counsel’s advice that settlements with insurance carriers have virtually stopped, the Company has fully reserved all accounts receivable related to the MDR process as of August 31, 2008, and written-off $8.7 million and $9.8 million of MDR accounts receivable in the fourth quarter of the fiscal year ended August 31, 2008, at our Garland and Pasadena facilities, respectively.

Total costs and expenses increased by $12,678,155, or 32%, from $39,169,842 in fiscal 2007 to $51,847,997 in fiscal 2008. The following describes the various changes in costs and expenses:

• Compensation and benefits increased by $4,922,137, or 41%. During fiscal year 2008, the Company incurred a $373,435 non-cash pre-tax compensation expense primarily related to employees’ incentive stock options granted in fiscal year 2007. Excluding this non-cash compensation expense, the increase in compensation and benefits in the current fiscal year is 38% compared to the prior fiscal year, primarily due to an increase in number of cases, and also due to annual cash incentive bonuses paid to employees.

During 2008 and 2007, the China Division operations were handled by contract employees, and payments to them are included in Other operating expenses.

• Medical services and supplies expenses increased $5,124,130, or 57%, while the number of surgery cases increased 24%. The increase was primarily due to a 102% increase in the number of inpatient procedures, which typically require more medical services and supplies. Medical services and supplies were consistent at 9.7% and 9.3% of gross billed charges for fiscal year 2008 and 2007, respectively.

Since the China Division had no revenues for fiscal years 2008 and 2007, there were no medical services and supplies expenses there.

• Other operating expenses increased by $2,850,633, or 18%.

U.S. Division

Other operating expenses for the U.S. Division increased by $1,046,677, or 7%, from $15,213,468 in 2007 to $16,260,145 in 2008. Even though the net patient service revenue increased by 41%, the marginal increase in other operating expenses is due to continued efforts made by the Company to reduce costs and expenses.

China Division

Other operating expenses for the China Division increased by $1,803,956, or 313%, from $576,584 in 2007 to $2,380,540 in 2008. In 2007 and part of 2008, development costs were incurred for the construction of a hospital in Shanghai. However, in 2008, the Company sold its interest in the property owned by DeAn.

The increase in other operating expenses in 2008 is primarily for growth and development of the China Division. The Company incurred expenses in its sale of the property owned by DeAn in July 2008, and in entering into the management agreement with the Rui An City Department of Health to oversee the construction of the Rui An Hospital in Rui An, China, and then manage that hospital upon its completion in October 2009. Another Dynacq subsidiary has entered into a marketing agreement to market the services of Dynacq in China and Southeast Asia. Dynacq is seeking to expand its operations into China to achieve

29

geographic diversity and take advantage of a high growth market in the provision of healthcare services in that country. The management arrangement will allow Dynacq to minimize its expenditure of capital to purchase assets, but still have the potential for an attractive return in its efficient management of the hospital facility.

Other income increased by $1,322,121 from $163,108 other expense, net, in 2007 to $1,159,013 other income, net, in 2008.

U.S. Division

Other income increased by $751,427 from $166,998 other expense, net, in 2007 to $584,429 other income, net, in 2008. Of this increase, interest income (expense), net, increased by $593,067, from net interest expense of $424,020 in 2007, to net interest income of $169,047 in 2008, primarily due to cash from operations.

China Division

Other income increased by $570,694 from $3,890 in 2007 to $574,584 in 2008. In 2008 the Company sold its interest in the property owned by DeAn and realized a gain of $473,796. Interest income increased by $96,898, from $3,890 in 2007 to $100,788 in 2008, primarily due to cash funding from U.S. Division.

The income (loss) from discontinued operations represents the income (loss) primarily at our Baton Rouge facility for the fiscal year 2008 and at our Baton Rouge and West Houston facilities for the fiscal year 2007.

The gain on sale of discontinued operations during fiscal year 2008 was $4,745,650. Provision for income taxes on this gain was $1,660,977.

The extraordinary gain, net of income taxes, relates to gains on the purchase of minority interests from certain minority interest holders at an amount less than the net book value of the minority interest liability on the date of purchase.

Liquidity and Capital Resources

The Company maintained sufficient liquidity to meet its business needs in fiscal 2008. As of August 31, 2008, its principal source of liquidity was $63.1 million in cash and net accounts receivable. The Company has approximately $45.1 million in cash as of August 31, 2008, the majority of which is deposited in national and international banks. The amounts at these financial institutions are substantially in excess of FDIC and Securities Investor Protection Corporation insurance limits; however, management believes that these financial institutions are of high quality and the risk of loss is minimal. Of the $45.1 million cash balance, $17.7 million is in the China Division, and $27.4 million is in the U.S. Division. Subsequent to the fiscal year ended August 31, 2008, the Company transferred an additional $20 million to the China Division due to attractive interest rates on time deposits. The cash balance in the China Division as of the date of this filing is $37 million. Of the $37 million in cash in the China Division, $23 million is deposited in banks in Hong Kong, where the government of Hong Kong has guaranteed the repayment of all bank deposits until 2010.

Subsequent to the end of the fiscal year ended August 31, 2008, the Company has engaged in negotiations to invest approximately $3.9 million in high yield bonds, which it expects to finalize in the first quarter of fiscal 2009.

Cash flows from operating activities

Total cash flow provided by operating activities was $27,712,623 (including $41,175 used in discontinued operations) during fiscal year 2008, primarily due to a net income before discontinued operations of $5,381,788, decreases in accounts receivable, restricted cash and inventories of $12,436,696, $4,388,857 and $717,711, respectively, increases in income tax payable of $2,215,109, and depreciation and amortization of $2,115,267.

Cash flows from investing activities

Total cash flow provided by investing activities was $21,049,171 (including $16,175,259 provided by

30

discontinued operations) primarily related to the sale proceeds of the assets of the Baton Rouge facility, land in The Woodlands, Texas and sale of the Company’s interest in DeAn, partially offset by purchases of property and equipment of $1,283,851.

Cash flows from financing activities

Total cash flow used in financing activities was $9,629,732 during the current period. During the fiscal year ended August 31, 2008, the Company paid down the entire outstanding balance of $7,073,813 under its Credit Agreement and also paid down $452,369 on the note payable for the class action lawsuit settlement. The Company repurchased 455,193 treasury shares for $2,309,898, at an average cost of $5.07 per share. The Company received $721,398 from the exercise of employees’ stock options.

The Company had working capital of $52,161,255 as of August 31, 2008, and maintained a liquid position by a current ratio of approximately 4.57 to 1.

Cancellation of line of credit

The Company and certain of its subsidiaries on May 27, 2005 entered into a Credit and Security Agreement (the “Credit Agreement”) with Merrill Lynch Capital for a new five-year revolving credit facility for up to $10 million, subject to a borrowing base based on eligible accounts receivable and further subject to a $2 million reserve until satisfaction of certain conditions. As of August 31, 2008, the Company had not drawn any amounts under the Credit Agreement. Subsequent to the end of the fiscal year 2008, on October 10, 2008, the Credit Agreement was terminated by the lenders due to technical defaults which related primarily to compliance in periodic reporting, as well as the Company’s investment in China. The Company has sufficient cash on hand and cash flows from operations, and had not used the credit facility since December 2007.

We believe we will be able to meet our ongoing liquidity and cash needs for fiscal year 2009 through the combination of available cash and cash flow from operations.

Off-Balance Sheet Arrangements

We are not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on us.

Contractual Obligations and Commitments

The Company has operating leases primarily for medical and office equipment. The Company also incurs rental expense for office space and medical equipment. The Company’s total minimum rental commitments under noncancellable operating leases are approximately $2.1 million in the next four fiscal years.

The Company, through its subsidiary, also had 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 and Garland facilities. These facilities received bariatric and orthopedic referrals from other sources, and the organizations referred clients to other area hospitals. Payments made related to these agreements for the fiscal years 2008 and 2007 were $4,545,000 and $5,145,000, respectively. The Company has a total commitment of approximately $6,750,000 to be incurred in the next two fiscal years related to these marketing agreements.

The Company is currently overseeing the construction of a hospital in Rui An, China to be completed October 1, 2009, at which time it will manage the hospital for a term of 15 years. As part of this agreement, the Company will provide a construction loan of approximately $2.1 million based on percentage of completion of construction of the hospital, and will also advance approximately $730,000 for equipment purchase. The Company also had a commitment to assume and discharge within ten years $883,000 of existing liabilities, of which $736,000 has already been paid in the fiscal year ended August 31, 2008. The Company has subsequent to the year ended August 31, 2008, signed an agreement for marketing its services to hospitals in China, for which the Company would incur at its discretion from $75,000 to $250,000 per month for the next three years.

31

The Company has contracts with doctors to manage various areas of the Company’s hospitals and other service agreements. The Company’s minimum commitments under these contracts are approximately $3.7 million to be incurred primarily in the next fiscal year.

Recent Accounting Pronouncements

See Note 1 to the Consolidated Financial Statements—Recent Accounting Pronouncements, which is incorporated here by reference.

Inflation

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

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Not required.

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	33
Consolidated Balance Sheets	34
Consolidated Statements of Operations	36
Consolidated Statements of Stockholders’ Equity	37
Consolidated Statements of Cash Flows	38
Notes to Consolidated Financial Statements	40

32

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. (the “Company”), as of August 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, 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. at August 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.

/s/ Killman, Murrell & Company, P. C.

Killman, Murrell & Company, P. C.

Houston, Texas

November 21, 2008

33

Dynacq Healthcare, Inc.

Consolidated Balance Sheets

	August 31,
	2008		2007
Assets
Current assets:
Cash and cash equivalents	$	45,099,800	$	5,436,787
Restricted cash		—		4,388,857
Accounts receivable, net of contractual allowances of approximately $226,355,000 and $197,108,000 at August 31, 2008 and 2007, respectively		18,018,673		30,437,665
Accounts receivable – other		—		17,704
Inventories		1,469,775		2,187,486
Prepaid expenses		475,251		430,391
Deferred tax assets		859,255		1,057,931
Income taxes receivable		868,249		1,519,138
Total current assets		66,791,003		45,475,959
Assets held for sale		—		13,187,738
Property and equipment, net		15,228,887		19,956,711
Other assets		228,672		274,553
Total assets	$	82,248,562	$	78,894,961

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

34

Dynacq Healthcare, Inc.

Consolidated Balance Sheets (continued)

	August 31,
	2008			2007
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	3,816,585		$	4,135,364
Accrued liabilities		5,915,560			5,681,328
Notes payable		480,269			7,526,181
Current taxes payable		4,417,334			534,425
Total current liabilities		14,629,748			17,877,298
Non-current liabilities:
Long-term portion of note payable		251,131			731,401
Deferred tax liabilities		355,808			426,327
Total liabilities		15,236,687			19,035,026
Minority interests		84,926			599,015
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, 16,010,924 and 15,843,557 shares issued at August 31, 2008 and 2007, respectively		16,011			15,844
Treasury stock, 455,193 at August 31, 2008, at cost		(2,309,898	)		—
Additional paid-in capital		15,023,927			13,829,616
Accumulated other comprehensive income		561,271			219,520
Retained earnings		53,635,638			45,195,940
Total stockholders’ equity		66,926,949			59,260,920
Total liabilities and stockholders’ equity	$	82,248,562		$	78,894,961

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

35

Dynacq Healthcare, Inc.

Consolidated Statements of Operations

	Year Ended August 31,
	2008			2007
Net patient service revenue	$	60,273,947		$	42,845,821
Costs and expenses:
Compensation and benefits		16,983,322			12,061,185
Medical services and supplies		14,108,723			8,984,593
Other operating expenses		18,640,685			15,790,052
Depreciation and amortization		2,115,267			2,334,012
Total costs and expenses		51,847,997			39,169,842
Operating income		8,425,950			3,675,979
Other income (expense):
Rent and other income		889,178			257,022
Interest income		402,205			34,878
Interest expense		(132,370	)		(455,008	)
Total other income (expense), net		1,159,013			(163,108	)
Income before income taxes, minority interests and extraordinary gain		9,584,963			3,512,871
Minority interest in earnings		(185,958	)		(121,563	)
Income before income taxes		9,399,005			3,391,308
(Provision) benefit for income taxes		(4,056,653	)		445,490
Income from continuing operations		5,342,352			3,836,798
Income (loss) from discontinued operations, net of income taxes		(26,763	)		303,540
Gain (loss) on sale of assets of discontinued operations, net of income taxes		3,084,673			(14,702	)
Extraordinary gain, net of $21,235 and $49,700 income tax expense in 2008 and 2007, respectively		39,436			29,844
Net income	$	8,439,698		$	4,155,480
Basic earnings per common share:
Income from continuing operations	$	0.34		$	0.24
Income (loss) from discontinued operations, net of income taxes		—			0.02
Gain (loss) on sale of assets of discontinued operations, net of income taxes		0.20			—
Extraordinary gain, net of income taxes		—			—
Net income	$	0.53		$	0.26
Diluted earnings per common share:
Income from continuing operations	$	0.32		$	0.24
Income (loss) from discontinued operations, net of income taxes		—			0.02
Gain (loss) on sale of assets of discontinued operations, net of income taxes		0.19			—
Extraordinary gain, net of income taxes		—			—
Net income	$	0.51		$	0.26
Basic average common shares outstanding		15,793,660			15,749,891
Diluted average common shares outstanding		16,457,888			15,910,117

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

36

Dynacq Healthcare, Inc.

Consolidated Statements of Stockholders’ Equity

	Common Stock			Treasury Stock				Additional Paid-In Capital		Other Compre- hensive Income Foreign currency transla- tion		Retained Earnings		Total
	Shares	Amount		Shares	Amount
Balance, August 31, 2006	15,740,711	$	15,741	—	$	—		$	13,056,974	$	105,659	$	41,040,460	$	54,218,834
Stock issued on exercise of employees’ stock options	102,846		103	—		—			503,842		—		—		503,945
Proceeds from sale of stock	—		—	—		—			67,375		—		—		67,375
Charge for granting stock options to employees	—		—	—		—			124,425		—		—		124,425
Income tax benefit for employees’ exercise of incentive stock options	—		—	—		—			77,000		—		—		77,000
Foreign currency translation adjustment, net of taxes of $113,000	—		—	—		—			—		113,861		—		113,861
Net income	—		—	—		—			—		—		4,155,480		4,155,480
Balance, August 31, 2007	15,843,557		15,844	—		—			13,829,616		219,520		45,195,940		59,260,920
Stock issued on exercise of employees’ stock options	167,367		167	—		—			721,231		—		—		721,398
Charge for granting stock options to employees	—		—	—		—			373,435		—		—		373,435
Income tax benefit for employees’ exercise of incentive stock options	—		—	—		—			99,645		—		—		99,645
Treasury shares acquired	—		—	455,193		(2,309,898	)		—		—		—		(2,309,898	)
Foreign currency translation adjustment, net of taxes of $189,200	—		—	—		—			—		341,751		—		341,751
Net income	—		—	—		—			—		—		8,439,698		8,439,698
Balance, August 31, 2008	16,010,924	$	16,011	455,193	$	(2,309,898	)	$	15,023,927	$	561,271	$	53,635,638	$	66,926,949

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

37

Dynacq Healthcare, Inc.

Consolidated Statements of Cash Flows

	Year Ended August 31,
	2008			2007
Cash flows from operating activities
Net income	$	8,439,698		$	4,155,480
Less income from discontinued operations, net of income taxes		(3,057,910	)		(288,838	)
Net income before discontinued operations		5,381,788			3,866,642
Adjustments to reconcile net income to net cash provided by operating activities:
Extraordinary gain, net of tax		(39,436	)		(29,844	)
Depreciation and amortization		2,115,267			2,334,012
Gain on disposal of assets		(503,226	)		—
Deferred income taxes		197,106			(744,604	)
Minority interests		185,958			121,563
Charge for granting stock options to employees		373,435			124,425
Income tax benefit for employees’ exercise of incentive stock options		99,645			77,000
Changes in operating assets and liabilities:
Restricted cash		4,388,857			469,000
Accounts receivable		12,436,696			(2,415,113	)
Inventories		717,711			(435,726	)
Prepaid expenses		(44,860	)		75,063
Income taxes receivable		392,740			212,054
Other assets		45,881			131,871
Accounts payable		(318,779	)		(1,106,950	)
Accrued liabilities		109,906			2,440,086
Income taxes payable		2,215,109			462,395
Cash provided by continuing activities		27,753,798			5,581,874
Cash provided by (used in) discontinued activities		(41,175	)		312,540
Net cash provided by operating activities		27,712,623			5,894,414
Cash flows from investing activities
Restricted cash for capital improvement		—			(4,049,149	)
Proceeds from sale of assets		6,157,763			—
Purchase of property and equipment		(1,283,851	)		(484,474	)
Purchase of accounts receivable-other		—			(312,449	)
Collections of purchased accounts receivable-other		—			144,745
Cash provided by (used in) continuing activities		4,873,912			(4,701,327	)
Cash provided by discontinued activities		16,175,259			41,360
Net cash provided by (used in) investing activities		21,049,171			(4,659,967	)

Continued.

38

Dynacq Healthcare, Inc.

Consolidated Statements of Cash Flows (continued)

	Year Ended August 31,
	2008			2007
Cash flows from financing activities
Principal payments on notes payable	$	(7,526,182	)	$	(216,231	)
Proceeds from note payable		—			734,601
Payments on capital lease		—			(5,920	)
Proceeds from issuance of restricted stocks		—			—
Proceeds from exercise of stock options		721,398			503,945
Proceeds from sale of stock		—			67,375
Treasury stock purchase		(2,309,898	)		—
Distributions and purchases of minority interest holders		(515,050	)		(179,245	)
Cash provided by (used in) continuing activities		(9,629,732	)		904,525
Cash used in discontinued activities		—			(130,299	)
Net cash provided by (used in) financing activities		(9,629,732	)		774,226
Effect of exchange rate changes on cash		530,951			45,782
Net increase in cash and cash equivalents		39,663,013			2,054,455
Cash and cash equivalents at beginning of year		5,436,787			3,382,332
Cash and cash equivalents at end of year	$	45,099,800		$	5,436,787
Supplemental cash flow disclosures
Cash paid during year for:
Interest	$	132,370		$	449,186
Income taxes	$	1,543,634		$	—
Non cash investing and financing activities:
Accrued liabilities	$	124,326		$	(1,400,000	)
Minority interest		(124,326	)		—
Note payable		—			1,400,000
Equipment from capital lease		—			(33,576	)
Capital lease obligation		—			33,576
Deferred tax liabilities		(68,949	)		—
Other comprehensive income		(189,200	)		—
Income tax receivable		258,149			—
Land cost from foreign currency gains		—			(203,490	)
Foreign currency gains		—			203,490
	$	—		$	—

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

39

Dynacq Healthcare, Inc.

Notes to Consolidated Financial Statements

August 31, 2008

1. Significant Accounting Policies

Business and Organization

Dynacq Healthcare, Inc. is a holding company that through its subsidiaries develops and manages general acute care hospitals which provide specialized general surgeries, such as neuro-spine, bariatric and orthopedic surgeries. We are composed of two divisions, based on our geographic area of operations, U.S. and China. Hereinafter, the “Company” will refer to Dynacq Healthcare, Inc. and its wholly or majority owned subsidiaries, unless the context dictates or requires otherwise.

The Company was incorporated under the laws of the State of Nevada in 1992. The Company was reincorporated in Delaware in November 2003 and reincorporated back in Nevada in August 2007.

In May 1998, Vista Community Medical Center, L.L.C., a Texas limited liability company, was organized 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, 2008 and 2007, the Company through its subsidiaries had a 99.9% and 98.5% ownership interest in the Pasadena facility, respectively.

In July 2003, Vista Hospital of Dallas, LLP was organized for the purposes of acquiring and operating a surgical hospital in Garland, Texas, (the “Garland facility”). As of August 31, 2008 and 2007, the Company had a 100% and 99%, respectively, membership interest in the Garland facility.

In April 2008, the Company formed a wholly owned subsidiary, Dynacq Huai Bei Healthcare, Inc. (“Dynacq-Huai Bei”), a Chinese corporation, to provide healthcare management services in China. The Company has also organized Sino Bond Inc. Limited, a Hong Kong corporation (“Sino Bond”), to hold investments in Hong Kong. Sino Bond has no operations to date but has entered into a marketing contract for the provision of healthcare services by Dynacq subsidiaries in China and Southeast Asia.

The Company owned a 70% equity interest in Shanghai DeAn Hospital, a joint venture formed under the laws of the People’s Republic of China (the “DeAn Joint Venture”). The DeAn Joint Venture entered into land use agreements with the Chinese government for the purpose of constructing a hospital in Shanghai, China that was to be owned and operated by the joint venture. In July 2008, the Company sold its interest in the property owned by DeAn.

The Company sold its West Houston facility in the quarter ended February 28, 2007, its land in The Woodlands, Texas in the quarter ended November 30, 2007, its Baton Rouge facility in the quarter ended February 29, 2008, and its interest in the property owned by DeAn in the quarter ended August 31, 2008.

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.

40

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted 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 $8.7 million and $8.8 million for the fiscal years 2008 and 2007, respectively.

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.

Reclassification

The assets related to the Baton Rouge and West Houston facilities, the land in The Woodlands, Texas, and the operating results for these facilities for all periods presented have been reclassified as Discontinued Operations. Certain balance sheet amounts have been reclassified in the consolidated balance sheet as of August 31, 2007 to conform to the presentation as of August 31, 2008.

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.

Restricted Cash

Restricted cash includes $4.0 million as of August 31, 2007 for capital improvements in the DeAn Joint Venture. During the fiscal year ended August 31, 2008, the interest in the DeAn Joint Venture was sold.

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.

	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	5.1 years

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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 records 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 a decision to sell an asset.

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 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 are based on estimated or historical cash collections as discussed below and may not represent amounts ultimately collected. At such time as the Company can determine that ultimate collections have exceeded or have been less than the revenue recorded on a group of accounts, additional revenue or reduction in revenue is recorded as a change in estimate during the current period. The Company does adjust current period revenue for actual differences in estimated revenue recorded in prior periods and actual cash collections. As the Company is able to identify specific closed blocks of business, the Company compares the actual cash collections on gross billed charges to the estimated collections that were recorded in revenue. The Company records additional revenue or a reduction in revenue in the current period equal to the difference in the estimate recorded and the actual cash collected.

In the last two fiscal years, the Company has recorded additional revenue as follows:

1. The Company has recorded additional revenue of $8,217,000 during the fiscal year ended August 31, 2008 related to amounts collected on MDR accounts receivable. The Company settled various MDR claims for our Pasadena and Garland facilities and collected a total of $26,713,000 for dates of service ranging from 2001 to 2005. This amount represents payments received initially at the time of filing of the claim, additional monies received upon filing the MDR claim and the settlement amount. On these closed MDR accounts receivable, the Company had recognized approximately $18,496,000 as net revenue during the relevant fiscal years when the service was performed. Gross billings on this block of receivables were $35,807,000. Since the Company actually collected $8,217,000 more on this block of receivables than was booked, additional revenue of $682,000, $3,835,000, $1,324,000 and $2,376,000 was recorded in the first, second, third and fourth quarters of the fiscal year ended August 31, 2008, respectively. We do not believe that the amount of additional revenues from MDR settlements reached in this fiscal year is indicative of the amounts that will be obtained from settlements reached in the next twelve months, since insurance companies who have not yet settled may be more likely to appeal their cases, which could delay settlement or a final judgment.

2. The Company collected $42,596,000 on a block of business generated at our Garland facility between September 2003 and February 2008. The accounts included in this block of business were not related to workers’ compensation. Gross billings on this block of receivables were $78,781,000. The contractual allowance booked on this block of receivables was $41,485,000, or approximately 52.7%, generating net revenue of $37,296,000. Since the Company actually collected $5,300,000 more than revenue booked on this block of receivables, additional revenue in the amount of $5,300,000 was recorded in the fourth quarter of the fiscal year ended August 31, 2008.

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3. The Company collected $28,572,000 on a block of business generated at our Pasadena facility between September 2005 and February 2008. The accounts included in this block of business were not related to workers’ compensation. Gross billings on this block of receivables were $60,715,000. The contractual allowance booked on this block of receivables was $36,643,000, or approximately 60.4%, generating net revenue of $24,072,000. Since the Company actually collected $4,500,000 more than revenue booked on this block of receivables, additional revenue in the amount of $4,500,000 was recorded in the fourth quarter of the fiscal year ended August 31, 2008.

4. Due to the uncertainties regarding the accounts receivable in the MDR process, and the recent Third Court of Appeals’ opinion and our legal counsel’s advice that settlements with insurance carriers have virtually stopped, the Company has fully reserved all accounts receivable related to the MDR process as of August 31, 2008, and written-off $8.7 million and $9.8 million of MDR accounts receivable in the fourth quarter of the fiscal year ended August 31, 2008, at our Garland and Pasadena facilities, respectively.

The net write down in net patient service revenue was $6.3 million in the fourth quarter of the fiscal year ended August 31, 2008, or $4.1 million net of income tax expense, or $0.25 per diluted share.

The table below sets forth the percentage of our gross patient service revenue by financial class for the fiscal years 2008 and 2007:

	2008		2007
Workers’ Compensation	37	%	47	%
Commercial	41	%	38	%
Medicare	10	%	9	%
Medicaid	—	%	1	%
Self-Pay	10	%	3	%
Other	2	%	2	%

Contractual Allowance

Starting March 1, 2008, the Company computes its contractual allowance based on the estimated collections on its gross billed charges. The Company computes its estimate by taking into account collections received for the services performed and also estimating amounts collectible within the next six months and after six months by considering historical collections ratio. Prior to March 1, 2008, the contractual allowance was calculated based on the ratio of the Company’s historical cash collections during the trailing twelve months on a case-by-case basis by operating facility. This ratio of cash collections to billed services was then applied to the gross billed services by operating facility. The following table shows gross revenues and contractual allowances for fiscal years 2008 and 2007:

	2008			2007
Gross billed charges	$	145,763,332		$	96,215,520
Contractual allowance		85,489,385			53,369,699
Net revenue	$	60,273,947		$	42,845,821
Contractual allowance percentage		59	%		55	%

A significant amount of our net revenue results from Texas workers’ compensation claims, which are governed by the rules and regulations of the Texas Department of Workers’ Compensation (“TDWC”) and the workers’ compensation healthcare networks. If one of our hospitals chooses to participate in a network, the amount of revenue that will be generated from workers’ compensation claims will be governed by the network contract.

For claims arising prior to the implementation of workers’ compensation networks and out of network claims, inpatient and outpatient surgical services are either reimbursed pursuant to the Acute Care In-Patient Hospital Fee Guideline or at a “fair and reasonable” rate for services in which the fee guideline is not applicable. Starting March 1, 2008, the Texas Workers’ Compensation 2008 Acute Care Hospital Outpatient and Inpatient Facility Fee Guidelines (the “Guidelines”) became effective. Under these Guidelines, the reimbursement amounts are determined by applying the most recently adopted and effective Medicare reimbursement formula and factors; however, if the maximum allowable reimbursement for the procedure performed cannot be calculated using these Guidelines, then reimbursement is determined on a fair and reasonable basis.

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Based on these new Guidelines, the reimbursement due the Company for workers’ compensation cases is lower than we previously experienced. The Company has continued accepting Texas workers’ compensation cases, and has not made any substantial changes in its focus towards such cases. Our net patient service revenue for Texas workers’ compensation cases as a percentage of gross billings has decreased primarily as a result of lower reimbursement rates for workers’ compensation procedures still being performed.

Should our facility disagree with the amount of reimbursement provided by a third-party payer, we are required to pursue the MDR process at the TDWC to request proper reimbursement for services. The Company has recently been successful in its pursuit of collections regarding the stop-loss cases pending before the State Office of Administrative Hearings (“SOAH”), receiving positive rulings in over 90% of its claims presented for administrative determination. The 2007 district court decision upholding our interpretation of the statute as applied to the stop-loss claims was recently appealed by certain insurance carriers, and the Third Court of Appeals determined that in order for a hospital to be reimbursed at 75% of its usual and customary audited charges for an inpatient admission, the hospital must not only bill at least $40,000, but also show that the admission involved unusually costly and unusually extensive services. Procedurally, the decision means that each case where a carrier raised an issue regarding whether the services provided were unusually costly or unusually extensive would be remanded to either SOAH or Medical Dispute Resolution (“MDR”) for a case-by-case determination of whether the services provided meet these standards, once the definitions of those standards are determined. We plan to appeal the Third Court of Appeals decision and anticipate further, lengthy litigation at the Travis County District Courts and the Texas Courts of Appeals to establish the legal definition for these standards. Because of this lengthy process and the uncertainty of recovery in these cases, collection of a material amount of funds in these pending stop-loss cases is not anticipated during the 2009 fiscal year.

To date, insurance carriers have voluntarily paid the awards in the decisions and orders issued by SOAH, plus interest, in approximately 180 cases, involving approximately $11 million. In most of these cases, the carriers have requested refunds of the payments made in the event that the SOAH decisions and orders are reversed on appeal. We believe the Company’s ultimate obligation to refund the payments is remote. Our request that the TDWC Commissioner enforce the awards which have not been voluntarily paid by the carriers has been refused in approximately 130 cases.

Claims regarding payment for hospital outpatient services remain pending at the TDWC. It is expected that these claims will be adjudicated at SOAH and ultimately in the Texas district and appellate courts. The basis for reimbursement for these services made the subject of these pending cases is the determination of “fair and reasonable” charges. In 2007, we received unfavorable rulings from SOAH in all of our appeals of unfavorable decisions related to services provided in 2001 and 2002. The 179 cases which have been appealed to the Travis County district courts challenge the constitutionality of the relevant statutory language. A lead case has been selected and is scheduled to be heard on January 14, 2009. Although we would appeal any negative ruling handed down in this lead case, such ruling will impact cases in which a fee guideline was not applicable, specifically all pending cases involving ambulatory surgical services provided in 2001 and 2002 as well as all pending cases involving hospital outpatient services provided prior to March 1, 2008. Successful collection of material amounts in these cases is unlikely.

We are currently pursuing claims against two healthcare agents relating to contracts with certain of our facilities which set out reimbursement guidelines by several workers’ compensation carriers at a minimum of 70% of the facility’s charges. Discovery is continuing on these claims to determine which carriers are involved and the amount of reimbursement due to us.

Due to the uncertainties regarding the accounts receivable in the MDR process, the recent Third Court of Appeals’ opinion and our legal counsel’s advice that settlements with insurance carriers have virtually stopped, the Company has fully reserved all accounts receivable related to the MDR process as of August 31, 2008. Any monies collected for these MDR accounts receivable will be recorded as current period’s net patient service revenues.

Accounts Receivable

Accounts receivable represent net receivables for services provided by the Company. Due to reasons discussed above for writing down all MDR accounts receivable, the Company does not have any long term receivables as at

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August 31, 2008, and expects to collect the net receivables within twelve months. At each balance sheet date management reviews the accounts receivable for collectibility.

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 partial 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 an individual receivable are recognized.

Stock Based Compensation

Effective at the beginning of fiscal year 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 “Share-Based Payment” (“SFAS No. 123(R)”) to account for stock-based compensation. Under SFAS No. 123(R), the Company estimates the fair value of stock options granted using the Black-Scholes option pricing model. The fair value for awards that are expected to vest is then amortized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. The amount of expense attributed is based on estimated forfeiture rate, which is updated based on actual forfeitures as appropriate. This option pricing model requires the input of highly subjective assumptions, including the expected volatility of our common stock, pre-vesting forfeiture rate and an option’s expected life. The financial statements include amounts that are based on the Company’s best estimates and judgments. Prior to fiscal year 2006, the Company accounted for stock-based compensation plans using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.”

Advertising Costs

Advertising and marketing costs in the amounts of $4,545,000 and $5,440,000 for the years ending August 31, 2008 and 2007, 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 0.1% to 7% during the fiscal year ended August 31, 2008, and was 0.1% at August 31, 2008 at the Pasadena facility). During 2008 and 2007, the Company purchased minority interests from certain minority interest holders at an amount that was $60,671 and $45,244 less than the net book value of the minority interest liability on the date of purchase, respectively. These gains have been recorded as an extraordinary gain during the respective periods. In fiscal 2008 and 2007, the buy-out amounts were made in accordance with the provisions of the various partnership agreements.

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The following table sets forth the activity in the minority interest liability account for the fiscal years ending August 31, 2008 and 2007:

Balance August 31, 2006	$	656,697
Earnings allocated to minority interest holders		121,563
Distribution to minority interest holders		(15,000	)
Acquisition of various minority interests		(164,245	)
Balance August 31, 2007		599,015
Earnings allocated to minority interest holders		185,958
Distribution to minority interest holders		(61,780	)
Acquisition of various minority interests		(638,267	)
Balance August 31, 2008	$	84,926

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 in years in which the Company has income.

Foreign Currency Translation

The Company has designated the Chinese Yuan Renminbi as the functional currency for the DeAn Joint Venture and Dynacq Huai Bei in China, and the Hong Kong Dollar for Sino Bond Inc. Limited in Hong Kong. Assets and liabilities are translated into U.S. dollars using current exchange rates as of the balance sheet date. Income and expense are translated at average exchange rates prevailing during the period. The effects of foreign currency translation adjustments are included as a component of Accumulated Other Comprehensive Income within stockholders’ equity.

Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”) and SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements” (“SFAS No. 160”). These new standards represent the outcome of the FASB’s joint project with the International Accounting Standards Board and are intended to improve, simplify and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements.

SFAS No. 141(R) replaces SFAS No. 141, “Business Combinations,” however, it retains the fundamental requirements of the former Statement that the acquisition method of accounting (previously referred to as the purchase method) be used for all business combinations and for an acquirer to be identified for each business. This Statement defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control. The new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination.

SFAS No. 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This Statement clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement

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changes the way the consolidated income statement is presented by requiring net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest and to disclose those amounts on the face of the income statement. It also aligns the reporting of noncontrolling interest in subsidiaries with the requirements in International Accounting Standard 27.

Both SFAS No. 141(R) and SFAS No. 160 are effective beginning in our fiscal 2010. SFAS No. 141 (R) will be applied to business combinations that are consummated beginning in fiscal 2010, and SFAS No. 160 will be applied prospectively to all noncontrolling interests, including any that arose before fiscal 2010. We are currently evaluating these Statements and have not yet determined their effect on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”) which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles (“GAAP”). As a result of SFAS 157 there is now a common definition of fair value to be used throughout GAAP. The FASB believes that the new standard will make the measurement of fair value more consistent and comparable and improve disclosures about those measures. SFAS 157 will be effective for the Company for fiscal year 2009. Management is currently evaluating the impact of the statement on the Company. Management does not believe the adoption of SFAS 157 will have a material impact on its consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 requires entities to provide enhanced disclosures about derivative instruments and hedging activities. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company does not currently have any derivative instruments or hedging activities.

2. Property and Equipment

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

	2008			2007
Land	$	2,452,110		$	6,225,000
Buildings and improvements		13,954,662			13,954,662
Equipment, furniture and fixtures		16,508,326			15,447,814
		32,915,098			35,627,476
Less accumulated depreciation and amortization		(17,686,211	)		(15,821,032	)
Construction in progress		—			150,267
Net property and equipment	$	15,228,887		$	19,956,711

For the years ended August 31, 2008 and 2007, depreciation expense was $2,106,100 and $2,324,012, respectively.

3. Assets held for sale

The Company sold its West Houston facility in the quarter ended February 28, 2007, its land in The Woodlands, Texas in the quarter ended November 30, 2007 its Baton Rouge facility in the quarter ended February 29, 2008, and its interest in the property owned by DeAn in the quarter ended August 31, 2008.

4. Discontinued operations

The Company has accounted for its Baton Rouge and West Houston facilities as discontinued operations, and has reclassified prior period financial statements to exclude these businesses from continuing operations. A summary of financial information related to the Company’s discontinued operations for each of the past two years is as follows:

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	Year Ended August 31,
	2008			2007
Net patient service revenue	$	3,796,025		$	12,389,320
Costs and expenses		(3,949,998	)		(11,945,046	)
Other income		112,798			34,966
Income (loss) before income taxes		(41,175	)		479,240
Benefit (provision) for income taxes		14,412			(175,700	)
Income (loss) from discontinued operations, net of income taxes		(26,763	)		303,540
Gain (loss) on sale of discontinued operations		4,745,650			(23,702	)
(Provision) benefit for income taxes		(1,660,977	)		9,000
Gain (loss) on sale of discontinued operations, net of income taxes		3,084,673			(14,702	)
Total income from discontinued operations, net of income taxes	$	3,057,910		$	288,838

Assets and liabilities of discontinued operations related to the Baton Rouge and West Houston facilities and the land in The Woodlands, Texas, consist of the following as of August 31, 2007:

Property and equipment, net	$	13,187,738
Total assets	$	13,187,738

5. Notes payable

At August 31, notes payable consisted of the following:

	2008		2007
Current portion of $1.4 million note payable related to class action lawsuit settlement dated October 10, 2006. The note bears interest at 6% per annum and is secured by a deed of trust on the Garland facility	$	480,269	$	452,368
Five-year revolving credit facility with a financial institution subject to a borrowing base based on eligible accounts receivable, secured by a first priority security interest in all existing and future accounts receivable and accounts receivable related items, other assets and deposit accounts of certain subsidiaries, a pledge of 75% of equity interest in the operating entities of the Garland and Pasadena facilities and a negative pledge for the equity interests in the Company and other subsidiaries, variable interest payable of 2.85% plus LIBOR rate. Subsequent to fiscal year ended August 31, 2008, this credit facility was terminated		—		7,073,813
Note payable – current portion		480,269		7,526,181
Long-term portion of $1.4 million note payable related to class action lawsuit settlement dated October 10, 2006. The note bears interest at 6% per annum and is secured by a deed of trust on the Garland facility		251,131		731,401
	$	731,400	$	8,257,582

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6. Income Taxes

The provision (benefit) for income taxes consisted of the following:

	Year Ended August 31,
	2008		2007
Current tax expense (benefit):
Federal	$	3,684,270	$	276,241
State		175,276		22,873
Total current		3,859,546		299,114
Deferred tax expense (benefit):
Federal		197,107		(687,666	)
State		—		(56,938	)
Total deferred		197,107		(744,604	)
Total income tax expense (benefit)	$	4,056,653	$	(445,490	)

As of August 31, 2008 and 2007, income tax benefits of $99,645 and $77,000, 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:

	2008			2007
Applicable to:
Differences between revenues and expenses recognized for federal income tax and financial reporting purposes	$	(258,079	)	$	333,827
Stock options and related employee compensation		—			(47,188	)
Allowance for uncollectible accounts		(84,584	)		(85,448	)
Asset impairment		(455,000	)		—
Difference in method of computing depreciation for tax and financial reporting purposes		937,464			(17,914	)
State tax rate change		89,996			—
Net operating loss usage (carry forward)		—			835,899
Valuation allowance change		—			(1,763,780	)
Other		(32,690	)		—
Deferred income tax expense (benefit)	$	197,107		$	(744,604	)

Significant components of the Company’s deferred tax liabilities and assets were as follows at August 31, 2008:

	Current			Noncurrent
Deferred tax liabilities:
Depreciation	$	—		$	(93,983	)
Exchange gains provision		—			(302,200	)
Deferred tax assets:
Revenue and expense differences		290,990			—
Allowance for uncollectible accounts		726,608			—
Other		(158,343	)		40,375
Net deferred tax asset (liability)	$	859,255		$	(355,808	)

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Significant components of the Company’s deferred tax liabilities and assets were as follows at August 31, 2007:

	Current			Noncurrent
Deferred tax liabilities:
Depreciation	$	—		$	(1,117,646	)
Exchange gains provision		—			(113,000	)
Deferred tax assets:
Revenue and expense differences		201,205			—
Allowance for uncollectible accounts		878,986			—
Asset impairment		—			493,026
Other		(22,260	)		123,505
Minority interest					187,788
Net deferred tax asset (liability)	$	1,057,931		$	(426,327	)

A reconciliation of the provision (benefit) for income taxes with amounts determined by applying the statutory federal income tax rate to income before income taxes, minority interests and extraordinary gain is as follows:

	Year Ended August 31,
	2008			2007
Provision for income taxes computed using the statutory rate of 35%	$	3,354,737		$	1,229,505
State income taxes, net of federal benefit		113,929			14,868
Minority interests in subsidiaries’ income		(65,085	)		(46,103	)
Non-deductible expenses		463,431			43,020
Change in valuation allowance		—			(1,763,780	)
State tax rate change		89,996			—
Tax benefit of employees stock options exercise		99,645			77,000
Provision (benefit) for income taxes	$	4,056,653		$	(445,490	)

7. Related Party Transactions

The Company has retained Redwood Health Corporation (“Redwood”), to furnish physicians to provide in-house emergency medical coverage for its Pasadena facility during the weekend hours and weekday nights at an hourly rate of $75. The son of the Company’s Chief Executive Officer is a physician and an affiliate of Redwood. The Company paid $437,100 and $433,500 for emergency room physician services to Redwood in fiscal 2008 and 2007, respectively. Management, as well as the Audit Committee that approved the agreement, believes that the hourly rate being paid is consistent with comparable in-house emergency medical coverage rates available in the area.

The Company leases 7,250 square feet of office space for its executive offices through September 1, 2011 for $6,525 per month. 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.

Dr. Ping Chu, a director, has paid the Company $13,088 and $19,768 during fiscal years ended August 31, 2008 and 2007, respectively for rent and management fees. As of August 31, 2008 and 2007, the Company had accounts receivable from Dr. Chu of $22,441 and $36,595, 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. Xiao Li, a director, was paid $189,275 and $188,975 to provide in-house medical services to the emergency room patients at the Pasadena facility during the fiscal years ended August 31, 2008 and 2007, respectively. Management, as well as the Audit Committee that approved the agreement, believes that the rate being paid is consistent with comparable in-house emergency medical services available in the area.

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8. Stockholders’ Equity and Stock Option Plan

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, 2008.

Treasury Stock

Of the 500,000 shares authorized to repurchase in January 2002, the Company purchased 10,000 shares in December 2007 at an average cost of $3.80 per share. Prior to that the Company had bought back 450,676 shares of its common stock during fiscal years 2002 - 2004, at an average cost of $14.08 per share, for a total purchase price of $6,345,680. The Company is no longer purchasing its shares under this program.

On February 29, 2008 the Company’s Board of Directors authorized a program of repurchasing up to 2 million of its outstanding securities from time to time in open market transactions at prevailing prices on NASDAQ. The Company has repurchased 445,193 shares at an average cost of $5.10 per share.

Stock Option Plan

The Company’s 2000 Incentive Plan (the “Plan”) provides 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 5,000,000 shares of common stock for future issuance under the Plan. As of August 31, 2008, there remain 1,219,854 shares which can be issued under the Plan, after giving effect to stock splits and shares issued under the Plan. The Plan permits 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 Plan 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 Plan is 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 Plan. 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 Plan is necessary only when required by applicable law or stock exchange rules.

On June 22, 2007, the Compensation Committee granted stock options to purchase an aggregate of 1.3 million shares, with a weighted average exercise price of $2.52 to all full time employees with a minimum of one year of employment with the Company. These stock options will vest in annual installments of 25 percent beginning on the first anniversary date, and expire after six years. Generally, options granted become exercisable in annual installments of 25 percent beginning on the first anniversary date, and expire after five to ten years.

On July 25, 2008, the Compensation Committee granted a performance share award to an employee whereby the employee can earn up to 1 million shares of the Company’s common stock if certain operating performance criteria are met, beginning in fiscal 2010. The number of shares that are issuable each year is to be determined by quantifying the performance criteria and dividing the quantified amount by $3.74, which was the market price of the Company’s stock on the date of grant of the award. The performance period extends for ten years or until such time as the 1 million shares of common stock have been awarded.

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On August 19, 2008, the Compensation Committee granted stock options to purchase an aggregate of 100,000 shares, with an exercise price of $5.10 to an employee. These stock options will vest in annual installments of 25 percent beginning on the first anniversary date, and expire after six years.

Beginning in fiscal year 2006, the Company adopted SFAS No. 123(R) on a modified prospective transition method to account for its employee stock options. Under the modified prospective transition method, fair value of new and previously granted but unvested equity awards is recognized as compensation expense in the income statement, and prior period results are not restated. Since all of the outstanding stock options as of August 31, 2005 were vested, there was no impact on the consolidated financial statements of the Company as a result of the adoption.

SAB No. 107, which provided the Staff’s views regarding valuation of share-based payments pursuant to SFAS No. 123(R), clarified that there is not a particular method of estimating volatility. SAB No. 107 also provided certain “simplified” methods for determining expected life in valuing stock options. To the extent that an entity cannot rely on its historical exercise data to determine the expected life, SAB No. 107 has prescribed a simplified “plain-vanilla” formula. The Company applied SAB No. 107 “plain-vanilla” method for determining the expected life.

The following table summarizes the stock option activities for the year ended August 31, 2008 (share amounts in thousands):

	Shares		Weighted Average Option Exercise Price Per Share		Weighted Average Grant Date Fair Value Per Share		Aggregate Intrinsic Value(1)
Outstanding, August 31, 2007	2,151		$	3.77	$	—	$	6,053,359
Granted	100			5.10		3.62		—
Exercised	(167	)		4.31		—		512,794
Expired or canceled	(513	)		4.59		—		—
Outstanding, August 31, 2008	1,571		$	3.52		—	$	2,139,450

⁽¹⁾ These amounts represent the difference between the exercise price and $4.85, the closing price of Dynacq common stock on August 31, 2008 as reported on the NASDAQ stock market, for all in-the-money options outstanding. For exercised options, intrinsic value represents the difference between the exercise price and the closing price of Dynacq common stock on the date of exercise.

For the years ended August 31, 2008 and 2007, the Company received $721,398 and $503,945, respectively, for stock options exercised. Total tax benefit realized for the tax deductions from stock options exercised was $99,645 and $77,000 for the years ended August 31, 2008 and 2007, respectively.

The following summarizes information related to stock options outstanding at August 31, 2008:

	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)
$ 2.50 – 2.75	886	4.8	$	2.53	253		$	2.52
$ 4.44 – 5.10	685	5.0		4.81	585			4.76
Total	1,571	4.9	$	3.52	838		$	4.09

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The fair value of the stock-based awards was estimated using the Black-Scholes model with the following weighted average assumptions for two fiscal years ended August 31, 2008:

	Year Ended August 31,
	2008		2007
Estimated fair value	$	3.62	$	1.70
Expected life (years)		4.04		4.32
Risk free interest rate		3.07%		5.00%
Volatility		204%		89%
Dividend yield		—		—

9. 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 2008 and 2007 were $81,111 and $50,901, respectively.

10. 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 shares outstanding for basic and diluted are the same, as an increase in the number of shares for dilution purposes would be anti-dilutive. The denominator for each period presented was determined as follows:

	Year Ended August 31,
	2008	2007
Denominator:
Basic net income per share—weighted average shares outstanding	15,793,660	15,749,891
Effect of dilutive securities:
Common stock options—treasury stock method	664,228	160,226
Diluted net income per share—weighted average shares outstanding	16,457,888	15,910,117

11. Comprehensive Income

Comprehensive income at August 31 is as follows:

	2008		2007
Net income	$	8,439,698	$	4,155,480
Foreign currency translation adjustment, net of income tax expense of $189,200 and $113,000, in fiscal years 2008 and 2007, respectively		341,751		113,951
Comprehensive income	$	8,781,449	$	4,269,431

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12. Accrued Liabilities

Accrued liabilities at August 31 is as follows:

	2008		2007
Marketing fees liability	$	639,224	$	1,951,100
Payroll, bonus and related taxes		2,657,086		961,209
Minority interest buy-out liability		383,068		—
Property taxes		321,969		441,014
Medicare liability		400,000		400,000
Lawsuit settlements and other related expenses		100,000		385,000
Sales tax liability		357,216		325,216
Insurance premium payable		95,715		157,383
Rui An management fee payable		146,088		—
Accrued interest		4,048		50,329
Year-end accruals of expenses and other		811,146		1,010,077
Total accrued liabilities	$	5,915,560	$	5,681,328

13. Commitments and Contingencies

Total rent and lease expenses paid by the Company for the fiscal years 2008 and 2007 were approximately $1,240,000 and $1,056,000, respectively. The Company’s total minimum rental commitments under noncancellable operating leases are approximately $2.1 million in the next four fiscal years.

The Company, through its subsidiary, also had 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 and Garland facilities. These facilities received bariatric and orthopedic referrals from other sources, and the organizations referred clients to other area hospitals. Payments made related to these agreements for the fiscal years 2008 and 2007 were $4,545,000 and $5,145,000, respectively. The Company has a total commitment of approximately $6,750,000 to be incurred in the next two fiscal years related to these marketing agreements.

The Company is currently overseeing the construction of a hospital in Rui An, China to be completed October 1, 2009, at which time it will manage the hospital for a term of 15 years. As part of this agreement, the Company will provide a construction loan of approximately $2.1 million based on percentage of completion of construction of the hospital, and will also advance approximately $730,000 for equipment purchase. The Company also has a commitment to assume and discharge within 10 years $883,000 of existing liabilities, of which $736,000 has already been paid in fiscal year ended August 31, 2008. The Company has subsequent to the year ended August 31, 2008, signed an agreement for marketing its services to hospitals in China, for which the Company would incur at its discretion from $75,000 to $250,000 per month for the next three years.

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, 2008 and 2007 were $3,276,000 and $2,888,000, respectively. The Company’s minimum commitments under these contracts are approximately $3.7 million to be incurred primarily in the next fiscal year.

Risks and Uncertainties

The Company maintains various insurance policies that cover each of its facilities. Specifically, the Company has occurrence medical malpractice coverage for its Pasadena and Garland facilities. 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, including flood coverage. The Company 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-

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loss levels appropriate for the Company’s group size. Coverage is maintained in amounts management deems adequate.

The Company is routinely involved in litigation and administrative proceedings that are incidental to its business. Specifically, all judicial review of unsatisfactory determinations of reimbursement amounts due us for our facility’s fees must be made in the district courts of Travis County, Texas in what can often be a lengthy procedure.

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, 2008, the Company had cash balances in excess of the FDIC and SIPC limits of $45.1 million.

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, 2008 and 2007 is as follows:

	2008		2007
Workers’ compensation	10	%	3	%
Workers’ compensation subject to Medical Dispute Resolution process	69	%	79	%
Commercial	9	%	9	%
Medicare	3	%	5	%
Medicaid	—	%	—	%
Self-pay	5	%	2	%
Other	4	%	2	%
	100	%	100	%

We had two third-party payers (customers) representing 11% and 10% of the Company’s gross revenue for the year ended August 31, 2008. We had one third-party payer (customer) representing 12% of the Company’s gross revenue for the year ended August 31, 2007. We did not have a single third-party payer (customer) who represented 10% of our gross receivables as of August 31, 2008. We had one third-party payer (customer) who represented 14% of our gross receivables as of August 31, 2007.

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, 2008 and 2007 approximate their fair value.

15. Industry Segments and Geographic Information

We manage our operations through two operating segments, based on our geographic areas: U.S. and China.

U.S. Division

Our U.S. Division develops and operates general acute care hospitals designed to handle specialized surgeries such as bariatric, orthopedic and neuro-spine surgeries. Certain of the Company’s facilities also provide sleep laboratory and pain management services, as well as minor emergency treatment services. The U.S. Division owns two hospitals, which are the Pasadena facility and the Garland facility.

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China Division

Our China Division is set up to provide healthcare management services in China. In the fiscal year ended August 31, 2008 and 2007, there have been no revenues in China.

DeAn, which was formed for the purpose of constructing, owning and operating a hospital in Shanghai, China, had entered into land use agreements with the Chinese government under which it leased, for a term of 50 years, approximately 28.88 acres of government-owned land on which the hospital would be constructed. After protracted negotiations with the Chinese government for, among other matters, the payment by the government of the amounts due by it under the Joint Venture Agreement which it had not funded, the sale by the government of its interest in DeAn to a third party, and the extension of the dates for completion of construction of the hospital, the Company, in July 2008, sold its interest in the property owned by DeAn for the construction of the hospital for approximately $4.3 million U.S., net of commissions.

In April 2008, the Company formed Dynacq-Huai Bei, to provide healthcare management services to hospitals in China. Dynacq Huai Bei has entered into an Agreement to Assign Management (“Management Agreement”) with Rui An City Department of Health assigning to Dynacq Huai Bei the right to manage the operations, human resources and financials of the Rui An Hospital beginning October 2009, when the new hospital currently under construction is completed and operational. Dynacq-Huai-Bei is currently overseeing the construction of the hospital until it is completed.

The Company has also organized Sino Bond to hold investments in Hong Kong. Sino Bond has no operations to date but has entered into a three-year marketing contract effective October 1, 2008 for the provision of healthcare services by Dynacq subsidiaries in China and Southeast Asia.

We generally evaluate performance based on profit or loss from operations before income taxes and non-recurring charges and other criteria. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. There are no transfers between segments.

Summarized financial information concerning the business segments from continuing operations is as follows:

	Year Ended August 31,
	2008			2007
Revenues from external customers
Net patient service revenues
U.S. Division	$	60,273,947		$	42,845,821
China Division		—			—
Consolidated	$	60,273,947		$	42,845,821
Income (loss) before taxes, discontinued operations and extraordinary gain
U.S. Division	$	11,304,946		$	4,136,103
China Division		(1,905,941	)		(744,795	)
Consolidated	$	9,399,005		$	3,391,308
Total Assets
U.S. Division	$	64,083,652		$	70,219,802
China Division		18,164,910			8,675,159
Consolidated	$	82,248,562		$	78,894,961

Many hospitals in China are owned and operated by the local governments subject to the oversight by the central government. The Company’s strategy is to minimize its capital investment by entering into long term mutually beneficial relationships by utilizing space from existing government hospitals and providing specialty medical treatment therapies that the government owned hospitals are lacking and are in high demand. There currently exist joint venture arrangements between foreign healthcare providers and government owned hospitals, principally in major cities, such as Shanghai and Beijing. Some of these competitors have greater financial and

56

other resources than the Company in China. The Company has no prior experience of operating hospitals and can provide no assurance that it will be able to compete successfully in China.

The above financial data are not reflective of the future trends, since revenue from China Division has not started as yet. Subsequent to the fiscal year ended August 31, 2008, the cash balance at the China Division has increased from $17.7 million to $37 million. The U.S. Division has transferred an additional $20 million in October 2008 to the China Division due to attractive interest rates on time deposits. Of the $37 million in cash in the China Division, $23 million is deposited in banks in Hong Kong, where the government of Hong Kong has guaranteed the repayment of all bank deposits until 2010.

Subsequent to the end of the fiscal year ended August 31, 2008, the Company has engaged in negotiations to invest approximately $3.9 million in high yield bonds, which it expects to finalize in the first quarter of fiscal 2009.

16. Subsequent Events

Subsequent to the fiscal year ended August 31, 2008, the cash balance at the China Division has increased from $17.7 million to $37 million. The U.S. Division has transferred additional $20 million in October 2008 to the China Division due to attractive interest rates on time deposits. Of the $37 million cash in the China Division, $23 million is deposited in banks in Hong Kong, where the government of Hong Kong has guaranteed the repayment of all bank deposits until 2010.

A three-year management support and marketing agreement was executed effective October 1, 2008 between Sino Bond, Inc. Ltd., the Company’s Hong Kong subsidiary and Otto Regent Ltd., a Hong Kong marketing company to develop strategies to lead the Company’s marketing activities in China including but not limited to recruitment of physicians, multi-media advertising and enhancing the reputation of the Company’s healthcare services, for which the Company would incur at its discretion from $75,000 to $250,000 per month for the next three years.

Subsequent to the end of the fiscal year ended August 31, 2008, the Company has engaged in negotiations to invest approximately $3.9 million in high yield bonds, which it expects to finalize in the first quarter of fiscal 2009.

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

None.

Item 9A(T). Controls and Procedures.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation to assess the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report, pursuant to Exchange Act Rule 13a-15(e). Based on that evaluation, our chief executive officer and chief financial officer concluded that, as of August 31, 2008, our internal disclosure controls and procedures were effective except for the filing of our Current Report on Form 8-K on June 25, 2008. That report disclosed that a subsidiary of the Company had entered into a hospital management agreement in China on April 28, 2008; however, the management agreement had been amended on May 30, 2008 in several respects. Those amendments were described in a Current Report on Form 8-K of the Company subsequently filed on November 6, 2008. The reason for this deficiency was a lack of effective communication between the executive officers and legal counsel of the Company. The executive officers of the Company have recognized this deficiency and resolved to communicate more effectively and timely with their legal counsel regarding events requiring public disclosure.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal controls over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including our chief executive officer and chief financial officer, an evaluation of the effectiveness of our internal controls over financial reporting was conducted based on the framework in Internal Controls – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation under the framework in Internal Controls – Integrated Framework issued by the COSO, our management concluded that our internal control over financial reporting were not effective as a result of a material weakness in internal controls as of August 31, 2008. That weakness was that the Company created a new entity in China during the first fiscal quarter of 2008 and had activity in its cash accounts early in the second fiscal quarter of 2008 but lacked general ledgers for its China operations. After the Company’s auditors pointed out this deficiency in the course of their audit during October 2008, the Company prepared general ledgers for its three separate China entities, which were completed prior to the completion of the audit.

An internal control material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements would not be prevented or detected on a timely basis by employees in the normal course of their work. Our internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations, and therefore can only provide reasonable assurance with respect to financial statement preparation and presentation. In order to address the material weaknesses identified, management has initiated corrective measures that will continue through 2009. The Company will continue to monitor the effectiveness of its internal controls and procedures on an ongoing basis and will take further actions, as appropriate.

Changes in Internal Control over Financial Reporting

There have been no significant changes in our internal control over financial reporting during the most recently completed fiscal quarter or in other factors that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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No Attestation Report

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only management’s report in this annual report.

Item 9B. Other Information

None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance.

The information required by this Item 10 is incorporated by reference from the Company’s Definitive Proxy Statement for our 2009 annual meeting to be filed on or before December 29, 2008.

Item 11. Executive Compensation.

The information required by this Item 11 is incorporated by reference from the Company’s Definitive Proxy Statement for our 2009 annual meeting to be filed on or before December 29, 2008.

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

The information required by this Item 12 is incorporated by reference from the Company’s Definitive Proxy Statement for our 2009 annual meeting to be filed on or before December 29, 2008.

Item 13. Certain Relationships and Related Transactions, and Director Independence.

The information required by this Item 13 is incorporated by reference from the Company’s Definitive Proxy Statement for our 2009 annual meeting to be filed on or before December 29, 2008.

Item 14. Principal Accounting Fees and Services.

The information required by this Item 14 is incorporated by reference from the Company’s Definitive Proxy Statement for our 2009 annual meeting to be filed on or before December 29, 2008.

PART IV

Item 15. Exhibits, Financial Statement Schedules.

(a)(1) Financial Statements: See Index to Consolidated Financial Statements under Item 8 on Page 32 of this Report.

(a)(2) Financial Statement Schedule: Not required.

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

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EXHIBIT NO.	IDENTIFICATION OF EXHIBIT
Exhibit 3.1	Certificate of Incorporation incorporated by reference to Exhibit 3.1 to the Form 10-K filed November 13, 2007.
Exhibit 3.2	Bylaws incorporated by reference to Exhibit 3.2 to the Form 10-K filed November 13, 2007.
+Exhibit 10.1	The Company’s Year 2000 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 10.2	Amended Management Support and Marketing Agreement between Otto Regent Limited and Sino Bond Inc. Limited dated October 1, 2008.
Exhibit 10.3	Agreement selling real estate owned by DeAn Joint Venture dated July 11, 2008.
+Exhibit 10.4	Performance Award Agreement dated July 25, 2008.
Exhibit 10.5	Form of Indemnification Agreement with various officers and directors of the Company, incorporated by reference to Exhibit 10.11 to the Form 10-K for the fiscal year ended August 31, 2004.
Exhibit 10.6	Purchase and Sale Agreement between Vista Holdings, LLC and the State of Louisiana dated November 8, 2007 incorporated by reference to Exhibit 10.7 to the Form 10-K filed November 13, 2007.
Exhibit 10.7	Management Support and Marketing Agreement dated October 15, 2003 between the Company and Medical Multimedia Advertising, Inc. and Addendum thereto, incorporated by reference to Exhibit 10.12 to the Form 10-K for the fiscal year ended August 31, 2003.
Exhibit 14.1	Code of Ethics for Principal Executive and Senior Financial Officers, incorporated by reference to Exhibit 14.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2003.
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.

+ Management contract or compensatory plan or arrangement.

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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: November 26, 2008	By:	/s/ Chiu M. Chan
		Chiu M. Chan, Chief Executive Officer

Pursuant to the requirements 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 (Principal Executive Officer)	Chairman of the Board, CEO and President	November 26, 2008
/s/ Philip S. Chan Philip S. Chan (Principal Financial and Accounting Officer)	Director, Vice President - Finance, CFO, and Treasurer	November 26, 2008
Stephen L. Huber	Director	November 26, 2008
/s/ Ping S. Chu Ping S. Chu	Director	November 26, 2008
/s/ James G. Gerace James G. Gerace	Director	November 26, 2008
/s/ Earl R. Votaw Earl R. Votaw	Director	November 26, 2008
/s/ Xiao H. Li Xiao H. Li	Director	November 26, 2008

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EXHIBIT INDEX

EXHIBIT NO.	IDENTIFICATION OF EXHIBIT
Exhibit 3.1	Certificate of Incorporation incorporated by reference to Exhibit 3.1 to the Form 10-K filed November 13, 2007.
Exhibit 3.2	Bylaws incorporated by reference to Exhibit 3.2 to the Form 10-K filed November 13, 2007.
+Exhibit 10.1	The Company’s Year 2000 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 10.2	Amended Management Support and Marketing Agreement between Otto Regent Limited and Sino Bond Inc. Limited dated October 1, 2008.
Exhibit 10.3	Agreement selling real estate owned by DeAn Joint Venture dated July 11, 2008.
+Exhibit 10.4	Performance Award Agreement dated July 25, 2008.
Exhibit 10.5	Form of Indemnification Agreement with various officers and directors of the Company, incorporated by reference to Exhibit 10.11 to the Form 10-K for the fiscal year ended August 31, 2004.
Exhibit 10.6	Purchase and Sale Agreement between Vista Holdings, LLC and the State of Louisiana dated November 8, 2007 incorporated by reference to Exhibit 10.7 to the Form 10-K filed November 13, 2007.
Exhibit 10.7	Management Support and Marketing Agreement dated October 15, 2003 between the Company and Medical Multimedia Advertising, Inc. and Addendum thereto, incorporated by reference to Exhibit 10.12 to the Form 10-K for the fiscal year ended August 31, 2003.
Exhibit 14.1	Code of Ethics for Principal Executive and Senior Financial Officers, incorporated by reference to Exhibit 14.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2003.
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.

+ Management contract or compensatory plan or arrangement.

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EX-10.2

Exhibit 10.2

AMENDED MANAGEMENT SUPPORT AND MARKETING AGREEMENT

This AMENDED MANAGEMENT SUPPORT AND MARKETING AGREEMENT (“Agreement,”) amends the Management Support and Marketing Agreement, which originally became effective on October 1, 2008, and is entered into and effective as of the 1^st day of October, 2008 (notwithstanding the date of actual execution) by and between OTTO REGENT LIMITED, (“OTTO”), and SINO BOND INC., LIMITED (“SBI”) as a wholly owned subsidiary and agent of DYNACQ HEALTHCARE, INC. and as an affiliate and agent of DYNACQ HUAI BEI HEALTHCARE, INC. (collectively referred to herein as “DYNACQ”).

WITNESSETH:

WHEREAS, OTTO is a duly and validly existing 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 nation of China;

WHEREAS, SBI enters into this Agreement on behalf of DYNACQ for the provision of Healthcare Services by DYNACQ subsidiaries and affiliates in China and Southeast Asia.

WHEREAS, DYNACQ is engaged in faciliating management and related items and services to physicians, professional associations, and other professional healthcare entities and in faciliating the provision of Healthcare Services to individuals in the nation of China;

WHEREAS, SBI desires and intends to facilitate such management, administrative, and business services, and the provision of Healthcare Services on behalf of DYNACQ in China and Southeast Asia, and OTTO is capable of assisting SBI in providing, all such management, administrative, and business services; and

WHEREAS, SBI and OTTO mutually desire an arrangement that:

(1) ensures consistency of service, quality of care, and safety of DYNACQ’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 DYNACQ, all for the benefit of those persons seeking Healthcare Services as patients of DYNACQ.

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:

Page 1 of 8

Covenants and Conditions Regarding Management and Advertising:

1.1. OTTO agrees that it has the primary responsibility for the marketing of the facilities, including but not limited to the following:

(a) recruitment of physicians to use and otherwise employ the services of the hospital;

(b) general efforts to improve the reputation and market the benefits of DYNACQ; and

(c) creation and publication of multi-media advertising (subject to advance SBI approval).

1.2 SBI agrees to pay a minimum of Seventy-five Thousand Dollars ($75,000) and a maximum of Two Hundred Fifty Thousand Dollars ($250,000.00) a month at SBI’s discretion to be used for adverstising and to pay fees and expenses of OTTO. OTTO and SBI agree that these funds will be deposited in an account to be managed and controlled solely by OTTO. From these funds, OTTO agrees to expend at least Eighty-Three Percent (83%) of the amount paid by SBI monthly, directly on advertising and the general marketing of DYNACQ, and the associated services of its healthcare facilities in China. Further, OTTO will provide to SBI a written report 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. OTTO shall employ or otherwise retain, and shall be responsible for selecting, training, supervising, scheduling, and terminating, all management and clerical personnel as OTTO deems reasonably necessary and appropriate in the performance of its duties and obligations under this Agreement. OTTO 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 Indemnification by OTTO. OTTO shall indemnify and hold SBI 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 OTTO, its employees, agents, or independent contractors in or about the DYNACQ’s facilities during the Term. To be entitled to such indemnification, SBI shall give OTTO prompt written notice of the assertion by a third party of any claim with respect to which SBI might bring a claim for indemnification hereunder, and in all events must provide such written notice to OTTO within the applicable period for defense of such claim by OTTO. OTTO shall, at its own expense, have the right to defend and litigate any such third-party claim.

2.1 Organization and Existence. SBI is a Hong Kong corporation duly organized, validly existing and in good standing under the laws of Hong Kong and has all requisite legal and

Page 2 of 8

corporate power to carry on its business as now conducted and to enter into and perform this Agreement.

2.2 Compliance with Laws. SBI 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 SBI properties and conduct of SBI’s business.

2.3 Brokers. SBI in not a party to or in any way obligated under any contract or other agreement for, and there are no outstanding claims against SBI 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 SBI’s Authority Relative to this Agreement. The execution, delivery and performance of this Agreement by SBI has been duly authorized and approved by the Board of Directors and no further corporate action is necessary on the part of SBI to make this Agreement valid and binding upon SBI in accordance with its terms. Neither the execution, delivery nor performance of this Agreement by SBI will result in a violation or breach of any term or provision under the Articles of Incorporation or Bylaws of SBI 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 SBI is a party or by which it or any of its respective assets are bound or governmental body.

3.1 Organization and Existence. OTTO is a Hong Kong corporation duly organized pursuant to the laws of Hong Kong 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 OTTO to make this Agreement valid and binding upon OTTO in accordance of its terms. Neither the execution, delivery nor performance of this Agreement by OTTO 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 OTTO 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.

3.3 Brokers. OTTO is not a party to or in any way obligated under any contract or agreement for, and there are no outstanding claims against OTTO for the payment of a broker’s or finder’s fee in connection with the origin, negotiation, execution, or performance of this Agreement.

4.1 Confidential Information. OTTO 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 SBI and DYNACQ’s business and operations. OTTO understands that all such information is confidential and has been or will be

Page 3 of 8

conceived or learned by OTTO in confidence, and agrees not to reveal any such information to any third person for any reason or under any circumstances. OTTO 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 DYNACQ, or for any purpose which may be harmful or detrimental to the business or interests of DYNACQ. 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 SBI. The parties agrees that any remedy at law for actual or threatened breach of the provisions of this section would be inadequate and that SBI 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 SBI may be legally entitled to recover as a result of any breach by the other party of the provisions of this section, and OTTO 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 1, 2008, and expiring as of September 30, 2011, unless and until terminated as provided hereinafter (“the Term”). SBI 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 SBI’s delivering to OTTO before the termination of the original Term written notice of SBI’s election to extend the Term of this Agreement as provided herein

5.2 Termination by SBI. SBI may terminate this Agreement upon thirty (30) days written notice to OTTO.

5.3 Termination by OTTO. OTTO may terminate this Agreement upon the occurrence of the dissolution of SBI, or if SBI fails to pay OTTO the advertising dollars as provided for in sec. 1.2 of this Agreement within thirty (30) days of the date such amounts are due.

5.4 Termination by Agreement. In the event OTTO and SBI 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.

Page 4 of 8

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 OTTO and SBI, 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 SBI to exercise control or direction of any nature, kind, or description over the manner or method by which OTTO performs its duties.

6.2. OTTO Representative. Except as may be herein more specifically provided, OTTO shall act with respect to all matters hereunder through its managers.

6.3 SBI Representative. Except as may be herein more specifically provided, SBI 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 delivered or mailed by prepaid certified mail, return receipt requested, addressed as follows:

If to OTTO:	Sandy Hui Flat A, 1/F., Hang Fat Industrial Building 550-556 Castle Park Road, Lai Chi Kok Kowloon, Hong Kong Telephone: (852) 27319101 Telefax: (852) 27225014
If to SBI:	Chiu Chan or Philip Chan 10304 I-10 East, Suite 369 Houston, Texas 77029 Telephone: (713) 378-2000 Telefax: (713) 378-3155

Page 5 of 8

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 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.

Page 6 of 8

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 OTTO and SBI. 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 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

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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.

IN WITNESS WHEREOF, OTTO and SBI have executed this Agreement in multiple originals this 25th day of November, 2008.

OTTO:	Otto Regent Limited
	By:	Sandy Hui
		Manager

SBI:	SBI
	By:	Chiu Chan
		CEO

Page 8 of 8

EX-10.3

Exhibit 10.3

AGREEMENT

Party A : Dynacq Healthcare, Inc., formerly Dynacq International, Inc.

Party B : Shanghai International Automobile City Spare Parts Assembly Inc.

Party C : Shanghai De an Hospital Inc.

Party A signed a development agreement on a tract of land located at Muoyu Road northwest, Anting Town, Jiading District, Shanghai on November 14, 2003. Party C had started the development procedures with Jiading District Housing and Land Administration Bureau on May 6, 2005. Due to the delay in developing the project, Shanghai City Housing and Land Administration listed the project as inactive. After discussion and negotiation, Parties A, B and C agreed to the following resolutions:

Party A and C will give up the right to develop the project with Jiading District Housing and Land Administration Bureau and return the land to Party B for development.

Party B will refund RMB $28,160,000 to Party C for the land of 114,505 square meters.

Part B will compensate Party C for the economic loss of RMB $12,320,000 for acquisition of the right to the land due to delay in development beyond its control.

Ten days after this Agreement date, Party B will pay Party C RMB $28,160,000. Within one month after the completion of all procedures with Jiading Housing and Land Administration Bureau, Party B will pay Party C RMB $12,320,000. If Party B does not pay Party C on a timely basis, Party B will pay Party C RMB $30,000 per day until fully paid.

Parties A and C guarantee that there is no lien on the land and will fully responsible for all economic disputes arising before this Agreement date, and Party B has no responsibility for the disputes.

This Agreement has to be signed and stamped by the legal representatives of Parties A, B and C to be effective provided that Parties A and C have submitted notice of giving up the right for the land and asked for a refund with Jiading Housing and Land Administration Bureau.

This Agreement has seven copies. Each of parties A, B and C has two copies and Jiading Housing and Land Administration Bureau has one copy.

Party A : Dynacq Healthcare, Inc., formerly Dynacq International, Inc.

/s/ Chiu Moon Chan

    Chiu Moon Chan, Legal Representative

Party B : Shanghai International Automobile City Spare Parts Assembly, Inc.

/s/ Sun Yi Qun

Legal Representative

Party C : Shanghai De An Hospital, Inc.

/s/ Chiu Moon Chan

Chiu Moon Chan, Legal Representative

Date: July 11, 2008

EX-10.4

EXHIBIT 10.4

CONFIDENTIAL TREATMENT REQUESTED

REDACTED VERSION—CONFIDENTIAL INFORMATION OMITED MARKED WITH [*]

PERFORMANCE AWARD AGREEMENT UNDER THE

DYNACQ HEALTHCARE, INC. YEAR-2000 STOCK INCENTIVE PLAN

THIS AWARD AGREEMENT is made and entered into as of July 25, 2008 (the “Date of Grant”), by and between Dynacq Healthcare, Inc. (the “Company”), and ****** (“Grantee”). To the extent not specifically defined in this Award Agreement, all capitalized terms used in this Award Agreement will have the same meanings ascribed to them in the Plan.

BACKGROUND

A.    The Board has adopted, and the Company’s shareholders have approved, the Dynacq Healthcare, Inc. Year-2000 Stock Incentive Plan (the “Plan”), pursuant to which Performance Share incentive awards may be granted to Grantees of the Company and its Subsidiaries and certain other individuals.

B.    The Company or one of its Subsidiaries has agreed to employ the Grantee and, as an inducement to Grantee accepting such employment, has agreed to grant to Grantee a Performance Award under the terms of the Plan.

C.    Grantee has agreed to accept such employment and the grant of the Performance Award under the terms of the Plan and as contained herein.

D.    Pursuant to the Plan, the Company and Grantee agree as follows:

AGREEMENT

1.    Grant of Award. The Company hereby grants to Grantee a Performance Award of up to 1,000,000 Performance Shares, based on the Performance Objectives and subject to the terms, conditions, and adjustments set forth in this Award Agreement. The Performance Award will be equal to *******************. The Committee or its designee shall certify in writing that these Performance Objectives have been met prior to the payment of the Performance Award to Grantee.

2.    Payment of Award. The Performance Award shall be paid exclusively in Performance Shares, to be paid to Grantee each fiscal quarter during the Performance Cycle. The number of Performance Shares to be paid to Grantee shall be determined by dividing the Performance Award for such quarter by $3.74, which represents the Fair Market Value of a share of Company Common Stock on the Date of Grant. Subject to early termination of this Award Agreement pursuant to the terms hereof, as soon as practicable but in no event later than 90 days following the end of each fiscal quarter during the Performance Cycle and during the fiscal quarter following the end of such Performance Cycle, the Company will deliver to Grantee one share of Company Common Stock for each Performance Share earned under this Award Agreement for such period. Any fractional share amount shall be rounded down to the nearest

CONFIDENTIAL TREATMENT REQUESTED

REDACTED VERSION—CONFIDENTIAL INFORMATION OMITED MARKED WITH [*]

EXHIBIT 10.4

whole share. A portion of the Performance Award may be withheld to satisfy the payment of taxes if required by law. The Committee shall cause stock certificates to be delivered to the Grantee with respect to such Performance Shares, free of restrictions on transfer.

3.    Award Subject to Plan. This Award is granted under, and is expressly subject to, the terms and provisions of the Plan, as amended from time to time, which terms are incorporated herein by reference, and this Award Agreement.

4.    Performance Cycle. The Performance Cycle for this Award shall begin on the Date of Grant and end on the earlier to occur of (i) ten (10) years after the Date of Grant, or (ii) the issuance to Grantee of the maximum of 1,000,000 Performance Shares granted under this Award Agreement.

5.    Termination of Employment. This Award Agreement will terminate effective upon the termination of employment of Grantee with the Company or any of its Subsidiaries. If Grantee’s employment terminates for any reason after the end of the Performance Cycle but before Grantee’s receipt of Performance Shares due him for the previous quarter, Grantee will be entitled to receive any Performance Shares payable under Section 2 of this Award Agreement. If Grantee’s employment terminates before the end of the Performance Cycle on account of death, Disability, Retirement or termination by the Company without Cause, any Performance Award due hereunder shall be calculated based on **************** through the date of termination of employment of Grantee, and any Performance Shares shall be awarded to Grantee or his estate, successor or legal representative, as the case may be, based on such calculation.

6.    Change in Control. Notwithstanding the foregoing or any provision of the Plan to the contrary, upon a Change in Control prior to the date on which the Performance Cycle ends:

(i) Provided that either Grantee continues to be actively employed by the Company or any Subsidiary on the date of such Change in Control, or such Grantee’s employment was terminated on account of death, Disability or Retirement prior to such Change in Control, the Performance Award and the payment thereof shall be unaffected by such Change in Control and this Award Agreement shall continue in full force and effect.

(ii) If Grantee’s employment was terminated by the Company without Cause prior to or effective upon such Change in Control and the Performance Objectives are ultimately achieved for the fiscal quarter in which the Change in Control occurred, the Performance Award due under Section 2 hereof shall be paid and Performance Shares shall be awarded to Grantee for the entire the Performance Cycle during which the Change in Control occurred.

7.    Grantee Rights. Unless and until the Performance Shares are paid pursuant to Section 2 hereof, Grantee shall have no rights to own, hold, vote, receive dividends or

CONFIDENTIAL TREATMENT REQUESTED

REDACTED VERSION—CONFIDENTIAL INFORMATION OMITED MARKED WITH [*]

EXHIBIT 10.4

distributions on or enjoy or exercise other rights of ownership regarding the Performance Shares. This Award Agreement shall not obligate the Company to continue the employment of Grantee for any specified period of time; Grantee is an “at will” employee of the Company or any of its Subsidiaries.

8.    Non-Transferability. Neither this Award nor any rights under this Award Agreement may be assigned, transferred, or in any manner encumbered, and any attempted assignment, transfer, mortgage, pledge or encumbrance except as herein authorized, will be void and of no effect.

9.    Independent Legal and Tax Advice. Grantee has and will obtain dependent legal and tax advice regarding the grant and exercise of this Award and the disposition of the Performance Shares acquired hereby.

10.    Amendment. This Award may not be amended, modified or waived except by a written instrument signed by the party against whom enforcement of any such modification, amendment or waiver is sought.

11.    Venue; Choice of Law. Venue for any action arising hereunder shall be exclusively in the federal and state courts of Harris County, Texas. To the extent that federal laws do not otherwise control, this Award Agreement and all determinations made and actions taken hereunder shall be governed by the laws of the State of Nevada, without giving effect to principles of conflicts of laws, and construed accordingly.

12.    Supersedure. This Award Agreement shall supersede and replace all prior oral agreements and understandings, and any written agreements or understandings not set forth in an Award Agreement in the form of a formal agreement substantially identical to this Award Agreement between the Company an the Grantee regarding the grant of any Award under the Plan.

An authorized representative of the Company has signed this Award Agreement, and Grantee has signed this Award Agreement to evidence Grantee’s acceptance of the Award on the terms specified in this Award Agreement, all as of the Date of Grant. By signing this Award Agreement, Grantee acknowledges receipt of a copy of the Plan and the related Plan Prospectus. The Grantee has reviewed the Plan and this Award Agreement in their entirety, has had an opportunity to obtain the advice of counsel prior to executing this Award Agreement, and fully understands all terms and conditions of this Award Agreement. The Grantee hereby agrees to accept as binding, conclusive and final all decisions or interpretations of the Committee or the Board of Directors on any questions arising under the Plan.

DYNACQ HEALTHCARE, INC.

By:_/s/__Philip Chan

Philip Chan, CFO

CONFIDENTIAL TREATMENT REQUESTED

REDACTED VERSION—CONFIDENTIAL INFORMATION OMITED MARKED WITH [*]

EXHIBIT 10.4

GRANTEE:

__/s/ ***********

Print Name: ***********

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
Ambulatory Infusion Therapy Specialist, Inc.	Texas
Dallas Nevada, Inc.	Nevada
Shanghai De’An Hospital, Ltd.	China
Doctors Practice Management, Inc.	Texas
DPM II, Inc.	Texas
Dynacq Huai Bei Healthcare, Inc.	China
Pasadena Nevada, Inc.	Nevada
Sino Bond Inc. Limited	Hong Kong
Surgery Specialty Hospitals of America, Inc.	Nevada
Vista Community Medical Center, LLP d/b/a Surgery Specialty Hospitals of America – Southeast Houston Campus (formerly Vista Medical Center Hospital)	Texas
Vista Dallas, LLC	Texas
Vista Healthcare, Inc.	Texas
Vista Holdings, LLC	Louisiana
Vista Hospital of Baton Rouge, LLC d/b/a Vista Surgical Hospital of Baton Rouge	Louisiana
Vista Hospital of Dallas, LLP d/b/a Vista Hospital of Dallas	Texas
Vista Land and Equipment, LLC	Texas
Vista Medical Management, LLC	Louisiana
Vista Surgical Center West, LLC	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 November 21, 2008 with respect to the consolidated financial statements of Dynacq Healthcare, Inc. included in this Annual Report (Form 10-K) for the year ended August 31, 2008.

/s/ Killman, Murrell & Company, P.C.

Killman, Murrell & Company, P.C.

Houston, Texas

November 26, 2008

EX-31.1

EXHIBIT 31.1

CERTIFICATION

I, Chiu M. Chan, certify that:

1. I have reviewed this Annual Report on Form 10-K for the 2008 fiscal year 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) 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

(d) 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: November 26, 2008	/s/ Chiu M. Chan
	Name: Chiu M. Chan Title: President and 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 for the 2008 fiscal year 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) 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

(d) 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: November 26, 2008	/s/ Philip S. Chan
	Name: Philip S. Chan Title: Vice President – Finance and Chief Financial Officer

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 periodic report of Dynacq Healthcare, Inc. (the “Company”) on Form 10-K for the year ending August 31, 2008 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, to the best of my knowledge:

(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: November 26, 2008	/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 periodic report of Dynacq Healthcare, Inc. (the “Company”) on Form 10-K for the year ending August 31, 2008 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, to the best of my knowledge:

(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: November 26, 2008	/s/ Philip S. Chan
	Philip S. Chan Vice President – Finance and Chief Financial Officer Dynacq Healthcare, Inc.