Edgar Filing: DYNACQ HEALTHCARE INC

Form 10-Q For the quarterly period ended February 28, 2010

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended February 28, 2010

¨	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)

(713) 378-2000

(Registrant’s telephone number, including area code)

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. (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 Exchange Act). Yes ¨ No x

As of April 6, 2010, the number of shares outstanding of the registrant’s common stock, par value $.001 per share, was 14,207,115.

Table of Contents


		Page
Report of Independent Registered Public Accounting Firm.		3

PART I–FINANCIAL INFORMATION		4

Item 1.	Financial Statements.	4

	Consolidated Balance Sheets as of February 28, 2010 and August 31, 2009.	4

	Consolidated Statements of Operations for the three and six months ended February 28, 2010 and 2009.	6

	Consolidated Statements of Cash Flows for the six months ended February 28, 2010 and 2009.	7

	Notes to Consolidated Financial Statements.	9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	18

Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	24

Item 4T.	Controls and Procedures.	24

PART II–OTHER INFORMATION		25

Item 1.	Legal Proceedings.	25

Item 1A.	Risk Factors.	25

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	25

Item 3.	Defaults Upon Senior Securities.	25

Item 4.	(Removed and Reserved).	26

Item 5.	Other Information.	26

Item 6.	Exhibits.	26

Signatures		27

Index of Exhibits		28

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To:	The Stockholders and Board of Directors

Dynacq Healthcare, Inc.

Houston, Texas

We have reviewed the accompanying consolidated balance sheet of Dynacq Healthcare, Inc., as of February 28, 2010, and the related consolidated statements of operations and cash flows for the three-month and six-month periods ended February 28, 2010 and 2009. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with United States of America generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Dynacq Healthcare, Inc., as of August 31, 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated November 23, 2009, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of August 31, 2009, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

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

Killman, Murrell & Company, P.C.

Houston, Texas

April 14, 2010

PART I-FINANCIAL INFORMATION

Item 1.

Financial Statements.

Dynacq Healthcare, Inc.

Consolidated Balance Sheets


	February 28, 2010		August 31, 2009
	(Reviewed)		(Audited)
Assets
Current assets:
Cash and cash equivalents	$	31,617,182	$	39,112,965
Accounts receivable, net of contractual allowances of approximately $245,095,000 and $236,996,000 at February 28, 2010 and August 31, 2009, respectively		4,912,583		8,671,389
Inventories		1,495,515		1,518,815
Interest receivable		259,221		270,374
Prepaid expenses		746,629		373,949
Income taxes receivable		2,447,151		—
Deferred tax assets		592,932		770,400

Total current assets		42,071,213		50,717,892
Investments available-for-sale		21,010,833		18,572,169
Property and equipment, net		14,662,659		14,858,207
Income tax receivable		868,249		868,249
Other assets		247,099		250,664

Total assets	$	78,860,053	$	85,267,181

See accompanying notes.

Dynacq Healthcare, Inc.

Consolidated Balance Sheets (continued)


	February 28, 2010			August 31, 2009
	(Reviewed)			(Audited)
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	3,349,111		$	3,395,053
Accrued liabilities		5,340,081			6,244,978
Notes payable		—			251,131
Current portion of capital lease obligations		75,570			80,627
Current taxes payable		83,000			128,420

Total current liabilities		8,847,762			10,100,209
Non-current liabilities:
Long-term portion of capital lease obligations		298,289			335,582
Deferred tax liabilities		3,562,889			2,751,619

Total liabilities		12,708,940			13,187,410

Commitments and contingencies
Equity:
Dynacq 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, 15,395,802 and 15,815,120 shares issued at February 28, 2010 and August 31, 2009, respectively		15,396			15,815
Treasury stock, 1,175,138 and 489,672 shares at February 28, 2010 and August 31, 2009, respectively, at cost		(3,801,470	)		(2,429,465	)
Additional paid-in capital		12,815,029			14,800,062
Accumulated other comprehensive income		7,954,797			6,297,908
Retained earnings		48,980,123			53,151,206

Total Dynacq stockholders’ equity		65,963,875			71,835,526

Non-controlling interest		187,238			244,245

Total equity		66,151,113			72,079,771

Total liabilities and equity	$	78,860,053		$	85,267,181

See accompanying notes.

Dynacq Healthcare, Inc.

Consolidated Statements of Operations

(Reviewed)


	Three months ended February 28,						Six months ended February 28,
	2010			2009			2010			2009
Net patient service revenue	$	6,189,394		$	12,787,320		$	15,174,005		$	23,666,558

Costs and expenses:
Compensation and benefits		4,027,753			3,902,678			8,109,660			7,584,218
Medical services and supplies		2,312,647			2,971,716			5,032,150			6,261,536
Other operating expenses		4,219,851			5,242,342			8,903,661			9,877,888
Depreciation and amortization		264,616			383,007			530,595			777,231

Total costs and expenses		10,824,867			12,499,743			22,576,066			24,500,873

Operating income (loss)		(4,635,473	)		287,577			(7,402,061	)		(834,315	)

Other income (expense):
Rent and other income (expense)		(113,452	)		34,855			236,166			106,533
Interest income		411,686			314,527			866,581			470,368
Interest expense		(9,482	)		(20,661	)		(20,875	)		(31,658	)

Total other income, net		288,752			328,721			1,081,872			545,243

Income (loss) before income taxes		(4,346,721	)		616,298			(6,320,189	)		(289,072	)
Benefit (provision) for income taxes		1,437,703			(325,866	)		2,059,599			(64,402	)

Net income (loss)		(2,909,018	)		290,432			(4,260,590	)		(353,474	)
Less: Net (income) loss attributable to the noncontrolling interest		70,038			(23	)		89,507			1,331

Net income (loss) attributable to Dynacq Healthcare, Inc.	$	(2,838,980	)	$	290,409		$	(4,171,083	)	$	(352,143	)

Basic income (loss) per common share:
Net income (loss) attributable to Dynacq Healthcare, Inc. stockholders	$	(0.19	)	$	0.02		$	(0.28	)	$	(0.02	)

Diluted income (loss) per common share:
Net income (loss) attributable to Dynacq Healthcare, Inc. stockholders	$	(0.19	)	$	0.02		$	(0.28	)	$	(0.02	)

Basic average common shares outstanding		14,725,039			15,546,516			14,964,060			15,550,465

Diluted average common shares outstanding		14,725,039			15,546,516			14,964,060			15,550,465

See accompanying notes.

Dynacq Healthcare, Inc.

Consolidated Statements of Cash Flows

(Reviewed)


	Six months ended February 28,
	2010			2009
Cash flows from operating activities
Net loss	$	(4,171,083	)	$	(352,143	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		530,595			777,231
Deferred income taxes		96,567			29,923
Noncontrolling interest		(89,507	)		(1,331	)
Charge for stock options to employees		225,758			243,511
Foreign currency exchange loss		127,516			—
Changes in operating assets and liabilities:
Accounts receivable		3,811,599			8,627,028
Interest receivable		11,153			—
Inventories		23,375			(14,251	)
Prepaid expenses		(372,679	)		117,226
Income taxes receivable		(2,438,151	)		(2,915,249	)
Other assets		5,249			(60,996	)
Accounts payable		(46,195	)		(103,606	)
Accrued liabilities		(927,147	)		(1,900,281	)
Income taxes payable		(45,420	)		(4,193,216	)

Net cash provided by (used in) operating activities		(3,258,370	)		253,846


Cash flows from investing activities
Purchase of equipment		(389,193	)		(180,678	)
Purchase of management rights		—			(2,628,198	)
Investment in available-for-sale securities		—			(3,906,000	)

Net cash used in investing activities		(389,193	)		(6,714,876	)


Cash flows from financing activities
Principal payments on notes payable		(175,561	)		(236,541	)
Contributions from, and distributions to, noncontrolling interest, net		32,500			—
Payments on capital lease		(117,791	)		(5,023	)
Purchase of treasury shares		(3,681,903	)		(69,377	)
Proceeds from exercise of stock options		89,688			—

Net cash used in financing activities		(3,853,067	)		(310,941	)

Effect of exchange rate changes on cash		4,847			(5,199	)

Net increase (decrease) in cash and cash equivalents		(7,495,783	)		(6,777,170	)
Cash at beginning of period		39,112,965			45,099,800

Cash at end of period	$	31,617,182		$	38,322,630

Continued.

Dynacq Healthcare, Inc.

Consolidated Statements of Cash Flows (continued)


	Six months ended February 28,
	2010			2009
Supplemental cash flow disclosures
Cash paid during the period for:
Interest	$	20,875		$	27,837

Income taxes	$	327,405		$	7,142,944


Non cash investing and financing activities:
Increase (decrease) in value of investment in bonds	$	2,566,180		$	(1,318,602	)
Accumulated other comprehensive income		(1,674,009	)		1,318,602
Deferred tax liabilities		(892,171	)		—
Common stock		(455	)		—
Additional paid-in capital		(2,309,443	)		—
Treasury stock		2,309,898			—
Accounts receivable		52,622			—
Property and equipment		(52,622	)		—
Equipment from capital lease		—			(435,498	)
Capital lease obligation		—			435,498

See accompanying notes.

Dynacq Healthcare, Inc.

Notes to Consolidated Financial Statements

February 28, 2010

(Reviewed)

Basis of Presentation

The accompanying reviewed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal and recurring nature. 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 $2.4 million and $3.0 million for the quarters ended February 28, 2010 and 2009, respectively, and $5.5 million and $5.7 million for the six months ended February 28, 2010 and 2009, respectively. These reviewed financial statements should be read in conjunction with the audited financial statements at August 31, 2009. Operating results for the quarter ended February 28, 2010 are not necessarily indicative of the results that may be expected for the year ending August 31, 2010.

Certain previously reported financial information has been reclassified to conform to the current year period’s presentation. The impact of such reclassification was not significant to the prior year period’s overall presentation.

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.

Investments Available-for-Sale

The Company has invested in various bonds. These investments are classified as available-for-sale securities, and are carried at fair value as of February 28, 2010, based on the quoted market prices as of that date. These investments are subject to default risk. The Company intends to hold these for a minimum period of an additional 12 months. Unrealized gains in the fair value are reported in accumulated other comprehensive income, net of related income tax effect. The Company monitors its investment portfolio for any decline in fair value that is other than temporary and records any such impairment as an impairment loss.

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.

General

As of February 28, 2010, the Company operated one facility each in the Houston metropolitan area (Pasadena facility) and in the Dallas-Fort Worth area (Garland facility) and owned 100% of the equity interest in Dynacq Huai Bei Healthcare, Inc. (“Dynacq-Huai Bei”), a corporation formed under the laws of the People’s Republic of China to provide healthcare management services in that country. On March 1, 2009, Dynacq-Huai Bei began managing Second People’s Hospital in Rui An, China, and included operating results since November 25, 2008.

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 the preparation of these financial statements.

Subsequent Events

The Company has evaluated subsequent events that have occurred through April 14, 2010, which is the date of issuance of these financial statements, and has accounted for and disclosed material subsequent events in these condensed consolidated financial statements as appropriate.

Net Income (Loss) per Share

The following is a reconciliation of the weighted average number of common shares outstanding with the number of shares used in the computations of net income (loss) per common and common equivalent share:


	Three months ended February 28,		Six months ended February 28,
	2010	2009	2010	2009
Number of weighted average common shares outstanding	14,725,039	15,546,516	14,964,060	15,550,465
Assumed exercise of stock options	—	—	—	—

Average diluted shares outstanding	14,725,039	15,546,516	14,964,060	15,550,465

Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the reporting period. Diluted net income (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For the calculation of diluted net income (loss) per share, the basic weighted average number of shares is increased by the dilutive effect of stock options determined using the treasury stock method. However, if it is anti-dilutive, the dilutive effect of the stock options is not included in the calculation of diluted net income (loss) per share. Stock options with exercise prices exceeding current market prices that were excluded from the computation of net income (loss) per share amounted to approximately 572,000 shares and 601,000 shares for the quarters ended February 28, 2010 and 2009, respectively.

Stock Based Compensation

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 February 28, 2010, there remain 1,424,654 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.

For the quarter ended February 28, 2010, there were no equity-based compensation awards granted. Generally, options granted become exercisable in annual installments of 25 percent beginning on the first anniversary date, and expire after five to ten years. The following table summarizes the stock option activities for the six months ended February 28, 2010 (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, 2009	1,376		$	3.47	—			$	713,300
Granted	—			—		—	—
Exercised	(36	)		2.50	—				57,259
Expired or canceled	(18	)		2.90	—		—

Outstanding, February 28, 2010	1,322		$	3.50	—			$	335,780

⁽¹⁾

These amounts represent the difference between the exercise price and $2.98, the closing price of Dynacq common stock on February 28, 2010 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 six months ended February 28, 2010 and 2009, the Company received $89,688 and $-0-, respectively, for stock options exercised. Total tax benefit realized for the tax deductions from stock options exercised was $9,000 and $-0- for the six months ended February 28, 2010 and 2009, respectively.

The following summarizes information related to stock options outstanding at February 28, 2010, and related weighted average price and life information:


	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	751	3.3	$	2.53	338		$	2.54
$ 4.44 – 5.10	571	3.3		4.78	496			4.73

Total	1,322	3.3	$	3.50	834		$	3.84

The above tables for stock option activities and stock options outstanding does not include a performance share award granted on July 25, 2008 by the Compensation Committee 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.

Additional information relating to the Plan at February 28, 2010 and August 31, 2009 is as follows (in thousands):


	February 28, 2010	August 31, 2009
Options exercisable	834	881
Options available for grant and reserved common stock shares for stock option plans	1,425	1,407

For the three and six month periods ended February 28, 2010, stock-based compensation expense associated with the Company’s stock options was $112,879 and $225,758, respectively. The total unrecognized compensation expense for outstanding stock options as of February 28, 2010 was $670,000, and will be recognized, in general, over 1.6 years. The weighted average number of years to recognize the compensation expense is 0.9 year.

Fair Value of Financial Instruments

On September 1, 2008, the Company adopted ASC Topic 825-10-25, “Financial Instruments” (formerly referred to as SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities (“SFAS 159”)), which permits entities to choose to measure certain financial assets and liabilities at fair value. The adoption of ASC Topic 825-10-25 had no impact on the consolidated financial statements because the Company did not elect the fair value option for any financial assets or financial liabilities that were not already recorded at fair value.

On September 1, 2008, the Company adopted ASC Topic 820, “Fair Value Measurements and Disclosures” (formerly referred to as SFAS 157) for our financial assets and liabilities. Management uses the fair value hierarchy of ASC Topic 820, which gives the highest priority to quoted prices in active markets. The fair value of financial instruments is estimated based on market trading information, where available. Absent published market values for an instrument or other assets, management uses observable market data to arrive at its estimates of fair value. Management believes that the carrying amount of cash and cash equivalents, accounts receivable and accrued liabilities approximate fair value. ASC Topic 820 defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC Topic 820 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The three levels of inputs used to measure fair value are as follows:

Level 1

Quoted prices in active markets for identical assets or liabilities.

Level 2

Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted price for identical or similar assets and liabilities in markets that are not active; or other input that are observable or can be corroborated by observable market data.

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of February 28, 2010, segregated among the appropriate levels within the fair value hierarchy:


	Fair Value Measurements at February 28, 2010
	Quoted prices in active markets for identical	Significant other observable inputs		Significant unobservable
	(Level 1)	(Level 2)		(Level 3)
Assets
Investments available-for-sale	—	$	21,010,833	—

All of the Company’s investments in securities are in perpetual bonds traded on the European markets. The cost of these securities is $9,135,146.

Foreign Currency Translation

The functional currency of the Company as a whole is the U.S. Dollar. The Company has designated the Chinese Yuan Renminbi as the functional currency for its subsidiaries in mainland China, and the U.S. 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.

Revenue Recognition

U.S. Division

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 may not represent amounts ultimately collected. The Company does adjust current period revenue for actual differences in estimated revenue recorded in prior periods and actual cash collections.

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, up to 30 days after the end of the period, for the services performed and also estimating amounts collectible within the next six months. 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 the three and six months ended February 28, 2010 and 2009:


	Three months ended February 28,						Six months ended February 28,
	2010			2009			2010			2009
Gross billed charges	$	23,730,510		$	38,249,185		$	51,714,896		$	76,669,648
Contractual allowance		17,972,510			25,461,865			37,571,667			53,003,090

Net revenue	$	5,758,000		$	12,787,320		$	14,143,229		$	23,666,558

Contractual allowance percentage		76	%		67	%		73	%		69	%

Except for emergency room patients, surgeries at our facilities are typically pre-certified or pre-authorized by the insurance carriers. A majority of the surgeries are either covered by workers’ compensation insurance or by commercial insurers on an out-of-network health plan basis. We currently participate in a small number of managed care contracts.

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 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 medical dispute resolution (“MDR”) process at the TDWC to request proper reimbursement for services. From January 2007 to November 2008, the Company had 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 appealed by certain insurance carriers, and on November 13, 2008 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 MDR for a case-by-case determination of whether the services provided meet these standards, once the definitions of those standards are determined. As a result of the Third Court of Appeals opinion, any stop-loss cases pending at SOAH have been remanded to the TDWC since these cases have not been reviewed or decided by the two-prong standard decided by the Third Court of Appeals. The SOAH Administrative Law judges determined that the most appropriate location for these cases is the TDWC, pending a final, non-appealable decision.

A petition asking the Texas Supreme Court to review the Third Court of Appeals decision is still pending. If the Texas Supreme Court declines a review of or affirms the Third Court of Appeals opinion, final adjudication in these pending stop-loss cases will depend on the uncertain outcome of a very lengthy process. We anticipate further, lengthy litigation at the Travis County District Courts and the Texas Courts of Appeals to establish the legal definition of unusually costly or unusually extensive services. 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 2010 fiscal year.

Through February 2010, 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 likelihood that the Company will be obligated 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. The Company received an unfavorable ruling in its lead case in March 2009, which ruling has been appealed to the Third Court of Appeals. If upheld by the Texas Court of Appeal, this 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. Probability of collection in these cases is marginal and depends on the rulings of the Third Court of Appeals.

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, the amount of reimbursement due to us, and the data used to determine “usual and customary” market rates for medical services in specific geographic regions.

Due to the uncertainties regarding the accounts receivable in the MDR process, the 2008 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 since August 31, 2008, and expects to collect the net receivables within twelve months from the end of the current period. 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.

China Division

Revenue Recognition Policy

In China, the local government Department of Health establishes billing rates for a hospital’s sale of prescription medication and medical services. A majority of the services provided by Second People’s Hospital is to cash pay patients, who pay for the services in advance. For services provided under the local government’s social healthcare insurance program, we are generally paid at approximately 95% of billed charges two to three months after the date of service. For the current year, however, receipt of these payments has been delayed due to our acquisition of the management of Second People’s Hospital from its prior managers in March 2009. The remaining 5% of billed charges is evaluated by the local government Department of Health on a semi-annual basis and may be paid to the hospital after that evaluation is complete. The Company had bad debt expenses of $8,892 and $9,997 for the three and six months ended February 28, 2010, respectively, related to denials under the social healthcare insurance program, which is less than 1% of the revenues of the China division for the same period. Since the amount of bad debt expense is minimal, it has been included with other operating expenses in the income statement.

Noncontrolling Interest

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 noncontrolling interest. Noncontrolling interest reported in the consolidated income statements reflects the respective interests in the income or loss of the limited partnerships or limited liability companies attributable to the minority investors (equity interest ranged from 1.75% to 2.35% at February 28, 2010).

Comprehensive Income (Loss) and Accumulated Other Comprehensive Income

Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) represents certain components of revenues, expenses, gains and losses that are included in comprehensive income (loss), but are excluded from net income (loss). Other comprehensive income (loss) amounts are recorded directly as an adjustment to stockholders’ equity, net of tax, and for the three and six months ended February 28, 2010 and 2009 were as follows:


	Three months ended February 28,						Six months ended February 28,
	2010			2009			2010			2009
Net income (loss)	$	(2,838,980	)	$	290,409		$	(4,171,083	)	$	(352,143	)
Other comprehensive income (loss), net of taxes:
Foreign currency translation adjustment, net of taxes of $(13,936), $(9,800), $(5,992) and $(1,800), respectively		(25,880	)		(18,375	)		(11,127	)		(3,400	)
Change in valuation of investment available-for-sale, net of taxes of $262,267, $(364,200), $898,163 and $(461,500), respectively		487,067			(676,402	)		1,668,017			(857,102	)

Total other comprehensive loss, net of taxes		(2,377,793	)		(404,368	)		(2,514,193	)		(1,212,645	)
Comprehensive loss attributable to the noncontrolling interest		—			—			—			—

Comprehensive loss attributable to Dynacq Healthcare, Inc.	$	(2,377,793	)	$	(404,368	)	$	(2,514,193	)	$	(1,212,645	)

The components of accumulated other comprehensive income were as follows:


	February 28, 2010		August 31, 2009
Foreign currency translation adjustment, net of taxes of $186,317 and $192,309, respectively	$	336,399	$	347,527
Change in valuation of investment available-for-sale, net of taxes of $4,102,214 and $3,204,051, respectively		7,618,398		5,950,381

Total accumulated other comprehensive income, net of taxes of $4,288,531 and $3,396,360, respectively	$	7,954,797	$	6,297,908

Contingencies

The Company maintains various insurance policies that cover each of its facilities; including occurrence medical malpractice coverage. 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 workers’ 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.

The management agreement for the Second People’s Hospital requires that 1% of the drug income, and drug income in excess of 40% of total sales, of the hospital be paid to the government. This requirement was designed to control the cost of drugs by discouraging the sale by the hospital of drugs purchased from other than approved drug vendors. However, the local government has not published a list of approved drug vendors and therefore has not enforced the payment provision since the inception of the original management agreement. The Company has been advised by a local attorney that enforcement of that provision is remote, so it has not accrued the amount that would be payable to the local government if this provision were enforced. If the government were to enforce this provision, Dynacq-Huai Bei could potentially owe approximately $1.2 million to the government for the period of time since inception of the original management contract on the hospital.

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 Texas facilities’ fees must be made in the district courts of Travis County, Texas in what can often be a lengthy procedure. Please refer to Revenue Recognition, as well as Business – Government Regulation – U.S. Division – Texas Workers’ Compensation Systems in our Form 10-K for the fiscal year ended August 31, 2009, 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.

Industry Segments and Geographic Information

We manage our operations through two operating segments, based on our geographic areas: U.S. and China, and have a general corporate division.

U.S. Division

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

China Division

Our China Division is set up to provide healthcare management services in China. It includes results of operations for managing Second People’s Hospital in Rui An, China, since November 25, 2008.

In 2010 Dynacq-Huai Bei will manage the Third People’s Hospital in Rui An upon completion of construction of that hospital.

The Company has organized Sino Bond Inc. Limited, a Hong Kong corporation (“Sino Bond”), to hold and manage investments in Hong Kong. Sino Bond has entered into a three-year marketing contract effective October 1, 2008 for marketing of healthcare services to be provided by Dynacq subsidiaries in China and Southeast Asia.

In August 2009 the Company organized Hu GangJing (Hang Zhou) Technology Co. Ltd. (“Hang Zhou Tech”) under the laws of the People’s Republic of China for the purpose of forming joint ventures to invest in companies in China engaged in businesses such as energy production, life sciences and pharmaceuticals.

Corporate Division

The Company has invested in available-for-sale securities which will be held until the Company is able to identify and fund attractive opportunities to acquire or manage operating companies in China and Southeast Asia. Corporate division includes interest and other income related to these investments in available-for-sale securities, corporate personnel compensation expenses, and general and administrative expenses. Such expenses and income are not allocated to our operating divisions, as they relate to our general corporate activities.

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:


	Three months ended February 28,						Six months ended February 28,
	2010			2009			2010			2009
Revenues from external customers
Net patient service revenues
U.S. Division	$	5,758,000		$	12,787,320		$	14,143,229		$	23,666,558
China Division		431,394			—			1,030,776			—

Consolidated	$	6,189,394		$	12,787,320		$	15,174,005		$	23,666,558

Income (loss) before taxes
U.S. Division	$	(2,764,712	)	$	2,227,753		$	(3,424,374	)	$	2,691,763
China Division		(1,040,575	)		(489,832	)		(1,465,648	)		(989,980	)
Corporate		(541,434	)		(1,121,623	)		(1,430,167	)		(1,990,855	)

Consolidated	$	(4,346,721	)	$	616,298		$	(6,320,189	)	$	(289,072	)


	February 28,
	2010		2009
Total Assets
U.S. Division	$	35,083,260	$	43,361,095
China Division		22,506,739		28,867,417
Corporate		21,270,054		2,621,231

Consolidated	$	78,860,053	$	74,849,743

Item 2.

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

This quarterly report on Form 10-Q contains forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. Such forward-looking statements relate to future events or future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our Company’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements, including the risks and uncertainties described in “Risk Factors” in our annual report on Form 10-K for the fiscal year ended August 31, 2009. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. You must read the following discussion of the results of our business and our operations and financial condition in conjunction with our reviewed consolidated financial statements, including the notes, included in this quarterly report on Form 10-Q and our audited consolidated financial statements, including the notes, included in our Annual Report on Form 10-K for the fiscal year ended August 31, 2009.

Update on Critical Accounting Policies and Estimates

There have been no changes to the critical accounting policies used in our reporting of results of operations and financial position for the quarter ended February 28, 2010. For a discussion of our critical accounting policies see Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K for the fiscal year ended August 31, 2009.

Results of Operations


	Three Months Ended February 28, 2010																		Three Months Ended February 28, 2009
	U.S. Division					China Division					Corporate			Total					U.S. Division					China Division			Corporate			Total
Net patient service revenue	$	5,758,000		100	%	$	431,394		100	%	$	—		$	6,189,394		100	%	$	12,787,320		100	%	$	—		$	—		$	12,787,320		100	%

Costs and expenses:
Compensation and benefits		3,075,492		53			345,901		80			606,360			4,027,753		65			3,145,915		25			37,500			719,263			3,902,678		31
Medical services and supplies		2,096,721		36			215,926		50			—			2,312,647		37			2,971,716		23			—			—			2,971,716		23
Other operating expenses		3,179,143		55			718,942		167			321,766			4,219,851		68			4,119,118		32			617,031			506,193			5,242,342		41
Depreciation and amortization		233,811		4			30,805		7			—			264,616		4			365,437		3			17,570			—			383,007		3

Total costs and expenses		8,585,167		149			1,311,574		304			928,126			10,824,867		175			10,602,186		83			672,101			1,225,456			12,499,743		98

Operating income (loss)		(2,827,167	)	(49	)		(880,180	)	(204	)		(928,126	)		(4,635,473	)	(75	)		2,185,134		17			(672,101	)		(1,225,456	)		287,577		2

Other income (expense):
Rent and other income (expense)		60,545		1			(173,997	)	(40	)		—			(113,452	)	(2	)		34,855		—			—			—			34,855		—
Interest income		11,392		—			13,602		3			386,692			411,686		7			28,425		—			182,269			103,833			314,527		2
Interest expense		(9,482	)	—			—		—			—			(9,482	)	—			(20,661	)	—			—			—			(20,661	)	—

Total other income (expense), net		62,455		1			(160,395	)	(37	)		386,692			288,752		5			42,619		—			182,269			103,833			328,721		3

Income (loss) before income taxes		(2,764,712	)	(48	)%		(1,040,575	)	(241	)%		(541,434	)		(4,346,721	)	(70	)		2,227,753		17	%		(489,832	)		(1,121,623	)		616,298		5

Benefit (provision) for income taxes															1,437,703		23														(325,866	)	(3	)

Net income (loss)															(2,909,018	)	(47	)													290,432		2
Less: Net loss (income) attributable to the noncontrolling interest															70,038		1														(23	)	—

Net income (loss) attributable to Dynacq Healthcare, Inc.														$	(2,838,980	)	(46	)%												$	290,409		2	%

Operational statistics (Number of medical procedures) for U.S. Division:
Inpatient:
Bariatrics		54																		136
Orthopedics		87																		67
Other		20																		33

Total inpatient procedures		161																		236

Outpatient:
Orthopedics		126																		171
Other		256																		354

Total outpatient procedures		382																		525

Total procedures		543																		761

Results of Operations (continued)


	Six Months Ended February 28, 2010																		Six Months Ended February 28, 2009
	U.S. Division					China Division					Corporate			Total					U.S. Division					China Division			Corporate			Total
Net patient service revenue	$	14,143,229		100	%	$	1,030,776		100	%	$	—		$	15,174,005		100	%	$	23,666,558		100	%	$	—		$	—		$	23,666,558		100	%

Costs and expenses:
Compensation and benefits		6,273,705		44			644,722		63			1,191,233			8,109,660		53			6,406,027		27			75,000			1,103,191			7,584,218		32
Medical services and supplies		4,511,355		32			520,795		51			—			5,032,150		33			6,261,536		26			—			—			6,261,536		26
Other operating expenses		6,471,539		46			1,406,452		136			1,025,670			8,903,661		59			7,742,583		33			1,108,808			1,026,497			9,877,888		42
Depreciation and amortization		469,396		3			61,199		6			—			530,595		3			742,092		3			35,139			—			777,231		3

Total costs and expenses		17,725,995		125			2,633,168		255			2,216,903			22,576,066		149			21,152,238		89			1,218,947			2,129,688			24,500,873		104

Operating income (loss)		(3,582,766	)	(25	)		(1,602,392	)	(155	)		(2,216,903	)		(7,402,061	)	(49	)		2,514,320		11			(1,218,947	)		(2,129,688	)		(834,315	)	(4	)

Other income (expense):
Rent and other income		151,178		1			84,988		8			—			236,166		2			106,533		—			—			—			106,533		—
Interest income		28,089		—			51,756		5			786,736			866,581		6			102,568		—			228,967			138,833			470,368		2
Interest expense		(20,875	)	—			—		—			—			(20,875	)	—			(31,658	)	—			—			—			(31,658	)	—

Total other income, net		158,392		1			136,744		13			786,736			1,081,872		7			177,443		1			228,967			138,833			545,243		2

Income (loss) before income taxes		(3,424,374	)	(24	)%		(1,465,648	)	(142	)%		(1,430,167	)		(6,320,189	)	(42	)		2,691,763		11	%		(989,980	)		(1,990,855	)		(289,072	)	(1	)

Benefit (provision) for income taxes															2,059,599		14														(64,402	)	—

Net loss															(4,260,590	)	(28	)													(353,474	)	(1	)
Less: Net loss attributable to the noncontrolling interest															89,507		1														1,331		—

Net loss attributable to Dynacq Healthcare, Inc.														$	(4,171,083	)	(27	)%												$	(352,143	)	(1	)%

Operational statistics (Number of medical procedures) for U.S. Division:
Inpatient:
Bariatrics		93																		293
Orthopedics		176																		128
Other		57																		77

Total inpatient procedures		326																		498

Outpatient:
Orthopedics		278																		346
Other		579																		725

Total outpatient procedures		857																		1,071

Total procedures		1,183																		1,569

Three Months Ended February 28, 2010 Compared to the Three Months Ended February 28, 2009

U.S. Division

Net patient service revenue decreased by $7,029,320, or 55%, from $12,787,320 to $5,758,000, and total surgical cases decreased by 29% from 761 cases in 2009 to 543 cases in 2010. Following are the percentage changes in net patient service revenues and number of cases at the hospital facilities:


	Percentage decrease from 2009 to 2010
Facility	Net patient revenue		Cases
Pasadena	(51	)%	(20	)%
Garland	(58	)	(37	)
Overall	(55	)	(29	)

The decrease in net patient service revenue was due to an overall decrease in number of cases by 29% in 2010 compared to 2009. There was a significant decrease of 32% in inpatient cases, which typically have higher average reimbursement per case compared to outpatient cases. While the number of cases and the gross billed charges decreased by 29% and 38%, respectively, net patient service revenue decreased 55% due to an increase in the contractual allowance as a percentage of gross billed charges. The contractual allowance increased from 67%of gross billed charges for the quarter ended February 28, 2009 to 76% of gross billed charges for the quarter ended February 28, 2010, due to lower reimbursements, primarily on workers’ compensation cases.

Total costs and expenses decreased by $2,017,019 or 19%, from $10,602,186 in 2009 to $8,585,167 in 2010. The following describes the various changes in costs and expenses:

•

Compensation and benefits decreased marginally by $70,423, or 2%, primarily due to lower net patient service revenues.

•

Medical services and supplies expenses decreased by $874,995, or 29%, and the number of surgery cases also decreased 29%.

•

Other operating expenses decreased by $939,975, or 23%. Marketing expenses, included in other operating expenses, decreased by $300,000 from $1,500,000 in 2009 to $1,200,000 in 2010. Other operating expenses, excluding marketing expenses, as a percentage of gross billed charges were 8.3% and 6.9% for 2010 and 2009, respectively.

China Division

For the quarter ended February 28, 2010, Second People’s Hospital had net patient service revenues of $431,394, with no such corresponding revenues in the prior period. The contract to manage the Second People’s Hospital in Rui An, China was executed in March 2009, and included operating results since November 25, 2008.

Total costs and expenses for the China Division increased by $639,473, from $672,101 in 2009 to $1,311,574 in 2010. In 2010, total costs and expenses includes the operations associated with Second People’s Hospital in Rui An, China.

Corporate Division

The Corporate division includes interest and other income related to the investments in available-for-sale securities, corporate personnel compensation expenses and general and administrative expenses. Such expenses and income are not allocated to our operating divisions, as they relate to our general corporate activities. Corporate costs and expenses decreased by $297,330 from $1,225,456 in 2009 to $928,126 in 2010, due to decreases in overall patient revenues. Interest income of $386,692 in 2010 and $103,833 in 2009 relates to the investments in available-for-sale securities, which were purchased at a cost of $9,135,146 and have appreciated in fair value to $21,010,833 as at February 28, 2010. Unrealized gains in these investments of $11,720,612 are included in accumulated other comprehensive income in the Consolidated Balance Sheet, net of taxes of $4,102,214.

Six Months Ended February 28, 2010 Compared to the Six Months Ended February 28, 2009

U.S. Division

Net patient service revenue decreased by $9,523,329, or 40%, from $23,666,558 to $14,143,229, and total surgical cases decreased by 25% from 1,569 cases in 2009 to 1,183 cases in 2010. Following are the percentage changes in net patient service revenues and number of cases at the hospital facilities:


	Percentage decrease from 2009 to 2010
Facility	Net patient revenue		Cases
Pasadena	(10	)%	—	%
Garland	(57	)	(44	)
Overall	(40	)	(25	)

The decrease in net patient service revenue was due to an overall decrease in number of cases by 25% in 2010 compared to 2009. There was a significant decrease of 35% in inpatient cases, which typically have higher average reimbursement per case compared to outpatient cases. While the number of cases and the gross billed charges decreased by 25% and 33%, respectively, net patient service revenue decreased 40% due to an increase in the contractual allowance as a percentage of gross billed charges. The contractual allowance increased from 69% of gross billed charges for the six months period ended February 28, 2009 to 73% of gross billed charges for the six months period ended February 28, 2010, due to lower reimbursements, primarily on workers’ compensation cases.

Total costs and expenses decreased by $3,426,243 or 16%, from $21,152,238 in 2009 to $17,725,995 in 2010. The following describes the various changes in costs and expenses:

•

Compensation and benefits decreased marginally by $132,322, or 2%, primarily due to lower net patient service revenues.

•

Medical services and supplies expenses decreased by $1,750,181, or 28%, and the number of surgery cases decreased 25%.

•

Other operating expenses decreased by $1,271,044, or 16%. Marketing expenses, included in other operating expenses, decreased by $331,000 from $3,031,000 in 2009 to $2,700,000 in 2010. Other operating expenses, excluding marketing expenses, as a percentage of gross billed charges were 7.3% and 6.2% for 2010 and 2009, respectively.

China Division

For the six months period ended February 28, 2010, Second People’s Hospital had net patient service revenues of $1,030,776, with no such corresponding revenues in the prior period. The contract to manage the Second People’s Hospital in Rui An, China was executed in March 2009, and included operating results since November 25, 2008.

Total costs and expenses for the China Division increased by $1,414,221, from $1,218,947 in 2009 to $2,633,168 in 2010. In 2010, total costs and expenses includes the operations associated with Second People’s Hospital in Rui An, China.

Corporate Division

The Corporate division includes interest and other income related to the investments in available-for-sale securities, corporate personnel compensation expenses and general and administrative expenses. Such expenses and income are not allocated to our operating divisions, as they relate to our general corporate activities. Corporate costs and expenses increased marginally by $87,215 from $2,129,688 in 2009 to $2,216,903 in 2010. Interest income of $786,736 in 2010 and $138,833 in 2009 relates to the investments in available-for-sale securities, which were purchased at a cost of $9,135,146 and have appreciated in fair value to $21,010,833 as at February 28, 2010. Unrealized gains in these investments of $11,720,612 are included in accumulated other comprehensive income in the Consolidated Balance Sheet, net of taxes of $4,102,214.

Liquidity and Capital Resources

Our 2009 Annual Report on Form 10-K includes a detailed discussion of our liquidity, contractual obligations and commitments. The information presented below updates and should be read in conjunction with the information disclosed in that Form 10-K.

Cash flow from operating activities

Total cash flow used in operating activities was $3,258,370 during the period ended February 28, 2010, primarily due to a loss of $4,171,083, decreases in accounts payable and accrued liabilities of $973,342, changes in income tax related accounts of $2,387,004, partially offset by decreases in accounts receivable of $3,811,599 and depreciation and amortization of $530,595.

Cash flow from investing activities

Total cash flow used in investing activities was $389,193 for purchase of equipment.

Cash flow from financing activities

Total cash flow used in financing activities was $3,853,067 primarily related to treasury stock purchases of $3,681,903 and $175,561 payments on the note payable for class action lawsuit settlement.

The Company had working capital of $33,223,451 as of February 28, 2010, and maintained a liquid position by a current ratio of approximately 4.8 to 1.

We believe we will be able to meet our ongoing liquidity and cash needs for fiscal year 2010 through the combination of available cash and cash flow from operations.

Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board issued Accounting Standards Codification (“ASC”) Topic 805-10, “Business Combinations” (formerly referred to as SFAS No. 141 (revised 2007)) and ASC Topic 810-10, “Consolidation” (formerly referred to as SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements”). 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.

ASC Topic 805-10 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.

ASC Topic 810-10 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 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.

The Company adopted the provisions of both ASC Topic 805-10 and ASC Topic 810-10 effective September 1, 2009, and its adoption did not have a material impact on our consolidated financial statements.

In April 2009, the FASB issued ASC Topic 820-10, “Fair Value Measurements & Disclosures” (formerly referred to as FASB Staff Position No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability has Significantly Decreased and Identifying Transactions That Are Not Orderly”) and ASC Topic 320-10, “Investments – Debt and Equity Securities” (formerly referred to as FASB Staff Position No. 115-2 and 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”). These two ASC Topics were issued to provide additional guidance about (1) measuring the fair value of financial instruments when the markets become inactive and quoted prices may reflect distressed transactions, and (2) recording impairment charges on investments in debt instruments. Additionally, the FASB issued ASC Topic 825-10-65, “Financial Instruments” (formerly referred to as FASB Staff Position No. 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments”) to require disclosures of fair value of certain financial instruments in interim financial statements. All of these ASC Topics were adopted in the fourth quarter of fiscal year ended August 31, 2009.

In May 2009, the FASB issued ASC Topic 855-10, “Subsequent Events” (formerly referred to as SFAS 165), which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The adoption in the fourth quarter of fiscal year 2009 did not have any material impact on the Company’s consolidated financial statements. For the quarter ended February 28, 2010, the Company evaluated subsequent events through April 14, 2010, the date the consolidated financial statements were issued.

In June 2009, the FASB issued ASC Topic 105-10, “Generally Accepted Accounting Principles”, (formerly referred to as SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles”). ASC Topic 105-10 establishes the ASC as the source of authoritative non-governmental generally accepted accounting principles (“GAAP”). The Company adopted the provisions of this statement effective September 1, 2009, and its adoption did not have a material impact on the Company’s consolidated financial statements, though it changed references of accounting literature disclosed in the notes to the consolidated financial statements.

In September 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-06, “Implementation Guidance on Accounting for Uncertainty in Income Taxes and Disclosure Amendments for Nonpublic Entities”. ASU 2009-06 provides additional implementation guidance on accounting for uncertainty in income taxes and eliminates the disclosures required by paragraph ASC Topic 740-10-50-15(a) through (b) for nonpublic entities. The Company adopted the provisions of ASU 2009-09, and its adoption did not have a material impact on its consolidated financial statements.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

Not required.

Item 4T.

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 February 28, 2010, our internal disclosure controls and procedures were effective.

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.

PART II-OTHER INFORMATION

Item 1.

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 Texas facilities’ fees must be made in the district courts of Travis County, Texas in what can often be a lengthy procedure. Please refer to Revenue Recognition, as well as Business – Government Regulation – U.S. Division –Texas Workers’ Compensation Systems and Management’s Discussion and Analysis of Financial Condition in our Form 10-K for the fiscal year ended August 31, 2009, 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 1A.

Risk Factors.

The Company’s Risk Factors as disclosed in its Form 10-K for the year ended August 31, 2009 have not changed.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

Purchases of Equity Securities by the Company

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. Shares repurchased during the quarter ended February 28, 2010 pursuant to our repurchase program include the following:


Period	Total Number of Shares Purchased		Average Price per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet be Purchased Under the Publicly Announced Plans or Programs
December 1 – 31, 2009	14,091		$	3.52	14,091	1,422,358
January 1 – 31, 2010	1,005,606	⁽¹⁾		3.20	5,520	1,416,838
February 1 – 28, 2010	13,282			2.96	13,282	1,403,556

Total	1,032,979		$	3.20	32,893	1,403,556

⁽¹⁾

This includes 1,000,086 shares of common stock of the Company purchased as treasury stock in a privately negotiated purchase from three individual shareholders. Two of those individual shareholders served as independent contractors to the Company under the General Manager of the China Division in 2009; one of those individuals continues to serve in that capacity to the Company.

Item 3.

Defaults Upon Senior Securities.

None.

Item 4.

(Removed and Reserved).

Item 5.

Other Information.

Election of Directors and Ratification of Engagement of Independent Auditors

Prior to the Annual Meeting of Shareholders held on February 15, 2010, the Board of Directors reduced the size of the Board to six persons and decided not to fill the vacancy in the Board created by the death shortly prior to the delivery of the proxy statements of one of its directors who had been nominated for re-election at the annual meeting. Each of our directors was reelected to serve until our next annual meeting of shareholders or until his or her respective successor is elected and qualified. The following table sets forth the results of the voting for the election of directors:


Nominee	For	Withheld	Abstentions and Broker Non-votes
Chiu M. Chan	9,190,274	331,859	—
Philip S. Chan	9,174,204	347,929	—
Stephen L. Huber	9,514,434	7,699	—
Ping S. Chu	9,515,403	6,730	—
James G. Gerace	9,515,037	7,096	—
Xiao H. Li	9,221,667	300,466	—

The stockholders also ratified the engagement of Killman, Murrell & Company, P.C. as the independent auditors for the fiscal year ending August 31, 2010. The proposal to ratify received 11,089,944 affirmative votes and 2,893 negative votes, with 100 votes abstaining.

Item 6.

Exhibits.


EXHIBIT NO.		IDENTIFICATION OF EXHIBIT
Exhibit 15.1		Awareness Letter of Killman, Murrell & Company, P.C.

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.

SIGNATURES

Pursuant to the requirements 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: April 14, 2010	By:	/s/ Chiu M. Chan
		Chiu M. Chan
		Chief Executive Officer
		(duly authorized officer)

Date: April 14, 2010	By:	/s/ Philip S. Chan
		Philip S. Chan
		Chief Financial Officer
		(principal financial and accounting officer)

INDEX OF EXHIBITS


EXHIBIT NO.		IDENTIFICATION OF EXHIBIT
Exhibit 15.1		Awareness Letter of Killman, Murrell and Company, P.C.

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.