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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the quarterly period ended November 30, 2006



| ̈ | 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



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DYNACQ HEALTHCARE, INC.

(Exact name of registrant as specified in its charter)



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|                                                              |  |                                     
|------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                      |  | 76-0375477                          
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                                  |            |      
|------------------------------------------------- | ---------- | -----
|10304 Interstate 10 East, Suite 369Houston, Texas |            | 77029
|                                                  | (Zip Code)
|(Address of principal executive offices)          |            |      

(713) 378-2000

(Registrants telephone number, including area code)



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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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2
of the Exchange Act. (Check One): Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer  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
January 8, 2007, the number of shares outstanding of the registrants common stock, par value $.001 per share, was 15,740,711.



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##### Table of Contents

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 November 30, 2006 and August 31, 2006.                     |  | 4 
|                                                         |  |                                                                                             
|                                                         |  | Consolidated Statements of Operations for the three months ended November 30, 2006 and 2005. |  | 6 
|                                                         |  |                                                                                             
|                                                         |  | Consolidated Statements of Cash Flows for the three months ended November 30, 2006 and 2005. |  | 7 
|                                                         |  |                                                                                             
|                                                         |  | Notes to Consolidated Financial Statements.                                                  |  | 9 
|                                                         |  |                                                                                             
|Item 2.                                                  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations.       |  | 14
|                                                         |  |                                                                                             
|Item 3.                                                  |  | Quantitative and Qualitative Disclosures About Market Risk.                                  |  | 19
|                                                         |  |                                                                                             
|Item 4.                                                  |  | Controls and Procedures.                                                                     |  | 19
|                                                         | 
|PART IIOTHER INFORMATION                                |  | 20                                                                                          
|                                                         |  |                                                                                             
|Item 1.                                                  |  | Legal Proceedings.                                                                           |  | 20
|                                                         |  |                                                                                             
|Item 1A.                                                 |  | Risk Factors.                                                                                |  | 20
|                                                         |  |                                                                                             
|Item 2.                                                  |  | Unregistered Sales of Equity Securities and Use of Proceeds.                                 |  | 20
|                                                         |  |                                                                                             
|Item 3.                                                  |  | Defaults Upon Senior Securities.                                                             |  | 21
|                                                         |  |                                                                                             
|Item 4.                                                  |  | Submission of Matters to a Vote of Security Holders.                                         |  | 21
|                                                         |  |                                                                                             
|Item 5.                                                  |  | Other Information.                                                                           |  | 21
|                                                         |  |                                                                                             
|Item 6.                                                  |  | Exhibits.                                                                                    |  | 21
|                                                         | 
|Signatures                                               |  | 21                                                                                          
|                                                         | 
|Index of Exhibits                                        |  | 22                                                                                          



2



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



|    |  |                                        
|--- |  | ---------------------------------------
|To: |  | The Stockholders and Board of Directors
|    |  | Dynacq Healthcare, Inc.                
|    |  | Houston, Texas                         

We have reviewed the consolidated balance sheet of Dynacq Healthcare, Inc., as of November 30, 2006, and the
related consolidated statements of operations and cash flows for the three-month periods ended November 30, 2006 and 2005. 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, 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 consolidated interim financial statements for them to be in conformity with United States 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, 2006, 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 7, 2006, 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, 2006, 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                      
|January 10, 2007                    



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##### Table of Contents

PART I - FINANCIAL INFORMATION

ITEM I - FINANCIAL STATEMENTS

Dynacq Healthcare, Inc.

Consolidated Balance Sheets



|                                                                                                                                                                                                                                                                  |  |                   |            |                 |   |           
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---------- | --------------- | - | ----------
|                                                                                                                                                                                                                                                                  |  | November 30, 2006 |            | August 31, 2006
|                                                                                                                                                                                                                                                                  |  | (Reviewed)        |            | (Audited)      
|Assets                                                                                                                                                                                                                                                            |  |                   |            |                 |   |           
|Current assets:                                                                                                                                                                                                                                                   |  |                   |            |                 |   |           
|Cash and cash equivalents                                                                                                                                                                                                                                         |  | $                 | 2,828,047  |                 | $ | 3,382,332 
|Restricted cash                                                                                                                                                                                                                                                   |  |                   | 339,708    |                 |   | 808,708   
|Current portion of accounts receivable, net of contractual allowances of approximately $62,275,000 and $65,240,000 and allowances for
uncollectible accounts of approximately $804,000 and $849,000 at November 30, 2006 and August 31, 2006, respectively        |  |                   | 9,899,885  |                 |   | 11,108,810
|Accounts receivable - other                                                                                                                                                                                                                                       |  |                   | 289,693    |                 |   | 14,423    
|Inventories                                                                                                                                                                                                                                                       |  |                   | 1,698,115  |                 |   | 1,751,760 
|Prepaid expenses                                                                                                                                                                                                                                                  |  |                   | 369,956    |                 |   | 505,454   
|Income taxes receivable                                                                                                                                                                                                                                           |  |                   | 1,731,192  |                 |   | 1,731,192 
|                                                                                                                                                                                                                                                                  |  |                   |            |                 |   |           
|Total current assets                                                                                                                                                                                                                                              |  |                   | 17,156,596 |                 |   | 19,302,679
|Assets held for sale                                                                                                                                                                                                                                              |  |                   | 13,252,800 |                 |   | 13,252,800
|Property and equipment, net                                                                                                                                                                                                                                       |  |                   | 21,019,194 |                 |   | 21,558,200
|Long-term portion of accounts receivable, net of contractual allowances of approximately $112,721,000 and $99,247,000 and allowances for
uncollectible accounts of approximately $1,455,000 and $1,291,000 at November 30, 2006 and August 31, 2006, respectively |  |                   | 17,919,198 |                 |   | 16,899,319
|Other assets                                                                                                                                                                                                                                                      |  |                   | 261,404    |                 |   | 259,974   
|                                                                                                                                                                                                                                                                  |  |                   |            |                 |   |           
|Total assets                                                                                                                                                                                                                                                      |  | $                 | 69,609,192 |                 | $ | 71,272,972
|                                                                                                                                                                                                                                                                  |  |                   |            |                 |   |           

See accompanying notes.



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##### Table of Contents

Dynacq Healthcare, Inc.

Consolidated Balance Sheets (continued)



|                                                                                                                                   |  |                   |            |                 |   |           
|---------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---------- | --------------- | - | ----------
|                                                                                                                                   |  | November 30, 2006 |            | August 31, 2006
|                                                                                                                                   |  | (Reviewed)        |            | (Audited)      
|Liabilities and stockholders equity                                                                                               |  |                   |            |                 |   |           
|Current liabilities:                                                                                                               |  |                   |            |                 |   |           
|Accounts payable                                                                                                                   |  | $                 | 4,222,360  |                 | $ | 5,242,314 
|Accrued liabilities                                                                                                                |  |                   | 6,179,229  |                 |   | 4,613,586 
|Notes payable                                                                                                                      |  |                   | 5,203,207  |                 |   | 6,339,212 
|Liabilities related to discontinued operations                                                                                     |  |                   | 91,791     |                 |   | 130,299   
|Current taxes payable                                                                                                              |  |                   | 72,030     |                 |   | 72,030    
|                                                                                                                                   |  |                   |            |                 |   |           
|Total current liabilities                                                                                                          |  |                   | 15,768,617 |                 |   | 16,397,441
|Non-current liabilities                                                                                                            |  |                   |           |                 |   |          
|                                                                                                                                   |  |                   |            |                 |   |           
|Total liabilities                                                                                                                  |  |                   | 15,768,617 |                 |   | 16,397,441
|                                                                                                                                   |  |                   |            |                 |   |           
|Minority interests                                                                                                                 |  |                   | 512,347    |                 |   | 656,697   
|                                                                                                                                   |  |                   |            |                 |   |           
|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, 15,740,711 shares issued at November 30, 2006 and at August 31,
2006 |  |                   | 15,741     |                 |   | 15,741    
|Additional paid-in capital                                                                                                         |  |                   | 13,056,974 |                 |   | 13,056,974
|Accumulated other comprehensive income                                                                                             |  |                   | 172,925    |                 |   | 105,659   
|Retained earnings                                                                                                                  |  |                   | 40,082,588 |                 |   | 41,040,460
|                                                                                                                                   |  |                   |            |                 |   |           
|Total stockholders equity                                                                                                         |  |                   | 53,328,228 |                 |   | 54,218,834
|                                                                                                                                   |  |                   |            |                 |   |           
|Total liabilities and stockholders equity                                                                                         |  | $                 | 69,609,192 |                 | $ | 71,272,972
|                                                                                                                                   |  |                   |            |                 |   |           

See accompanying notes.



5



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##### Table of Contents

Dynacq Healthcare, Inc.

Consolidated Statements of Operations

(Reviewed)



|                                                                    |  |                                 |            |   |      |   |            |  
|------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                    |  | Three months ended November 30, |           
|                                                                    |  | 2006                            |            |   | 2005 |  
|Net patient service revenue                                         |  | $                               | 9,971,245  |   |      | $ | 9,673,790  |  
|                                                                    |  |                                 |            |   |      |   |            |  
|Costs and expenses:                                                 |  |                                 |            |   |      |   |            |  
|Compensation and benefits                                           |  |                                 | 2,804,056  |   |      |   | 2,969,888  |  
|Medical services and supplies                                       |  |                                 | 2,228,875  |   |      |   | 1,822,600  |  
|Other operating expenses                                            |  |                                 | 4,780,292  |   |      |   | 4,804,064  |  
|Provision for uncollectible accounts                                |  |                                 | 104,730    |   |      |   | 118,406    |  
|Loss on disposal of assets                                          |  |                                 |           |   |      |   | 162,676    |  
|Depreciation and amortization                                       |  |                                 | 653,529    |   |      |   | 613,855    |  
|                                                                    |  |                                 |            |   |      |   |            |  
|Total costs and expenses                                            |  |                                 | 10,571,482 |   |      |   | 10,491,489 |  
|                                                                    |  |                                 |            |   |      |   |            |  
|Operating loss                                                      |  |                                 | (600,237   | ) |      |   | (817,699   | )
|                                                                    |  |                                 |            |   |      |   |            |  
|Other income (expense):                                             |  |                                 |            |   |      |   |            |  
|Rent and other income                                               |  |                                 | 31,775     |   |      |   | 56,682     |  
|Interest income                                                     |  |                                 | 14,396     |   |      |   | 3,878      |  
|Interest expense                                                    |  |                                 | (120,696   | ) |      |   | (94,072    | )
|                                                                    |  |                                 |            |   |      |   |            |  
|Total other expense, net                                            |  |                                 | (74,525    | ) |      |   | (33,512    | )
|                                                                    |  |                                 |            |   |      |   |            |  
|Loss before income taxes, minority interests and extraordinary gain |  |                                 | (674,762   | ) |      |   | (851,211   | )
|Minority interest in (earnings) loss                                |  |                                 | (19,894    | ) |      |   | 706        |  
|                                                                    |  |                                 |            |   |      |   |            |  
|Loss before income taxes                                            |  |                                 | (694,656   | ) |      |   | (850,505   | )
|Benefit for income taxes                                            |  |                                 |           |   |      |   | 310,503    |  
|                                                                    |  |                                 |            |   |      |   |            |  
|Loss from continuing operations                                     |  |                                 | (694,656   | ) |      |   | (540,002   | )
|Loss from discontinued operations, net of income taxes              |  |                                 | (308,460   | ) |      |   | (959,223   | )
|Extraordinary gain, net of $-0- income tax expense                  |  |                                 | 45,244     |   |      |   |           |  
|                                                                    |  |                                 |            |   |      |   |            |  
|Net loss                                                            |  | $                               | (957,872   | ) |      | $ | (1,499,225 | )
|                                                                    |  |                                 |            |   |      |   |            |  
|Basic and diluted loss per common share:                            |  |                                 |            |   |      |   |            |  
|Loss from continuing operations                                     |  | $                               | (0.04      | ) |      | $ | (0.04      | )
|Loss from discontinued operations, net of income taxes              |  |                                 | (0.02      | ) |      |   | (0.06      | )
|Extraordinary gain, net of income tax expense                       |  |                                 |           |   |      |   |           |  
|                                                                    |  |                                 |            |   |      |   |            |  
|Net loss                                                            |  | $                               | (0.06      | ) |      | $ | (0.10      | )
|                                                                    |  |                                 |            |   |      |   |            |  
|Basic and diluted average common shares outstanding                 |  |                                 | 15,740,711 |   |      |   | 14,851,568 |  
|                                                                    |  |                                 |            |   |      |   |            |  

See accompanying notes.



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Dynacq Healthcare, Inc.

Consolidated Statements of Cash Flows

(Reviewed)



|                                                                                          |  |                                 |            |   |      |   |            |  
|----------------------------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                          |  | Three months ended November 30, |           
|                                                                                          |  | 2006                            |            |   | 2005 |  
|Cash flows from operating activities                                                      |  |                                 |            |   |      |   |            |  
|Net loss                                                                                  |  | $                               | (957,872   | ) |      | $ | (1,499,225 | )
|Less loss from discontinued operations, net of income taxes                               |  |                                 | (308,460   | ) |      |   | (959,223   | )
|                                                                                          |  |                                 |            |   |      |   |            |  
|Net loss before discontinued operations                                                   |  |                                 | (649,412   | ) |      |   | (540,002   | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                                 |            |   |      |   |            |  
|Extraordinary gain, net of tax                                                            |  |                                 | (45,244    | ) |      |   |           |  
|Depreciation and amortization                                                             |  |                                 | 653,529    |   |      |   | 613,855    |  
|Loss on disposal of assets                                                                |  |                                 |           |   |      |   | 162,676    |  
|Provision for uncollectible accounts                                                      |  |                                 | 104,730    |   |      |   | 118,406    |  
|Deferred income taxes                                                                     |  |                                 |           |   |      |   | (310,503   | )
|Minority interests                                                                        |  |                                 | 19,894     |   |      |   | (706       | )
|Changes in operating assets and liabilities:                                              |  |                                 |            |   |      |   |            |  
|Restricted cash                                                                           |  |                                 | 469,000    |   |      |   |           |  
|Accounts receivable                                                                       |  |                                 | 70,247     |   |      |   | (1,431,873 | )
|Inventories                                                                               |  |                                 | 53,645     |   |      |   | 83,688     |  
|Prepaid expenses                                                                          |  |                                 | 135,498    |   |      |   | 88,588     |  
|Income taxes receivable                                                                   |  |                                 |           |   |      |   | 32,000     |  
|Other assets                                                                              |  |                                 | (3,930     | ) |      |   | 4,535      |  
|Cash overdrafts                                                                           |  |                                 |           |   |      |   |           |  
|Accounts payable                                                                          |  |                                 | (1,019,954 | ) |      |   | (58,761    | )
|Accrued liabilities                                                                       |  |                                 | 1,565,641  |   |      |   | 891,575    |  
|Income taxes payable                                                                      |  |                                 |           |   |      |   | (35,935    | )
|                                                                                          |  |                                 |            |   |      |   |            |  
|Cash provided by (used in) continuing activities                                          |  |                                 | 1,353,644  |   |      |   | (382,457   | )
|Cash (used in) provided by discontinued activities                                        |  |                                 | (294,389   | ) |      |   | (801,233   | )
|                                                                                          |  |                                 |            |   |      |   |            |  
|Net cash provided by (used in) operating activities                                       |  |                                 | 1,059,255  |   |      |   | (1,183,690 | )
|                                                                                          |  |                                 |            |   |      |   |            |  
|Cash flows from investing activities                                                      |  |                                 |            |   |      |   |            |  
|Purchase of property and equipment                                                        |  |                                 | (54,234    | ) |      |   | (235,961   | )
|Purchase of accounts receivable  other                                                   |  |                                 | (312,449   | ) |      |   |           |  
|Collections on purchased accounts receivable - other                                      |  |                                 | 37,179     |   |      |   | 143,824    |  
|                                                                                          |  |                                 |            |   |      |   |            |  
|Cash used in continuing activities                                                        |  |                                 | (329,504   | ) |      |   | (92,137    | )
|Cash provided by (used in) discontinued activities                                        |  |                                 |           |   |      |   |           |  
|                                                                                          |  |                                 |            |   |      |   |            |  
|Net cash used in investing activities                                                     |  |                                 | (329,504   | ) |      |   | (92,137    | )
|                                                                                          |  |                                 |            |   |      |   |            |  
|Cash flows from financing activities                                                      |  |                                 |            |   |      |   |            |  
|Principal payments on notes payable                                                       |  |                                 | (1,136,005 | ) |      |   |           |  
|Proceeds from notes payable                                                               |  |                                 |           |   |      |   | 1,402,994  |  
|Purchase of minority interest                                                             |  |                                 | (119,000   | ) |      |   |           |  
|                                                                                          |  |                                 |            |   |      |   |            |  
|Cash (used in) provided by continuing activities                                          |  |                                 | (1,255,005 | ) |      |   | 1,402,994  |  
|Cash used in discontinued activities                                                      |  |                                 | (38,508    | ) |      |   | (36,148    | )
|                                                                                          |  |                                 |            |   |      |   |            |  
|Net cash (used in) provided by financing activities                                       |  |                                 | (1,293,513 | ) |      |   | 1,366,846  |  
|                                                                                          |  |                                 |            |   |      |   |            |  
|Effect of exchange rate changes on cash                                                   |  |                                 | 9,477      |   |      |   |           |  
|                                                                                          |  |                                 |            |   |      |   |            |  
|Net (decrease) increase in cash and cash equivalents                                      |  |                                 | (554,285   | ) |      |   | 91,019     |  
|Cash at beginning of period                                                               |  |                                 | 3,382,332  |   |      |   | 3,337,835  |  
|                                                                                          |  |                                 |            |   |      |   |            |  
|Cash at end of period                                                                     |  | $                               | 2,828,047  |   |      | $ | 3,428,854  |  
|                                                                                          |  |                                 |            |   |      |   |            |  

Continued.



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|                                                                |  |   |         |   |  |   |            |  
|--------------------------------------------------------------- |  | - | ------- | - |  | - | ---------- | -
|Supplemental cash flow disclosures                              |  |   |         |   |  |   |            |  
|Cash paid during the period for:                                |  |   |         |   |  |   |            |  
|Interest                                                        |  | $ | 128,764 |   |  | $ | 82,985     |  
|                                                                |  |   |         |   |  |   |            |  
|Income taxes                                                    |  | $ |        |   |  | $ | 35,935     |  
|                                                                |  |   |         |   |  |   |            |  
|Non cash investing and financing activities:                    |  |   |         |   |  |   |            |  
|Land cost from foreign currency gains                           |  | $ | (57,789 | ) |  | $ |           |  
|Foreign currency gains                                          |  |   | 57,789  |   |  |   |           |  
|Property and equipment, net transferred to Assets held for sale |  |   |        |   |  |   | 2,124,219  |  
|Assets held for sale                                            |  |   |        |   |  |   | (2,124,219 | )

See accompanying notes.



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##### Table of Contents

Dynacq Healthcare, Inc.

Notes to Consolidated Financial Statements

November 30, 2006

(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 $2.9 million and $3.1
million for the quarters ended November 30, 2006 and 2005, respectively. These reviewed financial statements should be read in conjunction with the audited financial statements at August 31, 2006. Operating results for the quarter ended
November 30, 2006 are not necessarily indicative of the results that may be expected for the year ending August 31, 2007.

The
Company is a holding company and through its subsidiaries and its affiliates operates in one line of business. Its strategy is to develop and operate general acute care hospitals that provide principally specialized surgeries. The Company manages
these hospitals on an individual basis. The hospitals economic characteristics, nature of their operations, regulatory environment in which they operate and the way in which they are managed are all similar. Accordingly, the Company aggregates
its hospitals into a single reportable segment as that term is defined by Statement of Financial Accounting Standards (SFAS) No. 131 Disclosures About Segments of an Enterprise and Related Information.

General

As of November 30, 2006, the Company
operated two facilities in the Houston metropolitan area (Pasadena and West Houston Facilities), and one each in the Dallas-Fort Worth area (Garland Facility) and in Baton Rouge (Baton Rouge Facility). Dynacq also owns a 70% equity interest in a
joint venture formed under the laws of the Peoples Republic of China (the DeAn Joint Venture) to construct, own, and operate a hospital in Shanghai, China. The DeAn Joint Venture is currently negotiating a contract for the construction
of the hospital.

Assets Held for Sale

During the fiscal year 2006, the Company made the decision to sell the assets related to its Baton Rouge and West Houston Facilities, and its land in The Woodlands, Texas, and has retained the services of a broker to locate buyers for the
Baton Rouge Facility and the land in The Woodlands, Texas. The Company is also currently negotiating with prospective buyers for the sale of the West Houston Facility. The assets related to these facilities have been classified as Assets held
for sale.

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.



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Stock Based Compensation

The Companys 1995 Non-Qualified Stock Option Plan and the Year 2000 Stock Incentive Plan (the Plans) provide for options and other stock-based awards that may be granted to eligible employees,
officers, consultants and non-employee directors of the Company or its subsidiaries. The Company had reserved 6,000,000 shares of common stock for future issuance under the Plans. As of November 30, 2006, there remain 3,420,836 shares which can
be issued under the Plans, after giving effect to stock splits and shares issued under the Plans. All awards previously granted to employees under the Plans have been stock options, primarily intended to qualify as incentive stock
options within the meaning of Section 422 of the Internal Revenue Code. The Plans also permit stock awards, stock appreciation rights, performance units, and other stock-based awards, all of which may or may not be subject to the
achievement of one or more performance objectives.

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

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

For the quarter ended November 30, 2006, 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 ten years. All of the outstanding stock options were vested as of August 31, 2005. The following table summarizes the stock option activities for
the quarter ended November 30, 2006 (share amounts in thousands):



|                               |  |        |   |  |                                                  |      |                                                  |   |                           |  
|------------------------------ |  | ------ | - |  | ------------------------------------------------ | ---- | ------------------------------------------------ | - | ------------------------- | -
|                               |  | Shares |   |  | Weighted Average Option Exercise Price Per Share |      | Weighted Average Grant Date Fair Value Per Share |   | Aggregate Intrinsic Value
|Outstanding, August 31, 2006   |  | 1,018  |   |  | $                                                | 5.55 |                                                  |  |                           | 
|Granted                        |  |       |   |  |                                                  |     |                                                  |  |                           | 
|Exercised                      |  |       |   |  |                                                  |     |                                                  |  |                           | 
|Expired or canceled            |  | (13    | ) |  |                                                  | 4.90 |                                                  |  |                           | 
|                               |  |        |   | 
|Outstanding, November 30, 2006 |  | 1,005  |   |  | $                                                | 5.56 |                                                  |  |                           | 

Additional information relating to the Plans at November 30, 2006 and August 31, 2006 is as follows (in
thousands):



|                                                                                    |  |                   |  |                
|----------------------------------------------------------------------------------- |  | ----------------- |  | ---------------
|                                                                                    |  | November 30, 2006 |  | August 31, 2006
|Options exercisable                                                                 |  | 1,005             |  | 1,018          
|Options available for grant and reserved common stock shares for stock option plans |  | 3,421             |  | 3,408          

Beginning in the fiscal year 2006, the Company adopted SFAS No. 123(R), Share-Based
Payments 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 are recognized as
compensation expense in the income statement, and prior period results are not restated. Since all of the outstanding stock options were vested as of August 31, 2005, there was no impact on the financials of the Company as a result of the
adoption.



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##### Table of Contents

In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107
(SAB No. 107) that provided the Staffs views regarding valuation of share-based payments pursuant to SFAS No. 123(R). With respect to volatility, SAB No. 107 clarified that there is not a particular method of
estimating volatility. SAB No. 107 also provided a simplified method 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 has issued stock options having a ten-year expiration with generally a four-year annual vesting term. The Company applied the SAB
No. 107 plain-vanilla method for determining the expected life.

On August 31, 2005 the Compensation Committee
accelerated the vesting of all then outstanding stock options, and extended the exercise date of a stock option for an executive officer, primarily to avoid recognizing in its income statement approximately $1,874,000 in associated compensation
expense in future periods, of which approximately $824,000 would have been recognized in fiscal year 2006 as a result of the adoption of SFAS No. 123(R). Unvested stock options to purchase 979,173 shares, of which 100,000 are held by an
executive officer, became exercisable as a result of the vesting acceleration. The Compensation Committee also extended the exercise date for vested stock options to purchase 197,500 shares held by another executive officer of the Company. The
Company recorded approximately $138,000 non-cash compensation charge as a result of these actions, of which approximately $35,000 is related to the excess of the intrinsic value over the fair market value of the Companys stock on the
acceleration date of those options that would have been forfeited or expired unexercised had the vesting not been accelerated, and approximately $103,000 is related to the excess of the intrinsic value over the fair market value of the
Companys stock on the date of extension of the exercise date of those options that would have been forfeited or expired unexercised had the exercise date not been extended. In determining the forfeiture rates of the stock options, the Company
reviewed the current employee turnover rate, the unvested options original life, time remaining to vest and whether these options were held by officers of the Company. The compensation charge will be adjusted in future period financial results
as actual forfeitures are realized. For the quarter ended November 30, 2006, there were no material changes in actual forfeitures from estimates.

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

Historically, the Company has not participated in managed care contracts. However, during the
quarter ended November 30, 2005, the Company began participation in certain managed care contracts and anticipates entering into additional contracts in the future. So far these contracts have not resulted in any meaningful patient revenues.
The Company records revenue pursuant to the following policy. The Company has established billing rates for its medical services which it bills as gross revenue as services are delivered. Gross billed revenues are then reduced by the Companys
estimate of the discount (contractual allowance) to arrive at net patient service revenues. Net patient service revenues are based on historical cash collections as discussed below and may not represent amounts ultimately expected to be 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.

Contractual Allowance

The Company computes its
contractual allowance based on the ratio of the Companys historical cash collections during the trailing twelve months on a case-by-case basis by operating facility. This ratio of cash collections to billed services is then applied to the
gross billed services by operating facility. The following table shows gross revenues and contractual allowances for the three months ended November 30, 2006 and 2005:



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|                                 |  |      |            |   |      |   |            |  
|-------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                 |  | 2006 |            |   | 2005 |  
|Gross billed charges             |  | $    | 25,955,341 |   |      | $ | 23,435,309 |  
|Contractual allowance            |  |      | 15,984,096 |   |      |   | 13,761,519 |  
|                                 |  |      |            |   |      |   |            |  
|Net revenue                      |  | $    | 9,971,245  |   |      | $ | 9,673,790  |  
|                                 |  |      |            |   |      |   |            |  
|Contractual allowance percentage |  |      | 62         | % |      |   | 59         | %
|                                 |  |      |            |   |      |   |            |  

Accounts Receivable

Accounts receivable represent net receivables for services provided by the Company. The estimated accounts receivable not expected to be collected within twelve months of the balance sheet date have been shown as
long-term receivables and represent receivables in the Medical Dispute Resolution (MDR) process and legal third-party financial class. The contractual allowance is provided as revenue is recognized. At each balance sheet date management
reviews the accounts receivables for collectibility. If after the review management believes certain receivables are uncollectible, the receivables are written down to the expected collectible amount.

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.

Collections for services
provided are generally settled or written off as uncollectible against the contractual allowance within six months of the date of service, except for services provided to injured workers in Texas. Because the Company has in recent years focused on
providing services to injured workers in Texas, accounts receivable in the workers compensation MDR process have increased.

The MDR
process is an established reimbursement resolution process available to providers of healthcare services under the regulations guiding reimbursement for services provided to injured workers in the state of Texas. Accounts generally do not become
subject to the MDR process prior to being outstanding for at least 90 days subsequent to patient discharge. For medical services provided to injured workers in the state of Texas, the MDR process is specifically based upon the administrative and
statutory regulations promulgated by the Texas Labor Code, the Texas Administrative Code, and the Texas Insurance Code. The Company, in conjunction with most of the Texas hospital medical providers, continues its efforts to resolve the pending
claims regarding payment for the treatment of injured workers under the Texas workers compensation laws.

The Company has a significant
number of reimbursement disputes where the MDR decision was unsatisfactory to either the insurance carrier or us, and these decisions have subsequently been appealed to the State Office of Administrative Hearings (SOAH) or district
court. Many of these cases involve the stop-loss rule governing reimbursement to providers. The Company is pursuing these cases aggressively; however the number of cases that the Company has in the dispute resolution process continues to
grow, and payment on many of these cases will not be made until certain standards currently in dispute are established. The Travis County District Court has suggested that it will wait for a decision at SOAH regarding the stop-loss issue. The en
banc panel at SOAH recently heard the arguments of both the carriers and providers, but has not yet issued a decision regarding the stop-loss issue. The State Department of Insurance, through the office of the Texas Attorney General, has taken a
position at least partially supporting the claims made by the Company and other Texas hospitals.

The delays caused by the unexpected and
extended abatements of the SOAH proceedings for both the inpatient and outpatient cases have added significantly to the age of our accounts receivable for these types of services. If these disputes are ultimately resolved against the Companys
positions, it will have a material adverse effect on the financial statements.

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



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##### Table of Contents

Allowance for Uncollectible Accounts

The Company has estimated uncollectible accounts expense of 1% of gross outpatient revenue. The Company normally makes no charge offs against allowance for collectible accounts, as historically all charge offs have
been against the contractual allowance.

Discontinued Operations

In fiscal 2006, the Company decided to sell the assets related to the Baton Rouge and West Houston Facilities, since those operations were not core to our long-term objectives, and are not performing consistently with
the expectations the Company had for them at the time the investments were made. The Company has also made the decision to sell its land in The Woodlands, Texas, since it no longer intends to build on that site. None of those assets is encumbered by
secured lien or debt, so all proceeds from the sale of any of those assets, net of selling expenses, would be available to pay down the existing revolving credit facility which is based on eligible accounts receivable, improve liquidity for the
Companys day-to-day operations, and invest in the Companys core business activities, including the DeAn Joint Venture.

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 the three months ended November 30, 2006 and 2005 is as follows:



|                                                       |  |      |            |   |      |   |            |  
|------------------------------------------------------ |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                                       |  | 2006 |            |   | 2005 |  
|Net patient service revenue                            |  | $    | 2,522,319  |   |      | $ | 2,299,326  |  
|Costs and expenses                                     |  |      | (2,864,016 | ) |      |   | (3,586,933 | )
|Other income                                           |  |      | 33,237     |   |      |   | 9,594      |  
|                                                       |  |      |            |   |      |   |            |  
|Loss before income taxes                               |  |      | (308,460   | ) |      |   | (1,278,013 | )
|Benefit for income taxes                               |  |      |           |   |      |   | 318,790    |  
|                                                       |  |      |            |   |      |   |            |  
|Loss from discontinued operations, net of income taxes |  | $    | (308,460   | ) |      | $ | (959,223   | )
|                                                       |  |      |            |   |      |   |            |  

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 1% to 10% at November 30, 2006).

Comprehensive Loss

Comprehensive loss for the three months ended November 30, 2006 and 2005 is as follows:



|                                                              |  |      |          |   |      |   |            |  
|------------------------------------------------------------- |  | ---- | -------- | - | ---- | - | ---------- | -
|                                                              |  | 2006 |          |   | 2005 |  
|Net loss                                                      |  | $    | (957,872 | ) |      | $ | (1,499,225 | )
|Foreign currency translation adjustment, net of taxes of $-0- |  |      | 67,266   |   |      |   |           |  
|                                                              |  |      |          |   |      |   |            |  
|Comprehensive loss                                            |  | $    | (890,606 | ) |      | $ | (1,499,225 | )
|                                                              |  |      |          |   |      |   |            |  

Contingencies

The Company maintains various insurance policies that cover each of its facilities. Specifically, the Company has claims-made malpractice coverage for its West Houston Facility and occurrence coverage for its Pasadena
and Garland Facilities. In Louisiana, the Company is a member of the Louisiana Patient Compensation Fund and purchases insurance through the Louisiana Patient Compensation Fund for medical malpractice. In addition, all physicians granted privileges
at the Companys facilities are required to maintain medical malpractice insurance coverage. The Company also maintains general liability and property insurance coverage for each facility, including



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flood coverage. The Company maintains workers compensation coverage for the Baton Rouge Facility, but 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.

In the second quarter of 2004, eight class action lawsuits were filed in the United States District
Court for the Southern District of Texas alleging federal securities law causes of action against the Company and various current and former officers and directors. The plaintiffs were persons who purchased shares of the Companys common stock
on the open market generally during the period of January 14, 2003 through December 18, 2003. Under the procedures of the Private Securities Litigation Reform Act, the Court consolidated the actions and appointed lead plaintiffs in the
matter. An amended complaint was filed on June 30, 2004, asserting a class period of November 27, 2002, through December 19, 2003 and naming additional defendants, including Ernst & Young, LLP, the Companys prior
auditors. The amended complaint sought certification as a class action and alleged that the defendants violated Sections 10(b), 20(a), 20(A), and Rule 10b-5 under the Exchange Act by publishing materially misleading financial statements that did not
comply with generally accepted accounting principles, making materially false or misleading statements or omissions regarding revenues and receivables, operations and financial results, and engaging in an intentional fraudulent scheme aimed at
inflating the value of Dynacqs stock. After the Company filed its Form 10-K for fiscal 2003 on July 30, 2004, the plaintiffs filed a Second Amended Consolidated Class Action Complaint on September 30, 2004. All defendants filed
motions to dismiss the complaint. The plaintiffs voluntarily dismissed two of the former officers from the case. The Court dismissed the claims against one former officer and Ernst & Young, LLP, but denied the motions to dismiss the Company
and two current officers who are defendants. In August 2006 the parties reached an agreement in principle to settle all claims in the action for the principal amount of $1.5 million, and, on October 10, 2006, the parties signed a Stipulation of
Settlement setting forth the terms of their proposed settlement of the action. The settlement provides for Dynacq to pay $100,000 (less amounts already paid by Dynacq for notice to class members) within 30 days of final approval of the settlement by
the Court and to issue a note for $1.4 million to be paid in 36 equal monthly installments beginning 30 days thereafter. The note shall bear interest at 6% per annum and be secured by a deed of trust on the Garland Facility. As a result of this
settlement, the Company recorded a $1.5 million charge to operations during 2006. The settlement contains provisions releasing the Company, its two executive officers named as defendants and its subsidiaries from liability and prohibiting the filing
of any future claims by the members of the class relating to this matter. Dynacq and its current and former officers and directors did not admit liability or fault for the matters alleged in the lawsuit. On October 18, 2006, the Court signed an
order preliminarily approving the settlement, preliminarily certifying the class, and approving the form and substance of the notice to class members. At a settlement hearing on January 10, 2007, the Court (a) approved the settlement as
fair, reasonable and adequate; (b) entered an Order of Final Judgment and Dismissal; and (c) entered an Order approving the plan of allocation and awarding fees and expenses to Plaintiffs counsel.

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 Revenue Recognition  Accounts
Receivable, as well as Business  Government Regulation  Texas and Louisiana Workers Compensation Systems and Managements Discussion and Analysis of Financial Condition and Results of Operations  Revenue Recognition
 Accounts Receivable in our Form 10-K for the fiscal year ended August 31, 2006, 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 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



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##### Table of Contents

Factors in our annual report on Form 10-K for the fiscal year ended August 31, 2006. 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, 2006.

Executive Summary

Assets Held for Sale and Discontinued Operations

In 2006, the Company decided to sell the assets
related to the Baton Rouge and West Houston Facilities, since those operations were not core to our long-term objectives and are not performing consistently with the expectations we had for them at the time we made the investment. The Company has
also made the decision to sell its land in The Woodlands, Texas, since it no longer intends to build on that site. None of those assets is encumbered by secured lien or debt, so all proceeds from the sale of any of those assets, net of selling
expenses, would be available to pay down the existing revolving credit facility which is based on eligible accounts receivable, improve liquidity for the Companys day-to-day operations, and invest in the Companys core business
activities, including the DeAn Joint Venture.

The Company has retained the services of a broker to locate buyers for the Baton Rouge
Facility and the land in The Woodlands, Texas. The Company is also currently negotiating with prospective buyers for the sale of the West Houston Facility.

Update on MDRs

Following the recent procedural changes implemented by the TDWC on September 1, 2005 regarding appeals
in the MDR process, the Company has sought judicial review of TDWCs decisions regarding reimbursement for inpatient and outpatient surgical services at both the administrative level at SOAH and at the district court level in the Travis County
District Courts. However, these procedural changes, coupled with the uncertainty created by the lack of an accepted interpretation of the stop-loss methodology, have prevented many, if not all, of the stop-loss cases at all levels of the MDR process
from moving forward. Recently, the current appeals process under the 2005 Texas Workers Compensation Act has been held unconstitutional by a Travis County District Court, and it is expected that the process will be reviewed and revised in the
current session of the Texas Legislature. The Court ruled, in part, that the current law fails to provide fundamental due process in the appeals process because there is no provision for an evidentiary hearing (SOAH) prior to the filing of claims
with the State District Court. This may further delay the final resolution of the MDR process since the Findings and Decisions issued by the TDWC after September 1, 2005 will have to go through the SOAH hearing before filing with the State
District Court.

In July of 2006, the en banc panel which presides over the Consolidated Stop-Loss Docket at SOAH and which consists of
nine administrative law judges, issued a schedule establishing deadlines for both the carriers and the providers to submit briefs regarding the stop-loss issue and for scheduling oral argument. The carriers and the providers submitted their
respective briefs, and on November 3, 2006 the en banc panel heard the arguments of both the carriers and providers, but has not yet issued a decision regarding the stop-loss issue. Inpatient stop-loss cases pending at SOAH and in the Travis
County District Courts are currently awaiting a decision by the en banc panel and final interpretation of the stop-loss methodology. The Travis County District Court has suggested that it will wait for a decision at SOAH regarding the stop-loss
issue.

The MDR process, as it relates to the Companys outpatient surgical services disputes, have been divided into four
consolidated dockets, one of which is in the beginning stages of an expedited discovery period, culminating in the scheduling of trial beginning February 5, 2007 for cases with dates of service from 2001-2002.

Net Patient Service Revenues

Net patient service
revenues increased $297,455, or 3%, from the first fiscal quarter of 2006, primarily as a result of marginal increase in the number of inpatient cases. Overall, there were 5, or 1%, fewer cases performed in the current fiscal quarter than in the
same quarter of the prior year. However, an increase of 6 inpatient cases, or 4%, over the same quarter of the prior year resulted in the increase in net patient service revenue.



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##### Table of Contents

Costs and Expenses

Costs and expenses increased $79,993, or 1%, primarily due to increased medical services and supplies expenses which was partially offset by a decline in compensation and benefits.

Accounts Receivable

Our accounts receivable are
larger and older than those of typical healthcare companies because of our pursuit of additional reimbursements through the MDR process. The MDR system changed significantly as of September 1, 2005. Please see Accounts Receivable in our Notes
to Consolidated Financial Statements, as well as Accounts Receivable in our Form 10-K for the fiscal year ended August 31, 2006 for a more complete discussion. The delays caused by the unexpected and extended reimbursement process have
increased our collection costs, including legal fees and expenses associated with collection and reimbursement activities.

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 November 30, 2006. 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, 2006.

Results of Operations



|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|------------------------------------------------------- |  | ------------------------------- | ---------- | - | ---------- | --- | -- | ---- | - | ---------- | ---------- |  | --- | --
|                                                        |  | Three months ended November 30, |           
|                                                        |  | 2006                            |            |   | Percentage |     |    | 2005 |   |            | Percentage | 
|Net patient service revenue                             |  | $                               | 9,971,245  |   |            | 100 | %  |      | $ | 9,673,790  |            |  | 100 | % 
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Costs and expenses:                                     |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Compensation and benefits                               |  |                                 | 2,804,056  |   |            | 28  |    |      |   | 2,969,888  |            |  | 31  |   
|Medical services and supplies                           |  |                                 | 2,228,875  |   |            | 22  |    |      |   | 1,822,600  |            |  | 19  |   
|Other operating expenses                                |  |                                 | 4,780,292  |   |            | 48  |    |      |   | 4,804,064  |            |  | 50  |   
|Provision for uncollectible accounts                    |  |                                 | 104,730    |   |            | 1   |    |      |   | 118,406    |            |  | 1   |   
|Loss on disposal of assets                              |  |                                 |           |   |            |    |    |      |   | 162,676    |            |  | 2   |   
|Depreciation and amortization                           |  |                                 | 653,529    |   |            | 7   |    |      |   | 613,855    |            |  | 6   |   
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Total costs and expenses                                |  |                                 | 10,571,482 |   |            | 106 |    |      |   | 10,491,489 |            |  | 108 |   
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Operating loss                                          |  |                                 | (600,237   | ) |            | (6  | )  |      |   | (817,699   | )          |  | (8  | ) 
|Other expense, net                                      |  |                                 | (74,525    | ) |            | (1  | )  |      |   | (33,512    | )          |  |    |   
|Minority interest in (earnings) loss                    |  |                                 | (19,894    | ) |            |    |    |      |   | 706        |            |  |    |   
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Loss before income taxes                                |  |                                 | (694,656   | ) |            | (7  | )  |      |   | (850,505   | )          |  | (9  | ) 
|Benefit for income taxes                                |  |                                 |           |   |            |    |    |      |   | 310,503    |            |  | 3   |   
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Loss from continuing operations                         |  |                                 | (694,656   | ) |            | (7  | )  |      |   | (540,002   | )          |  | (6  | ) 
|Loss from discontinued operations, net of income taxes  |  |                                 | (308,460   | ) |            | (3  | )  |      |   | (959,223   | )          |  | (10 | ) 
|Extraordinary gain, net of $-0- income tax expense      |  |                                 | 45,244     |   |            | 1   |    |      |   |           |            |  |    |   
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Net loss                                                |  | $                               | (957,872   | ) |            | (10 | )% |      | $ | (1,499,225 | )          |  | (15 | )%
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Operational statistics (Number of medical procedures) : |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Inpatient:                                              |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Bariatrics                                              |  |                                 | 51         |   |            |     |    |      |   | 59         |            |  |     |   
|Orthopedics                                             |  |                                 | 111        |   |            |     |    |      |   | 93         |            |  |     |   
|Other                                                   |  |                                 | 8          |   |            |     |    |      |   | 12         |            |  |     |   
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Total inpatient procedures                              |  |                                 | 170        |   |            |     |    |      |   | 164        |            |  |     |   
|Outpatient:                                             |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Orthopedics                                             |  |                                 | 113        |   |            |     |    |      |   | 102        |            |  |     |   
|Other                                                   |  |                                 | 401        |   |            |     |    |      |   | 423        |            |  |     |   
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Total outpatient procedures                             |  |                                 | 514        |   |            |     |    |      |   | 525        |            |  |     |   
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   
|Total procedures                                        |  |                                 | 684        |   |            |     |    |      |   | 689        |            |  |     |   
|                                                        |  |                                 |            |   |            |     |    |      |   |            |            |  |     |   



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Three Months Ended November 30, 2006 Compared to the Three Months Ended November 30, 2005

Net patient service revenue increased by $297,455, or 3%, from $9,673,790 to $9,971,245, and total surgical cases decreased by 1% from 689 cases to 684
cases for the quarters ended November 30, 2005 and 2006, respectively. Following are the percentage changes in net patient service revenues and number of cases at the hospital facilities:



|         |  |                                                  |  |      
|-------- |  | ------------------------------------------------ |  | -----
|         |  | Percentage increase/(decrease) from 2005 to 2006
|Facility |  | Net patient service revenue                      |  | Cases
|Pasadena |  | (26)%                                            |  | (10)%
|Garland  |  | 80                                               |  | 17   
|Overall  |  | 3                                                |  | (1)  

The net patient service revenue per case increased $538, or 4%, from $14,040 in 2005 to $14,578 in
2006. Although the number of cases at our facilities decreased 1%, the 4% increase in net patient service revenue per case was the result of a marginal increase in the number of inpatient cases that typically have a higher average reimbursement per
case.

The Company computes its contractual allowance based on the ratio of the Companys historical cash collections during the
trailing twelve months to gross billed revenue on a case-by-case basis by operating facility. In compliance with this revenue recognition policy, due to slower collections on the receivables associated with the workers compensation dispute
resolution process, the Companys contractual allowance as a percentage of gross patient revenue has increased from 59% in 2005 to 62% in 2006.

Total costs and expenses increased by $79,993, or 1%, from $10,491,489 in 2005 to $10,571,482 in 2006. The following discusses the various changes in costs and expenses:



| |  |  | Compensation and benefits decreased by $165,832, or 6%. The Company made a concerted effort to reduce employee costs and expenses even though the revenue increased by 3%.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Medical services and supplies expenses increased by $406,275, or 22%, while the number of surgery cases decreased 1%. However, medical services and supplies expenses, as a
percentage of gross revenues, is consistent in 2006 and 2005 at 8.59% and 8.26%, respectively.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Other operating expenses decreased by $23,772. Even though the net patient service revenue increased, the marginal decrease in other operating expenses is due to the continued
efforts made by the Company to reduce costs and expenses.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In 2005, the Company had incurred loss on disposal of assets of $162,676.
| | - |  | -------------------------------------------------------------------------

The income tax benefit of the net operating loss does not have the expected relationship to net loss due to the Companys utilization of operating loss carry backs in prior years and the uncertainty of
realization of operating loss carry forwards in future years.

The loss on discontinued operations represents the losses at our Baton Rouge
and West Houston Facilities. The combined net patient service revenues at these facilities increased $222,993, or 10%, from $2,299,326 in 2005 to $2,522,319 in 2006, and the total surgical cases also increased 10% from 320 cases in 2005 to 352 cases
in 2006. The net patient revenue per case decreased marginally by $19, from $7,185 in 2005 to $7,166 in 2006. Total costs and expenses of the discontinued operations decreased by $722,917, or 20%, from $3,586,933 in 2005 to $2,864,016 in 2006. In
2006, the Company made concerted efforts to reduce costs and expenses at these facilities which resulted in a decrease in other operating expenses by $251,802. In addition, the assets related to the discontinued operations had depreciation expense
of $398,527 in 2005.

The extraordinary gain in 2006 of $45,244, 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.



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Liquidity and Capital Resources

Our 2006 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 provided by operating activities was $1,059,255 (including $294,389 used in discontinued operations) during the period ended
November 30, 2006, primarily due to increases in accrued liabilities of $1,565,641, a decrease in restricted cash of $469,000, and depreciation and amortization of $653,529, partially offset by a net loss of $957,872 and decreases in accounts
payable of $1,019,954.

Cash flow from investing activities

Total cash flow used in investing activities was $329,504 primarily due to the purchase of accounts receivables.

Cash
flow from financing activities

Total cash flow used in financing activities was $1,293,513 during the current period. During the
quarter ended November 30, 2006, the Company paid down $1,136,005 under its Credit Agreement.

The Company had working capital of
$1,387,979 as of November 30, 2006, and maintained a liquid position by a current ratio of approximately 1.09 to 1.

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 November 30, 2006, the Company had drawn $5.2 million of approximately $6.3 million available to it under the
Credit Agreement based on its borrowing base at that date. The Companys obligations are 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. The real estate
holding subsidiaries of Dynacq are not borrowers under the Credit Agreement, and their real estate and equipment assets are not pledged to secure the obligations under such facility.

The Credit Agreement, among other things, requires that the Company maintain certain performance financial covenants, restricts its ability to incur
certain additional indebtedness, and contains various customary provisions, including affirmative and negative covenants, representations and warranties and events of default. Please refer to the Form 8-K filed on June 1, 2005 for further
reference and information.

As of January 10, 2007, the Company had an approximately $4.6 million cash balance. As of January 10,
2007, the Company had drawn approximately $994,000 in the second quarter of fiscal 2007, and had drawn the maximum $6.2 million available under the Credit Agreement, based on its borrowing base on that date. The availability of borrowings under our
Credit Agreement is subject to various conditions as mentioned above.

We believe we will be able to meet our ongoing liquidity and cash
needs for fiscal year 2007 through the combination of available cash, cash flow from operations, proceeds from sales of assets, and borrowings under our Credit Agreement. Our inability to generate sufficient cash flow from operations and borrowings
under our Credit Agreement to meet our cash needs may cause us to sell certain of our assets held for sale at a time, for a price or under conditions which would not have the optimum results for the Company. However, since none of those assets held
for sale is encumbered by secured lien or debt, all proceeds from the sale of any of those assets, net of selling expenses, would be available to meet our ongoing liquidity and cash needs.

Recent Accounting Pronouncements

In July 2006, the
Financial Accounting Standards Board (FASB) published FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN No. 48), which prescribes a consistent recognition threshold



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##### Table of Contents

and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and
provides related guidance on derecognition, classification, disclosure, interest, and penalties. FIN No. 48 will apply to fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact, if any, the adoption
of FIN No. 48 will have on its financial position and results of operations.

In September 2006, the FASB published Statement of
Financial Accounting Standard (SFAS) No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value
measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The Company is currently evaluating the impact, if any, the adoption of SFAS No. 157 will have on its financial position and results of operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Market risks relating to the
Companys operations result primarily from changes in interest rates as well as credit risk concentrations. Except for the capital contributions of approximately $4.3 million to date and the required future contribution of $4.4 million to the
DeAn Joint Venture, the majority of which are in local currency, all of the Companys contracts are denominated in US dollars and, therefore, the Company has no significant foreign currency risk.

Interest Rate Risk

The Company is exposed to market
risk from changes in interest rates on funded debt. The Company had drawn approximately $5.2 million as of November 30, 2006 from its five-year revolving credit facility. The balance owed under the facility as of January 10, 2007 was
approximately $6.2 million. Borrowings under the facility bear interest at variable rates based on the LIBOR rate plus 2.85%. Based on the amount outstanding, a 100 basis point change in the applicable interest rates would not have a material impact
on the Companys annual cash flow or income.

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

Credit Risks

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

Item 4. Controls and Procedures.

Internal control over financial reporting, no matter how well designed,
has inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness
of internal control over financial reporting may vary over time.

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 internal control over financial reporting as of November 30, 2006. Based on that evaluation, we believe that, as of
November 30, 2006, our internal control over financial reporting is effective.

Subsequent to the evaluation and through the date of
this filing of Form 10-Q for the fiscal quarter ending November 30, 2006, there have been no significant changes in our internal controls or in other factors that have materially affected, or are reasonably likely to materially affect, our
internal controls.



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##### Table of Contents

PART II - OTHER INFORMATION

Item 1. Legal Pr
oceedings.

In the second quarter of 2004, eight class action lawsuits were filed in the United States District
Court for the Southern District of Texas alleging federal securities law causes of action against the Company and various current and former officers and directors. The plaintiffs were persons who purchased shares of the Companys common stock
on the open market generally during the period of January 14, 2003 through December 18, 2003. Under the procedures of the Private Securities Litigation Reform Act, the Court consolidated the actions and appointed lead plaintiffs in the
matter. An amended complaint was filed on June 30, 2004, asserting a class period of November 27, 2002, through December 19, 2003 and naming additional defendants, including Ernst & Young, LLP, the Companys prior
auditors. The amended complaint sought certification as a class action and alleged that the defendants violated Sections 10(b), 20(a), 20(A), and Rule 10b-5 under the Exchange Act by publishing materially misleading financial statements that did not
comply with generally accepted accounting principles, making materially false or misleading statements or omissions regarding revenues and receivables, operations and financial results, and engaging in an intentional fraudulent scheme aimed at
inflating the value of Dynacqs stock. After the Company filed its Form 10-K for fiscal 2003 on July 30, 2004, the plaintiffs filed a Second Amended Consolidated Class Action Complaint on September 30, 2004. All defendants filed
motions to dismiss the complaint. The plaintiffs voluntarily dismissed two of the former officers from the case. The Court dismissed the claims against one former officer and Ernst & Young, LLP, but denied the motions to dismiss the Company
and two current officers who are defendants. In August 2006 the parties reached an agreement in principle to settle all claims in the action for the principal amount of $1.5 million, and, on October 10, 2006, the parties signed a Stipulation of
Settlement setting forth the terms of their proposed settlement of the action. The settlement provides for Dynacq to pay $100,000 (less amounts already paid by Dynacq for notice to class members) within 30 days of final approval of the settlement by
the Court and to issue a note for $1.4 million to be paid in 36 equal monthly installments beginning 30 days thereafter. The note shall bear interest at 6% per annum and be secured by a deed of trust on the Garland Facility. As a result of this
settlement, the Company recorded a $1.5 million charge to operations during 2006. The settlement contains provisions releasing the Company, its two executive officers named as defendants and its subsidiaries from liability and prohibiting the filing
of any future claims by the members of the class relating to this matter. Dynacq and its current and former officers and directors did not admit liability or fault for the matters alleged in the lawsuit. On October 18, 2006, the Court signed an
order preliminarily approving the settlement, preliminarily certifying the class, and approving the form and substance of the notice to class members. At a settlement hearing on January 10, 2007, the Court (a) approved the settlement as
fair, reasonable and adequate; (b) entered an Order of Final Judgment and Dismissal; and (c) entered an Order approving the plan of allocation and awarding fees and expenses to Plaintiffs counsel.

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 Revenue Recognition  Accounts
Receivable, as well as Business  Government Regulation  Texas and Louisiana Workers Compensation systems and Managements Discussion and Analysis of Financial Condition and Results of Operations  Revenue Recognition
 Accounts Receivable in our Form 10-K for the fiscal year ended August 31, 2006, 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.

There have been no material changes in the information pertaining to the
Companys Risk Factors as disclosed in its Form 10-K for the year ended August 31, 2006.

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

None.



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##### Table of Contents

Item 3. Defaults Upon Senior Securities.

None.

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

None.

Item 5. Other Information.

None.

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: January 12, 2007 |  | By:                     |  | /s/ Chiu M. Chan                                                    
|                       |  |                         |  | Chiu M. Chan                                                        
|                       |  |                         |  | Chief Executive Officer (duly authorized
officer)                   
|                       | 
|                       |  |                        
|Date: January 12, 2007 |  | By:                     |  | /s/ Philip S. Chan                                                  
|                       |  |                         |  | Philip S. Chan                                                      
|                       |  |                         |  | Chief Financial Officer (principal
financial and accounting officer)
|                       | 



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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.



22