Edgar Filing: PAINCARE HOLDINGS INC

Amendment #2

As filed with the Securities and Exchange Commission on May 4, 2007

Registration No. 333-135883

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

PRE EFFECTIVE

AMENDMENT NO. 2

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

PainCare Holdings, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Florida

8090

06-1110906

(State or Other Jurisdiction of

Incorporation or Organization)

(Primary Standard Industrial

Classification Code Number)

(I.R.S. Employer

Identification Number)

1030 N. Orange Avenue, Suite 105 Orlando, Florida 32801 (407) 367-0944

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

Mark Szporka PainCare Holdings, Inc.

1030 N. Orange Avenue, Suite 105 Orlando, Florida 32801 (407) 367-0944

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service)

Copies to:

Joel D. Mayersohn, Esq.

Clint J. Gage, Esq.

Arnstein & Lehr, LLP

200 E. Las Olas Blvd., Suite 1700

Fort Lauderdale, Florida 33301

(954) 713-7600

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. x

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

CALCULATION OF REGISTRATION FEE


Title Of Each Class Of Securities To Be Registered	Amount To Be Registered	Proposed Maximum Offering Price Per Share (1)			Proposed Maximum Aggregate Offering Price (1)		Amount Of Registration Fee
Common Stock	3,305,033	$	3.125	(2)	$	10,328,228	$	1,106
Common Stock	1,349,884	$	3.450	(3)	$	4,657,100	$	499
Common Stock	19,278,157	$	3.125	(2)	$	60,244,241	$	6,447
Total	23,933,074						$	8,052	(4)

(1)	Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(c) of the Securities Act of 1933.

(2)	Computed on the basis of the average of the high and low sales prices of the shares of common stock on The American Stock Exchange of $3.125 on February 23, 2006 as prescribed by Rule 457(c).

(3)

Computed on the basis of the higher of (i) the $3.45 exercise price of the warrants, and (ii) the average of the high and low sales prices of the shares of common stock on The American Stock Exchange of $3.125 on February 23, 2006 as prescribed by Rule 457(c). Represents shares of common stock issuable upon exercise of share purchase warrants.

(4)	The filing fee associated with these shares was previously paid with an earlier Registration Statement on Form S-3, filed with the Commission on March 1, 2006.

Pursuant to Rule 429 under the Securities Act, this Registration Statement contains a combined prospectus that also relates to 9,615,323 shares of Common Stock registered pursuant to the Registrant’s Registration Statement on Form S-3 (File No. 333-118868), 34,059,612 shares of Common Stock registered pursuant to the Registrant’s Registration Statement on Form S-3 (File No. 333-112355) and 5,701,188 shares of Common Stock registered pursuant to the Registrant’s Registration Statement on Form S-3 (File No. 333-115031). The Filing fee associated with these shares was previously paid with the earlier registration statements.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

Subject to Completion, dated May 4, 2007


PROSPECTUS		Issued , 2006

73,309,197 Shares

PainCare Holdings, Inc.

COMMON STOCK

The selling shareholders named in this prospectus are offering 73,309,197 shares of our common stock. We will not receive any proceeds from the sale of our common stock by the selling shareholders.

Our common stock is listed on The American Stock Exchange under the symbol “PRZ.” On May 2, 2007, the closing sale price of our common stock as reported by the AMEX was $.35 per share.

Investing in our common stock involves risks. See “ Risk Factors” beginning on page 4.

The U.S. Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

TABLE OF CONTENTS


		Page
Prospectus Summary		1
Risk Factors		4
Special Note Regarding Forward-Looking Statements and Industry Data		16
Use of Proceeds		16
Common Stock Price Range and Dividends		17
Selected Consolidated Financial Data		17
Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
What We Do		47
Management		67
Selling Shareholders		80
Certain Relationships and Related Party Transactions		92
Description of Capital Stock		92
Plan of Distribution		94
Legal Matters		95
Experts		95
Where You Can Find More Information		95
Index to Consolidated Financial Statements		F-1

No one is authorized to provide you with information that conflicts with information in the registration statement we have filed with the Securities and Exchange Commission. The selling shareholders are offering to sell, and seeking offers to buy, shares of our common stock only where those offers and sales are permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of when this prospectus is delivered or any sale of our common stock occurs.

Neither we nor the selling shareholders have taken any action to permit a public offering of the shares of our common stock outside the United States or to permit the possession or distribution of this prospectus outside the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the shares of our common stock and the distribution of this prospectus outside of the United States.

Except as the context otherwise requires, “PainCare,” the “Company,” “we,” “our” or “us” refer to PainCare Holdings, Inc. and its consolidated subsidiaries.

PROSPECTUS SUMMARY

About This Prospectus

This prospectus is a part of a registration statement on Form S-1 filed by us with the Securities and Exchange Commission to register shares of our common stock for sale solely by selling stockholders. This prospectus does not contain all of the information set forth in the registration statement, certain parts of which are omitted in accordance with the rules and regulations of the SEC. Accordingly, you should refer to the registration statement and its exhibits for further information about us and our common stock. Copies of the registration statement and its exhibits are on file with the SEC. Statements contained in this prospectus concerning the documents we have filed with the SEC are not intended to be comprehensive, and in each instance we refer you to copies of the actual documents filed as exhibits to the registration statement or otherwise filed with the SEC.

We have not authorized anyone to provide you with information different from that contained or incorporated by reference in this prospectus. The selling stockholders are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of common stock.

About PainCare

PainCare Holdings, Inc. (“the Company”) is a provider of pain-focused medical and surgical solutions. Through its proprietary network of acquired or managed physician practices and ambulatory surgery centers, and in partnership with independent physician practices and medical institutions throughout the United States and Canada, PainCare is committed to utilizing the most advanced science and technologies to diagnose and treat pain stemming from neurological and musculoskeletal conditions and disorders.

We are a health care services company focused on the treatment of pain. We currently own or manage 24 pain-focused physician practices offering such services as: pain management, minimally invasive spine surgery and ancillary services including; orthopedic rehabilitation, electrodiagnostic medicine, intra-articular joint injections and diagnostic imaging services. Our physicians are trained in specialties such as interventional pain management, orthopedics or physiatry, and utilize the latest medical technologies, clinical practices and equipment to offer cost-effective pain relief.

PainCare has defined four reportable segments: pain management, surgery, ancillary service and corporate and other. See the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Note 23” of “ Notes to Consolidated Financial Statements” in the consolidated financial statements, included herein, for financial information about these segments for the years ended December 31, 2006, 2005 and 2004.

We have grown our business through a combination of organic growth and acquisitions of complementary physician practices and outpatient surgery centers. To grow our physician practice revenue, our strategy is to acquire or enter into management agreements with profitable, well-established physician practices and expand the range of services they offer. For practices we have acquired, we survey the acquired practice and determine whether to expand the scope of services provided by the practice, including adding additional specialists such as physicians certified in pain management, neurosurgery, orthopedics or physiatry. By providing these additional services within the practice, we believe each practice can improve clinical outcomes, shorten treatment time and improve its profitability.

We also have relationships with physician practices that we do not own, but provide limited management services to, such as in-house physical therapy, electrodiagnostic services and intra-articular joint injection programs. With these additional resources, the physician practice itself is able to offer a broader range of services to its patient base.

It is estimated that 75-150 million people in the United States have a chronic pain disorder according to a 2005 publication by the American Pain Society and, according to MarketData Enterprises, 2.9 million of those suffering seek treatment by pain specialists. Another 76.5 million Americans reported suffering from acute pain that persisted for more than 24 hours in duration according to the American Pain Foundation in 2006. These studies found that the back was the source of the most pain. As the “baby boom” population ages, the number of people who will require treatment for pain from back disorders, degenerative joint diseases, rheumatologic conditions, visceral diseases and cancer is expected to continue to rise. It is estimated by the National Pain Foundation that the annual cost to Americans suffering pain is $500 billion each year.

The medical community’s awareness of the need for pain management has increased in recent years.Both the Joint Commission on Accreditation of Healthcare Organizations (JCAHO) and the Veterans Health Administration have adopted Pain as the 5th Vital Sign. This initiative mandates that pain be taken seriously and assessed adequately and treated in the majority of hospitals and clinics nationwide according to the National Pain Foundation. In 2001, JCAHO published standards that incorporated pain management into the standards for accredited health care providers. The JCAHO standards stress patients’ rights to appropriate assessment and management of pain, and require treatment of pain along with the underlying disease or disorder. As a result, we believe that pain management is growing in significance as a medical specialty as is the increased demand for pain treatment.

We have relationships with 59 physician practices and ambulatory surgery center locations. Through our subsidiaries, we operate three types of practice arrangements:

•

We employ licensed physicians in 12 practices which we own;

•

We have acquired the non-medical assets and we provide general management services to 19 physician practices;

•

We provide limited management services to 35 physician practices in areas such as in-house physical therapy, electrodiagnostic services and intra-articular joint injection programs.

In a typical wholly-owned practice, we acquire all of the assets of a physician practice from the owner physicians. We establish a wholly-owned subsidiary to own and operate this practice. We enter into employment agreements with the selling physicians, usually for a five year term, which provide for base compensation and incentive compensation based upon increases in operating earnings. These contracts are subject to earlier termination in certain circumstances. The physicians are subject to confidentiality and non-competition provisions that typically run for two years following the termination of the physician’s employment agreement.

In a typical managed practice, we acquire all of the non-medical assets of a physician practice from the owner physicians and then enter into a management agreement with the physicians to manage the practice for a fee. The management agreement is usually for a 40 year term and is generally only subject to termination by the physician if we breach the agreement and fail to cure the breach upon at least 30 days’ written notice from the physicians.

In a typical limited management practice, we agree to provide a physician practice with orthopedic rehabilitation or electrodiagnostic services and equipment under a management agreement that is usually for an initial term of five years with two five year renewal options on our part. We provide the equipment, supplies and our management expertise, and the practice provides the space, personnel, billing and collection services. We receive a percentage of the practice’s collections from the service being managed by us.

We are now in the rollout phase of our latest business initiative centered on effecting a new industry paradigm in the delivery of state-of-the-art, pain-focused, medical care and payor administration. Through our new wholly-owned subsidiary, Integrated Pain Solutions (IPS), we plan to leverage our centralized and specialized knowledge base of advanced pain diagnostics, interventional pain management and functional restoration procedures and solutions. IPS is developing, administering and tracking the outcome of proprietary, evidence-based, clinical pathways for the management of acute or chronic pain. This clinical criteria will serve as the basis of the delivery of quality care by highly credentialed, multi-disciplined provider networks contracted and managed by IPS in select U.S. markets.

Business Strategy

Our objective is to become the leading provider of specialty pain care services in North America. To grow our practices, we intend to:

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Focus on pain treatment. All of our operations to date have been specifically focused in the area of pain treatment. We intend to continue to focus on the treatment of pain through acquisition, management, and the provision of services to practices that serve the pain treatment market.

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Deploy additional services to grow physician practices. We intend to enhance the capacity of our practices for organic growth by increasing the range of services offered by our practices. By deploying additional physicians and equipment, we can perform in-house those necessary procedures and services that would ordinarily be referred to other providers, which we believe can result in higher quality care and increased revenues to our practices.

•

Utilize advanced medical technologies. Many of our physicians are thought leaders in their respective fields and employ the latest clinical techniques and medical technologies for the treatment of pain. We intend to support the use of new technology in pain treatment through the deployment of additional specialized physicians who are familiar with these techniques and technologies and by providing the latest, state-of-the- art equipment. For example, we deploy MedX rehabilitation equipment to orthopedic rehabilitation facilities, which has demonstrated the ability to improve patient outcomes.

•

Adopt a more hands-on approach. We intend to focus on the management and organic growth of our existing national network of pain practices to provide pain management services in a cost efficient manner aimed at maximizing stockholder value.

As part of our growth strategy, we intend to continue to evaluate our acquisition program to target profitable acquisitions that are parallel to our core business and have the capacity for growth through the addition of specialized physicians and ancillary services.

Given the current status of liquidity, acquisitions in the near term will be made on a highly selective basis and meet parameters acceptable to our lenders.

While historical growth has primarily come from the acquisition of physician practices and the organic growth from those practices previously described, future growth is expected to come from Integrated Pain Solutions (“IPS”).

Our objective is to become the pre-eminent utilization management service provider for patients requiring pain-related treatment. To facilitate growth we intend to:

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Offer a “patient centered” network as part of its menu. Other menu items include individualized guidance, algorithm-based case management, care coaching and evidence based and outcome driven pain management.

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Build programs that balance patient medical conditions with health plan parameters. These programs will include case management, care coaching, quality improvement and physician education.

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Benefit providers by using an algorithm based triage system and accumulate all patient provider and encounter information in a centralized data warehouse. This data will subsequently be biostatistically analyized to determine clinical efficiency leading to the most effective treatment pathways.

Our Executive Offices

Our principal executive offices are located at 1030 North Orange Avenue, Suite 105, Orlando, Florida 32801, and our telephone number is (407) 367-0944. Our website is located at www.paincareholdings.com. Our website address is included as an inactive textual reference only.

Risks of Investing in PainCare

Our business involves various risks, including, but not limited to, the acquisition of businesses or the launch of new lines of business, which could increase operating expenses and dilute operating margins; the inability to attract new patients by our owned practices, the managed practices, and the limited management practices; increased competition, which could lead to negative pressure on our pricing and the need for increased marketing; the inability to maintain, establish, or renew relationships with physician practices, whether due to competition or other factors; the inability to comply with regulatory requirements governing our owned practices, the managed practices, and the limited management practices; that projected operating efficiencies will not be achieved due to implementation difficulties or contractual spending commitments that cannot be reduced; and to the general risks associated with our businesses. You should carefully consider the risks discussed in “Risk Factors” before deciding to invest in our common stock.


The Offering

Common Stock offered by selling stockholders:		73,309,197 shares

Common Stock outstanding immediately after this offering:		66,849,164 shares

Use of proceeds:		We will not receive any proceeds from the sale of shares in this offering, other than the exercise price payable to us upon the exercise of warrants held by certain of the selling stockholders. We intend to use any such proceeds for general working capital.

American Stock Exchange symbol:		PRZ

The total number of shares of common stock that will be outstanding after this offering is based on 66,849,164 shares outstanding as of May 2, 2007, and excludes:

•

11,403,867 shares of common stock issuable upon the exercise of options and warrants outstanding at May 2, 2007 at a weighted average exercise price of $2.05 per share; and

•

7,081,663 shares of common stock reserved for future issuance upon conversion of convertible debentures; and

•

7,648,677 shares of common stock reserved for future issuance under the earn-out provisions of various acquisition agreements.

RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information contained in this prospectus, before deciding to buy our common stock. Any of the risks we describe below could adversely affect our business, financial condition or operating results. The market price of our common stock could decline if one or more of these risks and uncertainties develop into actual events. You could lose all or part of your investment.

Risks Related to Our Business

The Company’s ability to continue as a going concern is dependent on the execution of our restructuring plan

BKHM, P.A., our independent registered public accounting firm, has included an explanatory paragraph in its report on our financial statements for the fiscal year ended December 31, 2006, which expresses substantial doubt about our ability to continue as a going concern due to the defaults on our HBK and CPMASC promissory notes and convertible debentures. The inclusion of a going concern explanatory paragraph in BKHM, P.A.’s report on our financial statements could have a detrimental effect on our stock price and our ability to raise additional capital.

Our financial statements have been prepared on the basis of a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We have not made any adjustments to the financial statements as a result of the outcome of the uncertainty described above. Accordingly, the value of the Company in liquidation may be different from the amounts set forth in our financial statements.

Our continued success will depend on our ability to continue to raise capital in order to fund the development and commercialization of our products. Failure to raise additional capital may result in substantial adverse circumstances, including delisting of our common stock shares from the American Stock Exchange, which could substantially decrease the liquidity and value of such shares, or ultimately result in our liquidation.

The Company plans to sell three surgery centers to raise funds for the purpose of restructuring our debt obligations. The proceeds would be used to either pay in full or a substantial portion of the $27.8 million of debt with HBK Investments, L.P. Also, the funds would be used to pay the amount due under the promissory note to the original sellers of the Center for Pain Management Ambulatory Surgery Center (CPMASC) of approximately $7.8 million.

The objective is to substantially reduce the debt outstanding by using the proceeds of the sale of the surgery center division. There may be an additional amount raised through the issuance of common stock or convertible debentures. These proceeds would primarily be used for working capital needs. The Company would have a significantly reduced debt load if the plan is executed.

The Company’s working capital needs for 2007 are primarily for contingent cash payments of up to $6.5 million for the acquisitions as the earnings requirements are met. The Company received a $1 million tax refund and expects to receive an additional $3 million during the third or fourth quarter of 2007. The refund will be used for working capital needs.

Restatement of consolidated financial statements.

On January 11, 2007 we received notification from the U.S. Securities and Exchange Commission that there was no further comment on the restatement of our Form 10-K filings for December 31, 2005 and December 31, 2004. Prior to the completion of the SEC’s review of our filings, we received comments from the SEC staff regarding our method of accounting for (i) certain term notes, freestanding and embedded derivatives, and (ii) intangible assets acquired in connection with physician

practice and surgery center acquisitions. In connection with the SEC review, we restated our consolidated financial statements for the years ended December 31, 2000, December 31, 2001, December 31, 2002, December 31, 2003, December 31, 2004 and the quarters ended March 31, 2005, June 30, 2005 and September 30, 2005. We also restated the quarters ended March 31, 2006, June 30, 2006 and September 30, 2006 for our accounting of the initial adoption of FAS 123R, Share-Based Payment.

A number of class action lawsuits have been filed against us and certain of our officers and directors.

We have become aware of eleven putative class action lawsuits and one derivative action filed against us and certain of our officers and directors. The lawsuits arose in connection with our determination to restate certain of our historical financial statements. We believe that the lawsuits lack merit and we have engaged the international law firm of McDermott Will & Emery LLP to vigorously defend against such allegations and claims. There can be no assurance at this time how the lawsuits in question will ultimately be resolved, or the impact, if any, such resolutions will have on our operations and/or financial condition.

We have received a notice of default from our lenders.

On May 2, 2006, June 20, 2006, August 9, 2006, and November 8, 2006, we entered into letter agreements (the “Waiver Letters”) with HBK Investments L.P. (the “Agent”), HBK Master Fund L.P., (“HBK-MF”) and Del Mar Master Fund Ltd. (“Del Mar,” and together with HBK-MF the “Lenders”) pursuant to which the Agent and the Lenders waived certain of our breaches of the terms of the loan and security agreement entered into by the parties on May 11, 2005, as amended (the “Loan Agreement”). In consideration of the entry by the Agent and the Lenders into the Waiver Letters, we paid fees to the Lenders in the amount of $300,000, $150,000, $100,000 and $150,000, respectively.

The August 9, 2006, Waiver Letter required us to cause the financial covenants in Section 7.18 of the Loan Agreement to be amended on or before October 15, 2006, in a manner satisfactory to the Agent and the Lenders. On October 13, 2006, we entered into a letter agreement with the Agent and the Lenders extending the October 15, 2006 deadline until November 15, 2006. On November 8, 2006, we entered into a letter agreement with the Agent and the Lenders extending the November 15, 2006 deadline until December 1, 2006.

On January 1, 2007, we entered into a Forbearance Agreement (the “Forbearance Agreement”) with the Agent and the Lenders pursuant to which the Agent and the Lenders agreed to forbear, until a date not later than March 31, 2007, from exercising their rights and remedies under the Loan Agreement with respect to certain specified events of default under the Loan Agreement that had either occurred or that were thought to likely occur during the forbearance period. In consideration for the forbearance, we agreed to certain additional covenants and to pay fees in the amount of (i) $277,500 at closing, plus, (ii) upon the repayment in full of our obligations under the Loan Agreement (the “Obligations”), an amount equal to the greater of (i) $500,000, and (ii) $277,500 for each month (or portion thereof) that has elapsed after the date of the Forbearance Agreement before the Obligations have been repaid in full.

Since our entry into the Forbearance Agreement we have failed to comply with certain covenants set forth in the Forbearance Agreement, and may have additionally violated certain terms and provisions set forth in the Loan Agreement. On March 21, 2007, we received a Notice of Default from the Agent setting forth certain alleged events of default by us under the Loan Agreement, including, but not limited to, a failure by us to make certain required payments. The Notice of Default further provides (i) the default rate of interest as set forth in the Loan Agreement is in effect until such time as all such alleged events of default have either been cured or waived in writing, and (ii) the Agent and Lenders expressly reserve all of their remedies, powers, rights, and privileges under the Loan Agreement, at law, in equity, or otherwise including, without limitation, the right to declare all obligations under the Loan Agreement immediately due and payable. Should the Agent take additional actions to enforce its rights under the Loan Agreement our business and operations could be materially adversely affected. We have entered into a standstill agreement with HBK which expires on May 7, 2007. We are actively engaged in negotiations with HBK in an effort to resolve the outstanding disputes between us.

On March 15, 2007, we received a notice of breach and default (the “CPM Notice”) from The Center for Pain Management, LLC (“CPM”) with respect to that certain Asset Acquisition Agreement dated December 1, 2004 (the “APA”) entered into by us, PainCare Acquisition Company XV, Inc. (the “Subsidiary”), CPM, and the owners of CPM (the “Members”).

(the “Pledge Agreement”) entered into by us and the Members, including, but not limited to, the right to foreclose on the issued and outstanding shares of stock of the Subsidiary. Any actions by CPM or the Members to enforce their rights under the APA and Pledge Agreement may trigger certain defaults under our senior credit facility with HBK, which could materially adversely affect our business and operations. We have entered into a standstill agreement with CPM and the Members which expires on May 7, 2007. We are actively engaged in negotiations with CPM and the Members in an effort to resolve the outstanding disputes between us.

Pursuant to the terms of the agreements under which we acquired certain of our practices we may be required to make payments in the amount of approximately $3.7 million within the first six months of 2007. Further, our convertible debentures and our secured convertible term notes contain certain provisions and restrictions, which if violated, could result in the full principal amount, $13,455,160 as of December 31, 2006, together with interest and other amounts, becoming immediately due and payable in cash. In addition, there can be no assurance that the lenders under our senior secured credit facility will not exercise certain rights they may have thereunder that might result in us having to make substantial payments to them to induce them to enter into additional forbearance agreements.

We need to continue to improve and implement our controls and procedures.

Requirements adopted by the SEC in response to the passage of the Sarbanes-Oxley Act of 2002 require us to (i) evaluate and report on a quarterly basis the effectiveness of our disclosure controls and procedures, and (ii) assess and report on an annual basis the effectiveness of our internal controls over financial reporting. During our assessment with respect to the effectiveness of the foregoing controls as of December 31, 2006, the end of our most recent fiscal year, management identified a number of material weaknesses, which are fully disclosed in Item 9A in this Form 10-K. As a result of the material weaknesses, management concluded that our disclosure controls and procedures and our internal controls over financial reporting as of December 31, 2006, the end of our most recent fiscal year, were not effective. In an effort to rectify the foregoing material weaknesses, we have modified our method of accounting for certain transactions and have implemented additional controls. In so doing, we restated our consolidated financial statements for the years ended December 31, 2000, December 31, 2001, December 31, 2002, December 31, 2003, December 31, 2004 and the quarters ended March 31, 2005, June 30, 2005, September 30, 2005, March 31, 2006, June 30, 2006 and September 30, 2006.

We continue to evaluate our disclosure controls and procedures and our internal controls over financial reporting, and may modify, enhance or supplement them as appropriate in the future. There can be no assurance that we will be able to maintain compliance with all of the SEC control requirements. Any modifications, enhancements or supplements to our controls systems could be costly to prepare or implement, divert the attention of our management from operating our business, and cause our operating expenses to increase over the ensuing year. Further, our stock price may be adversely affected by the current, or any future, determination that our disclosure controls and procedures and/or internal controls over financial reporting were not effective.

If we are unable to complete the disposition of our interests in our ambulatory surgery centers and/or enter into one or more financing transactions, we may not have enough cash to fund our operations.

While we are currently in the process of divesting our interests in our ambulatory surgery centers and are actively negotiating with a number of institutional investors over potential financings, there can be no guarantee that we will be able to effectuate either on terms we deem suitable. To the extent we are able to obtain financing and/or divest our interests in the ambulatory surgery centers we anticipate using a substantial percentage of the proceeds therefrom to reduce our debt obligations and satisfy our payment obligations to our acquired practices. Any financing transaction in which we enter will likely result in a significant ownership dilution to our existing stockholders, on a fully diluted basis, as a result of the current market price for our common stock.

In the event we are unable to accomplish either the divestiture of our ambulatory surgery centers or the closing of additional rounds of financing, we may not have sufficient cash to fund our operations in the short term.

The success of our growth strategy depends on the successful identification, completion and integration of acquisitions.

We have acquired or entered into general management agreements with 21 physician practices and nine ambulatory surgery centers since 2002 and we intend to pursue additional acquisitions and management relationships. Our future success will depend on our ability to identify and complete acquisitions as well as integrate the acquired businesses with our existing operations.

More recently, we have developed managed care initiatives through provisions of utilization management, case management, care coaching, and a provider network. There are inherent risks associated with expanding our product services line such as the inability to contract with physicians at a reduced treatment rate for each regional area as well as having the ability to convince insurance providers to reduce the rate of co-payment. . We are entering into a new paradigm of managed care which will require additional demands on our infrastructure in order to become a key competitor within this facet of the health care industry.

Our growth strategy will result in significant additional demands on our infrastructure, and will place a significant strain on our management, administrative, operational, financial and technical resources, and increase demands on our systems and controls. Our growth strategy involves numerous risks, including, but not limited to:

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the possibility that we are not able to identify suitable acquisition candidates or consummate acquisitions on acceptable terms;

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possible decreases in capital resources or dilution to existing stockholders;

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difficulties and expenses incurred in connection with an acquisition;

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the difficulties of operating an acquired business;

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the diversion of management’s attention from other business concerns;

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a limited ability to predict future operating results of acquired practices; and

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the potential loss of key physicians, employees and patients of an acquired practice.

In the event that the operations of an acquired practice do not meet expectations, we may be required to restructure the acquired practice or write-off the value of some or all of the assets of the acquired practice. We cannot assure you that any acquisition will be successfully integrated into our operations or will have the intended financial or strategic results.

In addition, acquisitions entail an inherent risk that we could become subject to contingent or other liabilities in connection with the acquisitions, including liabilities arising from events or conduct pre-dating our acquisition and that were not known to us at the time of acquisition. Although we conduct due diligence in connection with each of our acquisitions, this does not mean that we will necessarily identify all potential problems or issues in connection with any given acquisition, some of which could be significant.

Our failure to successfully identify and complete future acquisitions or to integrate and successfully manage completed acquisitions could have a material adverse effect on our business, financial condition and results of operations.

Our growth strategy may not prove viable and expected growth and value may not be realized.

Our strategy is to rapidly grow by acquiring, establishing and managing a network of pain management, minimally invasive spine surgery and orthopedic rehabilitation centers. Identifying appropriate physician groups and proposing, negotiating and implementing economically attractive affiliations with them can be a lengthy, complex and costly process. There can be no assurance that we will be successful in identifying and establishing relationships with orthopedic surgery and pain management groups. If we are successful in implementing our strategy of rapid growth, such growth may impair our ability to efficiently provide non-professional support services, facilities, equipment, non-professional personnel, supplies and non-professional support staff to medical practices. Our future financial results could be materially adversely affected if we are unable to manage growth effectively.

There can be no assurance that physicians, medical providers or the medical community in general will accept our business strategy and adopt the strategy offered by us. The extent to which, and rate at which, these services achieve market acceptance and penetration will depend on many variables including, but not limited to, the establishment and demonstration in the medical community of the clinical safety, efficacy and cost-effectiveness of these services, the advantage of these services over existing technology, and third-party reimbursement practices. There can be no assurance that the medical community and third-party payors will accept our technology. Similar risks will confront any other services developed by us in the future. Failure of our services to gain market acceptance would have a material adverse effect on our business, financial condition, and results of operations.

Integrated Pain Solutions is the nation’s first and foremost pain-focused managed services organization. Our services address the entire continuum of care for persons with acute and chronic pain conditions by offering a comprehensive, integrated array of products. There can be no assurance that the products we offer to pain suffering patients will prove to be a viable source to their healthcare needs. There can be no assurance that the medical community and third-party payors will accept our business strategy.

Our operations have not been profitable in recent periods.

For the years ended December 31, 2006, 2005 and 2004, net loss was $(26,482,506), $(5,339,378) and $(1,501,482), respectively. There is potential of this trend to continue into the future as the Company reduces its emphasis on acquisitions, divests interest in its ambulatory surgery centers, and focuses its efforts on organic growth and the IPS initiative.

A significant portion of our assets consists of goodwill and other intangible assets and any impairment, reduction, or elimination of these intangible assets could hurt our results of continuing operations.

As of December 31, 2006, we had other intangible assets and net goodwill for continuing operations, of approximately $90.6 million, which constituted 55.4% of our total consolidated assets. The net goodwill reflects the amount we pay for our acquired practices in excess of the fair value of other identifiable intangible and tangible assets. Our net goodwill will increase in the future as a result of our acquisitions as we pay the contingent purchase price for the acquisitions according to the terms of the respective purchase agreements. In addition, we expect to acquire additional goodwill in connection with future acquisitions. As prescribed by generally accepted accounting principles, we do not amortize goodwill; rather it is carried on our balance sheet until it is impaired. Although goodwill is not amortized, the other intangible asset, which is the physician referral network, is amortized over seven years. In addition, both goodwill and other intangibles are tested annually for impairment. Any determination of impairment could require a significant reduction, or the elimination, of goodwill, which could hurt our results of operations. Such impairment charges were identified and recorded in 2006 in the total amount of $34.0 million. Also, the effect of a prolonged downturn in our business will be exacerbated by the impairment, and resulting write-down, of goodwill related to a reduction in the value of our acquired practices.

Our cash flow and financial condition may be adversely affected by the assumption of credit risks.

Our managed and limited management practices bill their patients’ insurance carriers for services provided by the practices. By undertaking the responsibility for patient billing and collection activities, the practices assume the credit risk presented by the patient base, as well as the risk of payment delays attendant to reimbursement through governmental programs or third-party payors. If our practices are unsuccessful in collecting a substantial amount of such fees, it will have a material adverse affect on our financial condition because our compensation from these practices is dependent on the practices’ collections. During the second half of 2006, we performed an analysis of our historical cash collections and adjusted the current collection percentages on several practices. This resulted in a $4.2 million write off of net receivables.

We rely on the services of our physicians. We may not be able to attract and retain qualified physicians we need to support our business.

Our operations are substantially dependent on the services of our practices’ physicians. With respect to our owned practices, we have employment agreements with our physicians that generally have terms of five years, but may be terminated by either party in certain circumstances. Our management agreements with our managed practices generally have a 40 year term, while our agreements with limited management practices have a five year term with options for two additional five year renewal terms which are exercisable at our election. These agreements may be earlier terminated under certain circumstances. Although we will endeavor to maintain and renew such contracts, in the event a significant number of physicians terminate their relationships with us, our business could be adversely affected. While our employment and management agreements contain covenants not to compete with us for a period of generally two years after termination of employment, these provisions may not be enforceable.

We compete with many types of health care providers and government institutions for the services of qualified physicians. If we are unable to attract and retain physicians, our revenues will decrease and our business will suffer.

If certain key employees were to leave, we may be unable to operate our business profitably, complete existing projects or undertake certain new projects.

Our key employees and consultants include Merrill Reuter, M.D., Randy Lubinsky, Mark Szporka, and Ron Riewold. We have entered into employment agreements with Randy Lubinsky (Chief Executive Officer and Director), Ron Riewold (President and Director), Mark Szporka (Chief Financial Officer and Director), and Dr. Merrill Reuter (President of one of our subsidiaries and Chairman of the Board). Should the services of Dr. Reuter, Randy Lubinsky, Ron Riewold, or Mark Szporka or other key personnel become unavailable to us for any reason, our business could be adversely affected. There is no assurance that we will be able to retain these key individuals and/or attract new employees of the caliber needed to achieve our objectives. We do not maintain any key employee life insurance policies.

Our employment agreements with certain senior executive officers entitle them to individual annual bonuses equal to a minimum of $200,000 up to a maximum of 150% of salary.

Our employment agreements with our Chief Executive Officer, Chief Financial Officer and President, which expire on December 31, 2010, and were amended effective January 1, 2006, entitle each officer to a minimum annual bonus of $200,000 up to a maximum of 150% of their base salary in any one calendar year.

Increased costs associated with corporate governance compliance may significantly affect our results of operations.

The Sarbanes-Oxley Act of 2002 and our being subject to the Securities Exchange Act of 1934, as amended, requires changes in some of our corporate governance and securities disclosure and compliance practices, and requires a review of our internal control procedures. We expect these developments to increase our legal compliance and financial reporting costs. In addition, they could make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers. Finally, director and officer liability insurance for public companies has become more difficult and more expensive to obtain, and we may be required to accept reduced coverage or incur higher costs to obtain coverage that is satisfactory to us and our officers or directors. We are presently evaluating and monitoring regulatory developments and cannot estimate the timing or magnitude or additional costs we may incur as a result.

Changes associated with reimbursement by third-party payors for our services may adversely affect our operating results and financial condition

Our revenues are directly dependent on the acceptance of the services provided by our managed practices and limited management practices as covered benefits under third-party payor programs, including PPOs, HMOs and other managed care entities. The health care industry is undergoing significant changes, with third-party payors taking measures to reduce reimbursement rates or, in some cases, denying reimbursement for previously acceptable treatment modalities. There is no assurance that third-party payors will continue to pay for the services provided by our owned practices under their payor programs or by the managed practices. Failure of third-party payors to adequately cover minimally invasive surgery or other services will have a material adverse effect on us.

Professional liability claims could adversely impact our business.

Our managed practices are involved in the delivery of health care services to the public and are exposed to the risk of professional liability claims. Claims of this nature, if successful, could result in damage awards to the claimants in excess of the limits of any applicable insurance coverage. Insurance against losses related to claims of this type can be expensive and varies widely from state to state. There can be no assurance that our owned and managed practices will not be subject to such claims, that any claim will be successfully defended or, if our practices are found liable, that the claim will not exceed the limits of our insurance. Liabilities in excess of our insurance could have a material adverse effect on us.

Our business is subject to substantial competition which could have a material impact on our business and financial condition.

The health care industry, in general, and the markets for orthopedic, rehabilitation and minimally invasive surgery services in particular, are highly competitive. The practices we own or manage compete with other physicians and rehabilitation clinics who may be better established or have greater recognition in a particular community than the physicians in these practices. These practices also compete against hospitals and large health care companies, such as HealthSouth, Inc. and U.S. Physical Therapy, Inc., with respect to orthopedic and rehabilitation services, and Symbion and AmSurg Corp, with respect to outpatient

surgery centers. These hospitals and companies have established operating histories and greater financial resources than us. In addition, we expect competition to increase, particularly in the market for rehabilitation services, as consolidation of the physical therapy industry continues through the acquisition by hospitals and large health care companies of physician-owned and other privately owned physical therapy practices. We will also compete with our competitors in connection with acquisition opportunities.

Failure to obtain managed care contracts and legislative changes could adversely affect our business.

There can be no assurance that our owned or managed practices will be able to obtain managed care contracts. These practices’ future inability to obtain managed care contracts in their markets could have a material adverse effect on our business, financial condition or results of operation. In addition, federal and state legislative proposals have been introduced that could substantially increase the number of Medicare and Medicaid recipients enrolled in HMOs and other managed care plans. We derive, through these practices, a substantial portion of our revenue from Medicare and Medicaid. In the event such proposals are adopted, there can be no assurance that these practices will be able to obtain contracts from HMOs and other managed care plans serving Medicare and Medicaid enrollees. Failure to obtain such contracts could have a material adverse effect on the business, financial condition and results of operations. Even if our practices are able to enter into managed care contracts, the terms of such agreements may not be favorable to us.

Risks Related to Our Industry

The health care industry is highly regulated and our failure to comply with laws and regulations applicable to us or the owned practices, and the failure of the managed practices and the limited management practices to comply with laws and regulations applicable to them, could have an adverse effect on our financial condition and results of operations.

Our owned practices, the managed practices and the limited management practices are subject to stringent federal, state and local government health care laws and regulations. If we or they fail to comply with applicable laws, or if a determination is made that in the past we or the managed practices or the limited management practices have failed to comply with these laws, we may be subject to civil or criminal penalties, including the loss of our license or our physicians’ licenses to operate and our ability to participate in Medicare, Medicaid and other government sponsored and third-party health care programs. In addition, laws and regulations are constantly changing and may impose additional requirements. These changes could have the effect of impeding our ability to continue to do business or reduce our opportunities to continue to grow.

Periodic revisions to laws and regulations may reduce the revenues generated by the owned practices, managed practices and the limited management practices.

A significant amount of the revenues generated by our owned practices, the managed practices and the limited management practices is derived from governmental payors. These governmental payors have taken and may continue to take steps designed to reduce the cost of medical care. Private payors often follow the lead of governmental payors, and private payors have been taking steps to reduce the cost to them of medical care. A change in the makeup of the patient mix that results in a decrease in patients covered by private insurance or a shift by private payors to other payment structures could also adversely affect our business, financial condition and results of operations. If reductions in reimbursement occur, the revenues generated by the owned practices, the managed practices and the limited management practices could shrink. This shrinkage would cause a reduction in our revenues. Accordingly, our business could be adversely affected by reductions in or limitations on reimbursement amounts for medical services rendered, payor mix changes or shifts by payors to different payment structures.

Because government-sponsored payors generally pay providers based on a fee schedule, and the trend is for private payors to do the same, we may not be able to prevent a decrease in our revenues by increasing the amounts the owned practices charge for services. The same applies to the limited management practices and the managed practices. They cannot increase their charges in an attempt to counteract reductions in reimbursement for services. There can be no assurance that any reduced operating margins could be recouped through cost reductions, increased volume, and introduction of additional procedures or otherwise. We believe that trends in cost containment in the health care industry will continue to result in reductions from historical levels of per-patient revenue.

Federal and state healthcare reform may have an adverse effect on our financial condition and results of operations.

Federal and state governments have continued to focus significant attention on health care reform. A broad range of health care reform measures have been introduced in Congress and in state legislatures. It is not clear at this time what proposals, if any, will be adopted, or, if adopted, what effect, if any, such proposals would have on our business. Currently proposed federal and state legislation could have an adverse effect on our business.

Our affiliated physicians may not appropriately record or document services they provide.

Our affiliated physicians are responsible for assigning reimbursement codes and maintaining sufficient supporting documentation for the services they provide. The owned practices, managed practices and limited management practices use this information to seek reimbursement for their services from third-party payors. If these physicians do not appropriately code or document their services, our financial condition and results of operations could be adversely affected.

Unfavorable changes or conditions could occur in the geographic areas where our operations are concentrated.

A majority of our revenue in 2006 was generated by our operations in five states. Adverse changes or conditions affecting these particular markets, such as health care reforms, changes in laws and regulations, reduced Medicaid reimbursements and government investigations, may have a material adverse effect on our financial condition and results of operations.

Regulatory authorities could assert that the owned practices, the managed practices or the limited management practices fail to comply with the federal Stark Law. If such a claim were successfully asserted, this would result in the inability of these practices to bill for services rendered, which would have an adverse effect on our financial condition and results of operations. In addition, we could be required to restructure or terminate our arrangements with these practices. This result, or our inability to successfully restructure the arrangements to comply with the Stark Law, could jeopardize our business.

Section 1877 of Title 18 of the Social Security Act, commonly referred to as the “Stark Law”, prohibits a physician from making a referral to an entity for the furnishing of Medicare-covered “designated health services” if the physician (or an immediate family member of the physician) has a “financial relationship” with that entity. “Designated health services” include clinical laboratory services; physical and occupational therapy services; radiology services, including magnetic resonance imaging, computerized axial tomography scans, and ultrasound services (including the professional component of such diagnostic testing, but excluding procedures where the imaging modality is used to guide a needle, probe or catheter accurately); radiation therapy services and supplies; durable medical equipment and supplies; home health services; inpatient and outpatient hospital services; and others. A “financial relationship” is defined as an ownership or investment interest in or a compensation arrangement with an entity that provides designated health services. Sanctions for prohibited referrals include denial of Medicare payment and civil monetary penalties of up to $15,000 for each service ordered. Designated health services furnished pursuant to a referral that is prohibited by the Stark Law are not covered by Medicare and payments improperly collected must be promptly refunded.

The physicians in our owned practices have a financial relationship with the owned practices (they receive compensation for services rendered) and may refer patients to the owned practices for physical and occupational therapy services (and perhaps other designated health services) covered by Medicare. Therefore, an exception would have to apply to allow the physicians in our owned practices to refer patients to the owned practices for the provision by the owned practices of Medicare-covered designated health services.

There are several exceptions to the prohibition on referrals for designated health services which have the effect of allowing a physician that has a financial relationship with an entity to make referrals to that entity for the provision of Medicare-covered designated health services. The exception on which we rely with respect to the owned practices is the exception for employees, as all of the physicians employed in our owned practices are W-2 employees of the respective owned practices. Therefore, we believe that the physicians employed by our owned practices can refer patients to the owned practices for the provision of designated health services covered by Medicare. Nevertheless, should the owned practices fail to adhere to the conditions of the employment exception, or if a regulator determines that the employees or the employment relationship do not meet the criteria of the employment exception, the owned practices would be liable for violating the Stark Law, which could have a material adverse effect on us. We believe that our relationships with the managed practices and the limited management practices, respectively, do not trigger the Stark Law. Nevertheless, if a regulator were somehow to determine that these relationships are subject to the Stark Law, and that the relationships do not meet the conditions of any exception to the Stark Law, such failure would have a material adverse effect on us.

The referral of Medicare patients by physicians employed by or under contract with the managed practices and the limited management practices, respectively, to their respective practices, however, does trigger the Stark Law. We believe, nevertheless, that the in-office ancillary exception to the Stark Law has the effect of permitting these physician members of the respective managed practices and limited management practices to refer patients to their respective group practice for the provision by the respective group practice of Medicare-covered designated health services. If the managed practices or limited management practices were found not to comply with the terms of the in-office ancillary exception, they cannot properly bill Medicare for the designated health services provided by them. In such an event, our business could be materially adversely affected because the revenues we generate from these practices are dependent, at least in part, on the revenues or profits generated by those practices.

Regulatory authorities could assert that our owned practices, the managed practices or the limited management practices, or the contractual arrangements between us and the managed practices or the limited management practices, fail to comply with state laws analogous to the Stark Law. In such event, we could be subject to civil penalties and could be required to restructure or terminate the contractual arrangements.

At least some of the states in which we do business also have prohibitions on physician self-referrals that are similar to the Stark Law. These laws and interpretations vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion. As indicated elsewhere, we enter into management agreements with the managed practices and the limited management practices. Under those agreements, we provide management and other items and services to the practices in exchange for compensation. Although we believe that the practices comply with these laws, and although we attempt to structure our relationships with these practices in a manner that we believe keeps us from violating these laws (or in a manner that we believe does not trigger the law), state regulatory authorities or other parties could assert that the practices violate these laws and/or that our agreements with the practices violate these laws. Any such conclusion could adversely affect our financial results and operations.

Regulatory authorities or other persons could assert that our relationships with our owned practices, the managed practices or the limited management practices fail to comply with the anti-kickback law. If such a claim were successfully asserted, we could be subject to civil and criminal penalties and could be required to restructure or terminate the applicable contractual arrangements. If we were subject to penalties or are unable to successfully restructure the relationships to comply with the Anti-Kickback Statute it would have an adverse effect on our financial condition and results of operations.

The anti-kickback provisions of the Social Security Act prohibit anyone from knowingly and willfully (a) soliciting or receiving any remuneration in return for referrals for items and services reimbursable under most federal health care programs; or (b) offering or paying any remuneration to induce a person to make referrals for items and services reimbursable under most federal health care programs, which we refer to as the “Anti-Kickback Statute” or “Anti-Kickback Law.” The prohibited remuneration may be paid directly or indirectly, overtly or covertly, in cash or in kind.

Violation of the Anti-Kickback Statute is a felony and criminal conviction results in a fine of not more than $25,000, imprisonment for not more than five years, or both. Further, the Secretary of the Department of Health and Human Services (“DHHS”) has the authority to exclude violators from all federal health care programs and/or impose civil monetary penalties of $50,000 for each violation and assess damages of not more than three times the total amount of remuneration offered, paid, solicited or received.

As the result of a congressional mandate, the Office of the Inspector General (“OIG”) of DHHS promulgated a regulation specifying certain payment practices which the OIG determined to be at minimal risk for abuse. The OIG named these payment practices “Safe Harbors.” If a payment arrangement fits within a Safe Harbor, it will be deemed not to violate the Anti-Kickback Statute. Merely because a payment arrangement does not comply with all of the elements of any Safe Harbor, however, does not mean that the parties to the payment arrangement are violating the Anti-Kickback Statute.

We receive fees under our agreements with the managed practices and the limited management practices for management and administrative services and equipment and supplies. We do not believe we are in a position to make or influence referrals of patients or services reimbursed under Medicare, Medicaid or other governmental programs. Because the provisions of the Anti-Kickback Statute are broadly worded and have been broadly interpreted by federal courts, however, it is possible that the government could take the position that we, as a result of our ownership of the owned practices, and as a result of our relationships with the limited management practices and the managed practices, will be subject, directly and indirectly, to the Anti-Kickback Statute.

With respect to the managed practices and the limited management practices, we contract with the managed practices to provide general management services and limited management services, respectively. In return for those services, we receive compensation. The OIG has concluded that, depending on the facts of each particular arrangement, management arrangements may be subject to the Anti-Kickback Statute. In particular, an advisory opinion published by the OIG in 1998 (98-4) concluded that in a proposed management services arrangement where a management company was required to negotiate managed care contracts on behalf of the practice, the proposed arrangement could constitute prohibited remuneration where the management company would be reimbursed for its costs and paid a percentage of net practice revenues.

Our management agreements with the managed practices and the limited management practices differ from the management agreement analyzed in Advisory Opinion 98-4. Significantly, we believe we are not in a position to generate referrals for the managed practices or the limited management practices. In fact, our management agreements do not require us to negotiate managed care contracts on behalf of the managed practices or the limited management practices, or to provide marketing, advertising, public relation services or practice expansion services to those practices. Because we do not undertake to generate referrals for the managed practices or the limited management practices, and the services provided to these practices differ in scope from those provided under Advisory Opinion 98-4, we believe that our management agreements with the managed practices and limited management practices do not violate the Anti-Kickback Statute. Nevertheless, although we believe we have structured our management agreements in such a manner as not to violate the Anti-Kickback Statute, we cannot guarantee that a regulator would not conclude that the compensation to us under the management agreements constitutes prohibited remuneration. In such an event, our operations would be materially adversely affected.

The relationship between the physicians employed by the owned practices and the owned practices is subject to the Anti-Kickback Statute as well because the employed physicians refer Medicare patients to the owned practices and the employed physicians receive compensation from the owned practices for services rendered on behalf of the owned practices. Nevertheless, we have tried to structure our arrangements with our physician employees to meet the employment Safe Harbor. Therefore, it is our position that the owned practices’ arrangements with their respective employed physicians do not violate the Anti-Kickback Statute. Nevertheless, if the relationship between the owned practices and their physician employees is determined not to be a bona fide employment relationship, this could have a material adverse effect on us.

Our agreements with the limited management practices may also raise different Anti-Kickback concerns, but we believe that our arrangements are sufficiently different from those deemed suspect by the OIG so as not to violate the law. In April of 2003, the OIG issued a Special Advisory Bulletin where the OIG addressed contractual arrangements where a health care provider in one line of business (“Owner”) expands into a related health care business by contracting with an existing provider of a related item or service (“Manager”) to provide the new item or service to the Owner’s existing patient population. In those arrangements, the Manager not only manages the new line of business, but may also supply it with inventory, employees, space, billing and other services. In other words, the Owner contracts out substantially the entire operation of the related line of business to the Manager, receiving in return the profits of the business as remuneration for its federal program referrals to the Manager.

According to the OIG, contractual joint ventures have the following characteristics: (i) the establishment of a new line of business; (ii) a captive referral base; (iii) the Owner lacks business risk; (iv) the Manager is a would be competitor of the Owner’s new line of business; (v) the scope of services provided by the Manager is extremely broad, with the manager providing: day to day management; billing; equipment; personnel; office space; training; health care items, supplies and services; (vi) the practical effect of the arrangement is to enable the Owner to bill insurers and patients for business otherwise provided by the Manager; (vii) the parties agree to a non-compete clause barring the Owner from providing items or services to any patient other than those coming from the Owner and/or barring the Manager from providing services in its own right to the Owner’s patients.

We have attempted to draft our agreements with the limited management practices in a manner that takes into account the concerns in the Special Advisory Bulletin. Specifically, under our arrangements, the limited management practice takes business risk. It is financially responsible for the following costs: the space required to provide the services; employment costs of the personnel providing the services and intake personnel; and billing and collections. We do not reimburse the limited management practice for any of these costs. We provide solely equipment, supplies and our management expertise. In return for these items and services, we receive a percentage of the limited management practice’s collections from the services being managed by us. Consequently, we believe that the limited management practice is not being compensated for its referrals.

State regulatory authorities or other parties may assert that we are engaged in the corporate practice of medicine. If such a claim were successfully asserted, we could be subject to civil, and perhaps criminal, penalties and could be required to restructure or terminate the applicable contractual arrangements. This result, or our inability to successfully restructure our relationships to comply with these statutes, could jeopardize our business and results of operations.

Many states in which we do business have corporate practice of medicine laws which prohibit us from exercising control over the medical judgments or decisions of physicians. These laws and their interpretations vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion. We enter into management agreements with managed practices and limited management practices. Under those agreements, we provide management and other items and services to the practices in exchange for a service fee. We structure our relationships with the practices in a manner that we believe keeps us from engaging in the corporate practice of medicine or exercising control over the medical judgments or decisions of the practices or their physicians. Nevertheless, state regulatory authorities or other parties could assert that our agreements violate these laws.

Regulatory authorities or others may assert that our agreements with limited management practices or managed practices, or our owned practices, violate state fee splitting laws. If such a claim were successfully asserted, we could be subject to civil and perhaps criminal penalties, and could be required to restructure or terminate the applicable contractual arrangements. This result, or our inability to successfully restructure our relationships to comply with these statutes, could jeopardize our business and results of operations.

The laws of many states prohibit physicians from splitting fees with non-physicians (or other physicians). These laws vary from state to state and are enforced by the courts and by regulatory authorities with broad discretion. The relationship between us on the one hand, and the managed practices and limited management practices, on the other hand, may raise issues in some states with fee splitting prohibitions. Although we have attempted to structure our contracts with the managed practices and the limited management practices in a manner that keeps us from violating prohibitions on fee splitting, state regulatory authorities or other parties may assert that we are engaged in practices that constitute fee-splitting, which would have a material adverse effect on us.

Our use and disclosure of patient information is subject to privacy regulations.

Numerous state, federal and international laws and regulations govern the collection, dissemination, use and confidentiality of patient-identifiable health information, including the federal Health Insurance Portability and Accountability Act of 1996 and related rules, or HIPAA. In the provision of services to our patients, we may collect, use, maintain and transmit patient information in ways that may or will be subject to many of these laws and regulations. The three rules that were promulgated pursuant to HIPAA that could most significantly affect our business are the Standards for Electronic Transactions, or Transactions Rule; the Standards for Privacy of Individually Identifiable Health Information, or Privacy Rule; and the Health Insurance Reform Security Standards, or Security Rule. The respective compliance dates for these rules for most entities were October 16, 2002, April 16, 2003 and April 21, 2005. HIPAA applies to covered entities, which include most health care providers that will contract for the use of our services. HIPAA requires covered entities to bind contractors to comply with certain burdensome HIPAA requirements. Other federal and state laws restricting the use and protecting the privacy of patient information also apply to us, either directly or indirectly.

The HIPAA Transactions Rule establishes format and data content standards for eight of the most common health care transactions. When we perform billing and collection services for our owned practices or managed practices we may be engaging in one or more of these standard transactions and will be required to conduct those transactions in compliance with the required standards. The HIPAA Privacy Rule restricts the use and disclosure of patient information, requires covered entities to safeguard that information and to provide certain rights to individuals with respect to that information. The HIPAA Security Rule establishes elaborate requirements for safeguarding patient information transmitted or stored electronically. We may be required to make costly system purchases and modifications to comply with the HIPAA requirements that are imposed on us and our failure to comply may result in liability and adversely affect our business.

Federal and state consumer protection laws are being applied increasingly by the Federal Trade Commission, or FTC, and state attorneys general, to regulate the collection, use and disclosure of personal or patient information, through websites or otherwise, and to regulate the presentation of website content. Courts may also adopt the standards for fair information practices promulgated by the FTC, which concern consumer notice, choice, security and access.

Numerous other federal and state laws protect the confidentiality of private information. These laws in many cases are not preempted by HIPAA and may be subject to varying interpretations by courts and government agencies, creating complex compliance issues for us and potentially exposing us to additional expense, adverse publicity and liability. Other countries also have, or are developing, laws governing the collection, use and transmission of personal or patient information and, if applicable, these laws could create liability for us or increase our cost of doing business.

New health information standards, whether implemented pursuant to HIPAA, congressional action or otherwise, could have a significant effect on the manner in which we must handle health care related data, and the cost of complying with these standards could be significant. If we do not properly comply with existing or new laws and regulations related to patient health information, we could be subject to criminal or civil sanctions.

Risks Related to Our Common Stock

Because we use our common stock as consideration for our acquisitions, your interest in our company will be significantly diluted. In addition, if the investors in our recent financings convert their debentures and notes, or if we elect to pay principal and/or interest on the debentures and notes with shares of our common stock or anti-dilution rights in these securities are triggered, our existing stockholders will experience significant dilution.

We have used, and we expect in the future to use, our common stock as consideration for our acquisitions. In addition, a significant amount of our acquisitions’ purchase price is contingent upon future performance. We expect to issue a significant amount of our common stock to pay contingent purchase prices for previous acquisitions. In addition, because the value of the stock we issue as payment of contingent consideration is not fixed, to the extent our stock price decreases, our existing stockholders’ interest in our company will be even more diluted by the payment of contingent consideration.

To the extent that our outstanding debentures and notes are converted, a significantly greater number of shares of our common stock will be outstanding and the interests of our existing stockholders will be substantially diluted. In addition, if we complete a financing at a price per share that is less than the conversion price of our debentures and notes, the conversion price of our debentures and notes will be reduced to the financing price. We cannot predict whether or how many additional shares of our common stock will become issuable as a result of these provisions. Hence, such amounts could be substantial. Additionally, we may elect to make payments of principal and interest on the debentures and the notes in shares of our common stock, which could result in increased downward pressure on our stock price and further dilution to our existing stockholders.

Future sales of our common stock in the public market, including sales by our stockholders with significant holdings, may depress our stock price.

Most of our outstanding shares of common stock are freely tradable. In 2004, we filed registration statements registering the resale of 49,376,123 shares, which includes shares issuable upon conversion of convertible notes and debentures, upon exercise of options and warrants and shares that are issuable pursuant to the earnout provisions of various business acquisitions. The market price of our common stock could drop due to sales of a large number of shares or the perception that such sales could occur, including sales or perceived sales by our directors, officers or principal stockholders. These factors also could make it more difficult to raise funds through future offerings of common stock.

There is a limited market for our common stock and the market price of our common stock has been volatile.

There is a limited market for our common stock. There can be no assurance that an active trading market for the common stock will be developed or maintained. Historically, the market prices for securities of companies like us have been highly volatile. In fact, since January 1, 2002, our common stock price has ranged from a low of $0.12 to a high of $5.45 (as determined on a reverse-split basis). The market price of the shares could continue to be subject to significant fluctuations in response to various factors and events, including the liquidity of the market for the shares, announcements of potential business acquisitions, and changes in general market conditions.

We do not expect to pay dividends.

Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will be dependent upon our results of operations, financial condition, capital requirements, contractual restrictions and other factors deemed relevant by the Board of Directors. The Board of Directors is not expected to declare dividends or make any other distributions in the foreseeable future, but instead intends to retain earnings, if any, for use in business operations. In addition, the securities purchase agreement for our convertible notes contains restrictions on the payment of dividends. Accordingly, investors should not rely on the payment of dividends in considering an investment in our Company.

Provisions of Florida law and our charter documents may hinder a change of control and therefore depress the price of our common stock.

Our articles of incorporation, our bylaws and Florida law contain provisions that could have the effect of delaying, deferring or preventing a change in control of us by various means such as a tender offer or merger not approved by our board of directors. These provisions may have the effect of discouraging, delaying or preventing a change in control or an unsolicited acquisition proposal that a stockholder might consider favorable, including a proposal that might result in the payment of a premium over the market price for the shares held by stockholders. These provisions may also entrench our management by making it more difficult for a potential acquirer to replace or remove our management or board of directors. See “Description of Capital Stock.”

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

This prospectus, and future filings by the Company on Form 10-K, Form 10-Q and Form 8-K and future oral and written statements by PainCare and its management may include, certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to uncertainties that could cause actual future events and results to differ materially from those expressed in the forward-looking statements. These forward-looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events and results. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, and “should”, and variations of these words and similar expressions, are intended to identify these forward-looking statements. PainCare disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information, or otherwise.

Actual future events and results may differ materially from those expressed in these forward-looking statements as a result of a number of important factors. Representative examples of these factors include (without limitation) adverse changes in economic conditions in the markets served by PainCare; the extent, timing, and overall effects of competition in the health care business; material changes in the health care industry generally that could adversely affect physician relationships and customer relationships; changes in health care technology; the risks associated with the integration of acquired businesses; the effects of litigation; and the effects of federal and state legislation, rules, and regulations governing the health care industry.

In addition to these factors, actual future performance, outcomes and results may differ materially because of other, more general factors including (without limitation) general industry and market conditions and growth rates, economic

USE OF PROCEEDS

All of the proceeds from the sale of the shares of common stock offered under this prospectus are for the account of the selling stockholders. Accordingly, we will not receive any proceeds from the sales of these shares other than the exercise price payable to us upon the exercise of warrants held by certain of the selling stockholders. We intend to use any such proceeds for general working capital.

COMMON STOCK PRICE RANGE AND DIVIDENDS

Market Information

Our common stock traded on the Over-the-Counter Bulletin Board under the symbol HELP from September 29, 1997 to March 18, 2002. On June 16, 2003 our common stock commenced trading on the American Stock Exchange and our symbol was changed to PRZ.

(a)	Market Information. The table below sets forth, for the periods indicated, the reported high and low sale prices of our common stock on the American Stock Exchange.


	Common Stock
	High		Low
CALENDAR 2005
Quarter ending March 31, 2005	$	5.22	$	2.90
Quarter ending June 30, 2005	$	5.45	$	3.75
Quarter ending September 30, 2005	$	4.49	$	3.50
Quarter ending December 31, 2005	$	4.21	$	3.05
CALENDAR 2006
Quarter ending March 31, 2006	$	3.74	$	1.40
Quarter ending June 30, 2006	$	2.06	$	1.40
Quarter ending September 30, 2006	$	2.30	$	1.22
Quarter ending December 31, 2006	$	1.72	$	0.99
CALENDAR 2007
Quarter ending March 31, 2007	$	1.14	$	0.30

The last sale price of our common stock on May 2, 2007 as reported on the American Stock Exchange was $0.35 per share.

Shareholders

As of May 2, 2007, we had 66,849,164 shares of common stock outstanding and approximately 8,597 common stockholders of record obtained from ADP Investor Communication Services, including individual and broker-dealer position listings.

Dividends

Since July 2002, we have not declared or paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will be dependent upon our results of operations, financial condition, capital requirements, contractual restrictions and other factors deemed relevant by the Board of Directors. The Board of Directors is not expected to declare dividends or make any other distributions in the foreseeable future, but instead intends to retain earnings, if any, for use in business operations. In addition, the securities purchase agreement for our convertible notes contains restrictions on the payment of dividends. Accordingly, investors should not rely on the payment of dividends in considering an investment in our Company.

SELECTED CONSOLIDATED FINANCIAL DATA

Our selected consolidated financial data shown below should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus. The summary consolidated statements of operations data for the years ended December 31, 2004, 2005 and 2006 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The data shown below are not necessarily indicative of future results.


	Year Ended December 31,
							2004			2003			2002
	2006			2005			(Restated)			(Restated)			(Restated)
	(In thousands, except per share data)
Consolidated Statement of Operations Data:
Revenues:
Pain management	$	46,093		$	43,269		$	22,317		$	6,117		$	2,614
Surgeries		5,348			6,165			5,203			3,431			3,409
Ancillary services		12,288			14,114			10,398			5,433			1,475

Total revenues		63,729			63,548			37,918			14,981			7,498
Cost of revenues		20,270			11,550			6,664			4,587			2,698

Gross profit		43,459			51,998			31,254			10,394			4,800
General and administrative		39,829			38,511			20,409			21,315			4,324
Amortization expense		2,263			1,529			549			114			42
Impairment of goodwill		22,099			—			—			—			—
Impairment of intangible assets		11,896			—			—			—			—
Depreciation expense		2,361			1,425			837			463			207

Operating income (loss)		(34,989	)		10,533			9,459			(11,498	)		227
Interest expense		(3,610	)		(4,308	)		(3,464	)		(531	)		(359	)
Derivative benefit (expense)		9,997			(7,055	)		(3,256	)		(3,174	)		—
Other income		204			457			170			46			174

Income (loss) from continuing operations before income taxes		(28,398	)		(373	)		2,909			(15,157	)		42
Benefit (provision) for income taxes		2,931			(5,111	)		(4,410	)		3,674			(234	)

Loss from continuing operations		(25,467	)		(5,484	)		(1,501	)		(11,483	)		(192	)

Income (loss) from discontinued operations (less applicable income tax benefit of $91,130 and (184,972))		(336	)		145			—			—			—
Loss on disposal of discontinued operations (plus applicable income tax benefit of $1,112,918)		(1,671	)		—			—			—			—

Income (loss) from discontinued operations, net of tax		(2,007	)		145

Loss before cumulative effect of a change in accounting principle		(27,474	)		(5,339	)		(1,501	)		(11,483	)		(192	)
Cumulative effect of a change in accounting principle		992

Net loss	$	(26,482	)	$	(5,339	)	$	(1,501	)	$	(11,483	)	$	(192	)

Basic earnings per common share:
Loss from continuing operations	$	(0.39	)	$	(0.10	)	$	(0.05	)	$	(0.55	)	$	(0.02	)
Loss from discontinued operations	$	(0.03	)		—			—			—			—
Cumulative effect of a change in accounting principle	$	0.01			—			—			—			—

Net loss	$	(0.41	)	$	(0.10	)	$	(0.05	)	$	(0.55	)	$	(0.02	)

Diluted earnings per common share:
Loss from continuing operations	$	(0.39	)	$	(0.10	)	$	(0.05	)	$	(0.55	)	$	(0.02	)
Loss from discontinued operations	$	(0.03	)		—			—			—			—
Cumulative effect of a change in accounting principle	$	0.01			—			—			—			—

Net loss	$	(0.41	)	$	(0.10	)	$	(0.05	)	$	(0.55	)	$	(0.02	)

Basic weighted average common shares outstanding		64,600			51,317			32,923			20,773			10,591
Diluted weighted average common shares outstanding		64,600			51,317			32,923			20,773			10,591

Operating and Other Financial Data:
Cash flows provided by (used in) operating activities	$	(814	)	$	9,173		$	4,119		$	15		$	(1,170	)
Cash flows used in investing activities		(18,512	)		(36,474	)		(18,408	)		(7,683	)		(510	)
Cash flows provided by (used in) financing activities		600			30,913			25,466			13,513			3,413

Consolidated Balance Sheet Data for Continuing Operations:
Cash	$	3,598		$	22,508		$	19,101		$	7,924		$	2,709
Working capital (deficiency)		(36,410	)		(21,585	)		(20,923	)		(14,938	)		2,301
Total assets		163,378			183,311			112,929			53,087			13,625
Total long-term debt and obligations under capital leases, including current portion		49,646			34,367			20,280			11,968			5,584
Total stockholders’ equity		97,351			87,323			41,932			12,010			6,657

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our consolidated financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of PainCare as a whole.

Forward Looking Information

This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes, and future filings by the Company on Form 10-K, Form 10-Q and Form 8-K and future oral and written statements by PainCare and its management may include, certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to uncertainties that could cause actual future events and results to differ materially from those expressed in the forward-looking statements. These forward-looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events and results. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, and “should”, and variations of these words and similar expressions, are intended to identify these forward-looking statements. PainCare disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information, or otherwise.

This MD&A should be read in conjunction with our accompanying consolidated financial statements and related notes. See “Cautionary Statement Regarding Forward-Looking Statements” on page ii of this report for a description of important factors that could cause actual results to differ from expected results. See also Form 10-K, Risk Factors.

Executive Overview

The year 2006 has been marked by profound turmoil. During this period, a significant portion of our time and attention has been devoted to matters primarily outside the ordinary course of business such as responding to SEC comment letters regarding our prior year accounting for certain derivative instruments, restating our prior six years of accounting records and responding to various class action suits against our company for the accounting of certain derivative instruments. We have also devoted significant resources to improving fundamental business systems including our corporate governance functions, financial controls, and operational infrastructure.

Despite these difficulties, our board of directors, senior management team, and employees worked diligently throughout 2006 and made significant progress in addressing many of the significant obstacles created during 2006:

•

We responded to all comment letters received from the U.S. Securities and Exchange Commission (SEC) and subsequently received formal notification from the SEC indicating that it had completed its review and has no further comment at this time.

•

We completed the restatement of our accounting records and filed amended annual reports on Form 10-K/A for the fiscal year ended December 31, 2005.

•

The Company has been faced with derivative and class action lawsuits related to financial restatements. The settlement for the derivative lawsuit received court approval and the case was dismissed on April 20, 2007. The Company believes resolution of all remaining litigation is imminent.

•

We have begun initiatives to centralize certain accounting functions in an effort to reduce costs and mitigate material weakness.

•

We have implemented an aggressive marketing program to help establish a PainCare brand name.

•

We recruited seven physicians and nine physician assistants over the past year to increase facility productivity and efficiency.

While we have been primarily focused on responding to the pressing challenges, our business, and the health care market in general, have continued to evolve. On the positive side, health care sector growth continues to outpace the economy in response to an aging U.S. population. In addition, the delivery of health care services is migrating to outpatient environments, which suits our core business model. On the other hand, health care providers are beginning to see price cut pressures brought on by Medicare reform initiatives leading to reduced payments to various health care providers, such as our company.

As a whole, our core business remains sound. We continue to face operational challenges, but we believe our accomplishments in 2006 have positioned us to capitalize on our competencies and move forward with implementing our strategic growth plan.

Our Business

Our business is currently divided into four primary operating segments: pain management, surgery centers, ancillary services, and a fourth segment that manages corporate functions. These four segments correspond to our four reporting segments discussed later in this Item and throughout this annual report.

Pain Management. As of December 31, 2006 our pain management segment operates through 16 subsidiaries and comprises the majority of our net operating revenues. Our pain management segment provides such services as interventional and non-interventional therapies that treat both the chronic and acute pain patient. Treatments include: therapeutic injections, radiofrequency treatments, and physical and behavioral therapy. From 2004 to 2006, our pain management segment’s revenues more than doubled, dominating our portfolio and remaining the very center of our company’s core business model. We have begun to orchestrate various cost cutting initiatives within this segment to further increase the operational performance of these practices.

Surgeries. As of December 31, 2006 our surgeries segment operates through three subsidiaries providing minimally invasive surgical procedures. Our surgical services include full spectrum orthopedic surgery, minimally invasive spine surgery and foot and ankle surgery. From 2004 through 2006 net operating revenues and operating income remain relatively flat due in large part to only completing one surgical center acquisition and minimal same practice organic growth within this segment over the last two years. We have begun to orchestrate various cost cutting initiatives within this segment to further increase the operational performance of these practices.

Ancillary Services. As of December 31, 2006 our ancillary services segment operates through five subsidiaries and is our second largest revenue generating segment. This segment offers such services as an intra-articular joint program, physical therapy, nerve conduction testing and pharmacy dispensing. From 2004 to 2006 ancillary services saw a stable growth rate due in large part to highly profitable acquisitions added during these two years. However, our three ambulatory surgical centers

(ASC’s) within this segment are currently listed as held for sale. Upon the sale of the ASC locations, our ancillary services segment performance could be materially affected. We have begun to orchestrate various cost cutting initiatives within this segment to further increase the operational performance of these practices.

The following tables illustrate the Net Operating Revenues and Consolidated Adjusted EBITDA (as defined in this Item, “Consolidated Results of Operations,”) from our three primary operating segments and our corporate and other segment:

LOGO


Revenues by Segment							Consolidated Adjusted EBITDA by Segment

	2006 vs 2005		2006 vs 2004		2005 vs 2004			2006 vs 2005		2006 vs 2004		2005 vs 2004
Pain Management	6.5	%	106.5	%	93.9	%	Pain Management	-52.1	%	-8.1	%	91.8	%
Ancillary Services	-12.9	%	18.2	%	35.7	%	Ancillary Services	-42.9	%	-68.4	%	-44.7	%
Surgeries	-13.3	%	2.8	%	18.5	%	Surgeries	-129.0	%	-126.0	%	-10.6	%
Corporate and Other	—		—		—		Other	-117.6	%	-152.4	%	196.9	%

We believe that the aging of the U.S. population, changes in technology, and the continuing growth in health care spending will increase demand for the types of services we provide. We plan to prioritize investment of time and capital based on where realistic growth prospects are strongest, which we currently believe are our pain management and ancillary service segments.

Key Challenges

Although our business is continuing to generate revenues, and market factors appear to favor our pain management and ancillary service business models, we still have several immediate internal and external challenges to overcome before we can realize significant improvements in our business, including:

•

Operational Improvements. We are in the process of improving our operational efficiency within all segments. This includes streamlining our operational structure, implementing standardized accounting procedures, and ensuring high quality patient care. We also strive to reduce operational variation across all segments.

•

Continuing Litigation. We are party to class action lawsuits which will require considerable management attention and company resources until settlements are reached.

•

Price Pressure. We are seeing downward pressure on prices in our markets, from both commercial and government payors. We anticipate continuing price pressure in all our segments. For example, Medicare has frozen ASC pricing through 2009, and beginning in 2007, the Deficit Reduction Act of 2005 will cap ASC and imaging service payments at hospital outpatient department reimbursement levels. Other pricing changes may have a negative impact on our operating results.

•

Divesture of Assets. We are in the process of locating willing and able buyers for our three ambulatory surgical centers currently listed as held for sale.

•

Medical Reimbursement Rates. Congress and some state legislatures have proposed significant changes in the health care system. Many of these changes have the potential to result in limitations on and, in some cases, significant reductions in the levels of, reimbursement rates to health care providers for services under many government reimbursement programs.

•

Restatement and Sarbanes-Oxley Related Costs. We paid approximately $2.4 million in 2006 in connection with the restatement of our consolidated financial statements for the years ended December 31, 2004, 2003, 2002, 2001 and 2000, and internal controls over financial reporting. We anticipate incurring additional related costs in the future, although we expect these costs to decline over time.

Strategic Plan

Although management’s attention recently has been focused on a range of tactical issues relating to PainCare’s success, our senior management team has spent time developing a comprehensive strategic plan that is focused on PainCare’s future, not its past. The plan, which has been approved by our board of directors, is divided into the following three phases:

•

Operations Management. In an effort to enhance our operational structure and strengthen our core business strategy, the Company has set forth several initiatives to solidify our financial foundation. Such initiatives involve centralizing certain accounting functions in order to reduce overhead, re-syndicate the proposed sale of our ambulatory surgical centers (ASC’s) in an effort to attract potential buyers, and pay- down existing debt facilities upon the sales of the ASC’s.

•

Organic Growth. In order to grow currently owned physician practices, the Company intends to enhance the capacity of the practices for organic growth by increasing the range of services offered. By deploying additional physicians and equipment, practices can perform necessary procedures and services in-house that would ordinarily be referred to other providers, resulting in higher quality care and increased revenues. An example of organic growth would be to deploy imaging modalities such as mobile MRI equipment, or additional services such as in-office pharmaceutical dispensing.

•

Acquisition Strategy. PainCare has grown its business through a combination of organic growth and acquisitions of complimentary physician practices. Through an extensive, multi-point due diligence evaluation process that the Company performs prior to acquisition, including such criteria as clinical quality, physician reputation, profitability and procedure and revenue growth rates, PainCare intends to acquire practices that the Company believes to be well-established with the capacity for future profitability and organic growth.

We are in the first phase of our strategic plan and we are already making significant strides. We have turned certain accounting functions into a centralized procedure, thus reducing the reliance on the assistance of outside accounting firms in construction of certain subsidiary financial statements. We have also retained the Bloom Organization, LLC (“Bloom”) to sell our interests in three of our ambulatory surgical centers. Each ambulatory surgical center is marketed separately and Bloom believes that these transactions can be completed by the end of the second quarter of 2007.

We believe our strategic plan capitalizes on our strengths, market direction, and legitimate growth opportunities. We are implementing a realistic operations plan and creating the appropriate infrastructure, organization policies, protocols, systems, and reports to support it. Finally, we are setting priorities based on resources and with our long-range goals of quality, profitability, and stockholder value.

Consolidated Results of Operations

We are a health care services company focused on the treatment of pain. We provide services through a national network of pain management, surgery centers, ancillary service, and other health care providing facilities. During 2006, 2005 and 2004, we derived consolidated revenues from the following payor sources:


	For the year ended December 31,
	2006		2005		2004
Government	23.6	%	21.4	%	20.2	%
Private Insurance	48.8	%	47.6	%	51.9	%
Workers Compensation	14.6	%	10.5	%	8.6	%
Self Pay	2.3	%	3.0	%	3.0	%
Other	10.7	%	17.5	%	16.3	%

Total	100.0	%	100.0	%	100.0	%

We provide our patient services through three primary operating segments and certain other services through a fourth operating segment. These four segments correspond to our four reporting segments discussed in this Item, “Segment Results of Operations” and throughout this annual report.

When reading our consolidated statement of operations, it is important to recognize the following items are included within our results of operations:

•

Impairments. During 2006 we recorded an impairment charge of $34.0 million to reduce the carrying value of amortizable intangibles or certain operating facilities to their estimated fair market value. These charges are discussed in more detail in this Item, “Segment Results of Operations,” Note 1, “Goodwill” and Note 8, “Other Intangible Assets,” to our accompanying consolidated financial statements.

•

Professional restatement fees. During 2006 professional fees associated with the restatement of our previously issued 2005, 2004, 2003, 2002, 2001 and 2000 consolidated financial statements approximated $2.4 million.

•

Disposal of a business unit. The Company entered into and signed a rescission agreement with Amphora, LLC on December 11, 2006. At December 31, 2006, all consolidated transactional information pertaining to Amphora has been classified as loss on disposal.

•

Assets held for sale. The Company determined during the fourth quarter of 2006 that it would sell three ambulatory surgical centers, (“ASC’s”), reported within the Ancillary Services segment, to restructure the Company’s balance sheet. Originally the Company planned to sell the ASC’s as a single package deal, but on January 2, 2007, the Company was advised to syndicate these ASC’s in an effort to make them more attractive to a larger spectrum of potential suitors. These subsidiaries are now listed as assets held for sale on the Company’s consolidated financial statements. Additional details regarding assets held for sale can be found in this Item, “Results of Discontinued Operations and Assets Held for Sale,” and within this annual report.

From 2004 through 2006, our consolidated results of operations were as follows:


	For the years ended December 31,									Percentage change
	2006			2005			2004			2006 vs. 2005		2005 vs. 2004
Net operating revenues from continuing operations	$	63,728,882		$	63,548,313		$	37,917,900		0.3	%	67.6	%

Operating expenses from continuing operations:
Salaries, benefits and bonuses		31,052,760			22,162,326			12,765,955		40.1	%	73.6	%
Payroll tax and expense		3,571,094			2,000,477			1,504,020		78.5	%	33.0	%
Professional fees		7,889,457			4,814,176			2,135,045		63.9	%	125.5	%
Supplies		5,059,221			2,818,810			1,479,022		79.5	%	90.6	%
Interest expense		3,609,655			4,308,502			3,463,677		-16.2	%	24.4	%
Other operating expenses		12,323,169			17,807,642			9,017,991		-30.8	%	97.5	%
Depreciation and amortization		4,624,388			2,954,231			1,386,713		56.5	%	113.0	%
Derivative( benefit) expense		(9,997,201	)		7,055,502			3,256,372		-241.7	%	-116.7	%
Impairment of goodwill		22,098,675			—			—		100	%	N/A
Impairment of intangible assets		11,895,837			—			—		100	%	N/A

Total operating expenses		92,127,055			63,921,666			35,008,795		44.1	%	82.6	%

Gain (loss) from continuing operations before income tax benefit (expense)		(28,398,173	)		(373,353	)		2,909,105		-7,506.3	%	-112.8	%
Income tax benefit (expense)		2,930,928			(5,110,651	)		(4,410,587	)	157.3	%	15.9	%
Gain (loss) from discontinued operations, net of tax		(2,007,186	)		144,626			—		-1,487.8	%	100	%

Cumulative effect of a change in accounting principle, net of tax		991,925			—			—		100	%	N/A

Net loss	$	(26,482,506	)	$	(5,339,378	)	$	(1,501,482	)	-396.0	%	-255.6	%

Operating Expenses as a Percent of Net Operating Revenues


	For the years ended December 31,
	2006		2005		2004
Salaries, benefits and bonuses	48.7	%	34.9	%	33.7	%
Payroll tax expense	5.6	%	3.1	%	4.0	%
Professional fees	12.4	%	7.6	%	5.6	%
Supplies	7.9	%	4.4	%	3.9	%
Interest expense	5.7	%	6.8	%	9.1	%
Other operating expenses	19.3	%	28.0	%	23.8	%
Depreciation and amortization	7.3	%	4.6	%	3.7	%
Derivative (benefit) expense	-15.7	%	11.1	%	8.6	%
Impairment of goodwill, intangible assets	53.3	%	—		—

Total operating expenses as a % of net operating revenues	144.5	%	100.5	%	92.4	%

*	All numbers presented within the tables above are exclusive of all practices listed as discontinued operations and assets held for sale.

Net Operating Revenues

Our consolidated net operating revenues primarily include revenues derived from patient care services provided by one of our three primary consolidated operating segments.

Net operating revenues from continuing operations remained relatively flat from 2005 to 2006.

Net operating revenues from continuing operations increased $25.6 million, or 67.6%, from 2004 to 2005. The increase in net operating revenues was primarily due to acquisitions recorded in the latter half of 2004 representing same practice growth of approximately $17.1 million in net operating revenues in 2005 compared to their contributions in 2004.

Salaries, Benefits and Bonuses

Salaries, benefits and bonuses represent the most significant expense and include all amounts paid to full and part-time employees, including all related costs of benefits and bonuses provided to employees. It also includes amounts paid for contract labor.

Salaries, benefits and bonuses increased $8.9 million, or 40.1%, from 2005 to 2006. The increase was primarily due to the additional employees associated with our two acquisitions during 2006 which remain as continuing operations at year end. In addition, we have recruited several physicians at various locations as well as added support staff across all segments of our operations.

Salaries, benefits and bonuses increased $9.4 million, or 73.6%, from 2004 to 2005. The increase was primarily due to the additional employees associated with the additional four acquisitions during 2005 which remain as continuing operations at year end.

Payroll Tax and Expense

Payroll tax and expense includes the employer portion of payroll tax charged to all employers as well as all associated expenses incurred with the payroll process.

Payroll tax and expense increased $1.6 million, or 78.5%, from 2005 to 2006. This was primarily due to the additional employees recruited on all operational levels of the Company.

Payroll tax and expense increased $496,457, or 33.0%, from 2004 to 2005. Again, this increase was primarily due to the additional employees recruited on all operational levels of the Company.

Professional Fees

Professional fees include those fees associated with outside contractors performing professional development services. Professional fees also include professional consulting fees associated with operational initiatives, such as strategic planning.

From 2005 to 2006, professional fees increased $3.1 million, or 63.9%. This increase in professional fees is primarily due to an increased reliance on outside consulting firms to assist with operational functions such as Sarbanes-Oxley compliance and certain legal and accounting fees.

From 2004 to 2005, professional fees increased $2.7 million, or 125.5%. This increase in professional fees is primarily due to legal, accounting and various other professional fees incurred at the subsidiary level.

Supplies

Supplies include costs associated with supplies used while providing patient care at our facilities. Examples include bandages, syringes, linens, injectable pharmaceuticals, and numerous other items. In each year, our pain management and ancillary service segments comprised the majority of our supply expense.

From 2005 to 2006, supplies increased $2.2 million, or 79.5%. This increase is primarily due to an increase in supplies expense in our pain management and ancillary services segments due to increased costs associated with supplies as well as increased service offering and current year acquisitions leading to an increase in supplies expense.

From 2004 to 2005, supplies increased $1.3 million, or 90.6%. This increase is primarily due to additional supplies expense associated with the increasing costs of such supplies, current year acquisitions, and increased supplies associated with a broader range of patient services.

Interest Expense

Interest expense related to expenses associated with debt obligations, waiver fees associated with a breach of debt covenants and amounts paid in regard to various other debt instruments.

Interest expense remained relatively flat from 2005 to 2006.

Interest expense remained relatively flat from 2004 to 2005.

Other Operating Expenses

Other operating expenses include costs associated with managing and maintaining our operating facilities as well as the general and administrative costs related to the operations of our corporate office. These expenses include such items as repairs and maintenance, utilities, contract services, rent, and insurance.

Other operating expenses decreased $5.5 million, or 30.8%, from 2005 to 2006. This decrease primarily relates to a reduction in expenses classified as other operating expenses in 2006 versus 2005.

Other operating expenses increased $8.8 million, or 97.5% from 2004 to 2005. This increase primarily relates to a $1.5 million increase in rent and a $2.4 million increase in compensation expense relating to variable options from 2004 to 2005.

Depreciation and Amortization

Depreciation and amortization relate to the monthly and quarterly charge of our fixed and intangible assets. Such assets include property, plant and equipment, medical equipment and office equipment. Our intangible assets primarily relate to the physician referral network.

Depreciation and amortization expense increased $1.7 million, or 56.5%, from 2005 to 2006. This is primarily due to fixed assets additions during 2006 leading to higher depreciation expense.

Depreciation and amortization expense increased $1.6 million, or 113.0%, from 2004 to 2005. This increase is primarily due to additional fixed assets associated with current year acquisitions as well as the amortization charge of intangible assets.

Derivative (Benefit) Expense

Derivative (benefit)/expense is directly related to our current stock price. As our stock price increases, our derivative expense increases and as our stock price decreases, our derivative expense then becomes derivative income. During 2006 we recorded derivative benefit of $10.0 million versus derivative expense of $7.1 million in 2005.

Impairment of Goodwill and Intangible Assets

The expenses associated with impairment of goodwill and intangible assets relates to impairment charges taken against; subsidiary goodwill, our MedX contract right, our three owned EDX contract rights, two of our subsidiaries, and an impairment charge against our contract with Denver Pain Management.

Impairment of goodwill and intangible assets increased $34.0 million from 2005 to 2006. The increase in impairment of goodwill and intangible assets is due to charges relating to the write-down of goodwill to the subsidiaries respective fair market value of such goodwill and intangible assets.

Minority Interest in Earnings of Consolidated Affiliates

Minority interests in earnings of consolidated affiliates represent the share of net income or loss allocated to members or partners in our consolidated entities. For 2004 through 2006, the number and average of external ownership interest in these consolidated entities were as follows:


	As of and for the years ended December 31,
	2006		2005		2004
Active consolidated affiliates	2		2		—
Average external ownership interest	70.3	%	70.3	%	—

Of our active consolidated affiliates at December 31, 2006, approximately 100% are in our ancillary services segment. As of October 19, 2006 we listed all assets and liabilities associated with our ambulatory surgical centers as available for sale. Also, on December 11, 2006 we rescinded the acquisition of Amphora, LLC, in which we had 60% ownership interest.

Income Tax Benefit (Expense)

We realized a $2.9 million income tax benefit from continuing operations in 2006 as compared to an $5.1 million income tax expense from continuing operations in 2005. Deferred tax expense increased by approximately $1.5 million to reflect the change in the noncurrent deferred taxes associated with amortization of goodwill and other assets and allowance for doubtful accounts.

We realized a $5.1 million income tax expense from continuing operations in 2005 as compared to a $4.4 million income tax expense from continuing operations in 2004. Additionally, Paincare and its subsidiaries file separate income tax returns in a number of states, some of which result in current state income tax liabilities.

Net loss from continuing operations increased $4.0 million, or 265.2%, from 2004 to 2005. The increase in net loss from continuing operations resulted in additional income tax expense of approximately $700,000 from 2004 to 2005.

Consolidated Adjusted EBITDA

Management continues to believe that an understanding of Consolidated Adjusted EBITDA is an important measure of operating performance, leverage capacity, our ability to service our debt, and our ability to make capital expenditures for our stockholders.

In general terms, the definition of Consolidated Adjusted EBITDA, per our credit agreement, is defined as consolidated net earnings (or loss), minus extraordinary gains and interest income, plus interest expense, income taxes, and depreciation and amortization for such period, in each case, as determined in accordance with GAAP.

We use Consolidated Adjusted EBITDA on a consolidated basis to assess our operating performance. We believe it is meaningful because it provides investors a basis using criteria that are used by our internal decision makers. Our internal decision makers believe Consolidated Adjusted EBITDA is a meaningful measure, because it represents a transparent view of our recurring operating performance and allows management to readily view operating trends, perform analytical comparisons and benchmarking between segments. Additionally, our management believes the inclusion of professional fees associated with litigation, accounting restatement, audit and tax work associated with the restatement process, and the implementation of Sarbanes-Oxley Section 404 and other non-ordinary course charges distort within EBITDA their ability to efficiently assess and view the core operating trends on a consolidated basis and within segments. We reconcile consolidated Adjusted EBITDA to gain/(loss) from continuing operations.

We also use Consolidated Adjusted EBITDA on a consolidated basis as a liquidity measure. We believe this financial measure on a consolidated basis is important in analyzing our liquidity because it is also a component of certain material covenants contained within and defined by our credit agreement. These covenants are material terms of these agreements because they govern our credit agreement, which in turn represent a substantial portion of our capitalization. Non-compliance with these financial covenants under our credit facilities—our interest coverage ratio and our leverage ratio—could result in the lenders requiring us to immediately repay all amounts borrowed. Any such acceleration could also lead the investors in our public debt to accelerate their maturity. In addition, if we cannot satisfy these financial covenants in the indenture governing the credit agreements, we cannot engage in certain activities, such as incurring additional indebtedness, making certain payments, acquiring and disposing of assets. Consequently, Consolidated Adjusted EBITDA is critical to our assessment of our liquidity.

However, Consolidated Adjusted EBITDA is not a measure of financial performance under generally accepted accounting principles in the United States of America, and the items excluded from Consolidated Adjusted EBITDA are significant components in understanding and assessing financial performance. Therefore, Consolidated Adjusted EBITDA should not be considered a substitute for net gain/(loss) from continuing operations or cash flows from operating, investing, or financing activities. Because Consolidated Adjusted EBITDA is not a measurement determined in accordance with generally accepted accounting principles in the United States of America and is thus susceptible to varying calculations, Consolidated Adjusted EBITDA, as presented, may not be comparable to other similarly titled measures of other companies. Revenue and expenses are measured in accordance with the policies and procedures described in Note 1, Summary of Significant Accounting Policies, to our accompanying consolidated financial statements.

Reconciliation of Loss from Continuing Operations to Consolidated Adjusted EBITDA


	For the years ended December 31,
	2006 (Unaudited)			2005 (Unaudited)			2004 (Unaudited)
Loss from continuing operations	$	(25,467,245	)	$	(5,484,004	)	$	(1,501,482	)
Provision for income tax expense (benefit)		(2,930,928	)		5,110,651			4,410,587
Depreciation and amortization		4,624,388			2,954,231			1,386,713
Impairment of goodwill		22,098,675			—			—
Impairment of other assets		11,895,837			—			—
Interest expense		3,609,655			4,308,502			3,463,677
Other income		(203,229	)		(457,250	)		(170,568	)

Consolidated Adjusted EBITDA before medical malpractice legal settlement and professional fees restatement and non-cash compensation		13,627,153			6,432,130			7,588,927
Medical malpractice legal settlement		550,000			—			—
Professional fees—restatement		2,400,000			—			—
Non-cash compensation		(7,975,675	)		2,382,259			356,590

Consolidated Adjusted EBITDA	$	8,601,478		$	8,814,389		$	7,945,517

Reconciliation of Consolidated Adjustment EBITDA to Net Cash Provided by Operating Activities


	For the years ended December 31,
	2006 (Unaudited)			2005 (Unaudited)			2004 (Unaudited)
Consolidated Adjusted EBITDA	$	8,601,478		$	8,814,389		$	7,945,517
Professional fees—restatement		(2,400,000	)		—			—
Medical malpractice legal settlement		(550,000	)		—			—
Interest expense and amortization of debt and discount and fees		(3,609,655	)		(4,308,502	)		(3,463,677	)
Other income		203,229			457,250			170,568
Amortization of debt issue costs, debt discounts, and fees		2,176,744			1,383,324			1,805,846
Amortization of deferred financing costs		—			(475,717	)		—
Stock issued for interest payments		325,407			991,146			383,053
Current portion of income tax provision		5,729,369			(3,997,085	)		(3,661,964	)
Mark to market derivative		(9,997,201	)		7,055,502			3,256,372
Loss on disposal of property and equipment		—			88,651			—
Non-cash transactions		(835	)		28,143			30,415
Net cash provided by operating activities attributed to discontinued operations		(292,529	)		562,354			—
Change in operating assets and liabilities, net of assets acquired		(999,870	)		(1,426,358	)		(2,347,104	)

Net Cash Provided by Operating Activities	$	(813,863	)	$	9,173,097		$	4,119,026

Our Consolidated Adjusted EBITDA approximated 13.5%, 13.9%, and 21.0% of net operating revenues in 2006, 2005, and 2004, respectively.

Consolidated Adjusted EBITDA decreased $212,911, or 2.4%, from 2005 to 2006. The increase in Consolidated Adjusted EBITDA is primarily due to the impairment of intangible assets leading to a reduction in operating earnings and subsequent tax benefit for 2006 versus tax expense in 2005.

Consolidated Adjusted EBITDA increased $868,872, or 10.9%, from 2004 to 2005. The decrease in Consolidated Adjusted EBITDA is primarily due to a reduction in income from continuing operations from 2004 to 2005.

Segment Results of Operations

Our internal financial reporting and management structure is focused on the major types of services provided by PainCare. We currently provide various patient care services through three operating segments and certain other services through a fourth segment, which correspond to our four reporting business segments: (1) pain management, (2) surgery, (3) ancillary services, and (4) corporate and other. For additional information regarding our business segments, including a detailed description of the services we provide and financial data for each segment, please see Item 1, Business , and Note 23, Segment Reporting, to our accompanying consolidated financial statements. Future changes to this organizational structure may result in changes to the reportable segments disclosed.

Pain Management

Our pain management segment provides treatment through interventional and non-interventional therapies treating both the chronic and acute pain patient. Our pain management facilities are located in eight states in the United States and one province in Canada.

As of December 31, 2006 our pain management segment operated 16 facilities (three of which are wholly owned and 13 of which are managed contracts). Our pain management segment provides services to patients such as therapeutic injections, radiofrequency treatments and both physical and behavioral therapy.

For the years ended December 31, 2006, 2005 and 2004, our pain management segment comprised approximately 72.3%, 68.1% and 58.9%, respectively, of consolidated net operating revenues. Operating results for 2004 through 2006 were as follows:


	For the years ended December 31, (in thousands)
	2006			2005			2004
Net operating revenues	$	46,093		$	43,269		$	22,317
Operating expenses		68,275			24,751			12,202

Operating income (loss)	$	(22,182	)	$	18,518		$	10,115


For the years ended December 31, 2006, 2005 and 2004, pain management’s net operating revenues were derived from the following payor sources:

	For the years ended December 31,
	2006			2005			2004
Government		29.6	%		25.2	%		26.2	%
Private Insurance		48.2	%		48.3	%		58.8	%
Workers Compensation		15.8	%		14.8	%		11.9	%
Personal Injury		—			5.9	%		—
Self Pay		3.4	%		3.5	%		3.1	%
Other		3.0	%		2.3	%		—

Total		100.0	%		100.0	%		100.0	%

Net Operating Revenues

Our pain management segment’s net operating revenues increased $2.8 million, or 6.5%, from 2005 to 2006. The increase was primarily due to two pain management acquisitions during 2006. Total net operating revenues for the two additional pain management facilities added $4.8 million to the pain management segment.

Net operating revenues of our pain management segment increased $21.0 million, or 93.9%, from 2004 to 2005. This increase is primarily due to the realization, in 2005, of a full years net operating revenues regarding four facilities that were added in the latter half of 2004 verse a partial year realization of net operating revenues in 2004. These same four facilities accounted for $3.9 million, or 17.4%, of net operating revenues in 2004 verse $17.4 million, or 40.2% of net operating revenues in 2005.

Operating Expenses

Pain Management

Operating Expenses

(% of Total Pain Management Operating

Expenses)

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Salaries, Benefits and Bonuses

Salaries, benefits and bonuses consist of salaries paid to physicians, non-physician providers, general support staff, employee bonuses and any related employee benefits. Salaries, benefits and bonuses equated to 37.5%, 45.0%, and 31.2% of pain management’s total operating expenses from 2004 through 2006, respectively, making it critical to monitor and manage these expenses.

Salaries, benefits and bonuses increased $6.7 million, or 60.7%, from 2005 to 2006 primarily due to an increase in both physician salaries of approximately $3.1 million and non-physician provider salaries of approximately $1.4 million.

From 2004 to 2005 salaries, benefits and bonuses increased $5.7 million, or 103.7% . The increase in salaries, benefits and bonuses was due to an increase of approximately $1.5 million in non-physician provider salaries and $2.6 million in salaries of general employee staff.

Supplies

From 2005 to 2006, supply expense increased $2.2 million, or 103.7% . The increase in supplies expense was primarily due to expanded service lines requiring a greater volume of supplies.

From 2004 to 2005, supply expense increased $1.2 million, or 126.5% . The increase in supplies expense was primarily due to expanded service lines and increased costs of supplies.

All Other Operating Expenses

All other operating expenses increased $24.2 million, or 210.6%, from 2005 to 2006. The increase in other operating expenses was primarily due to the addition of two pain management facilities in October 2005 as well as two pain management facilities at the beginning of 2006.

All other operating expenses increased $3.3 million, or 40.2%, from 2004 to 2005. The increase in other operating expenses was primarily due to the addition of one pain management facility in December 2004, and three pain management facilities in 2005.

Operating Earnings

Net operating earnings for our pain management segment decreased $30.3 million, or 162.7%, from 2005 to 2006. This decrease is attributed to a disproportionate increase in our total operating expenses of 134.0% versus an increase in net operating revenues of only 6.5% . A portion of these increased expenses relates to the recruiting, training and maintaining of key employees as well as the additional expenses incurred with four pain management acquisitions since October of 2005.

Net operating earnings for our pain management segment increased $10.8 million, or 139.8%, from 2004 to 2005. This increase is attributed to an increase in net operating revenues of 93.9% versus an increase in total operating expenses of 69.4% . In addition, we recorded three pain management acquisitions during 2005 and four acquisitions in the latter half of 2004.

Surgery

Our surgeries segment provides patient services such as full spectrum orthopedic surgery, minimally invasive spine surgery and foot and ankle surgery. Our surgical facilities are located in three states in the United States. It should be noted that our surgery segment is exclusive of our three ambulatory surgical centers listed as held for sale. Information pertaining to the financial reporting of the ambulatory surgical centers can be found within the ancillary service segment as outlined later in this Item.

As of December 31, 2006 our surgery segment operated three facilities (one of which is wholly owned and two of which are managed contracts). For the years ended December 31, 2006, 2005 and 2004, our surgeries segment comprised approximately 8.4%, 9.7% and 13.7%, respectively, of consolidated net operating revenues. For 2004 through 2006, this segment’s operating results were as follows:


	For the years ended December 31,(in thousands)
	2006			2005		2004
Net operating revenues	$	5,348		$	6,165	$	5,203
Operating expenses		5,942			4,273		3,281

Operating income (loss)	$	(594	)	$	1,892	$	1,922

During 2006, 2005 and 2004, surgery’s net operating revenues were derived from the following payor sources:


	For the years ended December 31,
	2006		2005		2004
Government	10.1	%	12.7	%	11.0	%
Private Insurance	34.9	%	70.1	%	82.0	%
Workers Compensation	34.6	%	8.3	%	4.3	%
Personal Injury	19.0	%	0.5	%	—
Self Pay	1.4	%	8.4	%	2.7	%

Total	100.0	%	100.0	%	100.0	%

Net Operating Revenues

Our surgery segment’s net operating revenues decreased $817,499, or 13.3%, from 2005 to 2006. This decrease is primarily due to a change in accounts receivable net realizable value of $1.3 million, or 196.7% from 2005 to 2006.

Our surgery segment’s net operating revenues increased $962,409, or 18.5%, from 2004 to 2005. This increase is primarily due to the increase in patient volume from 2004 to 2005.

Operating Expenses

Surgery

Operating Expenses

(% of Total Surgery Operating Expenses)

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Salaries, Benefits and Bonuses

Salaries, benefits and bonuses consist of salaries paid to physicians, physician assistants (non-physician providers), general support staff, employee bonuses and any related employee benefits.

Salaries, benefits and bonuses increased $934,715, or 37.4%, from 2005 to 2006. This increase is primarily due to an increase in physician based salaries of approximately $800,000.

Salaries, benefits and bonuses increased $550,909, or 28.3%, from 2004 to 2005. This increase is primarily due to an increase in personnel as well as an increase in existing staff pay.

Supplies

Supplies expense relates to the necessary supplies needed to provide patient care. These supplies include all forms of medical supplies such as syringes, linens, injectable pharmaceuticals and bandages, as well as general office supplies. Our surgery segment did not experience any notable increases in supplies expense on a year-over-year basis.

All Other Operating Expenses

All other operating expenses increased $597,929, or 39.2%, from 2005 to 2006. The increase in all other operating expenses relates to an overall increase in all expense accounts from 2005 to 2006.

All other operating expenses decreased $303,371, or 16.6%, from 2004 to 2005. The decrease in all other operating expenses is primarily related to decreases in all expense accounts from 2004 to 2005.

Operating Earnings

Net operating earnings for our surgery segment decreased $2.4 million, or 125.1%, from 2005 to 2006. The decrease in net operating earnings is primarily due to an approximate $2.2 million decrease in same practice earnings from 2005 to 2006.

Net operating earnings for our surgery segment increased $691,277, or 57.0%, from 2004 to 2005. The increase in net operating earnings was due to an increase in net operating revenues of 18.5% while expenses remained relatively flat from 2004 to 2005.

Ancillary Services

Our ancillary services segment provides patient services such as orthopedic rehabilitation, diagnostic imagery, electrodiagnostic imaging and intra-articular joint rehabilitation program. Our ancillary services segment facilities are located in four states in the United States. It should be noted that our ambulatory surgery centers currently listed as held for sale are reported under ancillary services segment.

As of December 31, 2006 our ancillary services segment operated five facilities (two of which are wholly owned and three of which are managed contracts). For the years ended December 31, 2006, 2005 and 2004, our ancillary services segment comprised approximately 19.3%, 22.2% and 27.4%, respectively, of consolidated net operating revenues. Operating results from 2004 through 2006 were as follows:


	For the years ended December 31, (in thousands)
	2006			2005		2004
Net operating revenues from continuing operations	$	12,288		$	14,114	$	10,398
Operating expenses from continuing operations		8,258			10,321		5,699

Operating earnings from continuing operations	$	4,030		$	3,793	$	4,699


	For the years ended December 31, (in thousands)*
	2006			2005		2004
Net operating revenues from discontinued operations	$	20,411		$	5,115	$	—
Operating expenses from discontinued operations		22,418			4,971		—

Operating earnings from discontinued operations	$	(2,007	)	$	144	$	—

*	This chart is intended to give reference to all facilities listed as either discontinued or held for sale

During 2006, 2005 and 2004, ancillary service’s net operating revenues were derived from the following payor sources:


	For the years ended December 31,
	2006		2005		2004
Government	19.2	%	24.9	%	22.4	%
Private Insurance	55.9	%	63.9	%	64.2	%
Workers Compensation	3.8	%	4.6	%	5.0	%
Personal Injury	2.8	%	5.6	%	—
Self Pay	1.3	%	1.0	%	8.4	%
Other	17.0	%	—		—

Total	100.0	%	100.0	%	100.0	%

Net Operating Revenues

From 2005 to 2006, net operating revenues decreased $1.8 million, or 12.9% . This decrease is attributed to a reduction in net operating revenues generated from our same practice operations.

From 2004 to 2005, net operating revenues increased $3.7 million, or 35.7% . This increase relates to $3.8 million in additional revenues associated with same practice operations.

Operating Expenses

Ancillary Service

Operating Expenses

(% of Total Ancillary Services Operating Expenses)

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Salaries, Benefits and Bonuses

Salaries, benefits and bonuses consist of salaries paid to physicians, non-physician providers, general support staff, employee bonuses and any related employee benefits.

Salaries, benefits and bonuses remained relatively flat from 2005 to 2006.

Salaries, benefits and bonuses increased $2.5 million, or 76.2% from 2004 to 2005. This increase is primarily due to an increase of approximately $1.2 million in physician assistant salaries and $1.2 million in salaries of general staff.

Supplies

Supplies expense did not experience any notable increase on a year-over-year basis for our ancillary services segment.

All Other Operating Expenses

All other operating expenses remained relatively flat from 2005 to 2006.

All other operating expenses increased $1.8 million, or 26.8% from 2004 to 2005. The increase in all other operating expenses relates to an increase in general business expenditures.

Operating Earnings

Net operating earnings decreased $3.6 million, or 66.9%, from 2005 to 2006. The decrease in operating earnings is primarily due to $1.9 million reduction in net operating revenues from 2005 to 2006.

Net operating earnings increased $1.8 million, or 51.8%, from 2004 to 2005. The increase in operating earnings is primarily due to an increase in net operating revenues of $3.7 million from 2004 to 2005.

Corporate and Other

Corporate and other only includes cost functions that are managed directly by our corporate office and that do not fall within one of our three operating segments discussed above.

All of our corporate costs that relate to overhead are contained within this segment. These costs include among others: accounting, communications, compliance, human resources, information technology, internal audit, and legal which provide support functions to our three other operating segments.

From 2004 through 2006, this segment’s operating results were as follows:


	For the years ended December 31,(in thousands)
	2006			2005			2004
Net operating revenues	$	—		$	—		$	—
Operating expenses		16,242			13,670			7,277

Operating income (loss)	$	(16,242	)	$	(13,670	)	$	(7,277	)

Corporate and other’s primary operating expense is salaries, benefits and bonuses. Salaries, benefits and bonuses represents the most significant cost to the segment and includes all amounts paid to full- and part-time employees at our corporate headquarters, as well as the related costs and benefits provided to these employees. All general and administrative costs related to the operation of our corporate office are included in operating expenses. The most significant general and administrative expenses relate to salaries, interest, and amortization expense.

Operating Expenses

Corporate and Other

Operating Expenses

(% of Total Corporate and Other Operating

Expenses)

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Salaries, Benefits and Bonuses

Salaries, benefits and bonuses increased $1.0 million, or 35.5% from 2005 to 2006. The following key positions were added at our corporate headquarters during 2006: vice president of finance, general counsel, assistant controller and an internal auditor. Several other employees holding non-key positions were added during 2006 as well.

Salaries, benefits and bonuses did not materially change from 2004 to 2005.

All Other Operating Expenses

All other operating expenses decreased $6.3 million, or 24.1%, from 2005 to 2006. This decrease primarily relates to a change in derivative expense of $7.1 million in 2005 to a derivative benefit of $10.0 million in 2006 creating a decrease in all other operating expenses of $17.1 million. This decrease of $17.1 million is off-set by increases in professional fees, legal fees and amortization expense recorded during 2006.

All other operating expenses increased $16.7 million, or 174.0%, from 2004 to 2005. This increase primarily relates to an increase in derivative expense of $7.1 million and an increase in compensation expense of variable options amounting to $2.4 million.

Operating Earnings

From 2005 to 2006, operating earnings increased $15.1 million, or 48.3% . This increase in operating earnings is primarily due to a derivative benefit of $10.0 million in 2006 verse a derivative expense of approximately $7.1 million in 2005. This decrease in derivative expense is off-set by an increase of $2.5 million in interest expense and increases in professional fees, legal fees and amortization expense. Also, there was a $5.6 million income tax benefit in 2006 versus a $5.1 million tax expense in 2005.

From 2004 to 2005, operating earnings decreased $17.2 million, or 122.9% . This decrease in operating earnings is primarily due to an increase of $2.4 million, $4.1 million and $7.1 million in compensation expense, interest expense and derivative expense, respectively.

Results of Discontinued Operations and Assets Held for Sale

PainCare Holdings, Inc., through its subsidiaries, provides healthcare services for the treatment of pain through physician practices and surgery centers in North America and Canada. PainCare’s surgery segment constitutes a component of the entity because the operations of and cash flows of the surgery segment can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity.

With the intention of narrowing our core business strategy and to reduce debt obligations, PainCare’s management decided during 2006 to exit the ambulatory surgical center acquisition strategy, and has since committed to a plan to sell our interests in our three ambulatory surgical centers (ASC’s). PainCare’s ASC’s are classified as held for sale and measured at the lower of their carrying amount or fair value less costs to sell. The operations and cash flows of these ASC’s will be eliminated from continuing operations as a result of the sale transaction, and PainCare will have no continuing involvement in the operations of the product group after it is sold. The scenario meets the requirements of FASB Statement No. 144 . Therefore PainCare will report the results of operations of the component, including any gain or loss, in discontinued operations.

In accordance with FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company records impairment losses on long-lived assets held for sale when events and circumstances indicate that the assets might be impaired if the fair value less costs to sell of the assets are less than the carrying amount of those assets. During 2006, the Company developed a plan to sell our three ASC’s with the intention of using the proceeds to pay off debt obligations. The Company plans to sell those ASC’s during the first half of 2007 and has estimated the sales value, net of related costs to sell, at amounts derived from preliminary discussions with our investment bankers. Accordingly, the Company recorded an impairment loss of $2,297,013 in 2006 attributed to one of the ASC’s. The impairment was based on the Company’s best estimate of the fair value of the ASC less costs to sell. The amount included in discontinued operations could be adjusted in the near term if experience differs from current estimates.

The results of the discontinued operations of Amphora and the three ASC’s are included in the accompanying consolidated statements of operations for the years ended December 31, 2006 and 2005 as follows:


	2006									2005
	Amphora			ASC’s			Total			ASC’s
Net Revenue	$	3,812,504		$	16,598,101		$	20,410,605		$	5,115,484
Cost of revenue and operating expenses		2,266,710			11,531,482			13,798,192			3,068,079

Operating income (loss)		1,545,794			5,066,619			6,612,413			2,047,405
Other income (loss)		—			(4,633,752	)		(4,633,752	)		(1,500,114	)

Income (loss) before provision for income taxes and minority interest		1,545,794			432,867			1,978,661			547,291
Provision (benefit) for income taxes		483,973			(392,843	)		91,130			(184,972	)

Income (loss) before minority interest		1,061,821			825,710			1,887,531			732,263
Minority interest in earnings of discontinued operations		618,318			1,605,678			2,223,996			587,637

Income from discontinued operations		443,503			(779,968	)		(336,465	)		144,626
Loss from disposal of discontinued operations, net of tax		(1,670,721	)		—			(1,670,721	)		—

Total income (loss) from discontinued operations	$	(1,227,218	)	$	(779,968	)	$	(2,007,186	)	$	144,626

The assets and liabilities of Amphora and the ASC’s included in the consolidated balance sheets as of December 31, 2006 and 2005 were as follows:


	2006		2005
Assets
Cash	$	389,905	$	205,385
Accounts receivable		6,629,433		4,624,705
Deposits and prepaids		350,486		442,953
Deferred taxes		1,113,086		—

Current assets of discontinued operations		8,482,910		5,273,043

Property and equipment, net		1,110,898		889,640
Goodwill		26,040,567		13,928,431
Other assets		740,888		457,454
Non-current deferred tax asset		852,711		735,287

Non-current assets of discontinued operations		28,745,064		16,010,812

Total assets of discontinued operations		37,227,974		21,283,855

Liabilities
Accounts payable and accrued liabilities		533,973		434,754
Current portion of capital lease obligations		18,367		122,597

Current liabilities of discontinued operations		552,340		557,351

Capital lease obligations		32,609		41,749

Long term liabilities of discontinued operations		32,609		41,749

Total liabilities of discontinued operations		584,949		599,100

Minority interests related to discontinued operations		2,191,797		1,763,838

Book value of net assets	$	34,451,228	$	18,920,917

The discontinued operations of the ASC’s were allocated the debt of $27,084,377 and $22,385,987 computing for the purpose of interest expense for 2006 and 2005, respectively. This was allocated because the Company is required by our senior lender HBK Investments to repay their note upon the sale of the ASC’s. As a result, interest expense of $4,646,963 and $1,500,914, respectively, for 2006 and 2005 has been included in the results of the discontinued operations recorded as held for sale.

Liquidity and Capital Resources

Current situation

As of December 31, 2006, the Company had a working capital deficit of $(36,409,560), including $3,597,714 of cash and cash equivalents from continuing operations. During 2006, the Company sold 3,305,033 shares of common stock, raising net proceeds of $9,496,308. The Company’s cash provided by (used in) operating activities for the years ended December 31, 2006, 2005 and 2004 was ($521,334), $8,577,513 and $4,119,026, respectively for continuing operations.

The Company expects to utilize cash and cash equivalents to fund its operating activities. We have significantly curtailed our acquisition model and have a plan to reduce expenses prospectively. The Company is continuing to pursue fund-raising possibilities through either the sale of its securities, debt financing or asset dispositions. If the Company is unable to secure additional financing on reasonable terms or if the level of cash and cash equivalents falls below anticipated levels, the Company will not have the ability to continue as a going concern beyond the second quarter of 2007.

Selling securities to satisfy its capital requirements may have the effect of materially diluting the current holders of the Company’s outstanding stock. The Company may also seek additional funding through other financing vehicles. There can be no assurances that such funding will be available at all or on terms acceptable to the Company .

Senior Credit Facility

CPM Notice of Default

The CPM Notice set forth our failure to make certain installment payments of cash and common stock under the terms of the APA. The CPM Notice further provides that unless we cure the alleged events of default set forth in the CPM Notice, (i) certain non-competition and non-solicitation provisions binding the Members will cease as of April 24, 2007, and (ii) CPM and the Members will have, as of April 12, 2007, certain rights under that certain Stock Pledge Agreement dated December 1, 2004 (the “Pledge Agreement”) entered into by us and the Members, including, but not limited to, the right to foreclose on the issued and outstanding shares of stock of the Subsidiary. Any actions by CPM or the Members to enforce their rights under the APA and Pledge Agreement may trigger certain defaults under our senior credit facility with HBK, which could materially adversely affect our business and operations. We have entered into a standstill agreement with CPM and the Members which expires on May 7, 2007. We are actively engaged in negotiations with CPM and the Members in an effort to resolve the outstanding disputes between us.

Convertible Debentures

Pursuant to certain convertible debentures issued to Midsummer Investments, Ltd and Islandia LP, the Company is currently in technical default because the Company is in default with it’s primary lender. As of May 2, 2007, the Company has not received formal notification of default.

Historic Sources and Uses of Cash

Our principal sources of liquidity are cash on hand, cash from operations, and our revolving credit agreement. Historically, our primary sources of funding have been cash flows from operations and borrowing under our long-term debt agreements. Funds were used for working capital requirements, capital expenditures, and business acquisitions. The following chart shows cash flows provided by or used in operating, investing and financing activities for 2006, 2005 and 2004:


	For the years ended December 31,
	2006			2005			2004
Net cash provided by (used in) operating activities	$	(813,863	)	$	9,173,097		$	4,119,026
Net cash used in investing activities		(18,512,052	)		(36,474,158	)		(18,407,883	)
Net cash provided by financing activities		600,368			30,913,386			25,465,930

Net increase (decrease) in cash and cash equivalents	$	(18,725,547	)	$	3,612,325		$	11,177,073

2006 compared to 2005

Operating activities.

Net cash provided by operating activities decreased $10.0 million, or 108.9%, from 2005 to 2006. The decrease in net cash provided by operating activities primarily relates to the increased expenses relating to: restatement of prior year financials, adding additional corporate staff and increases in professional fees.

Investing activities.

Net cash used in investing activities decreased $17.9 million, or 49.2%, from 2005 to 2006. The decrease in cash used in investing activities primarily relates to recording four acquisitions in 2006 compared to six acquisitions in 2005.

Financing activities.

Net cash provided by financing activities decreased $30.3 million, or 98.1%, from 2005 to 2006. The decrease in net cash provided by financing activities relates to our revolving credit line with HBK. In 2005 we initiated a note payable agreement with HBK which contributed $28.2 million in cash. In 2006, we did not receive any additional funds under our revolving loan but we borrowed $3.0 million on August 2, 2006 with a convertible debenture, sold $4.0 million in stock and paid down approximately $4.0 million in debt.

2005 compared to 2004

Operating activities.

Net cash provided by operating activities increased $5.1 million, or 122.7%, from 2004 to 2005. The increase in net cash provided by operating activities primarily relates to increases in revenues generated from the additional consolidating entities added during 2005.

Investing activities.

Net cash used in investing activities increased $18.1 million, or 98.1%, from 2004 to 2005. The increase in cash used in investing activities primarily relates to the initial cash consideration paid regarding the acquisitions recorded during 2005 as well as first year cash consideration paid to the acquisitions recorded during 2004 and second year cash consideration paid to the acquisitions recorded during 2003.

Financing activities.

Net cash provided by financing activities increased $5.4 million, or 21.4%, from 2004 to 2005. The increase in net cash provided by financing activities relates to $28.2 million received in 2005 regarding our revolving loan with HBK compared to $26.8 million cash received in 2004 relating to proceeds from the issuance of debentures and common stock.

Contractual Obligations

Achieving optimal returns on cash often involves making long-term commitments. SEC regulations require that we present our contractual obligations, and we have done so in the table that follows. However, our future cash flow prospects cannot reasonably be assessed based on such obligations, as the most significant factor affecting our future cash flows is our ability to earn and collect cash from our patients and third-party payors. Future cash outflows, whether they are contractual obligations or not, will vary based on our future needs. While some such outflows are completely fixed (for example, commitments to repay principal and interest on capital obligations), most will depend on future events (for example, a facility has a lease for property that includes a base rent amount and an annual increase based on a percentage of the consumer price index). Further, normal operations involve significant expenditures that are not based on “commitments.” Examples of such expenditures include amounts paid for income taxes or for salaries and benefits.

Our consolidated contractual obligations as of December 31, 2006, are as follows:


Contractual Obligations	Total		Less than 1 Year		One-3 Years		Three-5 Years		5+ Years
Contractual Obligations	Total		Less than 1 Year		One-3 Years		Three-5 Years		5+ Years
Long-term debt	$	34,115,378	$	34,115,378	$	—	$	—	$	—
Convertible debentures		12,415,480		12,415,480		—		—		—
Capital leases		3,115,178		1,344,055		1,583,279		187,844
Operating leases		10,197,276		2,747,160		3,508,667		2,568,558		1,372,891
Acquisition consideration		4,026,209		4,026,209		—		—		—
Employment agreements		2,400,000		600,000		1,200,000		600,000		—

Total contractual obligations	$	66,269,521

Financial restructuring plan and working capital needs

The Company’s working capital needs for 2007 are primarily for contingent cash payments of up to $6.5 million for the acquisitions as the earnings requirements are met. The Company is expected to receive a total of approximately $4 million as a tax refund during the third or fourth quarter of 2007. The refund will be used for working capital needs. The Company has also accrued $1.3 million of penalties associated with the late filing of a registration statement.

Critical Accounting Policies

Our discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements which have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. In connection with the preparation of our consolidated financial statements, we are required to make assumptions and estimates about future events, and apply judgment that affects the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors we believe to be relevant at the time we prepared our consolidated financial statements. On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

Our significant accounting policies are discussed in Note 1,Summary of Significant Accounting Policies, to our accompanying consolidated financial statements. We believe the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results, as they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. We have reviewed these critical accounting policies and related disclosures with the Audit Committee of our board of directors.

Principles of Consolidation

The accompanying financial statements include the accounts of PainCare Holdings, Inc. and its wholly-owned subsidiaries. The Company consolidates PSHS Alpha Partners as it has a 67.5% ownership interest in this entity, and it consolidates PSHS Beta Partners as it has a 73% ownership interest. The other parties’ interest in these entities are reported as minority interests in the consolidated financial statements. All significant inter-company balances and transactions have been eliminated in consolidation. The two entities with minority stockholders are included in discontinued operations since the Company unveiled a plan to sell these facilities during the fourth quarter of 2006.

The Company operates thirteen practices in states with laws governing the corporate practice of medicine where a corporation is precluded from owning the medical assets and practicing medicine. Therefore, contractual arrangements are effected to allow the Company to manage the practice. Emerging Issues Task Force No. 97-2 (“EITF No. 97-2”) states that consolidation can occur when a physician practice management entity establishes an other than temporary controlling financial interest in a physician practice through contractual arrangements. All but one of the management services agreements between the Company and the physician satisfies all of the criteria of EITF No. 97-2. The Company includes revenue with respect to these practices in the consolidated financial statements in accordance with EITF No. 97-2.

Cumulative Effect of a Change in Accounting Principle

Cumulative effect of a change in accounting principle was $991,925 and $0, net of tax, for 2006 and 2005, respectively, and resulted from the change in accounting principle from APB No. 25 to SFAS 123R. The cumulative effect of a change in accounting principle resulted from the requirement of SFAS 123R to reduce the amount of stock-based compensation expense by an estimated forfeiture rate or, in other words, the estimated number of shares that are not expected to vest as a result of an employee terminating prior to becoming fully vested in an award. Prior to the adoption of SFAS 123R, we did not reduce stock-based compensation expense based on an estimated forfeiture rate but rather recorded an adjustment to stock-based compensation as actual forfeitures occurred. Additionally, at adoption the company previously recorded the options mark to market at intrinsic value. FAS 123R requires these to be recorded at fair value. The options were revalued on January 1, 2006 using the Company’s fair value methodologies and the difference is recorded as a cumulative effect of a change in accounting principle. The cumulative effect of a change in accounting principle is generally one time in nature and not expected to occur as part of our normal business on a regular basis

Property and Equipment

Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are depreciated over the shorter of the term of the lease, including renewal periods when appropriate, or the estimated useful lives of the improvements. Expenditures for repairs and maintenance are charged to expense as incurred. Expenditures for betterments and major improvements are capitalized and depreciated over the remaining useful life of the asset. The carrying amounts of assets sold or retired and related accumulated depreciation are eliminated in the year of disposal and the resulting gains and losses are included in other income or expense. The useful lives of operating equipment range from five to ten years, and the depreciation period for leasehold improvements ranges from three to ten years.

Advertising Costs

Advertising expenditures relating to marketing efforts consisting primarily of marketing material, brochure preparation, printing and trade show expenses are expensed as incurred. Advertising expense was $1,816,794, $1,478,285, and $866,557 for the years ended December 31, 2006, 2005 and 2004, respectively, and is included in general and administrative expense in the accompanying consolidated statements of operations.

Income Taxes

financial statement and income tax basis of its assets and liabilities. The Company estimates its income taxes in each of the jurisdictions in which it operates. This process involves estimating its tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheets.

The recording of a net deferred tax asset assumes the realization of such asset in the future, otherwise a valuation allowance must be recorded to reduce this asset to its net realizable value. The Company considers future pretax income and, if necessary, ongoing prudent and feasible tax planning strategies in assessing the need for such a valuation allowance. In the event that the Company determines that it may not be able to realize all or part of the net deferred tax asset in the future, a valuation allowance for the deferred tax asset is charged against income in the period such determination is made.

Fair Value Disclosures

The carrying values of cash, accounts receivable, deposits, prepaid expenses, accounts payable and accrued expenses generally approximate the respective fair values of these instruments due to their current nature.

The carrying value of acquisition consideration payable consists of the value of cash and Company stock to be paid per contractual obligations and approximates fair value due to the current nature of the cash obligation and the stock which is recorded at fair value.

The fair values of debt instruments for disclosure purposes only are estimated based upon the present value of the estimated cash flows at interest rates applicable to similar instruments.

The Company generally does not use derivative financial instruments to hedge exposures to cash flow or market risks. However, certain other financial instruments, such as warrants and embedded conversion features that are indexed to the Company’s common stock, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or (b) physical or net-share settlement is not within the control of the Company. In such instances, net-cash settlement is assumed for financial accounting and reporting, even when the terms of the underlying contracts do not provide for net-cash settlement. Such financial instruments are initially recorded at fair value and subsequently adjusted to fair value at the close of each reporting period.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. The Company maintains its cash and cash equivalents in deposit accounts with high quality, credit-worthy financial institutions. Funds with these institutions exceeded the federally-insured limits by approximately $1,533,339 on December 31, 2006.

Credit risk with respect to accounts receivable is limited due to the large number of customers comprising the Company’s customer base. The Company controls credit risk associated with its receivables through pre-approvals with insurance providers. Generally, the Company requires no collateral from its customers.

Use of Estimates

The preparation of financial statements in conformity with United States generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. The more significant estimates relate to revenue recognition, contractual allowances and uncollectible accounts, intangible assets, accrued liabilities, derivative liabilities, income taxes, litigation and contingencies. Estimates are based on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for judgments about results and the carrying values of assets and liabilities. Actual results and values may differ significantly from these estimates.

Cash and Cash Equivalents

All short-term investments with original maturities of three months or less when purchased are considered to be cash equivalents. At December 31, 2006 and 2005, the Company had cash and cash equivalents denominated in Canadian dollars that translate to U.S. dollar amounts of approximately $129,994 and $147,239, respectively.

The Company also has a qualified cash requirement from the HBK Investments credit facility. This requires the Company to maintain a minimum consolidated balance of $2,000,000 in cash and cash equivalents at all times.

Preferred Stock

The Board of Directors is expressly authorized at any time to provide for the issuance of shares of Preferred Stock in one or more series, with such voting powers, full or limited, but not to exceed one vote per share, or without voting powers, and with such designations, preferences and relative participating, optional or other special rights and qualifications, limitations or restrictions, as shall be fixed and determined in the resolution or resolutions providing for the issuance thereof adopted by the Board of Directors.

Comprehensive Income (Loss)

As reflected in the consolidated statements of stockholders’ equity, comprehensive income is a measure of net income (loss) and all other changes in equity that result from transactions other than with stockholders. Comprehensive income (loss) consists of net income (loss) and foreign currency translation adjustments. Comprehensive losses for the years ended December 31, 2006, 2005 and 2004 were $(26,483,341), $(5,323,127) and $(1,471,067), respectively.

Foreign Currency

The Company operates a subsidiary in Canada, which is subject to different monetary, economic and regulatory risks than its domestic operations. The subsidiary uses a functional currency other than U.S. dollars, and the balance sheet accounts are translated into U.S. dollars at exchange rates in effect at the end of each reporting period. The foreign entity’s revenues and expenses are translated into U.S. dollars at the average rates that prevailed during the reporting period. The resulting net translation gains and losses are reported as foreign currency translation adjustments in stockholders’ equity as a component of accumulated other comprehensive income. Exchange gains and losses on transactions and equity investments denominated in a currency other than their functional currency are included in results of operations as incurred.

Deferred Financing Costs

Deferred financing costs related to the Company’s various credit facilities are amortized over the related terms of the debt using the effective interest method. Net deferred financing costs were $2,536,302 and $1,688,431 at December 31, 2006 and 2005, respectively, and are included as a reduction to the liability as reflected in Note 10 “ Notes Payable “ and Note 11 “ Convertible Debentures .”

Revenue Recognition

Revenue consists of net patient fee-for-service revenue. Net patient fee-for-service revenue is recognized when services are rendered. Net patient service revenue is recorded net of contractual adjustments and other arrangements for providing services at less than established patient billing rates. Allowances for contractual adjustments and bad debts are provided for accounts receivable based on estimated collection rates. The Company estimates contractual allowances based on the patient mix at each location, the impact of contract pricing and historical collection information.

Substantially all of the accounts receivable are due under fee-for-service contracts from third party payers, such as insurance companies and government-sponsored healthcare programs or directly from patients. Services are generally provided pursuant to contracts with healthcare providers or directly to patients. Accounts receivable for services rendered have been recorded at their established charges and reduced by the estimated contractual adjustments and bad debts. Contractual adjustments result from the differences between the rates charged for services performed and reimbursements by government-sponsored healthcare programs and insurance companies. Receivables generally are collected within industry norms for third-party payors. The Company continuously monitors collections from its customers and maintains an allowance for bad debts based upon any specific payor collection issues that have been identified, the historical collection experience including each practice’s experiences, and the aging of patient accounts receivable balances. The Company is not aware of any claims, disputes or unsettled matters with third-party payors which could have a material effect on the financial statements. The Company either uses in-house billing or local billing companies in each location it operates. Therefore, the Company analyzes

its accounts receivable and allowance for doubtful accounts on a site-by-site basis as opposed to a company-wide basis. This allows the Company to be more detailed and more accurate with its collection estimates. While such credit losses have historically been within expectations and the provisions established, an inability to accurately estimate credit losses in the future could have a material adverse impact on operating results.

The estimated contractual allowance rates for each facility are reviewed periodically. The Company adjusts the contractual allowance rates, as changes to the factors discussed above become known. As these factors change, the historical collection experience is revised accordingly in the period known. These allowances are reviewed periodically and adjusted based on historical payment rates. Depending on the changes made in the contractual allowance rates, net revenue may increase or decrease.

Changes in contractual allowances for the years ended December 31, 2006 and 2005 were as follows:


	For the Years Ended December 31,
	2006			2005
Balance at beginning of year (including balances from purchased business combinations)	$	30,658,843		$	14,788,745
Increase for contractual allowance		87,951,661			40,263,885
Decrease to the contractual allowance for the current year		(98,735,556	)		(24,393,787	)

Balance at end of year	$	19,874,948		$	30,658,843

A summary of the activity in the allowance for uncollectible accounts is as follows:


	For the Years Ended December 31,
	2006			2005
Balance, beginning of year	$	1,763,777		$	335,459
Additions charged to provision for bad debts		3,529,695			2,788,601
Accounts receivable written off (net of recoveries)		(3,058,387	)		(1,360,283	)

Balance, end of year	$	2,235,085		$	1,763,777

The Company’s payor mix and aging table for continuing operations for the year ended December 31, 2006 were as follows:


Financial Class	Balance on December 31, 2006		Current		31-60 Days		61-90 Days		91 + Days
Private Insurance	$	7,147,195	$	1,928,021	$	1,268,546	$	659,248	$	3,291,380
Self-Pay		339,184		91,498		60,201		31,286		156,199
Workers-Comp		2,145,160		578,676		380,742		197,867		987,875
Government		3,464,006		934,447		614,822		319,515		1,595,222

Other		1,562,845		421,592		277,387		144,155		719,711

Total		14,658,390		3,954,234		2,601,698		1,352,071		6,750,387
Allowance for doubtful accounts		2,235,085		105,726		127,230		128,974		1,873,155

Net realizable value	$	12,423,305	$	3,848,508	$	2,474,468	$	1,223,097	$	4,877,232


Aging Category	Amount		Percentage estimated for allowance for doubtful accounts		Required balance in allowance for doubtful accounts
Current	$	3,954,234	2.7	%	$	105,726
31-60 days		2,601,699	4.9	%		127,230
61-90 days		1,352,071	9.5	%		128,974
Over 91 days		6,750,387	27.7	%		1,873,155

Year end balance of allowance for doubtful accounts					$	2,235,085

The Company’s payor mix and aging table for continuing operations for the year ended December 31, 2005 were as follows:


Financial Class	Balance on December 31, 2005		Current		31-60 Days		61-90 Days		91 + Days
Medicare	$	1,588,876	$	658,177	$	281,062	$	117,867	$	531,770
Private insurance		12,738,637		5,276,860		2,253,383		944,989		4,263,405
Self-pay		1,056,948		437,832		186,967		78,407		353,742
Workers compensation		2,606,677		1,079,792		461,104		193,371		872,410
Government		2,415,551		1,000,618		427,296		179,193		808,444
Medicaid		262,510		108,742		46,436		19,474		87,858
Other		2,357,983		976,772		417,112		174,922		789,177

Total		23,027,182		9,538,793		4,073,360		1,708,223		7,706,806
Allowance for doubtful accounts		1,763,777		333,355		305,287		162,191		962,944

Net realizable value	$	21,263,405	$	9,205,438	$	3,768,073	$	1,546,032	$	6,743,862


Aging Category	Amount		Percentage estimated for allowance for doubtful accounts		Required balance in allowance for doubtful accounts
Current	$	9,538,793	3.5	%	$	333,355
31-60 days		4,073,360	7.5	%		305,287
61-90 days		1,708,223	9.5	%		162,191
Over 91 days		7,706,806	12.5	%		962,944

Year end balance of allowance for doubtful accounts					$	1,763,777

Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. For any amount of those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities based on the technical merits of the position. FIN 48, which is effective for fiscal years beginning after December 15, 2006, also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The requirements of FIN 48 are effective for our fiscal year beginning January 1, 2007. The Company is evaluating the impact of FIN 48 and does not believe there will be an impact during the first quarter of 2007.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures related to fair value measurements that are included in a company’s financial statements. SFAS No. 157 does not expand the use of fair value measurements in financial statements, but emphasizes that fair value is a market-based measurement and not an entity-specific measurement that should be based on an exchange transaction in which a company sells an asset or transfers a liability (exit price). SFAS No. 157 also establishes a fair value hierarchy in which observable market data would be considered the highest level, while fair value measurements based on an entity’s own assumptions would be considered the lowest level. For calendar year companies like the Company, SFAS No. 157 is effective beginning January 1, 2008. The Company is currently evaluating the effects, if any, that SFAS No. 157 will have on its consolidated financial statements.

In November 2006, the FASB approved EITF 06-06, “Debtor’s Accounting for a Modification (or Exchange) of Convertible Debt Instruments” which modifies EITF 96-19 to require a change in the value of an embedded conversion feature of a modified debt to be tested in a separate calculation. Early adoption of EITF 06-06 is permitted, and the Company has elected early adoption and applied the provisions of EITF 06-06 to record the results of the December 2006 refinancing of its subordinated convertible notes.

In December 2006, the FASB approved EITF 00-19-2, “Accounting for Registration Payment Arrangements,” which establishes the standard that contingent obligations to make future payments under a registration rights arrangement shall be recognized and measured separately in accordance with Statement 5 and FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss . Early adoption of EITF 00-19-2 is permitted, and the Company has elected such early adoption. As a result we have recorded an estimate of the expected registration statement penalties of $1.3 million.

Business Outlook

We were forced to devote a significant portion of our time and attention in 2006 to matters primarily outside the ordinary course of business, and those efforts have continued in 2007, although to a much lesser extent. At the same time, we expect to experience volume volatility, payor pressure, and increased competition in our markets. Accordingly, we anticipate our operating results will show a decline between 2006 and 2007 based on various factors.

•

Ancillary Services. In 2007, our ancillary services segment will continue to experience potential divestures from the three surgery centers currently listed as assets held for sale.

•

Pain Management. In 2007, our focus within the pain management segment will be on increasing volume growth and financial control. We expect to see margin expansion through financial control of expenses, and by providing additional ancillary services to existing facilities as well as possible expansion to satellite locations.

•

Surgeries. In 2007, our focus within the surgeries segment will be to increase the productivity of our same practice operations as well as perform segment analyses on the possible expansion of potential revenue generating ancillary services.

•

Corporate. In 2007, we will strive to control costs associated with corporate segment, but this may prove difficult due to our continued investment in our infrastructure (both people and technology). We will also continue to focus on the remediation of weaknesses in our internal controls. We will continue to replace the work performed by external consultants with PainCare employees, and we will continue to add resources to provide the necessary level of support to our facilities and meet our operational needs.

While we expect our 2007 operating results will be consistent with the fact that PainCare is in a reorganization period, we are optimistic about the long-term positioning of PainCare. We continue to offer high quality services in growing segments of the health care industry which should provide long-term growth opportunities. In addition, we are stabilizing operations of our core business strategy of stabilized growth through highly profitable acquisitions and implementing additional ancillary services across all practices.

Whatever market conditions we face, we will continue to seek opportunities to improve operations, stabilize our finances, and develop new relationships with doctors as potential future acquisitions in our industry, with the ultimate goal of providing sustainable growth and return for our stockholders.

Quantitative and Qualitative Disclosures about Market Risk

Market risk generally represents the risk of loss that may result from the potential change in value of a financial instrument as a result of fluctuations in interest rates and market prices. We do not currently have any trading derivatives nor do we expect to have any in the future. We have established policies and internal processes related to the management of market risks, which we use in the normal course of our business operations.

Interest Rate Risk

Our interest rate risk, in the borrowings under our credit facility, is based on variable market interest rates. As of December 31, 2006, we had $27.8 million of variable rate debt outstanding under our credit facility. At December 31, 2006, the revolving credit line bore interest at a rate of LIBOR plus 7.25% or Prime plus 4.5%. On March 21, 2007 the Company received from the Agent for the debt notification that the interest rate would change to the default rate of LIBOR plus 10.25%. Additionally, the Company has estimated a rate increase of approximately 13.45% based on the average rate increase over the previous year under the variable debt. The combination of these two factors would yield a hypothetical average interest rate of 16.54% for the next year. These increases would correspondingly decrease our pre-tax earnings and operating cash flows by approximately $1,076,131. The actual change in the pre-tax earnings and operating cash flows for the default rate is approximately $832,500. The hypothetical change in the increase to pre-tax earnings and operating cash flows is $243,631.

Intangible Asset Risk

We have a substantial amount of intangible assets. We are required to perform goodwill impairment tests whenever events or circumstances indicate that the carrying value may not be recoverable from estimated future cash flows. As a result of our periodic evaluations, we may determine that the intangible asset values need to be written down to their fair values, which could result in material charges that could be adverse to our operating results and financial position. At December 31, 2006, we performed the impairment tests and determined impairment was needed for both goodwill and the other intangible assets. The total impairment was $33,994,512 for continuing operations and $2,297,013 for discontinued operations.

Equity Price Risk

We do not own any equity investments, other than in our subsidiaries. As a result, we do not currently have any direct equity price risk.

Commodity Price Risk

We do not enter into contracts for the purchase or sale of commodities. As a result, we do not currently have any direct commodity price risk.

WHAT WE DO

Overview

independent physician practices and medical institutions throughout the United States and Canada, PainCare is committed to utilizing the most advanced science and technologies to diagnose and treat pain stemming from neurological and musculoskeletal conditions and disorders.

PainCare has defined four reportable segments: pain management, surgery, ancillary service and corporate and other. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations “ and “Note 24” of “ Notes to Consolidated Financial Statements “ for financial information about these segments for the years ended December 31, 2006, 2005 and 2004.

We have relationships with 59 physician practices and ambulatory surgery center locations. Through our subsidiaries, we operate three types of practice arrangements:

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We employ licensed physicians in 12 practices which we own;

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We have acquired the non-medical assets and we provide general management services to 19 physician practices;

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We provide limited management services to 35 physician practices in areas such as in-house physical therapy, electrodiagnostic services and intra-articular joint injection programs.

physicians, usually for a five year term, which provide for base compensation and incentive compensation based upon increases in operating earnings. These contracts are subject to earlier termination in certain circumstances. The physicians are subject to confidentiality and non-competition provisions that typically run for two years following the termination of the physician’s employment agreement.

Business Strategy

Our objective is to become the leading provider of specialty pain care services in North America. To grow our practices, we intend to:

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Given the current status of liquidity, acquisitions in the near term will need to be done on a highly selective basis and meet parameters acceptable to our lenders.

Our objective is to become the pre-eminent utilization management service provider for patients requiring pain-related treatment. To facilitate growth we intend to:

- Offer a “patient centered” network as part of its menu. Other menu items include individualized guidance, algorithm-based case management, care coaching and evidence based and outcome driven pain management.

- Build programs that balance patient medical conditions with health plan parameters. These programs will include case management, care coaching, quality improvement and physician education.

- Benefit providers by using an algorithm based triage system and accumulate all patient provider and encounter information in a centralized data warehouse. This data will subsequently be biostatistically analyzed to determine clinical efficiency leading to the most effective treatment pathways.

Industry Background

In an effort to implement our core business strategy we continue to focus on evaluating our business and the broader health care market with the goal of positioning PainCare as a leading provider of pain-focused medical and surgical solutions and services. As we continue to develop our strategic plan, we will evaluate the role of each segment of our business. We have received inquiries from parties interested in acquiring three of our ambulatory surgical centers. An important consideration in our decision to divest any material assets from our portfolio would be whether the transaction would help to deleverage the company.

Industry Trends

As a provider of pain management, rehabilitative health care, ambulatory surgery, and diagnostic services, our revenues and growth are affected by trends in health care spending. According to estimates published by the Centers for Medicare and Medicaid Office of the Actuary, the healthcare sector is continuing to grow in relation to the overall gross domestic product (GDP). As a percent of GDP, healthcare spending is expected to reach 16.2% in 2005 and by 2015 healthcare spending in the U.S. is projected to reach $4.0 trillion or 20% of GDP. Healthcare is expected to continue to grow at a steady pace of 7.2% per year on average.

Demographic factors contribute to long-term growth projections in health care spending. According to the U.S. Census Bureau’s 2005 interim projections, there were approximately 36.8 million Americans age 65 or older. The number of Americans age 65 or older is expected to increase to approximately 40 million in 2010 and approximately 54 million in 2020. By 2030 the number of Americans age 65 or older is expected to reach 70 million.

We believe that the aging of the U.S. population and the continuing growth in health care spending will increase demand for the types of services we provide. First, many of the health conditions associated with aging-such as neurological disorder, diseases and injury to the muscles, bones and joints-will increase the demand for our pain management and rehabilitative services. Second, pressure from payors to provide efficient, high-quality health care services is forcing many procedures traditionally performed in acute care facilities out of the acute care environment.

Operating Segments

Our internal financial reporting and management structure is focused on the major types of services provided by PainCare. We currently provide various patient care services through three operating segments and certain other services through a fourth segment, which correspond to our four reporting business segments: (1) pain management, (2) surgeries, (3) ancillary services, and (4) corporate and other. Although we have no current plans to change our operating segments, we are continually evaluating and looking to optimize our operational structure and the mix of services we provide, which may lead to future changes in our operating segments.

Our consolidated net operating revenues from continuing operations were $63.7 million for the fiscal year ended December 31, 2006. We had a diversified payor mix across all our reporting segments, with Private Insurance representing the highest percentage of revenues.

For additional information regarding our business segments and related information, see the section, Management’s Discussion and Analysis of Financial Condition and Results of Operations, “ Segment Results of Operations,” and Note 24, Operating Segment and Geographic Information , to our accompanying consolidated financial statements.

Pain Management

Our pain management segment provides treatment through interventional and non-interventional therapies that treat both the chronic and acute pain patient. Our pain management facilities are located in eight states in the United States and one province in Canada.

As of December 31, 2006 our pain management segment operated 16 facilities (four of which are wholly owned and 12 of which are managed contracts). Our pain management segment provides services to patients who are in need of such services as therapeutic injections, radio frequency treatments and both physical and behavioral therapy.

Pain management has emerged as a separate specialty in medicine. Methods used to treat chronic or acute pain are continually evolving. Some of the more common approaches to the treatment of pain include the following:

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Analgesics. Pharmaceutical treatments for pain include nonopioid analgesics, including nonsteriodial anti- inflammatory drugs, or NSAIDS, such as aspirin and acetaminophen, opioid analgesics, such as morphine, and other drugs that have analgesic properties that are useful in treating pain, such as certain antiepileptic and antidepressant drugs;

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Diagnostic Injection.Injection of anesthetics and anti-inflammatory agents directly into the area surrounding the pain generating nerve can relieve pain symptoms and often allow the nerve area to heal and repair itself. These injections, often referred to as “epidural or facet blocks,” allow the pain specialist to identify the specific anatomic structure that is generating the pain response;

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Implantable Pumps. Implantable pain pumps are devices inserted in the patient’s body that deliver a constant dose of anesthetic to a particular region of the body. The pain specialist can alter the level of anesthetic delivered depending on patient need. Implantable pumps are often used to treat cancer pain or severe back pain;

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Neuromodulation Devices.Neuromodulation devices such as implantable stimulators or pumps are used to treat chronic pain by altering nervous system activity either electrically or pharmacologically; and

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Radio Frequency Nerve Ablation. RF Nerve Ablation is a procedure used to temporarily deactivate minor nerves around the spine by heating surrounding tissue with a special probe to deactivate the pain generating nerve fibers.

Acute and Chronic Pain

Clinical Approaches to Pain Treatment

The standard of care for treatment of chronic or acute pain may vary greatly depending on the underlying cause of the patient’s pain. A patient who is suffering from pain generally receives a clinical assessment, including a review of the patient’s medical history, to attempt to determine the cause of the patient’s pain.

Diagnosis. To assist in determining the pain’s origin, the physician may employ one or more imaging modalities, such as x-ray, computed tomography or CT scan, or magnetic resonance imagery or MRI. In addition, the physician may order an electrodiagnostic medical consultation, which can be helpful to establish an accurate diagnosis of a clinical problem that suggests neuromuscular disorder. Electrodiagnosis involves the placement of electrodes in proximity to the patient’s nervous system, and the application of electrical pulses that stimulate nerve function. By identifying those nerves that are generating the pain response, the physician can more accurately determine the cause of the patient’s pain and determine the appropriate treatment.

Orthopedic Rehabilitation. One of the most frequent causes of chronic pain is injury or disease affecting the spine. Orthopedic rehabilitation is often the first approach to the treatment of back pain and is frequently used following surgical treatment to post-operatively restore the patient’s muscle function. Depending on the underlying cause of the patient’s back pain and its severity, the physician may recommend orthopedic rehabilitation, which may include:

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Hot and cold packs;

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Electric stimulation or electrotherapy;

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Massage;

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Exercise;

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Ultrasound therapy; and

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Physical therapy sessions, utilizing specialized orthopedic rehabilitation equipment.

Surgeries

As of December 31, 2006 our surgery centers segment operated three managed facilities in Florida, Louisiana and Virginia. Our surgical services offered include full spectrum orthopedic surgery, minimally invasive spine surgery and foot and ankle surgery.

Minimally Invasive Surgery. In contrast to traditional open surgery approaches, minimally invasive surgery techniques have been developed that require only a small incision and the use of endoscopic instruments to perform the operation. Some of the minimally invasive surgical treatments for back pain include:

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Discogram,a diagnostic procedure that involves injecting a dye into the disc of the spine, and using an x-ray to determine whether the disc has been damaged;

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Intra-Discal Electro-Thermal AnnuloplastyorIDET,which is used to treat patients with pain due to disc herniation in the lower back. Using an x-ray for guidance, a small thermal catheter is inserted into the herniated disc and gradually heated, raising the temperature inside the disc. The heat contracts and thickens the protein of the disc wall as well as deactivating many of the nerve endings responsible for the pain in the damaged disc;

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Percutaneous Discectomy,which employs a mechanical or laser-based probe inserted into a herniated spinal disc, which removes material from the disc to relieve pressure and associated pain;

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Nucleoplasty,for the treatment of pain from mildly herniated discs causing pressure on adjacent nerve roots. Using an x-ray for guidance, a needle and specialized device are inserted into the herniated disc applying heat to remove the excess tissue and seal the disc; and

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Kyphoplasty,which is used to treat vertebral compression fractures associated with osteoporosis. Again using an x-ray for guidance, the bone is drilled and a balloon is inserted and inflated in the fracture area. The space created by the balloon is filled with orthopedic cement, binding the fracture and relieving pain.

Inpatient Spine Surgery.If the patient does not respond to orthopedic rehabilitation, or if the extent of the disease or injury is too great, the physician may elect surgical treatment for back pain. Traditional surgical treatments for back pain include surgeries such as:

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Spinal fusion, which involves fusing one or more vertebrae together using screws, rods or grafts;

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Anterior discectomy, which involves removal of a spinal disc;

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Anterior corpectomy, which involves removing a portion of the entire vertebra or disc; and

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Laminectomy, where a portion of the entire vertebra is removed to repair a disc, access the spinal cord or relieve degeneration of the spine.

These techniques are typically performed in an inpatient hospital setting and involve exposing a large area of the patient’s spine. Following the operation, a long recovery period with extensive rehabilitation is typically required. We believe that there are many advantages to minimally invasive surgery over traditional open surgery, including shorter time involved, reduced cost and faster patient recovery and return to normal activities.

Ancillary Services

As of December 31, 2006 our ancillary services segment operated five managed facilities in Florida, Illinois, Michigan and Maryland. Three of our ancillary service facilities are consolidated through managed contracts and two facilities are owned on a partnership basis. Our partnership interest in both Lake Worth Surgical Center and Coral Gables Surgical Center is 67.5% and 73.0%, respectively. For management reporting purposes, it should be noted that the three ambulatory surgery centers currently listed as held for sale are included in the ancillary services segment which relates to discontinued operations. See Item 7. Management Discussion and Analysis for further analysis. Our ancillary service segment provides the following services:

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Orthopedic Rehabilitation Services. We have a program for the deployment of orthopedic rehabilitation services to the physician practice that facilitates advanced strength testing and restoration of function within the physician office environment. As needed, we will establish an in-house, fully staffed and provisioned rehabilitation clinic, with additional physiatrists, physical therapists or technicians as practice requirements dictate. We provide all supplies and equipment necessary for the operation of the clinic including state-of-the- art MedX equipment. MedX equipment has been clinically and academically demonstrated to be efficacious in rehabilitating patients. We believe that by providing orthopedic rehabilitation services in-house, the physician is better able to monitor the patient’s progress toward recovery, which contributes to improved clinical outcomes.

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Electrodiagnostic Services. We also have a program for the deployment of an electrodiagnostic medicine program as a direct extension of the neurologic portion of the physical examination. We provide electrodiagnostic equipment, supplies, and technicians to perform procedures, and arrange for physician over- read and review of results. We believe that by performing these procedures in-house, we have the potential to enhance accuracy and time to diagnosis.

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Diagnostic Imagery. We deploy magnetic resonance imagery, or MRI, technology to selected facilities. We believe that providing diagnostic imagery technology to pain management practices will be more convenient for patients and allow physicians to better diagnose and treat acute and chronic pain.

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Intra-Articular Joint Program. In January 2005, we unveiled a new proprietary ancillary service designed to address severe knee pain and stiffness caused by osteoarthritis, which currently affects over 21 million Americans. The intra-articular joint program will be integrated into the service offerings provided by each suitable physician practice in our national healthcare organization. In addition, the intra-articular joint program will be marketed nationally to non-affiliated physician practice groups under a limited management agreement, similar to our proprietary orthopedic rehabilitation and electro diagnostic medicine programs. The intra- articular joint program is a proprietary, technologically advanced, non-operative knee treatment protocol that combines a five to six week series of strategically targeted injections of Hyalgan—the first FDA-approved hyaluronan therapy to treat osteoarthritis knee pain in the United States, with synergistic orthopedic rehabilitation procedures specifically designed to strengthen blood flow to the knee.

Corporate and Other

Corporate and other includes only cost functions that are managed directly from our corporate office and that do not fall within one of our three operating segments discussed above.

All corporate costs and related overhead are contained within this segment. These costs, include such expenses as: accounting, communications, compliance, human resources, information technology, internal audit, and legal and provide support functions to our operating segments.

Growth of Existing Practices

To grow revenue, we assist our owned and managed practices with the addition of selected specialty physicians and treatment services. This permits the practice to offer in house additional services that would previously be referred out to other providers. As a result, we believe that the treating physician is better able to monitor the patient, and respond to any specific treatment needs more rapidly and effectively than if the patient were using an outside provider. We believe that this approach results in the opportunity for improved clinical outcomes, shortened treatment times and increased revenue to the physician practice.

In our experience, physicians operating high-growth, busy practices often have limited time and resources to evaluate the potential impact of the deployment of additional services and equipment. Even if the physician has obvious demand for additional services, it can be time-consuming and costly to locate, qualify, negotiate with and incorporate additional specialists into the existing practice. Further, the time and resources required to physically expand the practice, through purchase or lease of additional real estate, design and construction of new facilities, and the acquisition and deployment of capital-intensive equipment are often significant barriers to growth for the practicing physician. Our approach is to relieve the physician of the administrative burdens associated with expanding the practice, which we believe allows the physician to focus more effectively on patient care, while creating opportunities for the physician’s practice to support organic growth.

Additional Physician Services

Depending on the size, growth profile and type of physician practice, we may deploy additional specialists certified in pain management, neurosurgery, orthopedics or physiatry. For example, with regard to an existing orthopedic surgery practice, we may add an additional spine surgeon to handle additional patients, and deploy an interventional pain management specialist to perform pain management procedures. Our objective is to offer complementary services to the physicians existing patient bases based on current trends.

We currently own and operate nine outpatient surgery centers which are located within physician offices. By providing these centers within the physician office, we are able to charge a technical fee for procedures performed on our premises, in addition to the professional fee charged by the physician. As needed, we will construct outpatient surgery centers or individual procedure rooms within our practice offices to enable outpatient procedures to be performed. We believe that such facilities are well suited to pain management and minimally invasive surgical procedures, and represent a lower-cost alternative to inpatient or dedicated surgery center facilities.

Real Estate Services. To support the growth of our physician practices, we provide real estate services to practices which require additional office space or a specialty installation such as a fluoroscopy suite or in-office procedure room. Our services include:

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Locating additional office space within the practice’s local area;

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Negotiation of purchase or lease terms;

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Analysis of building codes, architectural requirements and design services; and

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Construction management services.

We believe that by providing these real estate services to our practices, the physicians can devote more time to the clinical aspects of the practices, enhancing the quality of care delivered and the profitability of the practices.

Operations Management

When we acquire or enter into a management agreement with a practice, we focus on integrating the practice with our operations. We have an eight-member team that is charged with facilitating a smooth transition after closing. Our integration team, in coordination with our consultants, legal counsel and independent accountants, works with the existing practice administrators and staff to perform such functions as:

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Applying for provider numbers from Medicare and other health care payors to ensure continuity of reimbursement;

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Performing a complete post-transaction audit of the practice accounting records; and

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Developing detailed budgets for operating performance with physicians, which are based on historical operating performance.

Once initial integration is complete, our integration team works with the physician and practice administrators to develop a plan for the implementation of additional physician services and ancillary services. For example, our integration and real estate personnel may devise a plan for the addition of an interventional pain management specialist to the practice, and develop and implement a detailed plan for the addition of a fluoroscopy suite to support minimally invasive surgical treatments that require x-ray guidance.

Following the integration and deployment of additional services, our integration team assists PainCare’s management in monitoring the practice and ensuring that performance targets are met. If the practice’s growth needs warrant, the integration team may be deployed to provide additional services or assist the practice in achieving its growth targets.

In contrast to historical physician practice management business models that required the implementation of common information technology systems, such as shared billing and collection, clinical data and electronic health record systems, we deploy only those resources necessary to support the growth of additional services. Changes to information technology systems are kept to a minimum, and changes to billing and collection procedures are also minimized, subject to our legal, oversight and reporting requirements.

Recent Developments

Acquisitions

Since our founding in 2000, we have completed twenty-four practice acquisitions. The following acquisitions (all managed unless indicated otherwise) have been completed since January 1, 2006:


Name and Nature of Business	Effective Date of Purchase	Purchase Price
Center for Pain Management ASC, LLC, a fully accredited ambulatory surgical center with four locations in Maryland.	January 3, 2006	$3,750,000 in cash and 1,021,942 shares of common stock, plus promissory notes totaling $7,500,000 in principal, due one year from the closing date . On December 5, 2006, an additional $300,000 promissory note was issued and the due date of both the $7,500,000 and $300,000 promissory notes was extended until April 2, 2007.

REC, Inc. & CareFirst Medical Associates, P.A., co-located pain management and orthopedic rehabilitation practices located inWhitehouse, Texas.	January 6, 2006	$625,000 in cash and 191,131 shares of PainCare’s common stock, plus contingent payments of up to $1,250,000 in cash and common stock if certain performance goals are met.

Desert Pain Medicine Group, a pain management physician practice with three locations in California.	January 20, 2006	$1,500,000 in cash and 471,698 shares of PainCare’s common stock, plus contingent payments of up to $3,000,000 in cash and common stock if certain performance goals are met.

Amphora, LLC, an intraoperative monitoring company based in Denver, Colorado, serving medical institutions throughout Colorado, Wyoming, Arizona and Nebraska	February 1, 2006	PainCare purchased a 60% ownership interest and paid $3,250,000 in cash and 1,035,032 shares of PainCare’s common stock, plus contingent payments of up to $8,500,000 in cash and common stock if certain performance goals are met. This transaction was rescinded on December 11, 2006.

On November 15, 2006, PainCare formed a new wholly-owned subsidiary named Integrated Pain Solutions (IPS). Leveraging PainCare’s centralized and specialized knowledge base of advanced pain diagnostics, interventional pain management and functional restoration procedures and solutions, IPS will develop, administer and track the outcome of proprietary, evidenced-based, clinical pathways for the management of acute or chronic pain. This clinical criteria will serve as the basis for the delivery of quality care by highly credentialed, multi-disciplined provider networks contracted and managed by IPS in select U.S. markets.

Upon establishing each regionalized provider network, IPS will contract with third party payers, including insurance carriers, self-insured employers and large trade unions, among other similar groups, to provide utilization management services, specialized case management and prospective and concurrent risk assessment of patients requiring pain-related care and treatment. Further, IPS will endeavor to ultimately establish “Pain Centers of Excellence” in its primary service markets where it will centralize care addressing interventional pain management, functional restoration and behavioral health. PainCare expects to launch commercial operations of IPS late in the first quarter of 2007, following the necessary corporate set-up and development efforts required to activate the first provider network.

Dispositions

We continually evaluate the performance of our individual practices. Any practice that is deemed to be underperforming will become subject to more direct oversight by our management team. To the extent additional oversight fails to improve the practice’s performance over a period of time, the practice will become subject to additional company imposed actions, including, but not limited to, potential restructuring or divestiture.

On February 1, 2006, the Company and PainCare Neuromonitoring I, Inc. (“PCN,” and together with the Company the “Paincare Parties”) acquired a 60% interest (the “Amphora Transaction”) in Amphora LLC (“Amphora”) from Bruce Lockwood, M.D., John D. Bender, D.O., and Richard A. Flores (collectively the “Members”) pursuant to the terms of a Membership Interest Purchase Agreement (the “Amphora Purchase Agreement”), for a combination of cash and shares of common stock of the Company and the obligation to make certain additional payments post closing (the “Purchase Price”). On December 11, 2006 the Paincare Parties and the Members entered into an agreement providing for the rescission of the Amphora Transaction (the “Rescission Agreement”). Pursuant to the terms of the Rescission Agreement (i) the Amphora Purchase Agreement was rescinded, (ii) the Members paid the Paincare Parties a sum of $1,400,000 and returned to the Paincare Parties 1,035,032 shares of common stock of the Company, (iii) the Company delivered to the Members a noncompetition agreement, and (iv) the parties entered into mutual releases. The description of the Rescission Agreement set forth herein is qualified in its entirety by the specific terms of the Rescission Agreement.

On October 14, 2005, PainCare Holdings, Inc. (the “PainCare”), PainCare Acquisition Company XXI, Inc. (the “PainCare

Sub,” and together with PainCare the “PainCare Parties”), Christopher J. Centeno, M.D., P.C. (the “Original Practice”), Therapeutic Management, Inc. (“TMI”), Christopher J. Centeno, M.D. (“Centeno”), John Schultz, M.D. (“Schultz”), and Centeno Schultz, Inc. (“CSI”, and together with the Original Practice, Centeno, Schultz and TMI, the “Centeno Parties”), effected a transaction (the “Purchase Transaction”) by which (i) the PainCare Parties acquired substantially all of the assets of the Original Practice, pursuant to that certain Asset Purchase Agreement, by and among the PainCare Parties, Centeno, Schultz and CSI; (ii) the PainCare Parties acquired substantially all of the assets TMI pursuant to that certain Asset Purchase Agreement, by and among the PainCare Parties, TMI and Centeno; and (iii) CSI and the PainCare Sub entered into that certain Management Services Agreement (the “Management Agreement”) pursuant to which the PainCare Sub managed the business operations of CSI.

On February 28, 2007, the PainCare Parties and the Centeno Parties entered into a Settlement Agreement (the “Settlement Agreement”) and several ancillary documents (the “Settlement Transaction”) pursuant to which said parties rescinded the Purchase Transaction and terminated agreements among them. To effectuate the rescission of the Purchase Transaction, (i) the PainCare Sub sold, and the Original Practice purchased, substantially all of the assets of the PainCare Sub for purchase price of the lesser of $250,000 or the total amount of proceeds generated from the sale certain shares of common stock of PainCare (the “PainCare Shares”) issued to the Centeno Parties in the Purchase Transaction, and (ii) in exchange for the agreement of the PainCare Parties to terminate the Management Agreement and any and all other agreements between CSI and the PainCare Parties, CSI paid the PainCare Parties $750,000 plus all remaining proceeds in excess of $250,000 from the sale of the PainCare Shares.

With the intention of narrowing our core business strategy and to reduce debt obligations, PainCare’s management decided during 2006 that the ambulatory surgery centers no longer fit the Company’s acquisition model, and committed to a plan to sell the ASC’s. PainCare’s ambulatory surgery centers, which are consolidated through the ancillary services segment, are classified as held for sale and measured at the lower of their carrying amount or fair value less costs to sell. The operations and cash flows of these ASC’s will be eliminated from ongoing operations as a result of the sale transaction, and PainCare anticipates that it will have no continuing involvement in the operations of the product group after it is sold. Therefore PainCare is reporting the results of operations of the component, including any gain or loss, in discontinued operations, as per the requirements of FASB Statement No. 144 —“Accounting for the Impairment or Disposal of Long-Lived Assets.”

Our Operations

The following table is a list of our owned practices (“O”), managed practices (“M”) , continuing operations (“C”), discontinuing operations (“D”) and outpatient surgery centers, including the original specialty of these practices and the services that we have added to them after we acquired the non-medical assets and entered into management agreements with them.


Practice Name	Location	Effective Date of Transaction	Initial Specialty	Added Service(s)
Rothbart Pain Management Clinic, Inc.(M)(C)	Toronto, Canada	December 1, 2000	Pain Management	Additional Physicians

Advanced Orthopedics of South Florida II, Inc. (M)(C)	Lake Worth, FL	January 1, 2001	Orthopedic Surgery	Orthopedic Rehabilitation, Electrodianostic Medicine Additional Physicians, Intra-Articular Joint, Pharmacy Dispensing

Pain and Rehabilitation Network, LLC (M)(C)	Orange Park, FL	December 12, 2002	Pain Management	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Additional Physicians, Intra-Articular Joint, (1) Additional Location, Expansion of In Office Procedure Room



Medical Rehabilitation Specialists II, Inc. (O)(C)	Tallahassee, FL	May 16, 2003	Pain Management	Orthopedic Rehabilitation, Additional Building Space

Associated Physicians Group (M)(C)	O’Fallon, IL	August 6, 2003	Orthopedic Rehabilitation	Orthopedic Rehabilitation, Intra-Articular Joint, Additional Physicians, (1) Additional Location with In Office Procedure Room

Spine & Pain Center, P.C. (M) (C)	Bismarck, ND	December 23, 2003	Pain Management	Orthopedic Rehabilitation, Intra- Articular Joint

Health Care Center of Tampa, Inc.(O)(C)	Lakeland, FL	December 30, 2003	Pain Management	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Intra- Articular Joint, Additional Physician Provider

Bone & Joint Surgical Clinic, Inc.(O)(C)	Houma, LA	December 31, 2003	Orthopedic Surgery	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Additional Building Space, Intra-Articular Joint

Kenneth M. Alo, M.D., P.A. (M)(C)	Houston, TX	December 31, 2003	Pain Management	Electrodiagnostic Medicine

Denver Pain Management, P.C.(M)(C)	Denver, CO	April 29, 2004	Pain Management	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Intra- Articular Joint, Additional Physicians

Georgia Pain Physicians, P.C. / Georgia Surgical Centers, Inc. (M)(C)	Atlanta, GA	May 25, 2004	Pain Management	Fellowship Program, Additional Physicians, Pharmacy Dispensing Three Single Specialty Ambulatory Surgical Centers

Dynamic Rehabilitation Centers (M)(C)	Detroit, MI	June 1, 2004	Orthopedic Rehabilitation	Orthopedic Rehabilitation, Intra-Articular Joint

Rick Taylor, D.O., P.A. (M)(C)	Palestine, TX	June 7, 2004	Pain Management	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Diagnostic Imaging, Intra-Articular Joint, Additional Physicians, (1) Additional Location, including Physical Therapy and Procedure Room

Benjamin Zolper, M.D., Inc. (O)(C)	Bangor, ME	July 1, 2004	Pain Management	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Office Expansion, Additional NP & PT, and Physician Provider

The Center for Pain Management (M)(C)	Baltimore, MD	December 1, 2004	Pain Management	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Intra- Articular Joint, Additional PA & PT

Colorado Pain Specialists, P.C. (M)(C)	Denver, CO	April 15, 2005	Pain Management	Electrodiagnostic Medicine, Intra-Articular Joint, Additional PA

PSHS Alpha Partners, Ltd. d/b/a Lake Worth Surgical Center (M)-Partnership(D)	Lake Worth, FL	May 12, 2005	One Ambulatory Surgical Center	N/A



PSHS Beta Partners, Ltd. d/b/a Gables Surgical Center (M)- Partnership(D)	Miami, FL	August 1, 2005	One Ambulatory Surgical Center	N/A

Piedmont Center for Spinal Disorders, P.C. (M)(C)	Danville, VA	August 9, 2005	Orthopedic Surgery	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Intra-Articular Joint, Additional Physician and In Office Procedure Room

Floyd O. Ring, Jr., M.D., P.C. (M)(C)	Denver, CO	October 3, 2005	Pain Management	(1) Additional Location, Additional PA and In Office Procedure Room

Christopher J. Centeno, M.D., P.C. & Therapeutic Management, Inc. (M)(C)	Denver, CO	October 14, 2005	Pain Management	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Intra- Articular Joint, Additional PA. This transaction was rescinded on February 28, 2007.

The Center for Pain Management ASC, LLC (O)(D)	Baltimore, MD	January 3, 2006	Four Single Specialty Ambulatory Surgical Centers	N/A

REC, Inc. & CareFirst Medical Associates (M)(C)	Whitehouse, TX	January 6, 2006	Pain Management	Orthopedic Rehabilitation, Electrodiagnostic Medicine, Intra- Articular Joint, In Office Procedure Room

Desert Pain Medicine Group (M)(C)	Palm Springs, CA	January 20, 2006	Pain Management	Intra-Articular Joint, Expansion of Office location including New In Office Procedure Room, (2) Additional Physicians and (1) Additional PA

Amphora, LLC(D)	Denver, CO	February 1, 2006	Ancillary Service	This transaction was rescinded on December 11, 2006.

In addition to our four wholly-owned physician practices and seventeen managed physician practices, we provide limited management services and equipment to 35 other practices throughout the country, including orthopedic rehabilitation, electrodiagnostic services and intra-articular joint therapy and equipment

Competition

Pain Management

Our pain management and rehabilitation facilities face competition from large privately and publicly held companies such as Health South, and U.S. Physical Therapy, Inc.

We expect competition to increase, particularly in the market for rehabilitation services, as consolidation of the therapy industry continues through acquisitions by hospitals and large health care companies of physician-owned and other privately owned therapy practices.

Some of these competitors may have greater referral support and financial resources in particular markets than we do. We believe we compete successfully within the marketplace based on our size, reputation for quality and positive rehabilitation outcomes.

Surgery Centers

We face competition from other providers of ambulatory surgical care in developing ASC joint ventures, acquiring existing centers, attracting patients, and negotiating managed care contracts in each of our markets. There are several publicly held

companies, divisions or subsidiaries of publicly held companies, and several private companies that operate ASC’s. Further, many physician groups develop ASC’s without a corporate partner, utilizing consultants who typically perform these services for a fee who may not require an equity interest in the ongoing operations of the center.

We believe that we compete effectively in this market but no longer feel that surgery center facilities are a part of our core business model. On a forward looking basis, we do not plan to pursue any acquisitions with ASC service providers.

Ancillary Services

The market for ancillary services is highly fragmented and competitive. Many physicians and physician groups have opened up offices that offer ancillary services. Our ancillary services also compete with local hospitals, rehabilitation centers and local independent companies.

Regulatory Environment

General

Our practices are subject to substantial federal, state and local government health care laws and regulations. In addition, laws and regulations are constantly changing and may impose additional requirements. These changes could have the effect of impeding our ability to continue to do business or reduce our opportunities to continue to grow.

Every state imposes licensing requirements on individual physicians and health care facilities. In addition, federal and state laws regulate HMOs and other managed care organizations. Many states require regulatory approval, including certificates of need, before establishing certain types of health care facilities, including surgery centers, or offering certain services.

Many states in which we do business have corporate practice of medicine laws which prohibit us from owning practices or exercising control over the medical judgments or decisions of physicians. These laws and their interpretations vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion. In those states, we acquire the non-medical assets of these practices and enter into long-term management agreements with these managed practices and with respect to our limited management practices, we enter into shorter term limited management agreements. Under those agreements, we provide management services and other items to the practices in exchange for a service fee. We structure our relationships with the practices in a manner that we believe keeps us from engaging in the corporate practice of medicine or exercising control over the medical judgments or decisions of the practices or their physicians. Nevertheless, state regulatory authorities or other parties could assert that our agreements violate these laws.

managed practices and the limited management practices in a manner that keeps us from violating prohibitions on fee splitting, state regulatory authorities or other parties may assert that we are engaged in practices that constitute fee-splitting. This would have a material adverse effect on us.

Medicare and Medicaid Participation

A substantial portion of our revenues are expected to continue to be received through third-party reimbursement programs, including state and federal programs, primarily Medicare as well as Medicaid, and private health insurance programs. Medicare is a federally funded and administered health insurance program, primarily for individuals entitled to social security benefits who are 65 or older or who are disabled. Medicaid is a health insurance program jointly funded by state and federal governments that provides medical assistance to qualifying low income persons.

To participate in the Medicare program and receive Medicare payment, the owned practices, managed practices and limited management practices must comply with regulations promulgated by the Department of Health and Human Services. The requirements for certification under Medicare and Medicaid are subject to change and, in order to remain qualified for these programs, the practices may have to make changes from time to time in equipment, personnel or services. Although we believe these practices will continue to participate in these reimbursement programs, we cannot assure you that these practices will continue to qualify for participation.

Medicare Fraud and Abuse

The anti-kickback provisions of the Social Security Act (the “Anti-Kickback Statute”) prohibit anyone from knowingly and willfully (a) soliciting or receiving any remuneration in return for referrals for items and services reimbursable under most federal health care programs; or (b) offering or paying any remuneration to induce a person to make referrals for items and services reimbursable under most federal health care programs. The prohibited remuneration may be paid directly or indirectly, overtly or covertly, in cash or in kind.

Violation of the Anti-Kickback Statute is a felony, and criminal conviction results in a fine of not more than $25,000, imprisonment for not more than five years, or both. Further, the Secretary of the Department of Health and Human Services has the authority to exclude violators from all federal health care programs and/or impose civil monetary penalties of $50,000 for each violation and assess damages of not more than three times the total amount of remuneration offered, paid, solicited or received.

As the result of a congressional mandate, the Office of the Inspector General (OIG) of the Department of Health and Human Services promulgated regulations specifying certain payment practices which the OIG determined to be at minimal risk for abuse. The OIG named these payment practices “Safe Harbors.” If a payment arrangement fits within a safe harbor, it will be deemed not to violate the Anti-Kickback Statute. Merely because a payment arrangement does not comply with all of the elements of any Safe Harbor, however, does not mean that the parties to the payment arrangement are violating the Anti-Kickback Statute.

With respect to the managed practices and the limited management practices, we provide general management services and limited management services, respectively. In return for those services, we receive compensation. The OIG has concluded that, depending on the facts of each particular arrangement, management arrangements may be subject to the Anti-Kickback Statute. In particular, an advisory opinion published by the OIG in 1998 (98-4) concluded that in a proposed management services arrangement where a management company was required to negotiate managed care contracts on behalf of the practice, the proposed arrangement could constitute prohibited remuneration where the management company would be reimbursed its costs and paid a percentage of net practice revenues.

Our management agreements with the managed practices and the limited management practices differ from the management agreement analyzed in Advisory Opinion 98-4. Significantly, we believe we are not in a position to generate referrals for the managed practices or the limited management practices. In fact, our management agreements do not require us to negotiate managed care contracts on behalf of the managed practices or the limited management practices, or to provide marketing, advertising, public relation services or practice expansion services to those practices. Because we do not undertake to generate referrals for the managed practices or the limited management practices, and the services provided to these practices differ in scope from those provided under Advisory Opinion 98-4, we believe that our management agreements with the managed practices and limited management practices do not violate the Anti-Kickback Statute. Nevertheless, although we believe we have structured our management agreements in such a manner as not to violate the Anti-Kickback Statute, we cannot guarantee that a regulator would not conclude that the compensation to us under the management agreements constitutes prohibited remuneration. In such event, our operations would be materially adversely affected.

our position that the owned practices’ arrangements with their respective employed physicians do not violate the Anti-Kickback Statute. Nevertheless, if the relationship between the owned practices and their physician employees is determined not to be a bona fide employment relationship, this could have a material adverse effect on us.

Our agreements with the limited management practices may also raise different Anti-Kickback concerns. In April of 2003, the OIG issued a Special Advisory Bulletin which addressed contractual joint ventures where a health care provider in one line of business (“Owner”) expands into a related health care business by contracting with an existing provider of a related item or service (“Manager”) to provide the new item or service to the Owner’s existing patient population. In those arrangements, the Manager not only manages the new line of business, but may also supply it with inventory, employees, space, billing and other services. In other words, the Owner contracts out substantially the entire operation of the related line of business to the Manager, receiving in return the profits of the business as remuneration for its federal program referrals to the new line of business.

According to the OIG, contractual joint ventures have the following characteristics: (i) the establishment of a new line of business; (ii) a captive referral base; (iii) the Owner lacks business risk; (iv) the Manager is a competitor or would-be competitor of the Owner’s new line of business; (v) the scope of services provided by the Manager is extremely broad, with the manager providing: day to day management; billing; equipment; personnel; office space; training; health care items, supplies and services; (vi) the practical effect of the arrangement is to enable the Owner to bill insurers and patients for business otherwise provided by the Manager; (vii) the parties agree to a non-compete clause barring the Owner from providing items or services to any patient other than those coming from Owner and/or barring the Manager from providing services in its own right to the Owner’s patients.

We have attempted to draft our agreements with the limited management practices in a manner that takes into account the concerns in the Special Advisory Bulletin. Specifically, under our arrangements, the limited management practice takes business risk. It is financially responsible for the following costs: the space required to provide the services; employment costs of the personnel providing the services and intake personnel; and billing and collections. We do not reimburse the limited management practice for any of these costs. We provide solely equipment, supplies and our management expertise. In one of our limited management business lines we do not even provide the equipment. In return for these items and services, we receive a percentage of the limited management practice’s collections from the services being managed by us that is consistent with the fair market value of our services. Consequently, we believe that the limited management practice is not being compensated for or to induce its referrals.

Although we believe that our arrangements with the limited management practices do not violate the Anti-Kickback Statute for the reasons specified above, we cannot guarantee that our arrangements will be free from scrutiny by the OIG or that the OIG would not conclude that these arrangements violate the Anti-Kickback Statute. In a recent OIG Advisory Opinion No. 4-17, the OIG declined to issue a favorable opinion on a limited lease/management arrangement involving physician office-based pathology laboratory services. Although we believe that our limited management arrangements are distinguishable from the facts in Advisory Opinion No. 4-17, this opinion illustrates how broadly the OIG is applying its contractual joint venture analysis. In the event the OIG were to conclude that our limited management arrangements violate the Anti-Kickback Statute, this would have a material adverse effect on us.

Federal Anti-Referral Laws

Section 1877 of Title 18 of the Social Security Act, commonly referred to as the “Stark Law,” prohibits a physician from making a referral to an entity for the furnishing of Medicare-covered “designated health services” if the physician (or an immediate family member of the physician) has a “financial relationship” with that entity. “Designated health services” include clinical laboratory services; physical and occupational therapy services; radiology services, including magnetic resonance imaging, computerized axial tomography scans, and ultrasound services (including the professional component of such diagnostic testing, but excluding invasive procedures where the imaging modality is used to guide a needle, probe or catheter accurately); radiation therapy services and supplies; durable medical equipment and supplies; home health services; inpatient and outpatient hospital services; and certain other services. A “financial relationship” is defined as an ownership or investment interest in or a compensation arrangement with an entity that provides designated health services. Sanctions for prohibited referrals include denial of Medicare payment, and civil money penalties of up to $15,000 for each service ordered. Designated health services furnished pursuant to a referral that is prohibited by the Stark Law are not covered by Medicare and payments improperly collected must be promptly refunded.

There are several exceptions to the prohibition on referrals for designated health services which have the effect of allowing a physician that has a financial relationship with an entity to make referrals to that entity for the provision of Medicare-covered designated health services. The exception on which we rely with respect to the owned practices is the exception for employees, as all of the physicians employed in our owned practices are employees of the respective owned practices. Therefore, we believe that the physicians employed by our owned practices can refer patients to the owned practices for the provision of designated health services covered by Medicare. Nevertheless, should the owned practices fail to adhere to the conditions of the employment exception, or if a regulator determines that the employees or the employment relationship do not meet the criteria of the employment exception, the owned practices would be liable for violating the Stark Law, and that could have a material adverse effect on us. We believe that our relationships with the managed practices and the limited management practices, respectively, do not trigger the Stark Law. Nevertheless, if a regulator were somehow to determine that these relationships are subject to the Stark Law, and that the relationships do not meet the conditions of any exception to the Stark Law, such failure would have a material adverse effect on us.

The referral of Medicare patients by physicians employed by or under contract with the managed practices and the limited management practices, respectively, to their respective practices, however, does trigger the Stark Law. We believe, nevertheless, that the in-office ancillary exception to the Stark Law has the effect of permitting these physician members of the respective managed practices and limited management practices to refer patients to their respective group practice for the provision by the respective group practice of Medicare-covered designated health services. If the managed practices or limited management practices fail to abide by the terms of the in-office ancillary exception, they cannot properly bill Medicare for the designated health services provided by them. In such an event, our business could be materially adversely affected because the revenues we generate from these practices is dependent, at least in part, on the revenues or profits generated by those practices.

State Anti-Referral Laws

At least some of the states in which we do business also have prohibitions on physician self-referrals that are similar to the Stark Law. These laws and interpretations vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion. As indicated elsewhere, we enter into management agreements with the managed practices and the limited management practices. Under those agreements, we provide management and equipment and services to the practices in exchange for compensation. Although we believe that the practices comply with these laws, and although we attempt to structure our relationships with these practices in a manner that we believe keeps us from violating these laws (or in a manner that we believe does not trigger the law), state regulatory authorities or other parties could assert that the practices violate these laws and/or that our agreements with the practices violate these laws. Any such conclusion could adversely affect our financial results and operations.

A substantial portion of our business operations, including our corporate offices, are located in Florida. Florida’s prohibition on self-referrals, Fla. Stat. §456.053 (“Self-Referral Act”), prohibits health care providers from referring patients, regardless of payment source (not just Medicare and Medicaid beneficiaries), for the provision of certain designated health services (“Florida Designated Health Services”) to an entity in which the health care provider is an investor or has an investment interest. Under the Self-Referral Act, Florida Designated Health Services are defined as clinical laboratory, physical therapy, and comprehensive rehabilitative, diagnostic-imaging and radiation therapy services. We currently operate facilities, and plan to purchase additional practices that provide some or all of these Florida Designated Health Services. All health care products and services not considered Florida Designated Health Services are classified as “other health services.” The Self-Referral Act also prohibits the referral by a physician of a patient for “other health services” to an entity in which that physician is an investor, unless (i) the physician’s investment interest is in the registered securities of a publicly traded corporation whose shares are traded on a national exchange or over-the-counter market and which has net equity at the end of its most recent fiscal quarter in excess of $50,000,000; or (ii) the physician’s investment interest is in an entity whereby (a) no more than 50% of the value of the investment interests in the entity may be held by investors who are in a position to make referrals to the entity; (b) the terms under which an investment interest is offered must be the same for referring investors and non-referring investors; (c) the terms under which an investment interest is offered may not be related to the investor’s volume of referrals to the entity; and (d) the investor must not be required to make referrals or be in the position to make referrals to the entity as a condition for becoming or remaining an investor (the “50% Investor Exception”).

Entities that meet either exception must also (i) not lend to or guarantee a loan to an investor who is in a position to make referrals if the investor uses any part of that loan to obtain the investment interest, and (ii) distribute profits and losses to investors in a manner that is directly proportional to their capital investment.

The Self-Referral Act excludes from the definition of “referral” services by a health care provider who is a sole provider or member of a group practice (as defined by the Self-Referral Act) that are provided solely for the referring health care provider’s or group practice’s own patients (“Group Practice Exception”). Referrals by our physician investors who are not employed by an owned practice to an owned practice for “other health services” should qualify for the 50% Investor Exception, because physician-investors in a position to refer to our owned practice, but who are not employed by our owned practice, do not collectively own more than 50% of the investment value of PainCare. However, physician investors who are not employed by our owned practices cannot refer to our owned practices for Florida Designated Health Services because they are not members of our owned group practices and, thus, their referrals would not qualify for the Group Practice Exception. So long as physician investors who are not employed by our owned practices do not refer to our owned practices for Florida Designated Health Services, we believe we will be in compliance with the Self-Referral Act. Although we will have mechanisms in place to monitor referrals from physician investors, it is the responsibility of the physician investors to comply with the Self-Referral Act and there can be no assurances that physician investors will comply with such law. Violations thereof could adversely affect us, as well as result in regulatory action against the Company.

The Self-Referral Act also imposes certain disclosure obligations on us and physician investors who are referring physicians. Under the Self-Referral Act, a physician may not refer a patient to an entity in which he or she is an investor, even for services that are not Florida Designated Health Services, unless, before doing so, the patient is given a written statement disclosing, among other things, the physician’s investment interest in the entity to which the referral is made. Other obligations are imposed on the Company as a result of the Self-Referral Act. It is the responsibility of any referring physician investor to comply with such statutes, regulations and professional standards. However, this law may discourage certain physician investors from making referrals to us or encourage patients to choose alternative health care providers. In addition, the violation thereof could adversely affect us, as well as result in regulatory action against us.

Violations of the Florida self-referral laws may result in substantial civil penalties and administrative sanctions for individuals or entities as well as the suspension or revocation of a physician’s license to practice medicine in Florida. Such sanctions, if applied to us or any of our physician investors, would result in significant loss of reimbursement and could have a material adverse effect on us.

Florida also has a criminal prohibition regarding the offering, soliciting, or receiving of remuneration, directly or indirectly, in cash or in kind, in exchange for the referral of patients (the “Patient Brokering Act”). One of the exceptions to this prohibition is for business and compensation arrangements that do not violate the Anti-Kickback Statute. Accordingly, so long as we are in compliance with the Anti-Kickback Statute, then the arrangement should be in compliance with the Patient Brokering Act.

Information Privacy Regulations

Numerous state, federal and international laws and regulations govern the collection, dissemination, use and confidentiality of patient-identifiable health information, including the federal Health Insurance Portability and Accountability Act of 1996 and related rules, or HIPAA. In the provision of services to our patients, we may collect, use, maintain and transmit patient information in ways that may or will be subject to many of these laws and regulations. The three rules that were promulgated pursuant to HIPAA that could most significantly affect our business are the Standards for Electronic Transactions, or Transactions Rule; the Standards for Privacy of Individually Identifiable Health Information, or Privacy Rule; and the Health Insurance Reform Security Standards, or Security Rule. The respective compliance dates for these rules for most entities were October 16, 2002, April 16, 2003 and April 21, 2005. HIPAA applies to covered entities, which include most healthcare providers and health plans that will contract for the use of our services. HIPAA requires covered entities to bind contractors to compliance with certain burdensome HIPAA requirements. Other federal and state laws restricting the use and protecting the privacy of patient information also apply to us, either directly or indirectly.

engaging in one of more of these standard transactions and will be required to conduct those transactions in compliance with the required standards. The HIPAA Privacy Rule restricts the use and disclosure of patient information and requires entities to safeguard that information and to provide certain rights to individuals with respect to that information. The HIPAA Security Rule establishes elaborate requirements for safeguarding patient information transmitted or stored electronically. We may be required to make costly system purchases and modifications to comply with the HIPAA requirements that are imposed on us and our failure to comply with these requirements may result in liability and may adversely affect our business.

Federal and state consumer protection laws are being applied increasingly by the Federal Trade Commission, or FTC, and state attorneys general to regulate the collection, use and disclosure of personal or patient information, through websites or otherwise, and to regulate the presentation of website content. Courts may also adopt the standards for fair information practices promulgated by the FTC, which concern consumer notice, choice, security and access.

Numerous other federal and state laws protect the confidentiality of private information. These laws in many cases are not preempted by HIPAA and may be subject to varying interpretations by courts and government agencies, creating complex compliance issues for us and potentially exposing us to additional expenses, adverse publicity and liability. Other countries also have, or are developing, laws governing the collection, use and transmission of personal or patient information and these laws, if applicable, could create liability for us or increase our cost of doing business.

Employees

As of May 2, 2007, the Company and its subsidiaries employed and leased approximately 534 persons, of which approximately 444 are full time and 58 are licensed physicians. These employees do not include physicians and other allied healthcare personnel employed by our managed practices.

Our ability to provide our services is dependent upon recruiting, hiring, and retaining qualified technical personnel. To date, we have been able to recruit and retain sufficient qualified personnel. None of our employees is represented by a labor union. We have not experienced any work stoppages and consider relations with our employees to be in good standing.

Available Information

Our Internet address for our corporate website is www.paincareholdings.com. We make available free of charge, through the Investor Information section of our corporate website, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act) as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the United States Securities and Exchange Commission (“SEC”). We have not incorporated by reference into this Report the information on our corporate website, and you should not consider it to be a part of this Report. The Internet address for our corporate website is included as an inactive textual reference only.

Properties

Our principal executive office is located in Orlando, Florida where we lease office space for our corporate headquarters. In addition to our headquarters building, as of December 31, 2006 we leased approximately 47 facilities through various consolidated entities to support our operations. Our leases generally have initial terms of five years, but range from one to ten. Most of our leases contain options to extend the lease period for up to five additional years. Our consolidated entities are sometimes responsible for property taxes, property casualty insurance, and routine maintenance expenses. With regard to all of our consolidated facilities, none are material to our business.

Our headquarters, facilities, and other properties are suitable for their respective uses and are, in general, adequate for our present needs. Our properties are subject to various federal, state, and local statutes and ordinances regulating their operations. Management does not believe that compliance with such statutes and ordinances will materially affect our business, financial condition, or results of operations. Refer to Note 20, Related Party Transactions for a listing of related party lease agreements.

Legal Proceedings

We have become aware of eleven putative class action lawsuits and one derivative action filed against us and certain of our officers and directors. We understand that the lawsuits arose in connection with our determination to restate certain of our historical financial statements. We believe that the lawsuits lack merit and we have engaged the international law firm of McDermott Will & Emery LLP to vigorously defend against such allegations and claims. There can be no assurance at this time how the lawsuits in question will ultimately be resolved, or the impact, if any, such resolutions will have on our operations and/or financial condition.

On March 21, 2006, Roy Thomas Mould filed a complaint under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against the Company, as well as the Company’s chief executive officer and chief financial officer, before the United States District Court for the Middle District of Florida. The complaint is entitled Mould v. PainCare Holdings, Inc., et al. , Case No. 06-CV-00362-JA-DAB. Mr. Mould alleges material misrepresentations and omissions in connection with the Company’s financial statements which appear to relate principally to the Company’s previously announced intention to restate certain past financial statements. Ten additional complaints were filed shortly afterward before the same court which recite similar allegations. (Collectively, these cases will be referred to as the “Securities Litigation.”) Lead counsel was selected, a consolidated complaint was filed, the Company moved to dismiss, and oral argument on the motion was held on January 17, 2007 before the Magistrate Judge, and we are awaiting the issuance of the Magistrate Judge’s report and recommendation. In the consolidated complaint, the lead plaintiff seeks unspecified damages and purports to represent a class of shareholders who purchased the Company’s common stock from March 24, 2003 and March 15, 2006. The Company cannot predict the outcome of the Securities Litigation, but has advised us that it believes that the allegations lack merit and will vigorously defend against them.

On April 7, 2006, Kenneth R. Cope filed a derivative complaint against the directors of the Company before the United States District Court for the Middle District of Florida. The complaint is entitled Cope v. Reuter, et al. , Case No. 06-CV-00449-JA-DAB. Mr. Cope alleges that the directors breached their fiduciary duties by failing to supervise and manage the operations of the company, among other claims. (This litigation is referred to as the “Derivative Action.”)

On March 30, 2006, and May 3, 2006, two purported shareholders of the Company made separate demands on the Company’s board of directors. These demands raised many if not all of the same issues as the Derivative Action, but asked the independent directors to investigate the charges and to take “legal actions against those individuals responsible.”

In accordance with governing Florida law, the Company formed a special committee of independent directors (Tom Crane, Jay Rosen and Aldo Berti) to review and investigate the two derivative demands and the allegations of the derivative complaint, to oversee settlement discussions and to make recommendations concerning the handling of the demands and the complaints to the full board of directors. To assist with this charge, the special committee retained the law firm of Morris, Nichols, Arsht & Tunnell.

In November of 2006, the Company and the plaintiff in the Derivative Action entered into a Stipulation and Agreement of Compromise, Settlement and Release, filed on November 30, 2006, and conditioned upon court approval. Concurrently with the filing of the foregoing agreement, the parties jointly moved from preliminary court approval, and thereafter, for final approval following notice to the Company’s shareholders. On January 12, 2007, the court preliminary approved the Stipulation and Agreement and set a hearing on April 20, 2007, for final approval.

Further, the Company has received demands from Dr. Wright, The Centeno Group, and the Amphora Group related to alleged misrepresentations. With regard to these demands, no demand for monetary damages has been made nor has litigation been commenced, and the demands have since been resolved. The Company disputes the basis of any claim, and it is premature to be able to estimate the potential exposure, if any.

MANAGEMENT

Board of Directors and Executive Officers

The following table lists all of our incumbent executive officers of the Company on December 31, 2006, and is included pursuant to Item 401(b) of Regulation S-K:


Name	Age	Since	Positions
Randy Lubinsky	54	2002	Chief Executive Officer; Director
Mark Szporka	51	2002	Chief Financial Office; Director
Ronald Riewold	59	2002	President; Director
Merrill Reuter, M.D.	46	2002	President of AOSF; Chairman

The following table lists all directors of the Company as of December 31, 2006 and is included pursuant to Item 401 (a) of Regulation S-K. Directors are elected for a period of one year and thereafter serve until the next annual meeting at which their successors are duly elected by the stockholders. Officers and other employees serve at the will of the Board of Directors:

Identification of Directors


Name	Board Member Age	Since	Positions
Randy Lubinsky	54	2002	Director; Chief Executive Officer
Mark Szporka	51	2002	Director; Chief Financial Officer
Ronald Riewold	59	2002	Director; President
Merrill Reuter, M.D.	46	2002	Director; Chairman, President of AOSF
Jay Rosen, M.D	48	2002	Director
Arthur J. Hudson	55	2002	Director
Robert Fusco	56	2002	Director
Aldo F. Berti, M.D.	59	2004	Director
Thomas J. Crane	49	2004	Director

There are no arrangements or understandings known to us between any of the individuals listed above and any other person pursuant to which he or she was or is to be selected as an officer, other than any arrangements or understandings with officers of PainCare acting solely in their capacities as such.

Current Directors

Randy Lubinsky, Chief Executive Officer and Director of the Company, joined the Company on August 1, 2000 and has served as a Director of the Company since 2002. Mr. Lubinsky has over 25 years experience as a healthcare entrepreneur and investment banker. He has built businesses from the start-up phase in the healthcare and real estate industries, and has assisted several public companies in implementing roll-up strategies. In March of 2000, Mr. Lubinsky co-founded Quest Capital Partners, LC in Orlando, Florida, an investment banking firm specializing in healthcare where he acted as Managing Director until he joined PainCare in August of 2000. From September of 1999 until March of 2000, Mr. Lubinsky served as a Director of Cloverleaf Capital Advisors, L.L.C., an investment banking firm specializing in healthcare and e-learning, located in Ocoee, Florida. Mr. Lubinsky received a BA degree in finance from Florida International University.

Mark Szporka, Chief Financial Officer and Director of the Company joined the Company on August 1, 2000 and has served as a Director of the Company since 2002. Mr. Szporka has in excess of 25 years experience as an investment banker, chief financial officer and strategic planner. In March of 2000, he co-founded Quest Capital Partners, LC in Orlando, Florida, an investment banking firm specializing in healthcare where he acted as a Director until he joined PainCare in August of 2000. From September of 1999 until March of 2000, Mr. Szporka served as a Director of Cloverleaf Capital Advisors, L.L.C., an investment banking firm specializing in healthcare and e-learning, located in Ocoee, Florida. Mr. Szporka received a MBA from the University of Michigan and a BBA from the University of Notre Dame. He is a Certified Public Accountant (non-active) in New York.

Ronald L. Riewold, is the Company’s President and Director and has served as a Director of the Company since 2002. Effective February 7, 2003, the Board elected Mr. Riewold to succeed Dr. Rosen as President of the Company. From December 1999 until January 2001, Mr. Riewold served as a consultant for American Enterprise Solutions, Inc. (“AESI”), a healthcare delivery system and internet utility located in Tampa, Florida which focused on the connectivity of the Internet in the healthcare industry. Mr. Riewold later became Executive Vice President, then President and Chief Operating Officer of AESI. Mr. Riewold has a BA degree from Florida State University and a MBA from Temple University.

Merrill Reuter, M.D., is the Company’s Chairman of the Board and is the President of Advanced Orthopaedics of South Florida, Inc. and has served as a Chairman of the Board of Directors since 2002. Dr. Reuter founded Advanced Orthopaedics of South Florida, Inc. in Lake Worth, Florida in 1992 and from that date until the present has served as its President and Medical Director. He received a BS degree from Tulane University in 1982 and a Masters in Medical Science and a Medical Degree from Brown University in 1986. Dr. Reuter completed his General Surgical Internship and Orthopedic Surgery Residency Training Program at the University of Texas Medical Branch in Galveston, Texas.

Jay L. Rosen, M.D., has served as a Director of the Company since 2002. Dr. Rosen has over 15 years experience as a healthcare entrepreneur. Since 1992, he has and continues to serve as Chief Executive Officer and Executive Director of Tampa Bay Surgery Center, Inc., an outpatient surgical facility that specializes in minimally invasive spinal surgery and pain management procedures in Tampa, Florida. During his tenure with Tampa Bay Surgery Center, Dr. Rosen has successfully developed and managed outpatient surgery, diagnostic, specialized ambulatory treatment and physical rehabilitation centers. He also is active in managing Seven Springs Surgery Center in New Port Richey, Florida. Dr. Rosen received a BS degree from Fordham University and Medical Degree from Cetec University. He performed graduate medical research at Hahnemann University in Philadelphia and the Medical Center at SUNY at Stony Brook. Dr. Rosen is a Diplomat of the American Board of Quality Assurance and Utilization Review Physicians. He currently serves on the Board of Directors for Tampa Bay Surgery Center, Inc., Tampa Bay Surgery Associates, Inc., Rehab One, Inc., Open MRI & Diagnostic Center, Inc., Immuvac, Inc., and Intellicare, Inc.

Arthur J. Hudson, has served as a Director of the Company since November 2002. Mr. Hudson has been employed with Fidelitone, Inc. of Wauconda, Illinois since 1974. He currently serves as Senior Vice President of Corporate Development for the full service inventory management, distribution and logistics company. From 1998 to 2001, he also served as head of international sales for Aero Products International, Inc., a wholly owned subsidiary of Fidelitone. Mr. Hudson is a member of the board of directors of Fidelitone. He received a B.S. degree in economics from Colorado State University.

Robert Fusco, has served as a Director of the Company since November 2002. Mr. Fusco has over 20 years experience in the healthcare industry and was responsible for building Olsten Corporation into one of the largest home health and specialty pharmaceutical distribution services companies in North America. Since March 2000 when Olsten Corporation was sold to Addecco Corporation, Mr. Fusco has been an independent consultant. From January 1985 to April 2000, Mr. Fusco served in various capacities including President of Olsten Health Services and Executive Vice President of Olsten Corporation. From 1979 to 1985, he served as Executive Vice President of Bio-Medical Applications, inc., a subsidiary of National Medical Care, Inc., and had profit and loss responsibility for over 180 dialysis clinics nationally. Mr. Fusco received a BS degree from Manhattan College.

Aldo F. Berti, M.D., has served as a Director of the Company since November 2004. Since 1980, Dr. Berti has owned and provided physician and neurosurgical services to Aldo F. Berti, M.D. P.A. located in Miami, Florida. Additionally, Dr. Berti is an international medical and neurosurgical consultant, having published numerous academic articles and presented extensively at Medical Conferences worldwide. Dr. Berti has developed an expertise, and has a special interest, in complex spinal surgery, pain management, and spine rehabilitation. Dr. Berti is the Associate Director for Latin America at the Gamma Knife Institute at Jackson Memorial Medical Center at the University of Miami School of Medicine. Dr. Berti is a Fellow at the American College of Surgeons and the American Academy of Pediatrics. Dr. Berti has pioneered the field of CyberKnife Radiosugery in the State of Florida by having performed the first procedure in December of 2003. In the past Dr. Berti has been elected as chief of neurosurgery and chief of the department of surgery at Cedars Medical Center of Miami. Dr. Berti is affiliated with the following hospitals: Cedars Medical Center, Miami, Florida; Jackson Memorial Medical Center -Gamma Knife Institute, Miami, Florida; North Shore Medical Center, Miami, Florida; Palm Springs Hospital, Miami, Florida; and South Miami Hospital, Miami, Florida.

Thomas J. Crane, has served as a Director of the Company since November 2004. Since January 1991, Mr. Crane has owned and operated a specialized law practice located in Naples, Florida. Beginning in 2000, Mr. Crane formed, and currently acts as the Managing Director, of Cloverleaf Capital International, LLC, an investment banking firm focused on media, technology, and health care. In 1990, Mr. Crane founded and became President/CEO of Southwestern Broadcasting Corporation (SBC), a Naples, Florida based radio station group owner. In August of 1998, SBC sold its assets to Broadcast Entertainment Corporation (BEC), an affiliated company operating radio stations in Texas, New Mexico, and California. Mr. Crane was, at the time of the sale, and remains a principal stockholder and Chairman of the Board of Directors of BEC, with its corporate offices located in Clovis, New Mexico. Mr. Crane also sits on the Boards of Compass Knowledge Holdings, Inc. based in Ocoee, Florida and XTEL, Inc., a telecommunications network based in Miami, Florida, and has published several

legal articles concerning media, broadcasting, and communications. Mr. Crane holds a Juris Doctor degree from the University of Miami, School of Law, Miami, Florida, a Bachelor of Arts degree from Florida State University, Tallahassee, Florida and a Certificate of Languages from the University of Paris (Sorbonne), Paris, France. Mr. Crane is licensed to practice law in the States of Florida and Texas.

Committees and Meetings

The Board of Directors held five meetings in 2006 and a quorum of directors attended either in person or via teleconference. All directors hold office until the next annual meeting of stockholders and the election and qualification of their successors. Directors receive compensation for serving on the Board of Directors as described below.

Committees of the Board of Directors

The Company has established a standing Audit Committee, Compensation Committee and Stock Option Committee. The Company has not established a Nominating Committee.

Audit Committee

The Audit Committee retains and oversees the Company’s independent registered public accounting firm, reviews the scope and results of the annual audit of the Company’s consolidated financial statements, reviews non-audit services provided to the Company by its independent registered public accounting firm and monitors transactions among the Company and its affiliates, if any. The Audit Committee currently consists of Mr. Fusco, the chairman of the Audit Committee, Mr. Hudson and Mr. Crane, who are all independent under American Stock Exchange and SEC rules. The Board of Directors has determined that Mr. Fusco, chairman of the Audit Committee, is qualified as an Audit Committee Financial Expert. During fiscal 2006, the Audit Committee held five meetings at which all of the members of the Committee were present.

Compensation Committee

The Compensation Committee is responsible for supervising the Company’s compensation policies, administering the employee incentive plans, reviewing officers’ salaries and bonuses, approving significant changes in employee benefits and recommending to the Board such other forms of remuneration as it deems appropriate. The Compensation Committee currently consists of Mr. Crane, the chairman of the Compensation Committee, Dr. Berti and Mr. Hudson, who are all independent. During fiscal 2006, the Compensation Committee held one meeting, at which all of the members of the Committee were present.

Stock Option Committee

The Stock Option Committee is responsible for supervising and administering the Company’s Stock Option Plans, approving significant changes in the Plans and recommending to the Board such other forms of remuneration as it deems appropriate. The Stock Option Committee currently consists of Mr. Crane, the chairman of the Stock Option Committee, and Mr. Hudson, who are independent. During fiscal 2006, the Stock Option Committee held one meeting, at which all members of the Committee were present.

Executive Compensation

Overview of Compensation Program

The Compensation Committee (for purposes of this analysis, the “Committee”) of the Board has responsibility for establishing, implementing and continually monitoring adherence with the Company’s compensation philosophy. The Committee ensures that the total compensation paid is fair, reasonable, and competitive. Generally, the types of compensation and benefits provided to executive officers are similar to those provided to other executive officers.

Compensation Philosophy and Objectives

The Committee believes that the most effective executive compensation program is one that is designed to reward the achievement of specific annual, long-term and strategic goals by the Company, and which aligns executives’ interests with

those of the stockholders by rewarding performance above established goals, with the ultimate objective of improving stockholder value. The Committee evaluates both performance and compensation to ensure that the Company maintains its ability to attract and retain superior employees in key positions and that compensation provided to key employees remains competitive relative to the compensation paid to similarly situated executives of our peer companies. To that end, the Committee believes executive compensation packages provided by the Company to its executives, including the named executive officers should include both cash and stock-based compensation that reward performance as measured against established goals.

Role of Executive Officers in Compensation Decisions

The Committee makes all compensation decisions for the Chief Executive Officer and approves recommendations regarding equity awards to all elected officers of the Company. Decisions regarding the non-equity compensation of other executive officers are made by the Chief Executive Officer.

The Chief Executive Officer and the Committee review the performance of senior officers and executive officers of subsidiaries. The conclusions reached and the recommendations based on these reviews, including with respect to salary adjustments and annual award amounts, are presented to the Committee; however, it is the decision of the Chief Executive Officer to make final determination on all agreements with senior officers and executive officers of subsidiaries.

Setting Executive Compensation

Based on the foregoing objectives, the Committee has structured the Company’s annual and long-term incentive-based cash and non-cash executive compensation to motivate executives to achieve the business goals set by the Company and reward the executives for achieving such goals. In 2007, the Committee engaged Hay Group, Inc., an independent global human resources consulting firm, to conduct a review of the CEO’s base salary, total cash compensation and total direct compensation relative to a peer group of 13 companies approved by the Committee. The Committee will use this information to make compensation decisions concerning the CEO’s pay in 2007.

The Company’s executive compensation policy is designed to enable the Company to attract, motivate and retain senior management by providing a competitive compensation opportunity based significantly on performance. The objective is to provide fair and equitable compensation to senior management in a way that rewards management for reaching and exceeding objectives. The compensation policy links a significant portion of executive compensation to the Company’s performance, recognizes individual contribution as well as overall business results, and aligns executive and stockholder interests.

2006 Executive Compensation Components

For the fiscal year ended December 31, 2006, the principal components of compensation for named executive officers were:

•

base salary;

•

equity-based incentive compensation;

•

bonuses; and

•

perquisites and other personal benefits.

Base Salary

The Company provides named executive officers and other employees with base salary to compensate them for services rendered during the fiscal year. Base salary ranges for named executive officers are determined for each executive based on his or her position and responsibility by using market data. During its review of base salaries for executives, the Committee primarily considers:

•

market data provided;

•

internal review of the executive’s compensation, both individually and relative to other executive officers; and

•

individual performance of the executive.

Salary levels are typically considered annually as part of the Company’s performance review process as well as upon a promotion or other change in job responsibility.

Equity Based Awards Compensation

All awards of stock options are made at or above the market price at the time of the award. Annual awards of stock options to executives are made at the Committee’s regularly scheduled meeting.

Ownership Guidelines To directly align the interests of executive officers with the interests of the stockholders, the Committee requires that each named executive officer maintain a minimum ownership interest in the Company. The amount required to be retained varies depending upon the executive’s position. The guideline is a multiple of the executive’s base salary. Further, the Committee requires that under certain conditions the Company’s senior management hold for at least one year stock received upon the exercise of stock options.

Stock Option Program

The Stock Option Program assists the Company to:

•

enhance the link between the creation of stockholder value and long-term executive incentive compensation;

•

provide an opportunity for increased equity ownership by executives; and

•

maintain competitive levels of total compensation.

Stock option award levels which are determined based on market data, vary among participants based on their positions within the Company. Options are awarded at the American Stock Exchange’s closing price of the Company’s Common Stock on the date of the grant. In certain limited circumstances, the Committee may grant options to an executive at an exercise price in excess of the closing price of the Company’s Common Stock on the grant date.

The majority of the options granted by the Committee vest at a rate of 33% per year over the first three years of the five-year option term. Vesting and exercise rights cease upon termination of employment, except in the case of death (subject to a ninety day limitation), disability or retirement. Prior to the exercise of an option, the holder has no rights as a stockholder with respect to the shares subject to such option, including voting rights and the right to receive dividends or dividend equivalents.

Because all options have been granted at fair market value, any value which is ultimately realized by recipients through stock options is based entirely on the Company’s performance, as perceived by investors in the Company’s Common Stock who establish the price for Common Stock on the open market.

Bonuses

Fixed Bonus

The Company pays to the CEO, Chief Financial Officer (CFO), and President a fixed bonus of $200,000 per year payable in four equal quarterly installments.

Discretionary Bonus

Every six months beginning on June 30, 2006 and continuing each December 31 and June 30 during their respective employment terms, the Committee shall conduct a review of the CEO, CFO, and President’s performance of their respective duties. Based on the outcome of the review, the Committee may award an additional bonus to the officer. The bonus shall not exceed 150% of the officers’ base salary during any calendar year.

Perquisites and Other Personal Benefits

The Company provides the Chief Executive Officer, Chief Financial Officer, and the President with perquisites and other personal benefits that the Company and the Committee believe are reasonable and consistent with its overall compensation program to better enable the Company to attract and retain superior employees for key positions. The Committee periodically reviews the levels of perquisites and other personal benefits provided to named executive officers.

The CEO, CFO, and President are provided a monthly automobile allowance (including insurance, gas and maintenance), participation in the plans and programs described above, a country club membership at a country club of the employees’ choice, and a term life insurance policy in an amount of not less than $1,000,000.

Attributed costs of the personal benefits described above for the named executive officers for the fiscal year ended December 31, 2006, are included in column (f) of the “Summary Compensation Table.”

Tax and Accounting Implications

Deductibility of Executive Compensation

As part of its role, the Committee reviews and considers the deductibility of executive compensation under Section 162(m) of the Internal Revenue Code, which provides that the Company may not deduct compensation of more than $1,000,000 that is paid to certain individuals. The Company believes that compensation paid under the management incentive plans are generally fully deductible for federal income tax purposes. However, in certain situations, the Committee may approve compensation that will not meet these requirements in order to ensure competitive levels of total compensation for its executive officers.

Accounting for Stock-Based Compensation

Beginning on January 1, 2006, the Company began accounting for stock-based payments including its Stock Option Program in accordance with the requirements of FASB Statement 123(R), Share-Based Payments.

Potential Payment upon Termination or Change of Control

Information regarding applicable payments under such agreements for the named executive officers is provided under the heading “Payments Made Upon a Change in Control.”

Summary Compensation Table

The table below summarizes the total compensation paid or earned by each of the named executive officers for the calendar year ended December 31, 2006.


(a)	(b)	(c )		(d)			(e)		(f)			(g)
Name and Principal Position	Year	Salary		Bonus			Option Awards (1)(2)		All Other Compensation			Total
Randy Lubinsky	2006	$	320,000	$	200,000		$	364,544	$	43,626		$	928,170
Chief Executive Officer					(8	)				(3	)

Mark Szporka	2006		295,000		200,000			364,544		45,446		$	904,990
Chief Financial Officer					(8	)				(4	)

Ron Riewold	2006		295,000		200,000			628,423		35,857		$	1,159,280
President					(8	)				(5	)

Kathleen White	2006		148,000		10,000			39,637		16,872		$	214,509
Executive Vice President,					(9	)				(6	)
Operations
Craig Coppedge	2006		115,000		20,000			17,596		15,085		$	167,681
Controller					(10	)				(7	)

(1)

The amounts in column (e) reflect the dollar amount recognized for financial statement reporting purposes for the fiscal year ended December 31, 2006, in accordance with FAS123(R) of awards pursuant to the 2001 Stock Option Plan and thus include amounts from awards granted in and prior to 2006. Assumptions used in the calculation of this amount for fiscal years ended December 31, 2004, 2005, and 2006 are included in footnote disclosure 1 to the Company’s audited financial statements for the fiscal year ended December 31, 2006. Assumptions used in the calculation of this amount for fiscal year ended December 31, 2003, are included under the heading “Stock-Based Compensation Plans” in the Accounting and Policies and Notes to Consolidated Financial Statements included in the Form 10-KA for fiscal year ended December 31, 2005, filed with the Securities and Exchange Commission on December 20, 2006.

(2)

On May 20, 2006 the Company entered in an amendment to the CEO, CFO, and President’s employment agreements. The employment agreements called for the officers to waive all accrued bonuses earned up to December 31, 2005. As remuneration for the agreement all the options outstanding to these officers were immediately vested. In accordance with FAS 123(R) for awards that are modified the Company recorded additional compensation expense of $912,560 for the immediate vesting of these options.

(3)	Mr. Lubinsky received the following items included in column heading (f)

Automobile lease payments

Automobile maintenance payments