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GRMH > SEC Filings for GRMH > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for GRAYMARK HEALTHCARE, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for GRAYMARK HEALTHCARE, INC.


14-Nov-2012

Quarterly Report


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

Overview

Graymark Healthcare, Inc. is organized under the laws of the State of Oklahoma and is one of the largest providers of care management solutions to the sleep disorder market based on number of independent sleep care centers and hospital sleep diagnostic programs operated in the United States. We provide a comprehensive diagnosis and care management solutions for patients suffering from sleep disorders.

We provide diagnostic sleep testing services and care management solutions, or SMS, for people with chronic sleep disorders. In addition, we provide therapy services (delivery and set up of CPAP equipment together with training related to the operation and maintenance of CPAP equipment) and the sale of related disposable supplies and components used to maintain the CPAP equipment. Our products and services are used primarily by patients with obstructive sleep apnea, or OSA. Our sleep centers provide monitored sleep diagnostic testing services to determine sleep disorders in the patients being tested. The majority of the sleep testing is to determine if a patient has OSA. A continuous positive airway pressure, or CPAP, device is the American Academy of Sleep Medicine's, or AASM's, preferred method of treatment for obstructive sleep apnea. Our sleep diagnostic facilities also determine the correct pressure settings for patient CPAP devices via titration testing. We sell CPAP devices and disposable supplies to patients who have tested positive for sleep apnea and have had their positive airway pressure determined.

As of September 30, 2012, we operated 107 sleep diagnostic and therapy centers in 10 states; 26 of which are located in our facilities with the remaining centers operated under management agreements. There are certain noncontrolling interest holders in some of our testing facilities, who are typically physicians in the geographical area being served by the diagnostic sleep testing facility.

Our sleep management solution is driven by our clinical approach to managing sleep disorders. Our clinical model is led by our staff of medical directors who are board-certified physicians in sleep medicine, who oversee the entire life cycle of a sleep disorder from initial referral through continuing care management. Our approach to managing the care of our patients diagnosed with OSA is a key differentiator for us. We believe our overall patient CPAP usage compliance rate, as articulated by the Medicare Standard of compliance requirements, is approximately 80%, compared to a national compliance rate of approximately 50%. Five key elements support our clinical approach:

Referral: Our medical directors, who are board-certified physicians in sleep medicine, have forged strong relationships with referral sources, which include primary care physicians, as well as physicians from a wide variety of other specialties and dentists.

Diagnosis: We own and operate sleep testing clinics that diagnose the full range of sleep disorders including OSA, insomnia, narcolepsy and restless legs syndrome.

CPAP Device Supply: We sell CPAP devices, which are used to treat OSA.

Re-Supply: We offer a re-supply program for our patients and other CPAP users to obtain the required disposable components for their CPAP devices that must be replaced on a regular basis.

Care Management: We provide continuing care to our patients led by our medical directors who are board-certified physicians in sleep medicine and their staff.

Our clinical approach increases the long-term compliance of our patients, and enables us to manage a patient's sleep disorder care throughout the life cycle of the disorder, thereby allowing us to generate a long-term, recurring revenue stream. We generate revenues via three primary sources: providing the diagnostic tests and related studies for sleep disorders through our sleep diagnostic centers, the sale of CPAP devices, and the ongoing re-supply of components of the CPAP device that need to be replaced. In addition, as a part of our ongoing care management program, we monitor the patient's sleep disorder and as the patient's medical condition changes, we are paid for additional diagnostic tests and studies.


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In addition, we believe that our clinical approach to comprehensive patient care, provides higher quality of care and achieves higher patient compliance. We believe that higher compliance rates are directly correlated to higher revenue generation per patient compared to our competitors through increased utilization of our resupply or PRSP program and a greater likelihood of full reimbursement from federal payors and those commercial carriers who have adopted federal payor standards.

Going Concern and Management's Plan

As of September 30, 2012, we had an accumulated deficit of approximately $44.5 million and reported a net loss of approximately $9.4 million for the nine months then ending. In addition, we used approximately $3.7 million in cash from operating activities from continuing operations during the nine months ending September 30, 2012. In August 2012, we executed a definitive agreement to purchase Foundation Surgery Affiliates, LLC and Foundation Surgical Hospital Affiliates, LLC (collectively "Foundation") for 35 million shares of our common stock and a warrant for the purchase of 4 million shares of our common stock at an exercise price of $1.50 (assuming conversion of the preferred stock which was to be issued at closing). The Foundation acquisition has not closed and we do not believe that it will close in its current form due to certain external factors including the inability to obtain the consent of certain preferred interest holders of certain subsidiaries of Foundation. We are working on an alternative structure for the Foundation transaction, but there is no assurance that the Foundation acquisition will be closed. On November 12, 2012, we executed a subscription agreement with Graymark Investments, LLC (doing business as Oklahoma Health Partners ("OHP")) in which OHP agreed to purchase 1,444,445 shares of our common stock for $650,000 ($0.45 per share). The proceeds from OHP were received on November 13, 2012 and will be used to fund our operations. Including the stock proceeds from OHP, management estimates that we have enough cash to operate through December 31, 2012. We also plan on raising equity capital or issuing additional debt in the near term to meet our additional cash needs in 2013. In addition, management has initiated a cost reduction plan that is estimated will save us in excess of $2 million in 2013. The cost reduction plan includes a reduction in the labor force and general corporate expenses as well as process improvements that will result in lower bad debt expense. During the fourth quarter of 2012, management also anticipates developing a plan to close certain non-profitable lab locations. Historically, we have been able to raise the capital necessary to fund our operation and growth, but there is no assurance that we will be successful in raising the necessary capital to fund our operations.

As of September 30, 2012, our Debt Service Coverage Ratio is less than 1.25 to 1 which will be the required ratio under our loan agreement with Arvest Bank for each quarterly period beginning after March 31, 2013. In addition, beginning on March 31, 2013, we must have Positive EBITDA ("earnings before interest, taxes, depreciation and amortization"), as defined by Arvest Bank, for the previous three month period. Since the Debt Service Coverage Ratio becomes effective in less than 12 months and it is unlikely that we will initially meet the requirement, the associated debt with Arvest Bank has been classified as current in the accompanying condensed consolidated balance sheets as of September 30, 2012. Historically, we have been successful in obtaining default waivers from Arvest Bank, but there is no assurance that Arvest Bank will waive any future defaults.

These uncertainties raise substantial doubt regarding our ability to continue as a going concern. The consolidated condensed financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

Discontinued Operations

In May 2011, we executed an Asset Purchase Agreement ("Agreement") with Daniel I. Rifkin, M.D., P.C. providing for the sale of substantially all of the assets of our subsidiary, Nocturna East, Inc. ("East") for $2,500,000. In conjunction with the sale of East assets, the Management Services Agreement ("MSA") under which the Company provided certain services to the sleep centers owned by Independent Medical Practices ("IMA") including billing and collections, trademark rights, non-clinical sleep center management services, equipment rental fees, general management services, legal support and accounting and bookkeeping services will be terminated. Our decision to sell the assets of East was primarily based on our determination that the operations of East no longer fit into our strategic plan of providing a full continuum of care to patients due to significant regulatory barriers that limit our ability to sell CPAP devices and other supplies at the East locations. As a result of the sale of East, the historical assets, and liabilities, results of operations and cash flows of East have been classified as discontinued operations for financial statement reporting purposes.

On September 1, 2010, we executed an Asset Purchase Agreement, which was subsequently amended on October 29, 2010, (as amended, the "Agreement") providing for the sale of substantially all of the assets of the Company's subsidiary, ApothecaryRx to Walgreens. ApothecaryRx operated 18 retail pharmacies selling prescription drugs and a small assortment of general merchandise, including diabetic merchandise, non-prescription drugs, beauty products and cosmetics, seasonal merchandise, greeting cards and convenience foods. The final closing of the sale of ApothecaryRx's assets occurred in December 2010. As a result of the sale of ApothecaryRx's assets, the remaining assets, and liabilities, results of operations and cash flows of ApothecaryRx have been classified as discontinued operations for financial statement reporting purposes.


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Under the Agreement, the consideration for the ApothecaryRx assets purchased and liabilities assumed is $25,500,000 plus up to $7,000,000 for inventory ("Inventory Amount"), but less any payments remaining under goodwill protection agreements and any amounts due under promissory notes which are assumed by buyer (the "Purchase Price"). For purposes of determining the Inventory Amount, the parties agreed to hire an independent valuator to perform a review and valuation of inventory being purchased from each pharmacy location. We received approximately $24.5 million in net proceeds from the sale of assets of which $2.0 million was deposited into an indemnity escrow account (the "Indemnity Escrow Fund") as previously agreed pursuant to the terms of an indemnity escrow agreement. These proceeds are net of approximately $1.0 million of security deposits transferred to the buyer and the assumption by the buyer of liabilities associated with goodwill protection agreements and promissory notes. We also received an additional $3.8 million for the sale of inventory to Walgreens at 17 of our pharmacies with the inventory for the remaining pharmacy being sold as part of the litigation settlement. We used $22.0 million of the proceeds to pay-down our senior credit facility.

In December 2011 (the 12-month anniversary of the final closing date of the sale of ApothecaryRx), 50% of the remaining funds held in the Indemnity Escrow Fund ($1.0 million) were released, without deduction for any indemnification claims. All remaining funds held in the Indemnity Escrow Fund ($1.0 million) were released in June 2012 (the 18-month anniversary of the final closing date of the sale), without deduction for any indemnification claims.

Results of Operations

The following table sets forth selected results of our operations for the three and nine months ended September 30, 2012 and 2011. The following information was derived and taken from our unaudited financial statements appearing elsewhere in this report.

Comparison of the Three and Nine Month Periods Ended September 30, 2012 and 2011



                                      For the Three Months Ended             For the Nine months Ended
                                            September 30,                          September 30,
                                       2012                2011               2012               2011
Net Revenues:
Services                           $   3,167,411       $  3,287,272       $  9,711,137       $  9,388,267
Product sales                          1,123,607          1,195,700          3,254,655          3,707,840

                                       4,291,018          4,482,972         12,965,792         13,096,107

Cost of services                       1,396,400          1,299,030          4,133,334          3,814,933
Cost of sales                            412,876            462,048          1,210,069          1,259,404
Selling, general and
administrative                         3,517,041          3,316,295         10,989,745         10,039,289
Bad debt expense                         371,552            387,388          1,024,207            628,215
Impairment of goodwill                        -                  -           3,041,000                 -
Depreciation and amortization            313,669            279,463            920,905            836,936
Net other expense                        271,363            303,791            843,562            987,969

Loss from continuing
operations, before taxes              (1,991,883 )       (1,565,043 )       (9,197,030 )       (4,470,639 )
Provision for income taxes                    -              (3,498 )               -             (10,494 )

Loss from continuing
operations, net of taxes              (1,991,883 )       (1,568,541 )       (9,197,030 )       (4,481,133 )
Discontinued operations, net of
taxes                                   (283,961 )          (14,896 )         (364,172 )          376,478

Net loss                              (2,275,844 )       (1,583,437 )       (9,561,202 )       (4,104,655 )
Less: Noncontrolling interests           (45,269 )          (27,544 )         (138,510 )         (130,626 )

Net loss attributable to
Graymark Healthcare                $  (2,230,575 )     $ (1,555,893 )     $ (9,422,692 )     $ (3,974,029 )


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Discussion of Three Month Periods Ended September 30, 2012 and 2011

Services revenues declined $0.1 million or 3.6% during the three months ended September 30, 2012 compared with the third quarter of 2011. Our sleep diagnostic services are performed in two environments, our independent diagnostic testing facilities ("IDTF") and at contracted client locations ("Hospital/Outreach"). For studies performed in our IDTF locations, we generally bill third-party payors for the sleep study. In our Hospital/ Outreach locations, we are paid a contracted fee per study performed. In our more rural outreach locations, our contracted rates are typically higher due to the additional costs associated with servicing more remote locations. Our urban hospital agreements tend to be at a lower rate due to the reimbursement environment and lower costs to serve. The decrease in revenues from sleep diagnostic services during the third quarter of 2012 compared to the third quarter of 2011 was due to a $0.3 million decrease at our IDTF locations which was partially offset by a $0.2 million increase at our Hospital/Outreach locations.

The $0.3 million decline in IDTF revenues compared to the third quarter of 2012 was due to the following:

A decrease in the number of sleep studies performed at our existing (open for more than one year) sleep labs in the third quarter of 2012 compared to the third quarter of 2011 resulted in a decrease of $0.3 million;

A lower average reimbursement per sleep study performed at our existing sleep labs in the third quarter of 2012 compared to the third quarter of 2011 resulted in a decrease of $0.2 million;

Revenue from new facilities opened since the third quarter of 2011 contributed $0.2 million in revenue during the third quarter of 2012.

The $0.2 million increase in Hospital/Outreach revenues compared to the third quarter of 2012 was due to the following:

A decrease in the number sleep studies at existing facilities in the third quarter of 2012 compared to the third quarter of 2011 resulted in a decrease in revenue of $0.1;

An increase in average rate per sleep study at our existing facilities due to a change in the mix of patients between the various facilities resulted in an increase of $0.1 million during the third quarter of 2012 compared to the third quarter of 2011;

Periodically, we receive revenues from performing research studies at our clinics in Kansas City, Missouri. The volume of research studies is sporadic and is driven by the physicians who lead the studies. During the third quarter of 2012, we performed more research sleep studies compared to the third quarter of 2011 which resulted in an increase of in revenue of $0.1 million.

Revenue from new facilities opened since the third quarter of 2011 contributed $0.1 million in revenue during the third quarter of 2012.

Product sales revenues from our sleep therapy business decreased $0.1 million or 6.0% during the three months ended September 30, 2012 compared with the third quarter of 2011. The decrease was due to a $0.1 million reduction in revenue from the initial set-up of CPAP devices.

The reduction in CPAP set-up revenues was due to a reduction in set-up volumes compared to the third quarter of 2011 driven by a combination of lower sleep study volumes in our Kansas market and a lower conversion rate of sleep studies to set-ups in our Oklahoma, Texas and Nevada markets in the third quarter of 2012 compared to the third quarter of 2011.

Cost of services increased $0.1 million or 7.5% during the three months ended September 30, 2012 compared with the third quarter of 2011. The increase in cost of services is due to an increase in average cost per sleep study performed which was primarily due to non-recurring separation costs associated with the transition of our sleep study scoring process from an internal process to a contracted process during the third quarter of 2012.


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Cost of services as a percent of service revenue was 44.1% and 39.5% during the three months ended September 30, 2012 and 2011, respectively. The increase in cost of services as a percent of service revenue was primarily due to the separation costs associated with the transition of our sleep study scoring process from an internal process to a contracted process during the third quarter of 2012. These costs were one time in nature and the outsourcing of the scoring process is expected to drive overall cost savings when fully implemented in the fourth quarter of 2012.

Cost of sales from our sleep therapy business decreased approximately $49,000 or 10.6% during the three months ended September 30, 2012 compared with the third quarter of 2011. In addition, cost of sales as a percent of product sales was 36.7% and 38.6% during the three months ended September 30, 2012 and 2011, respectively. We have seen improvement in the average cost of the equipment utilized in our therapy business compared to the third quarter of 2011 which has driven the improved margins.

Selling, general and administrative expenses increased $0.2 million or 6.1% to $3.5 million or 82% of revenue from $3.3 million or 74% of revenue during the three months ended September 30, 2012, compared with the third quarter of 2011. The increase in selling, general and administrative expenses was primarily due to:

an increase in central shared service expense of $0.3 million as we added infrastructure and centralized certain operations to our corporate office. The added infrastructure was primarily in the areas of sales, compliance and human resources. In addition, we centralized patient scheduling and benefits verification from field locations to our corporate office;

an increase in corporate overhead expense of $0.2 million due to $0.3 million of non-recurring legal and other expenses related to potential acquisitions partially offset by $0.1 million related to the timing of stock compensation awards to our board members in 2012 compared to 2011;

a decrease in facility operating expenses $0.2 million due to a combination of the centralization of patient scheduling and verification as well as reductions in overhead costs due to organizational restructuring of our operations and renegotiated facility costs at some locations.

a decrease in operating expenses of $0.1 million due to the closure of our clinic facilities in Oklahoma in the fourth quarter of 2011.

Bad debt expense for the third quarter of 2012 was flat compared to the third quarter of 2011. Bad debt as a percent of revenue was 8.7% and 8.6% for the third quarters of 2012 and 2011, respectively.

Depreciation and amortization represents the depreciation expense associated with our fixed assets and the amortization attributable to our intangible assets. Depreciation and amortization increased approximately $34,000 or 12.2% during the three months ended September 30, 2012 compared to the third quarter of 2011. The increase is primarily due to the incremental depreciation of leasehold improvements and sleep equipment for new sleep labs and leasehold improvements at our corporate office location.

Net other expense represents interest expense on borrowings reduced by interest income earned on cash and cash equivalents. Net other expense decreased approximately $32,000 or 10.7% during the three months ended September 30, 2012 compared with the third quarter of 2011. The decrease is related to principal reductions made on our borrowings.

Discontinued operations represent the net loss from the operations of East and ApothecaryRx. In May 2011 and December 2010, we completed the sale of substantially all of the assets of East and ApothecaryRx, respectively. As a result, the related assets, liabilities, results of operations and cash flows of East and ApothecaryRx have been classified as discontinued operations. In addition, we have discontinued operations related to our discontinued internet sales division and discontinued film operations. During the third quarter of 2012, the loss from discontinued operations is primarily due to an increase in our estimate for future potential lease liabilities of $0.3 million at our former ApothecaryRx locations that have outstanding lease obligations.


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Noncontrolling interests were allocated approximately $45,000 of net loss during the three months ended September 30, 2012 compared with the third quarter of 2011 when noncontrolling interests were allocated approximately $28,000 of net loss. Noncontrolling interests are the equity ownership interests in our SDC Holdings subsidiaries that are not wholly-owned.

Net income (loss) attributable to Graymark Healthcare. Our operations resulted in a net loss of approximately $2.2 million during the third quarter of 2012, compared to a net loss of approximately $1.6 million during the third quarter of 2011.

Discussion of Nine Month Periods Ended September 30, 2012 and 2011

Services revenues increased $0.3 million or 3.4% during the nine months ended September 30, 2012 compared with the first nine months of 2011. Our sleep diagnostic services are performed in two environments, our independent diagnostic testing facilities ("IDTF") and at contracted client locations ("Hospital/Outreach"). For studies performed in our IDTF locations, we generally bill third-party payors for the sleep study. In our Hospital/ Outreach locations, we are paid a contracted fee per study performed. In our more rural outreach locations, our contracted rates are typically higher due to the additional costs associated with servicing more remote locations. Our urban hospital agreements tend to be at a lower rate due to the reimbursement environment and lower costs to serve.

The increase in revenues from sleep diagnostic services during the first nine months of 2012 compared to the first nine months of 2011 was due to a $0.7 million increase at our Hospital/Outreach locations which was partially offset by a $0.2 million decrease at our IDTF locations and a $0.2 million decrease at our clinic locations.

The $0.7 million increase in our Hospital/Outreach location revenue during the first nine months of 2012 compared to the first nine months of 2011 was due to the following:

We transitioned our Tulsa Midtown IDTF location to a contracted hospital location in May 2011. As a result for the first nine months of 2012, revenue from this location is included in our Hospital/Outreach category. This change accounts for $0.2 million of the Hospital/Outreach revenue increase in the first nine months of 2012 compared to the same period in 2011.

Revenue from new hospital agreements that commenced operations since the first nine months of 2011 contributed $0.2 million of the revenue increase in the first nine months of 2012 compared to the first nine months of 2011.

An increase in overall average reimbursement per sleep study due to a change in the mix of patients between the various facilities at our existing Hospital/Outreach locations in the first nine months of 2012 compared to the first nine months of 2011 resulted in an increase of $0.2 million in revenue.

Periodically, we receive revenues from performing research studies at our clinics in Kansas City, Missouri. The volume of research studies is sporadic and is driven by the physicians who lead the studies. During the first nine months of 2012, we performed more research sleep studies compared to the first nine months of 2011. This increase in research studies resulted in an increase of $0.1 million in revenue in compared to the first nine months of 2011.

The $0.2 million decrease in revenue at our IDTF locations compared to the first nine months of 2011 was due to the following:

We transitioned our Tulsa Midtown IDTF location to a contracted hospital location in May 2011. As a result for the first nine months of 2012, revenue from this location is included in our Hospital/Outreach category. This change accounts for $0.1 million of the IDTF revenue decrease in the first nine months of 2012 compared to the same period in 2011.

A decrease in the volume of sleep studies done at our existing facilities resulted in a $0.4 million decline in revenue in the first nine months of 2012 compared to the first nine months of 2011;


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A decrease in the overall average reimbursement per sleep study in our existing facilities resulted in a $0.3 million decline in revenue during the first nine months of 2012 compared to the first nine months of 2011. The decrease is due to a combination of a change in mix of the locations where studies were performed and the mix of payors at the various locations.

Revenue from new facilities opened since the third quarter of 2011 contributed $0.6 million in revenue compared to the first nine months of 2011.

The $0.2 million decline in revenues related to our clinic services were due to . . .

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