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GRMH > SEC Filings for GRMH > Form 10-K on 1-Apr-2013All Recent SEC Filings

Show all filings for GRAYMARK HEALTHCARE, INC.

Form 10-K for GRAYMARK HEALTHCARE, INC.


1-Apr-2013

Annual Report


Item 7. 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, 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.

There are non-controlling interests held in some of our testing facilities, typically by physicians located in the geographical area being served by the diagnostic sleep testing facility.

Going Concern and Management's Plan

As of December 31, 2012, we had an accumulated deficit of $57.6 million and reported a net loss of $22.4 million for 2012. In addition, we used $4.2 million in cash from operating activities from continuing operations during the year. On March 29, 2013, signed a definitive purchase agreement with Foundation Surgery Affiliates, LLC and Foundation Surgical Hospital Affiliates, LLC (collectively "Foundation") for 98.5 million shares of our common stock. We expect the transaction to close in the second quarter of 2013, however there is no assurance the acquisition will close at that time or at all. The closing of the Foundation transaction is subject to the consent of Arvest Bank (our senior lender), Foundation's senior lender and certain preferred interest holders of Foundation and there is no assurance that these consents will be obtained. For financial reporting purposes, the transaction will be recorded as a reverse merger and Foundation will be considered the accounting acquirer. If the transaction is closed, our primary focus will be the execution of the Foundation business plan which includes operating surgical hospitals and surgery centers. In addition, we anticipate that our existing strategy of providing diagnosis and care management solution for patients suffering from sleep disorders would be significantly curtailed.

There is no assurance that the Foundation transaction will close and we currently do not have sufficient cash on hand and do not expect to generate sufficient cash flow from operations to meet our cash requirements over the next 12 months. Historically, we have been able to raise the capital necessary to fund our operations and growth, but there is no assurance that we will be successful in raising the necessary capital to fund our operations and obligations.

If we are unable to close the Foundation transaction or raise additional funds, we may be forced to substantially scale back operations or entirely cease our operations and discontinue our business. 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.

Stock Offerings

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 the Company's common stock for $650,000 ($0.45 per share). The proceeds from OHP were received on November 13, 2012 and were used to fund our operations.


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In June 2011, we completed a public offering of 6,000,000 shares of common stock and warrants exercisable for the purchase of 6,700,000 shares for gross proceeds of $8,400,000 or $1.40 per combination of one share of common stock and a warrant to purchase one share of common stock. The underwriter of the offering received sales commissions of $420,350 (5% of the gross proceeds), a corporate finance fee of $168,140 (2% of the gross proceeds) and a legal and other expense allowance of $116,094 (1.4% of the gross proceeds). In conjunction with the offering, each investor received a warrant to purchase one share of common stock for each share of common stock purchased. The warrants are exercisable for the purchase of one share of common stock for $1.50 beginning June 20, 2011 and on or before June 20, 2016. We incurred $824,603 in expenses directly associated with the offering.

In conjunction with the offering, the underwriter had an option to purchase an additional 700,000 shares of our common stock and warrants to purchase 700,000 shares of our common stock solely to cover over-allotments. The underwriter exercised the full over-allotment option with respect to the warrants in June 2011 in connection with the initial closing and we received $7,000 for the purchase of such warrants. In July 2011, we received $472,600 in gross proceeds from the sale of 340,000 over-allotment shares that the underwriter purchased directly from us. The net proceeds of the over-allotment were $439,518.

In May 2011, we executed subscription agreements with existing accredited investors or their affiliates to sell 1,293,103 shares of our common stock in a private placement. The proceeds of the private placement were approximately $3 million ($2.32 per share). The proceeds included $2 million in cash and $1 million from the conversion of the Valiant Note. In conjunction with the private placement, each investor received a warrant to purchase one share of common stock for each common share purchased pursuant to the subscription agreement. The warrants are exercisable for the purchase of one share of common stock for $1.80 beginning November 4, 2011 and on or before May 4, 2014.

Reverse Stock Split

On January 26, 2011, our Board of Directors approved a reverse stock split in one of five ratios, namely 1 for 2, 3, 4, 5 or 6. On February 1, 2011, we received the consent of a majority of our shareholders for this reverse stock split. On May 18, 2011, our Board of Directors resolved to effect the reverse stock split of our common stock in a ratio of 1-for-4 effective after the close of business on June 3, 2011. We executed the reverse stock split to regain compliance with the continued listing standards of the Nasdaq Capital Market. The Nasdaq Capital Market requires issuers to maintain a $1.00 minimum bid price. In determining a reverse stock split ratio of 1-for-4, the Board of Directors considered the continued listing standards of the Nasdaq Capital Markets, considered a ratio that would allow us to achieve long-term compliance with the listing standards and which allowed us to have a number of outstanding shares to have sufficient trading volume. Our Board of Directors determined that a ratio of 1-for-4 was the best balance of these various factors. The effect of the reverse split reduced our outstanding common stock shares from 34,126,022 to 8,531,506 shares as of the date of the reverse split.

Discontinued Operations

On May 10, 2011, we executed an Asset Purchase Agreement ("Agreement") with Daniel I. Rifkin, M.D., P.C. pursuant to which we sold 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 we 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 was 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 the our ability to sell CPAP devices and other supplies at the East locations. As a result of the sale of East, the related assets, liabilities, results of operations and cash flows of East have been classified as discontinued operations in the accompanying consolidated financial statements.

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 our 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.

Business Strategy

We plan to grow our business via organic growth related to our Independent Sleep Care Centers, Hospital Sleep Diagnostic Programs (both increased volumes related to existing management agreements and the execution of new management agreements), therapy services and recurring re-supply fulfillment. We also plan to expand revenues at our existing locations through new billing under arrangements with hospitals in our existing markets. Acquisitions, the opening of new facilities and new management agreement with hospital sleep labs will also be an integral part of our growth strategy going forward. We will seek to acquire business operations that can be rolled into our existing operations as well as additional independent sleep care centers. We will also seek acquisition opportunities related to therapy service and re-supply business operations and new management agreement opportunities in both existing and new markets. We expect all acquisitions to be accretive to our earnings and fully integrated within ninety (90) days of closing.

In addition, we plan to acquire the surgery center and surgical hospital businesses of Foundation Healthcare Affiliates, LLC. On March 29, 2013, we entered into a purchase agreement to acquire these businesses from Foundation. The acquisition is subject to conditions to closing, including the consent of Arvest Bank, our secured lender and the consents or Foundation's lender and the preferred members of certain of their subsidiaries as well as other customary closing conditions. There is no assurance that we can close this acquisition as planned in the second quarter of 2013 or at all.

On December 12, 2011, we acquired 80% of the Village Sleep Center ("Village"), located in Plano, Texas, for a purchase price of up to $960,000. Under the purchase agreement, we paid $596,000 in cash and withheld $364,000 of the purchase price ("Withheld Funds") as collateral to secure any obligations the sellers have pursuant to the indemnification clauses of the purchase agreement. The Withheld Funds, less any amounts deducted, shall be paid in two equal installments, not to exceed $182,000. In order to receive the maximum installment payment, the trailing twelve months earnings before interest, taxes, depreciation and amortization ("EBITDA") for Village for the years ended December 31, 2012 and 2013 must be at least $200,000, respectively. If the EBITDA for 2012 and or 2013 is less than $200,000, the payment of Withheld Funds is reduced by the ratio of actual EBITDA to the required EBITDA of $200,000. We initially estimated the fair value of the contingent consideration or Withheld Funds to be $234,565. We revaluated the contingent consideration based on the actual EBITDA results as of December 31, 2012 and reduced the expected contingent consideration by $90,380.

Impairment of Goodwill and Intangible Assets

As of December 31, 2012, we have fully-impaired our goodwill and intangible assets

Goodwill and other indefinite-lived assets are not amortized, but are subject to impairment reviews annually, or more frequent if necessary. We are required to evaluate the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the related operating unit below its carrying amount. These circumstances may include without limitation


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a significant adverse change in legal factors or in business climate,

unanticipated competition, or

an adverse action or assessment by a regulator.

In evaluating whether goodwill is impaired, we must compare the fair value of the operating unit to which the goodwill is assigned to the operating units carrying amount, including goodwill. The fair value of the operating unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach that utilize comparable companies data. If the carrying amount of the operating unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of an operating unit to its carrying amount. In calculating the implied fair value of the operating unit goodwill, the fair value of the operating unit will be allocated to all of the other assets and liabilities of that operating unit based on their fair values. The excess of the fair value of an operating unit over the amount assigned to its other assets and liabilities will be the implied fair value of goodwill. An impairment loss will be recognized when the carrying amount of goodwill exceeds its implied fair value.

Based on our sleep study trends and forecasted cash flows, we determined that impairment indicators existed during the second quarter and fourth quarter of 2012. During the second quarter of 2012, the primary factor that drove impairment was our actual volume of sleep studies compared to the volumes that we had projected for 2012. During the fourth quarter of 2012 when we performed our annual impairment review, we noted continued negative trends in its sleep study volumes, coupled with deterioration in the overall sleep diagnostic market. During 2012, the sleep diagnostic market experienced a continued shift to home based testing and continued negative trends in reimbursement levels. Based on assumptions similar to those that market participants would make in valuing the our business, we determined that the carrying value of goodwill and other intangible assets related to our sleep centers exceeded their fair value. Accordingly, in June 2012 and December 2012, we recorded a noncash impairment charge on goodwill of $3.0 million and $10.7 million, respectively, for a total 2012 impairment charge on goodwill of $13.7 million. In addition, in December 2012, we recorded a noncash impairment charge on intangible assets of $1.1 million. Our evaluation of goodwill and indefinite lived intangible assets completed during December 2011 resulted in no impairment.

Operating Statistics:

The following table summarizes our locations as of December 31, 2012 and 2011:



                                             Number of Locations
                  Location Type             2012            2011
                  Sleep centers                  26              22
                  Managed sleep centers          82              78

                  Total                         108             100

The following table summarizes unit sales and other operating statistics, by quarter, for the years ended December 31, 2012 and 2011:

                             1st Qtr.       2nd Qtr.       3rd Qtr.       4th Qtr.       Total
 Sleep studies performed:
 2012                            4,234          4,185          4,247          3,673       16,339
 2011                            3,515          4,005          4,245          4,101       15,866
 CPAP set ups performed:
 2012                              586            662            583            544        2,375
 2011                              684            683            694            610        2,671


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Results of Operations

The following table sets forth selected results of our operations for the years ended December 31, 2012 and 2011. The following information was derived and taken from our audited financial statements appearing elsewhere in this report.

Comparison of 2012 and 2011



                                                              For the Years Ended
                                                                  December 31,
                                                           2012                  2011
Net revenues:
Services                                               $  12,509,355         $ 12,556,630
Product sales                                              4,451,747            4,953,164

                                                          16,961,102           17,509,794

Cost of services                                           5,324,688            5,137,027
Cost of sales                                              1,598,758            1,743,117
Selling, general and administrative expenses              14,055,409           13,743,820
Bad debt expense                                           1,444,525              895,863
Impairment of goodwill and intangible assets              14,787,165                   -
Depreciation and amortization                              1,233,943            1,110,735
Net other expense                                          1,084,767            1,282,884

Loss from continuing operations, before taxes            (22,568,153 )         (6,403,652 )
Provision for income taxes                                        -               (13,992 )

Loss from continuing operations, net of taxes            (22,568,153 )         (6,417,644 )
Income (loss) from discontinued operations, net
of taxes                                                    (224,470 )            291,155

Net loss                                                 (22,792,623 )         (6,126,489 )
Less: Non-controlling interests                             (342,920 )           (232,080 )

Net loss attributable to Graymark Healthcare           $ (22,449,703 )       $ (5,894,409 )

Discussion of Years Ended December 31, 2012 and 2011

Services revenues were flat for 2012 compared with 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 and outreach agreements, 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 flat revenues from sleep diagnostic services during 2012 compared to 2011 was comprised of a $0.6 million increase at our Hospital/Outreach locations which was offset by a $0.3 million decrease at our IDTF locations and a $0.3 million decrease at our clinic locations.

The $0.6 million increase in our Hospital/Outreach location revenue during 2012 compared to 2011 was due to the following:

We transitioned our Tulsa Midtown IDTF location to a contracted hospital location in May 2011. Through May 2011, the revenue for this location was included in IDTF revenue. For the same period in 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 2012 compared to 2011.


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

A decrease in overall average reimbursement per sleep study due to a change in the mix of patients at our existing Hospital/Outreach locations resulted in a decrease of $0.1 million in revenue in 2012 compared to 2011

An increase in the volume of sleep studies performed at our existing (operating for at least one year) Hospital/Outreach facilities resulted in an increase of $0.3 million in revenue.

The $0.3 million decrease in revenue in 2012 at our IDTF locations compared to 2011 was due to the following:

We transitioned our Tulsa Midtown IDTF location to a contracted hospital location in May 2011. Through May 2011, the revenue for this location was included in IDTF revenue. For the same period in 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 2012 compared to 2011.

A decrease in the volume of sleep studies done at our existing IDTF facilities resulted in a $0.9 million decline in revenue in 2012 compared 2011;

A decrease in the overall average reimbursement per sleep study in our existing IDTF facilities resulted in a $0.2 million decline in revenue during 2012 compared to 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 after the third quarter of 2011 (less than a full prior year operating results) resulted in an increase in revenue of $0.9 million in 2012 compared to 2011.

The $0.3 million decline in revenues related to our clinic services were due to the closing of our clinic service locations in Oklahoma City during the fourth quarter of 2011.

Product revenues from our sleep therapy business decreased $0.5 million (a 10.1% decrease) during 2012 compared to 2011. The decrease was due to a $0.7 million reduction in revenue from the initial set-up of CPAP devices, partially offset by a $0.2 million increase in revenue from our re-supply business.

The $0.7 million reduction in CPAP set-up revenues was due to a $0.3 million decrease related to the average revenue per set-up performed which was caused by a change in the mix of payors as well as rate reductions from some payors and a $0.4 million decrease due to lower set-up volumes during 2012 compared to 2011. The increase in re-supply revenue was driven by a $0.1 million increase related to increased volume during 2012 compared to 2011 and a $0.1 million increase in the average reimbursement per re-supply shipment.

Cost of services increased $0.2 million (a 3.7% decrease) to $5.3 million from $5.1 million during 2012 compared to 2011. The increase in cost of services was due to the overall increase in volume during 2012 compared 2011 driven primarily by new facilities opened since the third quarter of 2011.

Cost of services as a percent of service revenue was 42.6% and 40.9% during 2012 and 2011, respectively. The increase in cost of services as a percent of service revenue was primarily due to the shift in our business towards Hospital/Outreach sleep studies which have a lower reimbursement per sleep study compared to our IDTF locations, and as a result has a higher cost of service as a percentage of revenue. In addition, we saw a decline in 2012 of the average reimbursement per sleep study compared to 2011. During 2012, 55% of our sleep studies were performed in an IDTF location compared to 61% in 2011. The higher cost of service percentage in Hospital/Outreach locations is more than offset by the significantly lower operating expense associated with these locations, primarily related to the lack of facility costs.


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Cost of sales from our sleep therapy business decreased $0.1 million (an 8.3% decrease) during 2012 compared with 2011. Cost of sales as a percent of product sales was 35.9% and 35.2% during 2012 and 2011, respectively. The decrease in cost of sales compared to 2011 is primarily due to a lower number of set-ups performed in 2012 compared to 2011.

Selling, general and administrative expenses increased $0.3 million (a 2.3% increase) to $14.0 million or 83% of revenue in 2012 from $13.7 million or 79% of revenue during 2011. The increase in selling, general and administrative expenses was primarily due to:

an increase in central shared service expense of $1.3 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 $0.3 million due to . . .

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