UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2010
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 001-34171
GRAYMARK HEALTHCARE, INC.
(Exact name of registrant as specified in its charter)
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OKLAHOMA
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20-0180812 |
(State or other jurisdiction of
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(I.R.S. Employer |
incorporation or organization)
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Identification No.) |
210 Park Avenue, Ste. 1350
Oklahoma City, Oklahoma 73102
(Address of principal executive offices)
(405) 601-5300
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class |
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Name of each exchange on which registered |
Common Stock, $0.0001 Par Value
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The Nasdaq Stock Market LLC |
Securities registered under Section 12(g) of the Exchange Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
(§229.405 of this chapter) is not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
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Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer o
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Smaller reporting company þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o No þ
As of June 30, 2010, the aggregate market value of Graymark Healthcare, Inc. common stock, par
value $0.0001, held by
non-affiliates (based upon the closing transaction price on The Nasdaq Stock
Market) was approximately $18,036,000.
As of March 30, 2011, 28,953,611 shares of the registrants common stock, $0.0001 par value, were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement to be filed within 120 days after December 31, 2010 for
the Registrants Annual Shareholders Meeting are incorporated by reference into Part III of this
Report on Form 10-K.
GRAYMARK HEALTHCARE, INC.
FORM 10-K
For the Fiscal Year Ended December 31, 2010
TABLE OF CONTENTS
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the captions Item 1. Business, Item 1A. Risk Factors, and
Item 7. Managements Discussion and Analysis Financial Condition and Results of Operations, and
elsewhere in this report constitute forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Certain, but not necessarily all, of such forward-looking statements can be identified
by the use of forward-looking terminology such as anticipates, believes, expects, may,
will, or should or other variations thereon, or by discussions of strategies that involve risks
and uncertainties. Our actual results or industry results may be materially different from any
future results expressed or implied by such forward-looking statements. Factors that could cause
actual results to differ materially include general economic and business conditions; our ability
to implement our business strategies; competition; availability of key personnel; increasing
operating costs; unsuccessful promotional efforts; changes in brand awareness; acceptance of new
product offerings; and changes in, or the failure to comply with, and government regulations.
Throughout this report the first personal plural pronoun in the nominative case form we and
its objective case form us, its possessive and the intensive case forms our and ourselves and
its reflexive form ourselves refer collectively to Graymark Healthcare, Inc. and its
subsidiaries and Sleep Management Solutions, or SMS, refers to our sleep centers and related
service and supply business, and ApothecaryRx refers to the discontinued operations of
ApothecaryRx, LLC, our subsidiary that operated retail pharmacies through December 2010.
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PART I
We are 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 solution for
patients suffering from sleep disorders.
Sleep Management Solutions Overview
Our Sleep Management Market Opportunity
We believe that the market for Sleep Management Solutions is large and growing with no clear
market leader. A number of factors support the future growth of this market:
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Large and undiagnosed population of patients that suffer from sleep disorders.
There are a substantial number of undiagnosed patients who could benefit from diagnosis
and treatment of sleep disorders. There are an estimated 40 million Americans that
suffer from chronic, long-term sleep disorders, according to the National Institutes of
Health, or NIH. There are over 80 different sleep disorders, including obstructive
sleep apnea, or OSA, insomnia, narcolepsy and restless legs syndrome. The primary
focus of our business is OSA, which the National Sleep Foundation estimates occurs in
at least 18 million Americans. Moreover, according to the American College of
Physicians, about 80-90% of persons with sleep apnea go undiagnosed. |
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Increasing awareness of diagnosis and treatment options, particularly for OSA.
We believe there is an increasing awareness among the U.S. population and physicians in
particular about the health risks and the availability and benefits of treatment
options for sleep disorders. Of significant importance, OSA can have serious effects
on peoples health and personal lives. OSA is known to increase the risk for several
serious health conditions, including obesity, high blood pressure, heart disease,
stroke, diabetes, depression and sexual dysfunction. Additionally, OSA may result in
excessive daytime sleepiness, memory loss, lack of concentration and irritability. OSA
and its effects may increase the risk for automobile accidents and negatively affect
work productivity and personal relationships. In addition, as physicians become aware
of the links between OSA and other serious health conditions, physicians are
increasingly referring patients for sleep studies. |
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Growth in obesity rates. OSA is found in people of every age and body type,
but is most commonly found in the middle-aged, obese population. Obesity is currently
found in approximately 72 million adults and is a growing problem in the United States.
Obesity exacerbates OSA by enlarging the upper airway soft tissue structures and
narrowing the airway. Not only does obesity contribute to sleep disorders such as OSA,
but sleep disorders can also contribute to obesity. We believe individuals suffering
from OSA generally have less energy and ability to exercise or keep a strict diet.
Medical studies have also shown that sleep disorders can impair metabolism and disrupt
hormone levels, promoting weight gain. |
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Large aging population. An aging U.S. population, led by approximately 78
million baby-boomers, is becoming increasingly at risk for OSA. As their soft palates
enlarge, their pharyngeal fat pads increase in size and the shape of bony structures
around the airway change. |
We believe these factors present a significant business opportunity for us because we provide
a complete continuum of care for those who suffer from OSA from initial diagnosis to treatment
with a continuous positive airway pressure, or CPAP, device to providing ongoing CPAP supplies and
long-term follow-up care.
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The amount being spent on sleep disorder diagnosis and treatment is increasing.
A 2010 Frost & Sullivan report estimated the U.S. sleep diagnostic market was $1.4
billion in 2008, and that it will grow to $3.4 billion by 2015 for a combined annual
growth rate of 14.3%. |
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The sleep diagnostic market is highly fragmented. Our presence as one of the
largest overall providers of sleep diagnostic services with 26 independent sleep care
centers and 72 hospital sleep diagnostic programs, out of a total we estimate includes
4,000 sleep clinics in the United States, illustrates the level of fragmentation in the
market. Only a limited number of companies provide a comprehensive solution which
includes initial diagnosis to treatment with a CPAP device to providing ongoing CPAP
supplies to long-term follow-up care. |
Our Sleep Management Solution
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 between 17 and 54%. Five key elements support our clinical approach:
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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. |
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Diagnosis: We own and operate sleep testing clinics that diagnose the full
range of sleep disorders including OSA, insomnia, narcolepsy and restless legs
syndrome. |
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CPAP Device Supply: We sell CPAP devices, which are used to treat OSA. |
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Re-Supply: We offer a re-supply program for our patients and other CPAP users
to obtain the required components for their CPAP devices that must be replaced on a
regular basis. |
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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 patients sleep disorder care throughout the lifecycle 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 patients sleep disorder and as the patients medical condition changes, we are paid
for additional diagnostic tests and studies.
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 patient reorder supply program, or PRSP, and a greater
likelihood of full reimbursement from federal payors and those commercial carriers who have adopted
federal payor standards.
Referral and Diagnosis
Patients at risk for, or suspected of suffering from, a sleep disorder are referred to one of
our sleep clinics by independent physicians, dentists, group practices, or self-referrals. At our
independent sleep care centers and hospital sleep diagnostic programs, which we refer to as our
sleep clinics, we administer an overnight polysomnogram, or sleep study, to determine if our
patients suffer from a sleep disorder. Our medical directors provide a diagnosis and comprehensive
report to the referring physician based on analysis of the patients sleep study results.
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CPAP Device Supply
If the physician determines the patient suffers from OSA following the review of the sleep
study results, then the patient is generally prescribed the American Academy of Sleep Medicines,
or AASM, preferred method of treatment, which is with a CPAP, device. Patients return to our
clinic for an overnight study to determine the optimal air pressure to prescribe with the CPAP
device. Sometimes, both the diagnosis and air pressure study are done in one night. Effective
January 1, 2010, regulatory restrictions prevent Medicare from making payments to sleep diagnostics
centers that sell CPAP devices unless the diagnosis has been made by a medical director who is
board-certified in sleep medicine or who meets other specified criteria. All of the sleep studies
we conduct, except for those conducted at one of our non-accredited centers, qualify us to receive
Medicare reimbursement for the sale of CPAP devices.
Re-supply
In addition to selling CPAP devices to people with OSA, we offer our patient reorder supply
program, or PRSP. The PRSP periodically supplies the components of the CPAP device that must be
regularly replaced (such as masks, hoses, filters, and other parts) to our patients and other CPAP
users. This enables them to better maintain their CPAP devices, increasing the probability of
ongoing compliance and a better long-term clinical outcome and providing us with a long-term
recurring revenue stream.
Care Management
Our thorough wellness and continuing care program led by our medical staff provides the
greatest opportunity for our patients to use their CPAP devices properly and stay compliant. After
the initial CPAP device set-up, our clinical staff contacts the patient regularly during the
initial six months (at 48 hours, two weeks, two months and six months) and each six months
thereafter to enhance patient understanding and to ensure the greatest chance for the short- and
long-term success for the patient. Most importantly, where we have the program in place, our
medical staff has an in-person visit with the patient and their CPAP device approximately 45 days
after the initial set-up. The purpose of the visit is to verify initial compliance and to enhance
compliance by assuring proper fit and feel of the CPAP device (usually the mask), determining if
there are any medical impediments to compliance (such as untreated allergies), and answering any
questions about the operation or care of the equipment. We also work closely with the patients
physicians to aid in their follow-up care and monitoring of the treatment.
Recently, as the public and medical communities have become increasingly aware of the sleep
diagnostic and treatment markets, federal and state lawmakers and regulators have taken a greater
interest in implementing stricter criteria to ensure a high standard of care. Beginning in 2009,
federal payors, and commercial carriers who have adopted similar standards, will only pay CPAP
providers for equipment over a 13-month period in equal installments. Payment is stopped if the
CPAP provider cannot document patient compliance levels that meet their established standards
within the first 90 days after the initial set-up. We believe that our clinical approach provides
us with higher patient compliance (80%) than the national compliance rate (17-54%), more often
resulting in full reimbursement from these payors.
ApothecaryRx Overview
Historically, we owned and operated 18 retail pharmacies located in Colorado, Illinois,
Missouri, Minnesota, and Oklahoma. On December 6, 2010, we completed the sale of substantially all
of the assets of ApothecaryRx to Walgreens. See ApothecaryRx Discontinued Operations for more
information on our sale of ApothecaryRxs assets and ApothecaryRxs historical business of
independent retail pharmacies.
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Our Growth Strategy
We intend to grow our SMS business as a provider of sleep diagnostic services and care
management for sleep disorders. The following are the key elements of our growth strategy:
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Expand sleep diagnostic and care management capabilities through strategic
acquisitions. We intend to drive growth primarily by acquiring successful sleep
clinics and hospital sleep diagnostic centers in
our existing geographic markets and by expanding into new markets. We believe that we
are well-positioned to acquire and successfully integrate sleep clinics because of our
size, our experienced management team, and our knowledge of the regulatory environment.
Our scale allows us to provide central services to our sleep clinics, which create
economic synergies across acquired sleep clinics and reduces our operating costs per
clinic. We expect to focus our acquisition opportunities on large diagnostic clinics
that will be accretive to our earnings and that have not previously provided, or have
not maximized the opportunity for providing, comprehensive services to their patients.
When we acquire additional hospital sleep diagnostic centers we enter into a management
contract to manage the existing sleep center without any purchase price or capital
outlay on our part which allows us to increase our therapy business through additional
patient referrals without adding to our cost base. We expect to add our care management
and ongoing re-supply services to existing high volume diagnostic services to generate
additional revenues. Through acquisitions, we intend to continue to standardize and
integrate billing, human resources, purchasing and IT systems, diversify our payor rates
through expansion into different geographic markets and promote best clinical and
operational practices across each of our sleep clinics. Over the past several years, we
have completed four acquisitions of sleep companies, each with multiple locations,
raising the total number of independent sleep care centers we own and/or operate to 26
and the total number of hospital sleep diagnostic programs to 72. |
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Drive internal growth in our Sleep Management Solutions segment. We use
marketing initiatives to increase the awareness of sleep disorders and their negative
health effects, as well as to promote our comprehensive solution to those that suffer
from sleep disorders in the markets we serve. We also use direct marketing
representatives to identify strategic hospital and physician group alliances and to
market our sleep diagnostic services and care management alternatives to area
physicians. We believe that these initiatives, along with a growing, underserved
primary target demographic, will increase utilization rates at our sleep clinics and
drive revenue growth. We intend to increase referrals from non-traditional sources,
including a focus on self-pay customers and corporate customers. We believe that
corporate payors in a number of industries, such as trucking and other common carriers,
could benefit from the diagnosis and treatment of sleep disorders of their employees.
In addition, based on our understanding of and compliance with heightened regulatory
requirements, we believe that we will be able to expand our business more easily than
other independent sleep care centers. |
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Expand on-going care management and disposable re-supply program. Generally
OSA is a long-term chronic disorder, and patients being treated for OSA are generally
treated for life. With our comprehensive model of care, ability to improve patient
compliance with therapy, and scale, we are able to maintain a long-term, diversified,
recurring revenue stream. We provide our patients with an ongoing supply of disposable
supplies for their therapy as well as periodic replacement of their CPAP devices.
Since our PRSP was initiated in 2009, approximately 70% of our patients have enrolled
into the PRSP at the time they were equipped with a CPAP device. After we acquire a
sleep center, we are generally successful in enrolling existing patients into our PRSP.
In addition, by virtue of our long-term approach to managing a patients sleep
disorder, patients periodically undergo additional diagnostic tests and CPAP pressure
optimization. |
Company History
We were formed on January 2, 2008, when our predecessor company, Graymark Productions Inc.,
acquired ApothecaryRx, LLC, and SDC Holdings, LLC, collectively referred to as the Graymark
Acquisition. For financial reporting purposes, Graymark was deemed acquired by ApothecaryRx, LLC
and SDC Holdings, LLC and, accordingly, the historical financial statements prior to December 31,
2007 are those of ApothecaryRx, LLC and SDC Holdings, LLC as adjusted for the effect of the
Graymark Acquisition. In conjunction with the Graymark Acquisition, all former operations of
Graymark Productions were discontinued. On December 6, 2010, we completed the sale of
substantially all of the assets of ApothecaryRx. As a result of the sale of ApothecaryRxs assets,
the related assets, liabilities, results of operations and cash flows of ApothecaryRx have been
classified as discontinued operations. Over the last three years, we have acquired four sleep
businesses, raising the total number of sleep clinics we own and/or operate to 25 independent sleep
care centers, and 73 hospital sleep diagnostic programs in 11 states: Oklahoma, Texas, Nevada,
Kansas, Nebraska, South Dakota, Minnesota, Iowa, Missouri, New York and Florida.
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On March 13, 2008, our Board of Directors approved a reverse split of our common stock at a
ratio of one-for-five shares. The effective date of the reverse split was April 11, 2008.
Specifically, during the period from January 1, 2008 to December 31, 2010, our SMS business
completed the following acquisitions:
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Acquisition Date |
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Business Acquired |
April 2008
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Minority interests in sleep centers |
June 2008
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Sleep Center of Waco, Ltd.; Assets of Plano Sleep
Center, Ltd.; Assets of Southlake Sleep Center, Ltd. |
June 2008
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Nocturna Sleep Center, LLC |
August 2009
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somniCare, Inc. |
August 2009
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somniTech, Inc. |
September 2009
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Avastra Eastern Sleep Center, Inc. |
Sleep Clinics and Care Management
Our SMS business provides a comprehensive diagnosis, and care management solution for the
growing population of Americans with sleep disorders. Patients at risk for, or suspected of
suffering from, a sleep disorder are referred to one of our sleep clinics by independent
physicians, dentists, group practices, or self-referrals that generally come from our reputation in
the community and our marketing and advertising efforts. Our sleep clinics typically consist of
two to eight bed facilities and are overseen by our medical directors. At our sleep clinics, we
administer an overnight polysomnogram, or sleep study, to our patients, which monitors blood oxygen
level, heart rate, respiratory function, brain waves, leg movement and other vital signs through
small and painless electrical sensors applied to the patient. We compile this information into a
detailed sleep report which includes an interpretation of the data and diagnosis by our medical
director.
If the physician determines the patient suffers from OSA, the most commonly diagnosed sleep
disorder, the patient is generally prescribed the AASMs preferred method of treatment, which is a
CPAP device. A CPAP device is a nasal or facial mask connected by a tube to a small portable
airflow generator that delivers compressed air at a prescribed continuous positive pressure. The
continuous air pressure acts as a pneumatic splint to keep the patients upper airway open and
unobstructed, resulting in a smooth breathing pattern and the reduction or elimination of other
symptoms associated with OSA, including loud snoring. Patients return to our clinic for an
additional study to determine the optimal air pressure to prescribe with the patients CPAP device.
For certain patients, we may perform a split-night study, with the first half of the night being
used to perform the initial diagnosis and the second half of the night being used to determine the
optimal air pressure setting for that patients CPAP device.
After completion of the sleep study and pressure setting process, the patient can purchase a
CPAP device from us. The initial CPAP device set-up for those patients that purchase a CPAP device
from us typically occurs at the clinic where the patient received their sleep study. Our clinical
staff contacts the patient by phone two days, two weeks, two months, six months and each six months
thereafter. We question each patient on their compliance, their product satisfaction and their
need for additional supplies. We work with these patients to ensure that they are satisfied with
the fit of their mask. Our medical staff has a meeting with each new CPAP device user
approximately 45 days after receipt of the device. At that meeting, we download actual patient
compliance data from their CPAP device, determine the true compliance to-date and take steps to
ensure the greatest chance for long-term success for the patient, including additional medical
intervention, if necessary. We believe that this continuing contact with the patient separates us
from our competition, helps raise patient compliance and ultimately results in patient
satisfaction. We also work closely with the patients physician to aid in follow-up care and
monitoring of the treatment. In addition to selling CPAP devices to patients with OSA, we offer a
program by which patients can routinely receive the components of the CPAP device that must be
regularly replaced (such as masks, hoses, filters and other parts). Our patient reorder supply
program, or PRSP, is offered through our Nocturna Sleep Therapy business. The PRSP periodically
supplies the disposable components of the CPAP system to our patients, which enables them to better
maintain their CPAP devices for a better patient outcome and provides us with a long-term
recurring revenue stream. Typically there is a need for replacement parts in three or six
month increments. We use insurance recommendations to determine the timing on shipments. We
believe our PRSP program also assists in the long-term success of our patients. We believe that
our compliance monitoring programs exceed industry standard practices. For example, we are not
aware of any national competitor for CPAP equipment that has dedicated medical personnel that offer
such in-person care. The majority of our competitors ship the CPAP device to the patients house
with no regularly scheduled in-person contact with dedicated medical staff. We believe that our
continuing care management positions us well as federal payors have implemented standards which
require proof of CPAP compliance prior to payment beyond three months of treatment, and
increasingly, commercial carriers are adopting similar standards.
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Sleep Disorders Obstructive Sleep Apnea
There are over 80 different sleep disorders, including obstructive sleep apnea, or OSA,
insomnia, narcolepsy and restless legs syndrome. The most common diagnosis for patients at sleep
medicine centers is OSA, a sleep disorder, which the National Sleep Foundation estimates occurs in
at least 18 million Americans. OSA occurs when the soft tissue in the rear of the throat narrows
and repeatedly closes during sleep, causing the body to temporarily stop breathing. Those that
suffer from OSA typically have an apnea-hypopnea index, or AHI, which represents the average number
of times they stop breathing per hour during the night, of five or more. These frequent episodes
can have a serious, deleterious effect on the health and personal lives of those with OSA. OSA is
known to increase the risk for obesity, high blood pressure, heart disease, stroke, diabetes,
depression and sexual dysfunction, among other negative health conditions. Additionally, OSA may
result in excessive daytime sleepiness, memory loss, lack of concentration and irritability, all of
which can increase the risk for automobile accidents and negatively affect work productivity and
personal relationships.
OSA is most commonly found in obese men over the age of 40, but it can also occur in men and
women of all ages and body types. The National Center for Health Statistics, or a NCHS, estimates
that in 2005-2006 more than one-third of U.S. adults, or over 72 million people, were obese.
According to the Centers for Disease Control and Prevention, or CDC, study obesity-related diseases
accounted for over 9% of all U.S. medical spending in 2008, or over $147 billion, roughly double
the amount spent in 1998. The rate of obesity in the United States is increasing at an alarming
rate. Obesity increases the size of the upper airway soft tissue structures, narrowing the airway
and increasing the risk of OSA. Not only does obesity contribute to sleep problems such as sleep
apnea, but sleep problems can also contribute to obesity. We believe individuals suffering from
OSA generally have less energy and motivation to exercise or keep a healthy diet. Studies have
also shown that sleep disorders can impair metabolism and disrupt hormone levels, promoting weight
gain. Additionally, an aging American population, led by approximately 78 million baby-boomers, is
becoming increasingly at risk for OSA as their soft palates gets longer, their pharyngeal fat pads
increase in size and the shape of bony structures around the airway change.
OSA is most commonly treated with the use of a CPAP device, the AASMs preferred method of
treatment. Other treatment alternatives include surgery, which is generally used when non-surgical
alternatives fail, oral appliances, which are most commonly used in mild to moderate OSA, or nasal
devices.
Sleep Disorder Product Supplier Relationships
We purchase our sleep disorder and CPAP devices from Nelcor Puritan Bennet LLC, Fisher &
Paykell Appliances Limited, Respironics Inc., ResMed Inc. and others. We maintain a limited
inventory of sleep disorder products to lessen the impact of any temporary supply disruption.
Our ability to sell sleep disorder products is restricted by strict federal regulations that
prohibit us from diverging from a physicians prescription. If a physician prescribes a sleep
disorder product by name other than one of the products we offer, we are prohibited by federal
regulations from substituting a different sleep disorder product.
Sleep Management Solutions Advertising and Promotion
We frequently promote sleep awareness issues and our sleep testing facilities through radio
commercials, billboard displays, print media and other marketing efforts. Our clinics also have a
strong presence at local health
fairs and other public events. We use direct marketing representatives to market to area
physicians about our sleep services. Our medical directors are involved in promoting the clinics
through local and regional public educational seminars, physician continuing education programs and
through individual meetings with referring physicians and hospitals.
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Sleep Management Solutions Management Information Systems
We employ an integrated sleep diagnostic and management information system to perform our
sleep diagnostic studies. This system provides secure transfer of sleep diagnostic study results
and other information from sleep studies to the appropriate physicians and corporate personnel. We
also employ an integrated scheduling and medical billing information system which allows for
optimal utilization of available beds for sleep studies, optimizes labor scheduling, and
streamlines information transfer for insurance and patient billing. We also utilize an enterprise
reporting and planning system to track and report both our financial performance and operational
metrics, allowing us to provide timely management information on the performance of our sleep
centers and overall business.
Sleep Disorder Diagnostic and Care Management Competition
Competition within the sleep disorder diagnostic and care management market is intense. We
face competition in each area of our sleep management solutions segment.
Sleep Diagnostics. In the sleep diagnostics business we compete primarily with independent
sleep care centers, hospital sleep diagnostic programs and with home testing services. Competition
in the sleep diagnostic market is primarily based on market presence and reputation, price,
quality, patient or client service, and achieved treatment results. We believe that our services
and products compete favorably with respect to these alternatives as we offer patients the option
of participating in our clinics as well as resupply and continuing care program, in addition to
diagnosis in one of our clinics.
We also compete with providers of home sleep diagnostic tests. In a home sleep test, patients
are attached to a portable monitoring device overnight while sleeping in their own bed. We believe
that home sleep tests have several limitations compared to overnight sleep tests in a clinic. Home
sleep tests are administered in the absence of a trained technician who, when present, is able to
correct or make equipment adjustments. In many of our clinics or facilities we have the
capabilities to pre-screen patients in a clinic under physician-supervised care, which provides the
opportunity to test in the most conducive environment for our patients. Inherent limitations exist
in home diagnostics, as the optimal pressure to be prescribed for a CPAP device still must be
performed in a clinical setting. We periodically evaluate additional opportunities to expand and
improve patient access and care including home testing.
Treatment Alternatives. Currently, the AASMs preferred method of treatment for OSA is a CPAP
device. Alternative treatments for OSA include surgery, oral appliances and nasal devices. In
addition, pharmaceuticals may be prescribed for other sleep disorders where they offer a clinical
benefit such as for insomnia, narcolepsy and restless legs syndrome.
CPAP Device Supply. We compete with durable medical equipment, or DME, providers, whether
national, regional or local when providing CPAP devices. These DME providers include Apria
Healthcare and Lincare Holdings. The purchase of a CPAP device is allowed by prescription only.
While we believe most DME providers drop ship CPAP devices to the patients home, we assist the
patient with the set-up of the machine at one of our sleep centers. We work with the patient to
ensure proper calibration of the CPAP device as well as proper fit and comfort of the mask.
CPAP Supplies. We compete with DME providers as well as e-commerce web sites for supplying
patients with the masks, hoses and filters that must be periodically replaced. We seek to have
patients who utilize us for diagnostic and therapy services registered with our patient resupply
program, or PRSP, to periodically receive supplies for their CPAP device. We believe that our PRSP
provides a convenient way for these patients to obtain their periodic supply.
Intellectual Property
In the course of our operations, we develop trade secrets and trademarks that may assist in
maintaining any developed competitive position. When determined appropriate, we may enforce and
defend our developed and established trade secrets and trademarks. In an effort to protect our
trade secrets, we require certain employees, consultants and advisors to execute confidentiality
and proprietary information agreements upon commencement of employment or consulting relationships
with us.
9
Government Regulation
Our operations are and will be subject to extensive federal, state and local regulations.
These regulations cover required qualifications, day-to-day operations, reimbursement and
documentation of activities. We continuously monitor the effects of regulatory activity on our
sleep center operations.
Licensure and Accreditation Requirements
The diagnosis of sleep disorders is a component of the practice of medicine. We engage
physicians as independent contractors or employees to provide professional services and serve as
medical directors for the sleep centers. The practice of medicine is subject to state licensure
laws and regulations. We ensure that our affiliated physicians are appropriately licensed under
applicable state law. If our affiliated physicians lose those licenses, our business, financial
condition and results of operations may be negatively impacted.
Corporate Practice of Medicine. Generally, state laws prohibit anyone but duly licensed
physicians from exercising control over the medical judgments or decisions rendered by other
physicians. This is commonly referred to as the corporate practice of medicine doctrine. States
vary widely in the interpretation of the doctrine. Some states permit a business entity (such as a
regular business corporation or limited liability company) to hold, directly or indirectly,
contracts for the provision of medical services, including the performance and/or interpretation of
diagnostic sleep studies, and to own a medical practice that provides such services, as long as
only physicians exercise control over the medical judgments or decisions of other physicians.
Other states, including states such as New York, Illinois, Texas, California, have more specific
and stringent prohibitions. In such states, the medical practice in which a physician is employed
or engaged as an independent contractor must itself be licensed or otherwise qualified to do
business as a professional entity (and owned exclusively by physicians who are licensed to practice
medicine in the state) or as a licensed diagnostic and treatment facility. Failure to comply with
these laws could have material and adverse consequences, including the judicially sanctioned
refusal of third-party payors to pay for services rendered, based upon violation of a statute
designed to protect the public, as well as civil or criminal penalties. We believe that we are in
compliance with the corporate practice of medicine laws in each state in which our sleep centers
operate. We do not exercise control over the medical judgments or decisions of our affiliated
physicians. While we believe we are in compliance with the requirements of the corporate practice
of medicine laws in each state where our sleep centers are located, these laws and their
interpretations are continually evolving and may change in the future. Moreover, these laws and
their interpretations are generally enforced by state courts and regulatory agencies that have
broad discretion in their enforcement.
Fee Splitting. Generally, state laws prohibit a physician from splitting fees derived from
the practice of medicine with anyone else. We believe that the management, administrative,
technical and other nonmedical services we provide to each of our sleep centers for a service fee
does not constitute fee splitting. However, these laws and their interpretations also vary from
state to state and are also enforced by state courts and regulatory authorities that have broad
discretion in their enforcement.
If our arrangements with our affiliated physicians or our sleep centers are found to violate
state laws prohibiting the practice of medicine by general business entities or fee splitting, our
business, financial condition and ability to operate in those states could be adversely affected.
With respect to our sleep centers, there has been a trend developing to require facilities
that provide sleep diagnostic testing to become accredited by the American Academy of Sleep
Medicine (AASM) or The Joint Commission, as well as additional credentialing for physicians
diagnosing sleep studies and the licensing of technical personnel to perform diagnostic testing
procedures. As of November 15, 2010, 14 of our free standing sleep centers have been accredited by
the AASM. Another three free standing sleep centers are accredited through
The Joint Commission. We are actively working on having our remaining sleep centers
accredited. We believe we will achieve full accreditation for these centers by mid-2011.
Additionally, as of September 30, 2009, Medicare required that all Durable Medical Equipment (DME)
suppliers be accredited with the exception of pharmacies whose deadline was extended to January 1,
2010. As of June 15, 2010, all of our sleep therapy facilities providing DME were granted
accreditation by The Joint Commission or by the Accreditation Commission for Healthcare (ACHC).
10
Medicare and Medicaid
Our sleep centers operate under regulatory and cost containment pressures from federal and
state legislation primarily affecting Medicaid and Medicare.
In order to submit claims directly to Medicare for reimbursement, our centers must be enrolled
as independent diagnostic testing facilities, or IDTFs. Some of our centers are not enrolled as
IDTFs and do not accept Medicare patients for testing. Our centers that are not enrolled as IDTFs
may perform sleep studies for Medicare patients if the center enters into a contract with a
hospital to perform the studies under arrangements for the hospital, in which case the hospital
bills Medicare under its own provider number. Enrollment as an IDTF or the performance of services
under arrangements for hospitals requires compliance with numerous regulations, and the failure
to comply with applicable requirements could result in revocation of an IDTF enrollment or the
ineligibility of the hospital to obtain reimbursement for services performed on its behalf by one
of our centers. Additionally, not all private health plans permit services to be performed by our
sleep centers under arrangements for a hospital.
In some locations, we supply CPAP devices and other DME to sleep studies patients who are
diagnosed with sleep disorders, as ordered by a physician. Medicare suppliers of DME, prosthetics,
orthotics and supplies, or DMEPOS, unless exempt, must be accredited and secure a surety bond.
Medicare generally prohibits a physician who performs a covered medical service from
reassigning to anyone else the performing physicians right to receive payment directly from
Medicare, except in certain circumstances. We believe we satisfy one or more of the exceptions to
this prohibition.
The Medicare and Medicaid programs are subject to statutory and regulatory changes,
retroactive and prospective rate adjustments, administrative rulings, executive orders and freezes
and funding restrictions, all of which may significantly impact our sleep center operations. There
is no assurance that payments for sleep testing services and DME under the Medicare and Medicaid
programs will continue to be based on current methodologies or even remain similar to present
levels. We may be subject to rate reductions as a result of federal or state budgetary constraints
or other legislative changes related to the Medicare and Medicaid programs.
We receive reimbursement from government sponsored third-party plans, including Medicaid and
Medicare, non-government third-party plans, including managed-care organizations, and also directly
from individuals, or private-pay. During 2010, our sleep center payor mix, as a percentage of
total sleep center revenues, was approximately 78% commercial insurance, 16% Medicaid/Medicare and
6% private-pay. During 2009, our sleep center payor mix, as a percentage of total sleep center
revenues, was approximately 78% commercial insurance, 18% Medicaid/Medicare and 4% private-pay.
Pricing for private-pay patients is based on prevailing regional market rates.
In addition to requirements mandated by federal law, individual states have substantial
discretion in determining administrative, coverage, eligibility and reimbursement policies under
their respective state Medicaid programs that may affect our sleep center operations.
Fraud and Abuse Laws
We are subject to federal and state laws and regulations governing financial and other
arrangements among healthcare providers. Commonly referred to as the Fraud and Abuse laws, these
laws prohibit certain financial relationships between pharmacies, physicians, vendors and other
referral sources. During the last several years, there has been increased scrutiny and enforcement
activity by both government agencies and the private plaintiffs bar relating to pharmaceutical
marketing practices under the Fraud and Abuse laws. Violations of Fraud and Abuse
laws and regulations could subject us to, among other things, significant fines, penalties,
injunctive relief, pharmacy shutdowns and possible exclusion from participation in federal and
state healthcare programs, including Medicare and Medicaid. Additionally, in its Fiscal Year 2010
Work Plan, the Office of Inspector General of the Department of Health and Human Services
identified that it would study the appropriateness of Medicare payments for polysomnography and
assess provider compliance with federal program requirements. Changes in healthcare laws or new
interpretations of existing laws may significantly affect our business. Some of the Fraud and
Abuse Laws that have been applied are discussed below.
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Federal and State Anti-Kickback Statutes: The federal anti-kickback statute, Section 1128B(b)
of the Social Security Act (42 U.S.C. 1320a-7b(b)), prohibits, among other things, the knowing and
willful offer, payment, solicitation or acceptance of remuneration, directly or indirectly, in
return for referring an individual to a provider of services for which payment may be made in whole
or in part under a federal healthcare program, including the Medicare or Medicaid programs.
Remuneration has been interpreted to include any type of cash or in-kind benefit, including the
opportunity to participate in investments, long-term credit arrangements, gifts, supplies,
equipment, prescription switching fees, or the furnishing of business machines. Several courts
have found that the anti-kickback statute is violated if any purpose of the remuneration, not just
the primary purpose, is to induce referrals.
Potential sanctions for violations of the anti-kickback statute include felony convictions,
imprisonment, substantial criminal fines and exclusion from participation in any federal healthcare
program, including the Medicare and Medicaid programs. Violations may also give rise to civil
monetary penalties in the amount of $50,000, plus treble damages.
Similarly, many state laws prohibit the solicitation, payment or receipt of remuneration in
return for, or to induce, the referral of patients to private as well as government programs.
Violation of these anti-kickback laws may result in substantial civil or criminal penalties for
individuals or entities and/or exclusion from participating in federal or state healthcare
programs.
Although we believe that our relationships with vendors, physicians, and other potential
referral sources comply with Fraud and Abuse laws, including the federal and state anti-kickback
statutes, the Department of Health and Human Services has acknowledged in its industry compliance
guidance that many common business activities potentially violate the anti-kickback statute. There
is no assurance that a government enforcement agency, private litigant, or court will not interpret
our business relations to violate the Fraud and Abuse laws.
The False Claims Act: Under the False Claims Act, or FCA, civil penalties may be imposed upon
any person who, among other things, knowingly or recklessly submits, or causes the submission of
false or fraudulent claims for payment to the federal government, for example in connection with
Medicare and Medicaid. Any person who knowingly or recklessly makes or uses a false record or
statement in support of a false claim, or to avoid paying amounts owed to the federal government,
may also be subject to damages and penalties under the FCA.
Furthermore, private individuals may bring whistle blower (qui tam) suits under FCA, and
may receive a portion of amounts recovered on behalf of the federal government. These actions must
be filed under seal pending their review by the Department of Justice. Penalties of between $5,500
and $11,000 and treble damages may be imposed for each violation of FCA. Several federal district
courts have held that FCA may apply to claims for reimbursement when an underlying service was
delivered in violation of other laws or regulations, including the anti-kickback statute.
In addition to FCA, the federal government has other civil and criminal statutes that may be
utilized if the Department of Justice suspects that false claims have been submitted. Criminal
provisions that are similar to FCA provide that if a corporation is convicted of presenting a claim
or making a statement that it knows to be false, fictitious or fraudulent to any federal agency, it
may be fined not more than twice any pecuniary gain to the corporation, or, in the alternative, no
more than $500,000 per offense. Many states also have similar false claims statutes that impose
liability for the types of acts prohibited by FCA. Finally, the submission of false claims may
result in termination of our participation in federal or state healthcare programs. Members of
management and persons who actively participate in the submission of false claims can also be
excluded from participation in federal healthcare programs.
Additionally, some state statutes contain prohibitions similar to and possibly even more
restrictive than the FCA. These state laws may also empower state administrators to adopt
regulations restricting financial relationships or payment arrangements involving healthcare
providers under which a person benefits financially by referring a patient to another person.
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We believe that we have sufficient procedures in place to provide for the accurate completion
of claim forms and requests for payment. Nonetheless, given the complexities of the Medicare and
Medicaid programs, we may code or bill in error, and such claims for payment may be treated as
false claims by the enforcing agency or a private litigant.
Physician Self-Referral Prohibitions. The federal physician self-referral statute, known as
the Stark law, prohibits a physician from making a referral of Medicare beneficiaries for certain
designated health services, including outpatient prescription drugs and DME (including CPAPs), to
any entity with which the physician has a financial relationship, unless there is an exception in
the law that allows the referral. Sleep studies are not designated health services unless they are
performed under arrangements for a hospital and billed by the hospital. The entity that receives a
prohibited referral from a physician may not submit a bill to Medicare for that service. Federal
courts have ruled that a violation of the Stark statute, as well as a violation of the federal
anti-kickback law described above, can serve as the basis for an FCA suit. Many state laws
prohibit physician referrals to entities with which the physician has a financial interest, or
require that the physician provide the patient notice of the physicians financial relationship
before making the referral. Violation of the Stark law can result in substantial civil penalties
for both the referring physician and any entity that submits a claim for a healthcare service made
pursuant to a prohibited referral. We believe that all of our customer arrangements are in
compliance with the Stark law. However, these laws could be interpreted in a manner inconsistent
with our operations. Federal or state self-referral regulation could impact our arrangements with
certain physician investors or independent contractors.
Medicare Anti-Markup Rule. CMS has recently finalized certain anti-markup rules relating to
diagnostic tests paid for by the Medicare program. The anti-markup rules are generally applicable
where a physician or other supplier bills for the technical component or professional component of
a diagnostic test that was ordered by the physician or other supplier (or ordered by a party
related to such physician or other supplier through common ownership or control), and the
diagnostic test is performed by a physician that does not share a practice with the billing
physician or other supplier. If the anti-markup rule applies to a diagnostic test, then the
reimbursement provided by Medicare to a billing physician or other supplier for that transaction
may be limited. Because our sleep labs bill Medicare for the technical and professional fees of
sleep diagnostic tests that are ordered by community physicians or our affiliated physicians, we
believe that the anti-markup rule does not apply to the professional services our affiliated
physicians perform or the technical services that our sleep labs perform.
Healthcare Information Practices
The Health Insurance Portability and Accountability Act of 1996, or HIPAA, sets forth
standards for electronic transactions; unique provider, employer, health plan and patient
identifiers; security and electronic signatures as well as privacy protections relating to the
exchange of individually identifiable health information. The Department of Health and Human
Services, or DHHS, has released several rules mandating compliance with the standards set forth
under HIPAA. We believe our sleep centers achieved compliance with DHHSs standards governing the
privacy of individually identifiable health information and DHHSs standards governing the security
of electronically stored health information. In addition, we have fully implemented the required
uniform standards governing common healthcare transactions. Finally, we have taken or will take
all necessary steps to achieve compliance with other HIPAA rules as applicable, including the
standard unique employer identifier rule, the standard healthcare provider identifier rule and the
enforcement rule.
HIPAA authorizes the imposition of civil money penalties against entities that employ or enter
into contracts with individuals or entities that have been excluded from participation in the
Medicare or Medicaid programs. We perform background checks on our affiliated physicians, and we
do not believe that we engage or contract with any excluded individuals or entities. However, a
finding that we have violated this provision of HIPAA could have a material adverse effect on our
business and financial condition.
HIPAA also establishes several separate criminal penalties for making false or fraudulent
claims to insurance companies and other non-governmental payors of healthcare services. These
provisions are intended to punish some of the same conduct in the submission of claims to private
payors as the FCA covers in connection with governmental health programs. We believe that our
services have not historically been provided in a way that would place either our clients or
ourselves at risk of violating the HIPAA anti-fraud statutes, including those in which we received
direct reimbursement because of the reassignment by affiliated physicians to us or those in which
we may be considered to receive an indirect reimbursement because of the reassignment by us to
hospitals of the right to collect for professional interpretations and technical services.
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We continue to evaluate the effect of the HIPAA standards on our business. At this time, we
believe that our sleep centers have taken all appropriate steps to achieve compliance with the
HIPAA requirements. Moreover, HIPAA compliance is an ongoing process that requires continued
attention and adaptation. We do not currently believe that the cost of compliance with the
existing HIPAA requirements will be material to our operations; however, we cannot predict the cost
of future compliance with HIPAA requirements. Noncompliance with HIPAA may result in criminal
penalties and civil sanctions. The HIPAA standards have increased our regulatory and compliance
burden and have significantly affected the manner in which our sleep centers use and disclose
health information, both internally and with other entities.
In addition to the HIPAA restrictions relating to the exchange of healthcare information,
individual states have adopted laws protecting the confidentiality of patient information which
impact the manner in which patient records are maintained. Violation of patient confidentiality
rights under common law, state or federal law could give rise to damages, penalties, civil or
criminal fines and/or injunctive relief. We believe that our sleep center operations are in
compliance with federal and state privacy protections. However, an enforcement agency or court may
find a violation of state or federal privacy protections arising from our sleep center operations.
Third-Party Reimbursement
The cost of medical care in the United States and many other countries is funded substantially
by government and private insurance programs. We receive payment for our products or services
directly from these third-party payors and our continued success is dependent upon the ability of
patients and their healthcare providers to obtain adequate reimbursement for those products and
sleep disorder diagnostic services. In most major markets, our services and supplies are utilized
and purchased primarily by patients suffering from obstructive sleep apnea. Patients are generally
covered by private insurance. In those cases, the patient is responsible for his or her co-payment
portion of the fee and we invoice the patients insurance company for the balance. Billings for
the products or services reimbursed by third-party payors, including Medicare and Medicaid, are
recorded as revenues net of allowances for differences between amounts billed and the estimated
receipts from the third-party payors. In hospitals, we contract with the hospital on a fee for
service basis and the hospital assumes the risk of billing.
The third-party payors include Medicare, Medicaid and private health insurance providers.
These payors may deny reimbursement if they determine that a device has not received appropriate
FDA clearance, is not used in accordance with approved applications, or is experimental, medically
unnecessary or inappropriate. Third-party payors are also increasingly challenging prices charged
for medical products and services, and certain private insurers have initiated reimbursement
systems designed to reduce healthcare costs. The trend towards managed healthcare and the growth
of health maintenance organizations, which control and significantly influence the purchase of
healthcare services and products, as well as ongoing legislative proposals to reform healthcare,
may all result in lower prices for our products and services. There is no assurance that our sleep
disorder products and services will be considered cost-effective by third-party payors, that
reimbursement will be available or continue to be available, or that payors reimbursement policies
will not adversely affect our ability to sell our products and services on a profitable basis, if
at all.
Minimum Wage Requirements
We are impacted by recent legislation in states that increase the minimum hourly wages to
$7.25 on July 25, 2009. While the increase in minimum hourly wages impacts our cost of labor, most
of our employees are skilled and are already above the minimum hourly wage level. Additionally, we
believe we can offset a significant portion of any cost increase through initiatives designed to
further improve labor efficiency.
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ApothecaryRx Discontinued Operations
On September 1, 2010, we agreed to sell substantially all of the assets of ApothecaryRxs
independent retail pharmacy business to Walgreens. The final closing was completed on December 6,
2010. Through ApothecaryRx, we operated independent retail pharmacy stores 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. We had historically grown our pharmacy business by acquiring financially
successful independently-owned retail pharmacies from long-term owners that were approaching
retirement. The acquired pharmacies successfully maintained market share due to their convenient
proximity to healthcare providers and services, high customer service levels, longevity in the
community, competitive pricing. Additionally, our independent pharmacies offered supportive
services and products such as pharmaceutical compounding, durable medical equipment, and assisted
and group living facilities. The pharmacies were located in mid-size, economically-stable
communities and we believed that a significant amount of the value of the pharmacies resides in
retaining the historical pharmacy name and key staff relationships in the community. Prior to the
sale, we owned and operated 18 retail pharmacies located in Colorado, Illinois, Missouri,
Minnesota, and Oklahoma.
Employees
As of March 22, 2011, we had 177 full-time and 29 part-time employees at Graymark Healthcare,
Inc. Our employees are not represented by a labor union.
We have limited liquidity and we have insufficient capital to fund our operations for the next
twelve months or less.
We have insufficient liquidity to fund our operations for the next twelve months or less.
While we are in the process of re-engineering our business operations to operate on a positive
operating cash flow basis, we do not have sufficient liquidity to operate until such time without
additional funds.
As of December 31, 2010, we had an accumulated deficit of approximately $29.2 million and
reported a net loss of approximately $19.1 for the year then ended. We used approximately $2.4
million in cash from operating activities of continuing operations during the year ending December
31, 2010. Furthermore, we have a working capital deficit of approximately $20.5 million as of
December 31, 2010. We are required to make a $3 million principal payment to Arvest Bank by June
30, 2011 and we are not currently in compliance with certain covenants required by our lending
agreement with Arvest Bank.
We expect to raise $15 million or more in a public stock offering by the end of April 2011.
From the proceeds of the offering, if any, we will be required to pay the greater of one-third of
the proceeds of the equity offering or $3 million to Arvest Bank. We also intend to prepay
approximately $2.0 million to Arvest Bank representing the remaining amount of principal and
interest due through December 31, 2011 to be applied in accordance with the Arvest Credit Facility
in order to obtain a waiver from Arvest of the Debt Service Coverage Ratio and Minimum Net Worth
covenants through such date. We also intend to pay up to $1.0 million to repay outstanding amounts
under our loan with Valiant Investments. We intend to use the remaining proceeds, if any, to
provide working capital for our continued operations. In the event that we are unable to obtain
debt or equity financing or we are unable to obtain such financing on terms and conditions
acceptable to us, we may have to cease or severely curtail our operations.
We have insufficient liquidity to fund our operations for the next twelve months or less. In
addition, any of the following factors could result in insufficient capital to fund our operations
for a period significantly shorter than twelve months:
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if our capital requirements or cash flow vary materially from our current
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if we are unable to timely collect our accounts receivable; |
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if we are unable to re-engineer our business operations to operate on a
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if we are unable to raise funds to operate our business; and |
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if other unforeseen circumstances occur. |
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Inability to fund our operations may require us to substantially curtail our operations, which
will likely result in a complete loss of any investment in shares of our common stock.
Our independent registered public accounting firm has expressed substantial doubt about our ability
to continue as a going concern. This report may impair our ability to raise additional financing
and adversely affect the price of our common stock.
The report of our independent registered public accounting firm contained in our consolidated
financial statements as of and for the year ended December 31, 2010 includes a paragraph that
explains that we have incurred significant operating losses, have serious liquidity issues and may
require additional financing in the foreseeable future. The report concludes that these matters,
among others, raise substantial doubt about our ability to continue as a going concern. Reports of
independent auditors questioning a companys ability to continue as a going concern are generally
viewed unfavorably by analysts and investors. This report may make it difficult for us to raise
additional financing necessary to grow or operate our business.
We have a bank credit facility of approximately $22 million and we may not achieve compliance with
the Debt Service Coverage Ratio requirements which begin June 30, 2011.
We are party to an amended Loan Agreement with Arvest Bank (the Arvest Credit Facility).
The Arvest Credit Facility provides for a term loan in the principal amount of $30 million
(referred to as the Term Loan) and provides an additional credit facility in the principal amount
of $15 million (the Acquisition Line) for total principal of $45 million. As of December 31,
2010, the outstanding principal amount of the Arvest Credit Facility was $22,396,935. In
connection with our sale of the assets of ApothecaryRx to Walgreens, we reduced the outstanding
balance on the Arvest Credit Facility by $22 million during 2010. Commencing with the calendar
quarter ending June 30, 2010 and thereafter during the term of the Arvest Credit Facility, based on
the latest four rolling quarters, we agreed to continuously maintain a Debt Service Coverage
Ratio of not less than 1.25 to 1. As of December 31, 2010, our Debt Service Coverage Ratio is
less than 1.25 to 1. The Debt Service Coverage Ratio is calculated using the latest four rolling
quarters. We are currently developing and executing a combination of strategic, operational and
debt reduction strategies and expect to be in compliance with the Debt Service Coverage Ratio, but
do not anticipate being in compliance by June 30, 2011. If we are unsuccessful in fully executing
these strategies, there is no assurance that Arvest Bank will waive or further delay the
requirement. Arvest Bank has agreed to waive the Debt Service Coverage Ratio and the Minimum Net
Worth covenants through December 31, 2011 if we pay to Arvest Bank the greater of $3 million or
one-third of the proceeds of our next public offering, plus the principal and interest due for the
remainder of 2011, plus, if we raise over $15 million in proceeds from this transaction, we will
need to deposit into an escrow account the amount required to make principal and interest payments
to Arvest Bank from January 1, 2012 to June 30, 2012.
If an event of default is not cured within 10 days following notice of the default by Arvest
Bank, Arvest Bank will have the right to declare the outstanding principal and accrued and unpaid
interest immediately due and payable. Payment and performance of our obligations under the Arvest
Credit Facility are secured by the personal guaranties of certain of our current and former
executive officer and our largest stockholder and in general our assets. In addition, in
connection with a third amendment to the Arvest Credit Facility in July 2010, we also entered into
a Deposit Control Agreement with Arvest Bank covering our accounts at Valliance Bank. Arvest Bank
may exercise its rights to give instructions to Valliance Bank under the Deposit Control Agreement
only in the event of an uncured default under the Loan Agreement, as amended.
If Arvest Bank accelerates the payment of outstanding principal and interest, we will need to
file a current report on Form 8-K with the SEC disclosing the event of default and the acceleration
of payment of all principal and interest. In addition, we do not expect to be able to pay all
outstanding principal and interest if Arvest Bank accelerates the due dates for such amounts.
Since we have granted Arvest Bank a security interest in all of our assets, Arvest Bank could elect
to foreclose on such assets as well as to move to enforce the guaranty which is provided by certain
of our current and former officers and directors. If Arvest Bank declares an event of default
and/or accelerates the payment of our obligations under the Arvest Credit Facility, then the
disclosure of such fact may cause a material decrease in the price of our stock on The Nasdaq
Capital Market. The declaration of an event of default and the move to foreclose on our assets may
cause a material adverse effect on our ability to operate our business in the ordinary course of
business as well as a material adverse effect on our liquidity, results of operations and financial
position.
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We need to obtain additional financing to fund our ongoing working capital needs.
We currently fund our working capital needs with cash generated from operations, from funds
previously raised from equity and debt financings and from funds generated from the sale of the
assets of ApothecaryRx. We are currently evaluating various measures to maintain sufficient
liquidity for the continuity of normal business operations. Certain of these options include the
acceleration of collection of our accounts receivable, the deceleration of payments on our trade
payables, the negotiation of extended payment terms with certain of our vendors and the possibility
of raising additional capital through the issuance and sale of equity or debt securities. We
continually project and evaluate our cash and working capital needs and plan for the timing of
these payments, but there can be no assurance that we can raise additional capital or maintain
liquidity sufficient to fund our working capital for normal business operations. If we are unable
to maintain working capital sufficient for normal business operations, our business, results of
operation and financial position may be materially adversely affected.
We require a significant amount of cash flow from operations and third-party financing to pay our
indebtedness, to execute our business plan and to fund our other liquidity needs.
We may not be able to generate sufficient cash flow from operations, and future borrowings may
not be available to us under existing loan facilities or otherwise in an amount sufficient to pay
our indebtedness, to execute our business plan or to fund our other liquidity needs. We anticipate
the need for substantial cash flow to fund future acquisitions, which is our primary growth
strategy. In addition, we may need to refinance some or all of our current indebtedness at or
before maturity.
We incurred indebtedness with an outstanding balance at December 31, 2010 of approximately $22
million to fund the acquisitions of our existing sleep centers. The outstanding principal amounts
under the Arvest Bank credit facility and the term loan bear interest at the greater of the Wall
Street Journal prime rate or 6%. Prior to June 30, 2010, the floor rate was 5%. Further details
about this indebtedness can be found in the footnotes to our interim financial statements included
elsewhere in this report and Managements Discussion and Analysis of Financial Condition and
Results of Operations.
At December 31, 2010, we had total liabilities of approximately $28.5 million. Because of our
lack of significant historical operations, there is no assurance that our operating results will
provide sufficient funding to pay our liabilities on a timely basis. There is no assurance that we
will be able to refinance any of our current indebtedness on commercially reasonable terms or at
all. Failure to generate or raise sufficient funds may require us to modify, delay or abandon some
of our future business growth strategies or expenditure plans.
The markets for sleep diagnostic services and sale of related products are highly competitive, and
we compete against substantially larger healthcare providers, including hospitals and clinics.
Competition among companies that provide healthcare services and supplies is intense. If we
are unable to compete effectively with existing or future competitors, we may be prevented from
retaining our existing customers or from attracting new customers, which could materially impair
our business. There are a number of companies that currently offer or are in the process of
offering services and supplies that compete with our sleep diagnostic and care management services
and related product and supplies sales. These competitors may succeed in providing services and
products that are more effective, less expensive or both, than those we currently offer or that
would
render some of our services or supplies obsolete or non-competitive. Some of our competitors
may submit lower bids in a competitive bidding process or may be able to accept lower reimbursement
rates from third party payors, thus gaining market share in our target markets. Many of our
competitors have greater financial, research and development, manufacturing, and marketing
resources than we have and may be in a better position than us to withstand the adverse effects on
gross margins and profitability caused by price decreases prevalent in this competitive
environment.
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If third party payors determine that we violate Medicare, Medicaid or other payor reimbursement
laws, regulations, or requirements, our revenues may decrease, we may have to restructure our
method of billing and collecting Medicare, Medicaid or other payor program payments, respectively,
and we could incur substantial defense costs and be subject to fines, monetary penalties and
exclusion from participation in government-sponsored programs such as Medicare and Medicaid.
Our operations, including our billing and other arrangements with healthcare providers, are
subject to extensive federal and state government regulation and requirements of other third-party
payors. Such regulations and requirements include numerous laws directed at payment for services,
conduct of operations, preventing fraud and abuse, laws prohibiting general business corporations,
such as us, from practicing medicine, controlling physicians medical decisions or engaging in some
practices such as splitting fees with physicians, laws regulating billing and collection of
reimbursement from government programs, such as Medicare and Medicaid, and requirements of other
payors. Those laws and requirements may have related rules and regulations that are subject to
alternative interpretations and may not provide definitive guidance as to their application to our
operations, including our arrangements with hospitals, physicians and professional corporations.
For our SMS business, we verify patient benefit eligibility prior to providing services or
products. We submit claims for service and products after they have been provided. Claims are
supported by required documentation including physician orders. Despite our measures to ensure
compliance with Medicare, Medicaid, or other payor billing standards, such third-party payors may
disallow, in whole or in part, requests for reimbursement based on determinations that certain
amounts are not reimbursable, that the service was not medically necessary, that there was a lack
of sufficient supporting documentation, or for other reasons. Incorrect or incomplete
documentation and billing information could result in nonpayment, recoupment or allegations of
billing fraud.
We are not aware of any inquiry, investigation or notice from any governmental entity or other
payor indicating that we are in violation of any of the Medicare, Medicaid or other payor
reimbursement laws, regulations, or requirements. We believe we are in substantial compliance with
these laws, rules and regulations based upon what we believe are reasonable and defensible
interpretations of these laws, rules and regulations. However, such laws and related regulations
and regulatory guidance may be ambiguous or contradictory, and may be interpreted or applied by
prosecutorial, regulatory or judicial authorities in ways that we cannot predict. If federal or
state government officials or other payors challenge our operations or arrangements with third
parties that we have structured based upon our interpretation of these laws, rules and regulations,
the challenge could potentially disrupt our business operations and we may incur substantial
defense costs, even if we successfully defend our interpretation of these laws, rules and
regulations. In addition, if the government or other payors successfully challenge our
interpretation as to the applicability of these laws, rules and regulations as they relate to our
operations and arrangements with third parties, we would potentially incur substantial cost
restructuring our billing practice, as well as fines or penalties for non-compliance which could
have a material adverse effect on our business, financial condition and results of operations.
In the event regulatory action were to limit or prohibit us from carrying on our business as
we presently conduct it or from expanding our operations to certain jurisdictions, we may need to
make structural, operational and organizational modifications to our company and/or our contractual
arrangements with third-party payors, physicians, or others. Our operating costs could increase
significantly as a result. We could also lose contracts or our revenues could decrease under
existing contracts. Any restructuring would also negatively impact our operations because our
managements time and attention would be diverted from running our business in the ordinary course.
We are subject to complex rules and regulations that govern our licensing and certification, and
the failure to comply with these rules can result in delays in, or loss of, reimbursement for our
services or civil or criminal sanctions.
There has been a trend developing to require facilities that provide sleep diagnostic testing
and durable medical equipment to become accredited by an approved accreditation organization as
well as additional credentialing for physicians diagnosing sleep disorders and the licensing of
technical personnel to perform diagnostic testing procedures. As of March 1, 2011, 16 of our free
standing sleep centers are accredited by the American Academy of Sleep Medicine, or the AASM.
Another three free standing sleep centers are accredited through The Joint Commission. We are
actively pursuing accreditation for our remaining sleep centers. We believe we will achieve full
accreditation for these centers by mid-2011. Additionally, as of September 30, 2009, Medicare
required that all Durable Medical Equipment (DME) suppliers be accredited with the exception of
pharmacies supplying DME, whose deadline was extended to January 1, 2010. All of our sleep therapy
facilities providing DME were granted accreditation by The Joint Commission or by the Accreditation
Commission for Healthcare, or ACHC. One of our DME suppliers, somniCare Overland Park, Kansas
location, recently underwent the nations first ever DME site accreditation visit held by the AASM,
to which we expect to have a letter of certification as the first accredited sleep therapy company
by the AASM.
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Physicians, physician assistants, nurse practitioners, and respiratory therapists who provide
services as part of our operations are required to obtain and maintain certain professional
licenses or certifications and are subject to state regulations regarding professional standards of
conduct.
Some states also require our free-standing diagnostic testing facilities and DME providers to
be licensed by or registered with state authorities such as state departments of health. We
believe that we are in compliance with the licensing and registration in applicable states.
Some state laws require that companies dispensing DME and supplies within the state be
licensed by the state board of pharmacy. We currently have a pharmacy license for dispensing of
durable medical equipment and supplies in applicable states.
The relevant laws and regulations are complex and may be unclear or subject to interpretation.
Currently we believe we are in compliance with all requisite regulatory authorities; however,
agencies that administer these programs may find that we have failed to comply in some material
respects. Failure to comply with these licensing, certification and accreditation laws,
regulations and standards could result in our services being found non-reimbursable or prior
payments being subject to recoupment, and can give rise to civil or, in extreme cases, criminal
penalties.
Government and private insurance plans may further reduce or discontinue healthcare reimbursements,
which could result in reductions in our revenue and operating margins.
A substantial portion of the cost of medical care in the United States is funded by managed
care organizations, insurance companies, government funded programs, employers and other
third-party payors, which are collectively referred to as third-party plans. These plans
continue to seek cost containment. If this funding were to be reduced in terms of coverage or
payment rates or were to become unavailable to our sleep disorder patients, our business will be
adversely affected. Furthermore, managed care organizations and insurance companies are evaluating
approaches to reduce costs by decreasing the frequency of treatment or the utilization of a medical
device or product. These cost containment measures have caused the decision-making function with
respect to purchasing to shift in many cases from the physician to the third-party plans or payors,
resulting in an increased emphasis on reduced price, as opposed to clinical benefits or a
particular products features. Efforts by U.S. governmental and private payors to contain costs
will likely continue. Because we generally receive payment for our sleep diagnostic services and
related products directly from these third-party plans, our business operations are dependent upon
our ability to obtain adequate and timely reimbursement for our sleep diagnostic services and
related products.
The third-party payors include Medicare, Medicaid and private health insurance providers.
These payors may deny reimbursement if they determine that a diagnostic test was not covered under
the patients plan or performed properly or that a device is not covered under the patients plan,
is not used in accordance with approved indications, or is unnecessary or deemed to be
inappropriate treatment for the patient. For example, federal payors
and commercial concerns that have adopted similar standards will only fully reimburse us for a
CPAP device if the patient can demonstrate compliance for the first 90 days after the initial
set-up. Third-party payors are also increasingly challenging prices charged for medical products
and services. There is no assurance that our sleep diagnostic services and the related products
will be considered cost-effective by third-party payors, that reimbursement will be available, or
that payors reimbursement policies will not adversely affect our ability to offer and sell our
services and products on a profitable basis, if at all.
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Changes in reimbursement levels for sleep diagnostic services and related products continue to
reduce our margins and could have a material, adverse effect on our overall operating results.
During the years ended December 31, 2010, 2009 and 2008, we were wholly or partially
reimbursed by third-party plans for approximately 94%, 96% and 99%, respectively of our revenue
from sleep diagnostic services and product sales. The sleep diagnostic revenue reimbursed by
third-party plans, including Medicare and Medicaid plans, generally have lower gross margins
compared to sales or services paid outside a third-party plan. Increases in the costs of our sleep
related products may not be sufficiently offset by increases in reimbursement rates. In addition,
continued increases in co-payments by third-party plans may result in decreases in sales and
revenue, operating and cash flow losses, and may deplete working capital reserves.
In particular, Medicare and Medicaid programs are subject to statutory and regulatory changes,
retroactive and prospective reimbursement rate adjustments, administrative rulings, executive
orders and freezes and funding restrictions, all of which may significantly impact our operations.
During the years ended December 31, 2010, 2009 and 2008, 16%, 18% and 6%, respectively, of our
sleep diagnostic revenues were attributable to Medicaid and Medicare reimbursement. Over the last
several years, a number of states experiencing budget deficits have moved to reduce Medicaid
reimbursement rates as part of healthcare cost containment.
We depend on reimbursements by third-party payors, as well as payments by individuals, which could
lead to delays and uncertainties in the reimbursement process.
We receive a substantial portion of our payments for sleep center services and related
supplies from third-party payors, including Medicare, Medicaid, private insurers and managed care
organizations. The reimbursement process for these third-party payors is complex and can involve
lengthy delays. Third-party payors continue their efforts to control expenditures for healthcare,
including proposals to revise reimbursement policies. While we recognize revenue when healthcare
services are provided, there can be delays before we receive payment. In addition, third-party
payors may disallow, in whole or in part, requests for reimbursement based on determinations that
certain amounts are not reimbursable under plan coverage, that services provided were not medically
necessary, or that additional supporting documentation is necessary. Retroactive adjustments may
change amounts realized from third-party payors. These risks may be exacerbated for patients for
whom we are out-of-network. We are subject to governmental audits of our reimbursement claims
under Medicare and Medicaid and may be required to repay these agencies if a finding is made that
we were incorrectly reimbursed. Delays and uncertainties in the reimbursement process may
adversely affect accounts receivable, increase the overall costs of collection and cause us to
incur additional borrowing costs.
We also may not be paid with respect to co-payments and deductibles that are the patients
financial responsibility, or in those instances when our facilities provide services to uninsured
and underinsured individuals. Amounts not covered by third-party payors are the obligations of
individual patients for which we may not receive whole or partial payment. In such an event, our
earnings and cash flow would be adversely affected.
Healthcare reform has been enacted into law and could impact the profitability of our business.
The Affordable Care Act, enacted in March 2010, is dramatically altering the U.S. health care
system. The law is intended to increase access to health care and health insurance services,
increase the quality of care that is provided, and control or reduce health care spending. In
addition, health care reform reduces Medicare and Medicaid payments to hospitals and other
healthcare providers and bundle payments to hospitals, physicians, and other providers for certain
services. We are unable to predict how changes in the law or new interpretations of existing laws
may have a dramatic effect on the costs associated with doing business and the amount of
reimbursement patients and customers receive both from government and third-party plans or payors.
Federal, state
and local government representatives will, in all likelihood, continue to review and assess
alternative regulations and payment methodologies.
Healthcare reform and enforcement initiatives of federal and state governments may also affect our
sales and revenue. These include:
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Significant reductions in spending on Medicare, Medicaid and other government
programs; |
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changes in programs providing for lower reimbursement rates for the cost
healthcare products and services by third-party plans or payors; |
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regulatory changes relating to the approval process for healthcare products and
services in general. |
There is uncertainty regarding the nature of healthcare reform implementation and whether
there will be other changes in the administration of governmental healthcare programs or
interpretations of governmental policies or other changes affecting the healthcare system.
Recently enacted or future healthcare or budget legislation or other changes, including those
referenced above, may materially adversely affect our business resulting in operating and cash flow
losses, depletion of working capital reserves and adversely affect our financial condition.
We rely on primary suppliers of sleep related products to sell their products to us on satisfactory
terms, and a disruption in our relationship with these suppliers could have a material, adverse
effect on our business.
We are dependent on merchandise vendors to provide sleep disorder related products for our
resale. Our largest sleep product supplier is Fisher and Paykel Healthcare, which supplied
approximately 39% and 44% of our sleep supplies in the years ended December 31, 2010 and 2008,
respectively. In the fiscal year ended December 31, 2009, our largest sleep product supplier was
Resmed, which supplied approximately 37% of our sleep supplies. In our opinion, if any of these
relationships were terminated or if any contracting party were to experience events precluding
fulfillment of our needs, we would be able to find a suitable alternative supplier, but possibly
not without significant disruption to our business. This could take a significant amount of time
and result in a loss of customers and revenue, operating and cash flow losses and may deplete
working capital reserves.
We could be subject to professional liability lawsuits, some of which we may not be fully insured
against or reserved for, which could adversely affect our financial condition and results of
operations.
In recent years, physicians, hospitals and other participants in the healthcare industry have
become subject to an increasing number of lawsuits alleging medical malpractice and related legal
theories such as negligent hiring, supervision and credentialing, and vicarious liability for acts
of their employees or independent contractors. Many of these lawsuits involve large claims and
substantial defense costs. We maintain professional liability insurance, which covers third-party
claims that may be brought against the physicians and staff that work at our sleep centers, up to a
maximum of $3 million, which amount may be insufficient to satisfy all third-party claims that may
be brought against our healthcare professionals.
We are dependent upon our ability to recruit and retain physicians who are properly licensed and
certified in the specialty of sleep medicine to oversee our sleep centers and provide medical
services to our patients.
Our success depends largely upon our ability to recruit and retain physicians who are licensed
to practice medicine in the jurisdictions relevant to the sleep diagnostic testing centers. We
currently have medical directors who oversee each of our sleep centers, provide sleep study
interpretations and consultations to our patients. The loss of one or more medical directors could
result in a time-consuming search for a replacement, and could distract our management team from
the day-to-day operations of our business. Any change in our relationship with our supervising or
interpreting physicians, whether resulting from a dispute between the parties, a change in
government regulation, or the loss of contracts with these physicians, could impair our ability to
provide services and could have a material adverse affect on our business, financial condition and
operations.
In many markets our success is highly dependent upon the continuing ability to recruit and
retain qualified sleep specialists to supervise sleep diagnostic testing services and interpret
results of such tests for us due to the
current shortage of sleep specialists in the medical profession. We face competition for
sleep specialists from other healthcare providers, including hospitals and other organizations.
The competitive demand for sleep specialists may require us in the future to offer higher
compensation in order to secure the services of sleep specialists. As a result, our compensation
expense for our affiliated sleep specialists may increase and if we were not able to offset any
such increase by increasing our prices, this could have a material adverse effect on our results of
operations. An inability to recruit and retain sleep specialists would have a material adverse
effect on our ability to maintain accreditation status and would adversely affect our results of
operations.
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The loss of our accreditation or our inability to obtain accreditation could negatively impact our
business and operating results.
There has been a trend developing to require facilities that provide sleep diagnostic testing
and equipment to become accredited by a Medicare approved accreditation organization in order to
obtain reimbursement for provided such services. It is anticipated that many other government and
private payors will follow suit requiring accreditation by certain approved organizations as a
condition to reimbursement for sleep testing and treatment services or products. The loss of our
accreditation or our inability to obtain accreditation for new facilities or existing facilities
not yet accredited could cause us to be unable to provide services to certain accredited
institutions, could cause non-compliance with certain of our third party payor contracts, and could
cause us to lose our ability to participate in certain government programs such as Medicare, all of
which could, in turn, negatively impact our financial condition and results of operations.
As a result of corporate practice of medicine laws in certain states in which we are located, we
are highly dependent upon our Independent Medical Practices, which we do not own.
We provide our services directly to our patients in most circumstances. However, some states
in which we operate, such as New York and Florida, prohibit the practice of medicine by a general
business corporation. In those states we provide administrative and other services to independent
medical practices, Daniel I. Rifkin, M.D., P.C. d/b/a Amherst Sleep Medicine and Coral Springs
Sleep Medicine, Inc. (collectively referred to as Independent Medical Practices). The Independent
Medical Practices are wholly owned by Dr. Daniel I. Rifkin. While the ownership of Independent
Medical Practices is subject to certain restrictions contained in management agreements between us
and each of them, any change in our relationship, whether resulting from a dispute between the
entities or their respective owners, a change in government regulation, or the loss of these
Independent Medical Practices, could impair our ability to provide services and could have a
material adverse affect on our business, financial condition and operations in those particular
states. In addition, if we acquire other sleep diagnostic businesses in states that require an
independent medical practice structure, this risk would intensify.
If our arrangements with physicians or our patients are found to violate state laws prohibiting the
practice of medicine by general business corporations or fee splitting, our business, financial
condition and ability to operate in those states could be adversely affected.
The laws of many states, including states in which we engage physicians to perform medical
services, prohibit us from exercising control over the medical judgments or decisions of physicians
and from engaging in certain financial arrangements, such as splitting professional fees with
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 states which do not allow
us to exercise control over physicians or prohibit certain financial arrangements, we enter into
agreements with physicians as independent contractors pursuant to which they render professional
medical services. In some states, such as New York, we are only able to enter into agreements with
independent physicians in which we provide administrative and other services. In addition, in some
states, we enter into agreements with physicians to deliver professional sleep interpretation
services and professional clinic services in exchange for a service fee.
We structure our relationships with physicians in a manner that we believe is in compliance
with prohibitions against the corporate practice of medicine and fee splitting. While we have not
received notification from any state regulatory or similar authorities asserting that we are
engaged in the corporate practice of medicine or that the payment of service fees to us by
physicians or to physicians by us constitutes fee splitting, if such a claim were successful we
could be subject to substantial civil and criminal penalties and could be required to restructure
or terminate the applicable contractual arrangements and our contractual arrangements may be
unenforceable in that particular state. A determination that our arrangements with physicians
violate state statutes, a change in government regulation, or our inability to successfully
restructure these arrangements to comply with these statutes, could eliminate business located in
certain states from the market for our services, which would have a material adverse effect on our
business, financial condition and operations.
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Our failure to comply with government regulations, including broad and complex federal and state
fraud and abuse laws, may result in substantial reimbursement obligations, damages, penalties,
injunctive relief or exclusion from participation in federal or state healthcare programs.
Our sleep diagnostic, therapy, and supply operations are subject to a variety of complex
federal, state and local government laws and regulations targeted at fraud and abuse, including:
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The federal Anti-Kickback Statute, which prohibits persons from knowingly and
willfully soliciting, offering, receiving or providing remuneration, directly or
indirectly, in cash or in kind: (i) for referring an individual to a person for the
provision of an item or service for which payment may be made under federal healthcare
programs such as Medicare and Medicaid; or (ii) to induce a person to refer an
individual to a person for the provision of an item or service covered under a federal
healthcare program, or arrange for or recommend that someone purchase, lease, or order
a good, facility, service, or item covered under a federal healthcare program; |
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State law equivalents to the federal Anti-Kickback Statute, which may not be
limited to government reimbursed items; |
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The federal False Claims Act, which prohibits any person from knowingly
presenting, or causing to be presented, a false claim for payment to the federal
government or knowingly making, or causing to be made, a false statement in order to
have a false claim paid. The federal governments interpretation of the scope of the
law has in recent years grown increasingly broad. Most states also have statutes or
regulations similar to the federal false claims laws, which apply to items and services
reimbursed under Medicaid and other state programs, or, in several states, apply
regardless of the payor; |
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The Health Insurance Portability and Accountability Act of 1996, or HIPAA,
which prohibits fraud on a health benefit plan and false statements. HIPAA created a
federal healthcare fraud statute that prohibits knowingly and willfully executing a
scheme to defraud any healthcare benefit program, including private payors. Among
other things, HIPAA also imposes criminal penalties for knowingly and willfully
falsifying, concealing or covering up a material fact or making any materially false,
fictitious or fraudulent statement in connection with the delivery of or payment for
healthcare benefits, items or services, along with theft or embezzlement in connection
with a healthcare benefits program and willful obstruction of a criminal investigation
involving a federal healthcare offense; |
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The Stark Law prohibits the referral of Medicare and Medicaid designated
health services which includes outpatient prescription drugs and durable medical
equipment such as CPAP devices and may also include sleep diagnostic testing if the
testing is billed by a hospital to Medicare or Medicaid to an entity if the physician
or a member of such physicians immediate family has a financial relationship with
the entity, unless an exception applies. The Stark Law provides that the entity that
renders the designated health services may not present or cause to be presented a
claim for designated health services furnished pursuant to a prohibited referral. A
person who engages in a scheme to circumvent the Stark Laws prohibitions may be fined
up to $100,000 for each applicable arrangement or scheme. |
In addition, anyone who presents or causes to be presented a claim in violation of the Stark
Law is subject to payment denials, mandatory refunds, monetary penalties of up to $15,000 per
service, an assessment of up to three times the amount claimed, and possible exclusion from
participation in federal healthcare programs; and
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Many state laws prohibit physician referrals to entities with which the
physician has a financial interest, or require that the physician provide the patient
notice of the physicians financial relationship before making the referral. State law
equivalents to the Stark law may be applicable to different types
of services than those that are designated health services under the federal law and
may have fewer or different exceptions. |
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In addition to those sanctions described above, violations of these or other government
regulations could result in material penalties, including: civil monetary penalties, suspension of
payments from government programs, loss of required government certifications, loss of licenses,
loss of authorizations to participate in or exclusion from government reimbursement programs
(including Medicare and Medicaid programs). Also, violations of federal, state, and common law
privacy protections could give rise to significant damages, penalties, or injunctive relief. We
believe that our practices are not in violation of the federal anti-kickback statute, false claims
laws, HIPAA, the Stark law, or state equivalents, but we cannot assure you that enforcement
authorities will not take action against us and, if such action were successful, we could be
required to pay significant fines and penalties and change our corporate practices. Such
enforcement could have a significant adverse effect on our ability to operate our business and to
enforce our contracts with payors and others.
Non-compliance with federal and state anti-kickback laws could affect our business, operations or
financial condition.
Various federal and state laws govern financial arrangements among healthcare providers. The
federal Anti-Kickback Statute prohibits the knowing and willful offer, payment, solicitation or
receipt of any form of remuneration in return for, or with the purpose to induce, the referral of
Medicare, Medicaid or other federal healthcare program patients, or in return for, or with the
purpose to induce, the purchase, lease or order of items or services that are covered by Medicare,
Medicaid or other federal healthcare programs. Similarly, many state laws prohibit the
solicitation, payment or receipt of remuneration in return for, or to induce, the referral of
patients in private as well as government programs. There is a risk that an investment in our
shares or in our subsidiary sleep centers by our affiliated physicians, including the distribution
of any profits to our affiliated physicians, referrals for sleep testing or treatment services by
physicians who own our securities, the marketing of our affiliated physicians services or our
compensation arrangements with our affiliated physicians may be considered a violation of these
laws. Violation of these anti-kickback laws may result in substantial civil or criminal penalties
for individuals or entities and/or exclusion from participating in federal or state healthcare
programs. If we are excluded from federal or state healthcare programs, our affiliated physicians
who participate in those programs would not be permitted to continue doing business with us. We
believe that we are operating in compliance with applicable laws and believe that our arrangements
with providers would not be found to violate the anti-kickback laws. However, these laws could be
interpreted in a manner inconsistent with our operations.
We have physicians who own non-controlling investment interests in some of our sleep
diagnostic testing facilities who also have a referral relationship with our sleep testing or care
management services. If the ownership distributions paid to physicians by our testing facilities
are found to constitute prohibited payments made to physicians under the federal Anti-kickback
Statute, physician self-referral or other fraud and abuse laws, our business may be adversely
affected. Over the years, the federal government has published regulations that established safe
harbors to the federal Anti-Kickback Statute. An arrangement that meets all of the elements of
the safe harbor is immunized from prosecution under the federal Anti-Kickback Statute. The failure
to satisfy all elements, however, does not necessarily mean the arrangement violates the federal
Anti-Kickback Statute. We endeavor to meet safe harbors designed for small entity investments and
believe we are in compliance with such laws. However, if we were found to be violation of a
federal or state anti-kickback statute, our business, results of operations, and financial
condition would be harmed and we would be subject to substantial civil and criminal penalties.
If government laws or regulations change or the enforcement or interpretation of them change, we
may be obligated to purchase some or all of the ownership interests of the physicians associated
with us.
Changes in government regulation or changes in the enforcement or interpretation of existing
laws or regulations could obligate us to purchase at the then fair market value some or all of the
ownership interests of the physicians who have invested in our sleep diagnostic facilities.
Regulatory changes that could create this obligation include changes that:
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make illegal the referral of Medicare or other patients to our sleep diagnostic
facilities by physicians affiliated with us, |
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create the substantial likelihood that cash distributions from our sleep
diagnostic facilities to our physician partners will be illegal, or |
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make illegal the ownership by physicians of their interests in our sleep
diagnostic facilities. |
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From time to time, we may voluntarily seek to increase our ownership interest in one or more
of our sleep diagnostic testing facilities, in accordance with any applicable limitations. We may
seek to use shares of our common stock to purchase physicians ownership interests instead of cash.
If the use of our stock is not permitted or attractive to us or the physicians, we may use cash or
promissory notes to purchase the physicians ownership interests. Our existing capital resources
may not be sufficient for the acquisition or the use of cash may limit our ability to use our
capital resources elsewhere, limiting our growth and impairing our operations. The creation of
these obligations and the possible adverse effect on our affiliation with these physicians could
have a material adverse effect on us.
Federal or state self-referral regulations could impact our arrangements with our affiliated
physicians.
The federal physician self-referral statute, known as the Stark statute, prohibits a
physician from making a referral for certain designated health services, including DME such as CPAP
devices, to any entity with which the physician has a financial relationship, unless there is an
exception in the statute that allows the referral. The entity that receives a prohibited referral
from a physician may not submit a bill to Medicare for that service. Many state laws prohibit
physician referrals to entities in which the physician has a financial interest, or require that
the physician provide the patient notice of the physicians financial relationship before making
the referral. There is a risk that an investment in our shares or in our subsidiary sleep centers
by our affiliated physicians, including the distribution of any profits to our affiliated
physicians, the use of our equipment by physicians who own our securities, any assistance from
healthcare providers in acquiring, maintaining or operating sleep diagnostic testing equipment, the
marketing of our affiliated physicians services or our compensation arrangements with our
affiliated physicians, could be interpreted as a violation of the federal Stark statute or similar
state laws, if we were to accept referrals from our affiliated physicians. Violation of the Stark
statute can result in substantial civil penalties for both the referring physician and any entity
that submits a claim for a healthcare service made pursuant to a prohibited referral. In addition,
federal courts have ruled that violations of the Stark statute can be the basis for a legal claim
under the Federal False Claims Act. We believe that all of our affiliated physician arrangements
are in compliance with the Stark statute. However, these laws could be interpreted in a manner
inconsistent with our operations.
Because we submit claims to the Medicare program based on the services we provide, it is possible
that a lawsuit could be brought against us under the Federal False Claims Act, and the outcome of
any such lawsuit could have a material adverse effect on our business, financial condition and
results of operations.
The federal False Claims Act provides, in part, that the federal government may bring a
lawsuit against any person whom it believes has knowingly presented, or caused to be presented, a
false or fraudulent request for payment from the federal government, or who has made a false
statement or used a false record to have a claim approved. Federal courts have ruled that a
violation of the anti-kickback provision of the Stark statute can serve as the basis for the
federal False Claims Act suit. The federal False Claims Act further provides that a lawsuit
brought under that act may be initiated in the name of the United States by an individual who was
the original source of the allegations, known as the relator. Actions brought under the federal
False Claims Act are sealed by the court at the time of filing. The only parties privy to the
information contained in the complaint are the relator, the federal government and the court.
Therefore, it is possible that lawsuits have been filed against us that we are unaware of or which
we have been ordered by the court not to discuss until the court lifts the seal from the case.
Penalties include fines ranging from $5,500 to $11,000 for each false claim, plus three times the
amount of damages that the federal government sustained because of the act of the violator.
We believe that we are operating in compliance with the Medicare rules and regulations and,
thus, the federal False Claims Act. However, if we were found to have violated certain rules and
regulations and, as a result, submitted or caused our affiliated physicians to submit allegedly
false claims, any sanctions imposed under the federal False Claims Act could result in substantial
fines and penalties or exclusion from participation in federal and
state healthcare programs, which could have a material adverse effect on our business and
financial condition. If we are excluded from participation in federal or state healthcare
programs, our affiliated physicians who participate in those programs could not do business with
us.
Federal regulatory and law enforcement authorities have recently increased enforcement
activities with respect to Medicare and Medicaid fraud and abuse regulations and other
reimbursement laws and regulations, including laws and regulations that govern our activities and
the activities of providers of sleep diagnostic testing and durable medical equipment. These
increased enforcement activities may have a direct or indirect adverse affect on our business,
financial condition and results of operations.
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Additionally, some state statutes contain prohibitions similar to and possibly even more
restrictive than the federal False Claims Act. These state laws may also empower state
administrators to adopt regulations restricting financial relationships or payment arrangements
involving healthcare providers under which a person benefits financially by referring a patient to
another person. We believe that we are operating in compliance with these laws. However, if we
are found to have violated such laws, our business, results of operations and financial condition
would be harmed.
Future changes in healthcare regulation are difficult to predict and may constrain or require us to
restructure our operations, which could negatively impact our business and operating results.
The healthcare industry is heavily regulated and subject to frequent changes in governing laws
and regulations as well as to evolving administrative interpretations. Our business could be
adversely affected by regulatory changes at the federal or state level that impose new requirements
for licensing, new restrictions on reimbursement for medical services by government programs, new
pretreatment certification requirements for patients seeking sleep testing procedures or treatment
products, or new limitations on services that can be performed by us. In addition, federal, state
and local legislative bodies have adopted and continue to consider medical cost-containment
legislation and regulations that have restricted or may restrict reimbursement to entities
providing services in the healthcare industry and referrals by physicians to entities in which the
physicians have a direct or indirect financial interest or other relationship. For example,
Medicare recently adopted a regulation that limits the technical component of the reimbursement for
multiple diagnostic tests performed during a single session at medical facilities other than
hospitals. Any of these or future reimbursement regulations or policies could limit the number of
diagnostic tests ordered and could have a material adverse effect on our business.
The Center for Medicare & Medicaid Services, or CMS, recently finalized certain anti-markup
rules relating to diagnostic tests paid for by the Medicare program. The anti-markup rules are
generally applicable where a physician or other supplier bills for the technical component or
professional component of a diagnostic test that was ordered by the physician or other supplier (or
ordered by a party related to such physician or other supplier through common ownership or
control), and the diagnostic test is performed by a physician who does not share a practice with
the billing physician or other supplier. If the anti-markup rule applies to an interpretation,
then the reimbursement provided by Medicare to a billing physician or other supplier for that
interpretation may be limited. Because our sleep diagnostic testing facilities bill Medicare for
the technical and professional fees of sleep diagnostic tests that are ordered by community
physicians or our affiliated physicians, we believe that the anti-markup rule does not apply to the
professional services our affiliated physicians perform or the technical services that our sleep
diagnostic testing facilities perform. However, this rule could be subject to an interpretation
that affects the amounts that may be reimbursed by Medicare for professional diagnostic
interpretations.
Although we monitor legal and regulatory developments and modify our operations from time to
time as the regulatory environment changes, we may not be able to adapt our operations to address
every new regulation, and such regulations may adversely affect our business. In addition,
although we believe that we are operating in compliance with applicable federal and state laws, our
business operations have not been scrutinized or assessed by judicial or regulatory agencies. We
cannot assure you that a review of our business by courts or regulatory authorities would not
result in a determination that adversely affects our operations or that the healthcare regulatory
environment will not change in a way that will restrict our operations.
26
Non-compliance with state and federal regulations concerning health information practices may
adversely affect our business, financial condition or operations, and the cost of compliance may be
material.
We collect and use information about individuals and their medical conditions. Numerous
federal and state laws and regulations, including the federal Health Insurance Portability and
Accountability Act of 1996 (HIPAA) and the Health Information Technology For Economic and
Clinical Health Act (HITECH Act), govern the collection, dissemination, security, use and
confidentiality of such patient-identifiable health information. HIPAA sets forth standards for
electronic transactions between health plans, providers and clearinghouses; unique provider,
employer, health plan and patient identifiers; security and electronic signatures as well as
privacy protections relating to the exchange of individually identifiable health information. The
Department of Health and Human Services (DHHS) has released several rules mandating compliance
with the standards set forth under HIPAA. We believe our sleep centers and sleep related products
and services achieved compliance with DHHSs standards governing the privacy of individually
identifiable health information and DHHSs standards governing the security of electronically
stored health information. In addition, we have fully implemented the required uniform standards
governing common healthcare transactions. Finally, we have taken or will take all necessary steps
to achieve compliance with other HIPAA rules as applicable, including the standard unique employer
identifier rule, the standard health care provider identifier rule and the enforcement rule. While
it is believed that we currently comply with HIPAA, there is some uncertainty of the extent to
which the enforcement or interpretation of the HIPAA regulations will affect our business.
Continuing compliance and the associated costs with these regulations may have a significant impact
on our business operations. Criminal and civil sanctions may be imposed for failing to comply with
HIPAA.
In addition to the HIPAA restrictions relating to the exchange of healthcare information,
individual states have adopted laws protecting the confidentiality of patient information which
impact the manner in which patient records are maintained. Violation of patient confidentiality
rights under common law, state or federal law could give rise to damages, penalties, civil or
criminal fines and/or injunctive relief. We believe that our sleep center operations are in
compliance with federal and state privacy protections. However, an enforcement agency or court may
find a violation of state or federal privacy protections arising from our sleep center operations.
The failure to comply with other provisions of HIPAA potentially could result in liability, civil
and criminal penalties, and could have a material adverse effect on our business and financial
condition.
HIPAA authorizes the imposition of civil money penalties against entities that employ or enter
into contracts with individuals or entities that have been excluded from participation in the
Medicare or Medicaid programs. We perform background checks on our affiliated physicians, and we
do not believe that we engage or contract with any excluded individuals or entities. However, a
finding that we have violated this provision of HIPAA could have a material adverse effect on our
business and financial condition.
HIPAA also establishes several separate criminal penalties for making false or fraudulent
claims to insurance companies and other non-governmental payors of healthcare services. These
provisions are intended to punish some of the same conduct in the submission of claims to private
payors as the federal False Claims Act covers in connection with governmental health programs. We
believe that our services have not historically been provided in a way that would place either our
clients or ourselves at risk of violating the HIPAA anti-fraud statutes, including those in which
we received direct reimbursement because of the reassignment by affiliated physicians to us or
those in which we may be considered to receive an indirect reimbursement because of the
reassignment by us to hospitals of the right to collect for professional interpretations and
technical services.
We believe that our sleep centers have taken all appropriate steps to achieve compliance with
the HIPAA requirements. We do not currently believe that the ongoing cost of compliance with the
existing HIPAA requirements will be material to our operations; however, we cannot predict the cost
of future compliance with HIPAA requirements.
Our failure to successfully implement our growth plan may adversely affect our financial
performance.
We have grown primarily through acquisitions. We intend to continue to grow incrementally
through acquisitions with our current focus primarily on the sleep disorder market through our
comprehensive sleep management care model. As this growth plan is pursued, we may encounter
difficulties expanding and improving our operating and financial systems to maintain pace with the
increased complexity of the expanded operations and
management responsibilities.
The success of our growth strategy will also depend on a number of other factors, including:
|
|
|
consumer preferences and purchasing power; |
27
|
|
|
the ability to attract and retain sleep technicians and physicians; |
|
|
|
financing and working capital requirements; |
|
|
|
the ability to negotiate sleep center leases on favorable terms; and |
|
|
|
the availability of new locations at a reasonable cost. |
Even if we succeed in acquiring established sleep centers as planned, those acquired
facilities may not achieve the projected revenue or profitability levels comparable to those of
currently owned sleep centers in the time periods we estimate or at all. Moreover, our newly
acquired sleep centers may reduce the revenues and profitability of our existing locations and
other operations. The failure of our growth strategy may have a material adverse effect on our
operating results and financial condition.
We identified a material weakness in the design and operation of our internal controls over
financial reporting.
During the sale of substantially all of the assets of ApothecaryRx, we incurred significant
charges related to the accounts receivable and inventory balances at ApothecaryRx. In addition, we
noted additional control deficiencies that in aggregate with the material special charges incurred
at our subsidiary, ApothecaryRx, have caused us to conclude that we have a material weakness in our
internal control over financial reporting.
A material weakness is a deficiency, or a combination of control deficiencies, in internal
control over financial reporting such that there is a reasonable possibility that a material
misstatement of the companys annual or interim financial statements will not be prevented or
detected on a timely basis. Although the accounts receivable trends and the inventory physical
counts related to ApothecaryRx throughout prior periods did not generate unusual results or cause
us to question the validity of the accounts receivable or inventory balances, we feel that the
significant charges recorded as a result of adjusting the inventory and accounts receivable amounts
to their net realizable value subsequent to the sale of the ApothecaryRx represent a material
weakness in our internal controls over financial reporting.
Since the operations of ApothecaryRx were sold, no remediation efforts are needed relating to
those specific control deficiencies. However, we are evaluating the circumstances and potential
changes to entity wide controls to address the other identified control deficiencies.
Material weaknesses in the design and operation of the internal controls over financial reporting
of companies that we acquire could have a material adverse effect on our financial statements.
Our business has primarily grown through the acquisition of existing businesses and in the
future we intend to continue to grow our SMS business through the acquisition of existing
businesses. When we acquire such existing businesses our due diligence may fail to discover
defects or deficiencies in the design and operations of the internal controls over financial
reporting of such companies, or defects or deficiencies in the internal controls over financial
reporting may arise when we try to integrate the operations of these newly acquired businesses with
our own. We can provide no assurances that we will not experience such issues in future
acquisitions, the result of which could have a material adverse effect on our financial statements.
The goodwill and other intangible assets acquired pursuant to our acquisitions of sleep centers may
become further impaired and require additional write-downs and the recognition of additional substantial
impairment expense.
At December 31, 2010, we had approximately $13.0 million and $2.4 million in goodwill and
other intangible assets, respectively, that was recorded in connection with the acquisitions of our
sleep centers during the years 2007 through September 30, 2009. We periodically evaluate whether
or not to take an impairment charge on our goodwill, as required by the applicable accounting
literature. Based on our (i) assessment of current and expected future economic conditions, (ii)
trends, strategies and forecasted cash flows at each business unit and (iii) assumptions similar to
those that market participants would make in valuing our business units, we determined that the
carrying value of goodwill related to our sleep centers located in Oklahoma, Nevada and Texas
exceeded their fair value. In addition, we determined the carrying value of our intangible assets
associated with Eastern and certain other intangibles exceeded their fair value. Accordingly, we
recorded a noncash impairment charge, in December 2010, of $7.5 million and $3.2 million,
respectively, on goodwill and other intangible assets. In the event that this goodwill or other
intangible assets are determined to be further impaired for any reason, we will be required to
write-down or reduce the value of the goodwill and recognize an impairment expense. The impairment
expense may be substantial in amount and, in which case, adversely affect the results of our
operations for the applicable period and may negatively affect the market value of our common
stock.
28
Risks Related to Ownership of Our Common Stock
If the trading price of our common stock remains below $1 per share or if we fail to maintain any
of the other required listing standards, our common stock could be delisted from the NASDAQ Capital
Market.
We must meet NASDAQs continuing listing requirements in order for our common stock to remain
listed on the NASDAQ Capital Market. The listing criteria we must meet include, but are not
limited to, a minimum bid price for our common stock of $1.00 per share. Failure to meet NASDAQs
continued listing criteria may result in the delisting of our common stock on the NASDAQ Capital
Market.
On February 4, 2011, we received a notice from NASDAQ stating that the minimum bid price of
our common stock had been below $1.00 per share for 30 consecutive business days and that we were
therefore not in compliance with the minimum bid price requirement for continued listing on The
NASDAQ Capital Market set forth in Listing Rule 5550(a)(2). The notice indicated that we had been
granted 180 calendar days, or until August 3, 2011, to regain compliance.
If we decide to implement a reverse stock split, the split must be complete no later than ten
business days prior to August 3, 2011 in order to regain compliance. On February 1, 2011, we
received shareholder approval for an amendment to our certificate of incorporation in order to
affect a reverse stock split in one of 5 ratios, namely 1 for 2, 3, 4, 5 or 6. Our board of
directors must take additional action to implement this reverse stock split. We intend to
implement a stock split in connection with the consummation of a public equity offering. Our board
is not required to implement the reverse stock split in connection with such offering or otherwise.
A delisting from the NASDAQ Capital Market would make the trading market for our common stock
less liquid, and would also make us ineligible to use Form S-3 to register the sale of shares of
our common stock or to register the resale of our securities held by certain of our security
holders with the SEC, thereby making it more difficult and expensive for us to register our common
stock or other securities and raise additional capital.
Our current principal stockholders have significant influence over us and they could delay, deter
or prevent a change of control or other business combination or otherwise cause us to take action
with which you might not agree.
Our executive officers, directors and holders of greater than 5% of our outstanding common
stock together beneficially own approximately 70% of our outstanding common stock. As a result,
our executive officers, directors and holders of greater than 5% of our outstanding common stock
will have the ability to significantly influence all matters submitted to our stockholders for
approval, including:
|
|
|
changes to the composition of our Board of Directors, which has the authority
to direct our business and appoint and remove our officers; |
|
|
|
proposed mergers, consolidations or other business combinations; and |
|
|
|
amendments to our certificate of incorporation and bylaws which govern the
rights attached to our shares of common stock. |
This concentration of ownership of shares of our common stock could delay or prevent proxy
contests, mergers, tender offers, open market purchase programs or other purchases of shares of our
common stock that might otherwise give you the opportunity to realize a premium over the then
prevailing market price of our common stock. The interests of our executive officers, directors
and holders of greater than 5% of our outstanding common stock may not always coincide with the
interests of the other holders of our common stock. This concentration of ownership may also
adversely affect our stock price.
29
The market price of our common stock may be volatile and this may adversely affect our
stockholders.
The price at which our common stock trades may be volatile. The stock market has recently
experienced significant price and volume fluctuations that have affected the market prices of
securities, including securities of healthcare companies. The market price of our common stock may
be influenced by many factors, including:
|
|
|
our operating and financial performance; |
|
|
|
variances in our quarterly financial results compared to expectations; |
|
|
|
the depth and liquidity of the market for our common stock; |
|
|
|
future sales of common stock or the perception that sales could occur; |
|
|
|
investor perception of our business and our prospects; |
|
|
|
developments relating to litigation or governmental investigations; |
|
|
|
changes or proposed changes in healthcare laws or regulations or enforcement of
these laws and regulations, or announcements relating to these matters; or |
|
|
|
general economic and stock market conditions. |
In addition, the stock market in general has experienced price and volume fluctuations that
have often been unrelated or disproportionate to the operating performance of healthcare companies.
These broad market and industry factors may materially reduce the market price of our common
stock, regardless of our operating performance. In the past, securities class-action litigation
has often been brought against companies following periods of volatility in the market price of
their respective securities. We may become involved in this type of litigation in the future.
Litigation of this type is often expensive to defend and may divert our management teams attention
as well as resources from the operation of our business.
We do not anticipate paying dividends on our common stock in the foreseeable future and,
consequently, your ability to achieve a return on your investment will depend solely on
appreciation in the price of our common stock.
We do not pay dividends on our shares of common stock and intend to retain all future earnings
to finance the continued growth and development of our business and for general corporate purposes.
In addition, we do not anticipate paying cash dividends on our common stock in the foreseeable
future. Any future payment of cash dividends will depend upon our financial condition, capital
requirements, earnings and other factors deemed relevant by our Board of Directors. Our current
credit facility with Arvest Bank restricts our ability to pay dividends, see Managements
Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital
Resources Arvest Credit Facility.
|
|
|
Item 1B. |
|
Unresolved Staff Comments. |
None
30
Facilities
Our corporate headquarters and offices and the executive offices of our SMS operating segment
are located in Oklahoma City, Oklahoma. These office facilities consist of approximately 9,700
square feet and are occupied under a month-to-month lease with Oklahoma Tower Realty Investors,
LLC, requiring monthly rental payments of approximately $7,000. Mr. Roy T. Oliver, one of our
greater than 5% shareholders and affiliates, controls Oklahoma Tower Realty Investors, LLC. We
believe that suitable additional or substitute space will be available as needed on reasonable
terms.
As of December 31, 2010, we operated 26 sleep clinics in 11 states. Each location is occupied
under multiple-year (or long-term) lease arrangements requiring monthly rental payments. The
following table presents, as of December 31, 2010, the locations and lease expiration dates of
occupancy leases of each sleep center or clinic.
|
|
|
|
|
Lease |
Sleep Center and Clinic |
|
Expiration |
(City and State) |
|
Date |
Florida: |
|
|
Coral Springs |
|
Oct. 2013 |
Iowa: |
|
|
Waukee |
|
Jul. 2011 |
Waukee |
|
Mar. 2012 |
Pleasant Hill |
|
Nov. 2012 |
Kansas: |
|
|
Overland Park |
|
Sep. 2011 |
Overland Park |
|
Oct. 2027 |
Missouri: |
|
|
Lees Summit |
|
Sep. 2015 |
Kansas City |
|
Dec. 2014 |
Nebraska: |
|
|
Omaha |
|
Nov. 2013 |
Nevada: |
|
|
Charleston |
|
Month-to-month |
Henderson |
|
Dec. 2013 |
New York: |
|
|
Williamsville |
|
May 2014 |
Buffalo |
|
Month-to-month |
Dunkirk |
|
Mar. 2012 |
Lockport |
|
May 2011 |
West Seneca |
|
Jan. 2012 |
Buffalo |
|
Jul. 2011 |
Tonawanda |
|
Jul. 2017 |
Oklahoma: |
|
|
Tulsa |
|
Nov. 2015 |
Oklahoma City |
|
Sep. 2014 |
Norman |
|
Jan. 2014 |
South Dakota: |
|
|
Sioux Falls |
|
Nov. 2013 |
Texas: |
|
|
Southlake Keller |
|
Jul. 2013 |
McKinney |
|
Sep. 2011 |
Granbury |
|
Apr. 2011 |
Bedford |
|
Dec. 2013 |
Waco |
|
Jan. 2018 |
31
Our former ApothecaryRx executive offices are located in Golden Valley, Minnesota, under a
lease arrangement that expires in November 2013.
|
|
|
Item 3. |
|
Legal Proceedings. |
From time to time, we are subject to claims and suits arising in the ordinary course of our
business, including claims for damages for personal injuries. In our managements opinion, the
ultimate resolution of any of these pending claims and legal proceedings will not have a material
adverse effect on our financial position or results of operations.
On December 6, 2010, we settled the litigation with certain former employees of our retail
pharmacy in Sterling, Colorado and their affiliates. As part of the settlement, we and Walgreens
sold assets to certain of the defendants comprising the long-term care pharmacy business and
certain other assets and we agreed to revoke the preliminary injunction and the defendants agreed
to non-competition arrangements. We previously reported in our most recent quarterly report on
Form 10-Q, that on October 8, 2010, we commenced litigation in U.S. District Court for the District
of Colorado against certain former employees of our retail pharmacy in Sterling, Colorado and their
affiliates. We claimed, among other things, breaches of certain contractual arrangements and seek
monetary damages. On October 13, 2010, a stipulated preliminary injunction was issued in our
favor.
|
|
|
Item 4. |
|
(Removed and Reserved). |
PART II
|
|
|
Item 5. |
|
Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
Market
Our common stock is listed on The Nasdaq Capital Market (Nasdaq) under the symbol GRMH. The
following table sets forth, during the calendar quarters presented, the high and low sale prices of
our common stock for the period our common stock was listed on Nasdaq and as reported by the
Nasdaq.
|
|
|
|
|
|
|
|
|
Quarter Ended |
|
High |
|
|
Low |
|
December 31, 2010 |
|
$ |
1.50 |
|
|
$ |
0.70 |
|
September 30, 2010 |
|
$ |
1.34 |
|
|
$ |
1.09 |
|
June 30, 2010 |
|
$ |
1.52 |
|
|
$ |
1.00 |
|
March 31, 2010 |
|
$ |
1.84 |
|
|
$ |
1.06 |
|
December 31, 2009 |
|
$ |
2.95 |
|
|
$ |
1.75 |
|
September 30, 2009 |
|
$ |
3.50 |
|
|
$ |
1.40 |
|
June 30, 2009 |
|
$ |
2.85 |
|
|
$ |
1.50 |
|
March 31, 2009 |
|
$ |
2.89 |
|
|
$ |
1.30 |
|
On March 29, 2011, the closing price of our common stock as quoted on Nasdaq was $0.75.
The market price of our common stock is subject to significant fluctuations in response to,
and may be adversely affected by:
|
|
|
variations in quarterly operating results, |
|
|
|
changes in earnings estimates by analysts, |
|
|
|
developments in the sleep disorder diagnostic and treatment markets, |
|
|
|
announcements and introductions of product or service innovations, and |
|
|
|
general stock market conditions. |
32
Holders of Equity Securities
As of March 21, 2011, we have approximately 760 owners of our common stock, 80 record owners
and approximately 680 owners in street name.
Dividend Policy
Historically, we have not paid dividends on our common stock, and we do not currently intend
to pay and you should not expect to receive cash dividends on our common stock. Our dividend
policy is to retain earnings to support the expansion of our operations. If we were to change this
policy, any future cash dividends will depend on factors deemed relevant by our board of directors.
These factors will generally include future earnings, capital requirements, our financial
condition contractual restrictions, such as our existing credit facilities. Our existing credit
facility restricts our ability to pay dividends without the approval of our lenders. See
Managements Discussion and Analysis of Financial Condition and Results of Operations Liquidity
and Capital Resources Arvest Credit Facility. Furthermore, in the event we issue preferred
stock shares, although unanticipated, no dividends may be paid on our outstanding common stock
shares until all dividends then due on our outstanding preferred stock will have been paid.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth as of December 31, 2010, information related to each category
of equity compensation plan approved or not approved by our shareholders, including individual
compensation arrangements with our non-employee directors. The equity compensation plans approved
by our shareholders are our 2008 Long-Term Incentive Plan, 2003 Stock Option Plan and 2003
Non-Employee Stock Option Plan. All stock options and rights to acquire our equity securities are
exercisable for or represent the right to purchase our common stock.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of |
|
|
|
|
|
|
|
|
|
|
|
securities |
|
|
|
Number of |
|
|
|
|
|
|
remaining |
|
|
|
securities to be |
|
|
Weighted-average |
|
|
available for |
|
|
|
issued upon exercise |
|
|
exercise price of |
|
|
future issuance |
|
|
|
of outstanding |
|
|
outstanding |
|
|
under equity |
|
|
|
options, warrants |
|
|
options, warrants |
|
|
compensation |
|
Plan category |
|
and rights |
|
|
and rights |
|
|
plans |
|
Equity compensation plans
approved by security holders: |
|
|
|
|
|
|
|
|
|
|
|
|
2008 Long-Term Incentive Plan |
|
|
229,398 |
|
|
$ |
2.83 |
|
|
|
2,640,602 |
|
2003 Stock Option Plan |
|
|
16,000 |
|
|
$ |
3.75 |
|
|
|
|
|
2003 Non-Employee
Stock Option Plan |
|
|
16,000 |
|
|
$ |
3.75 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity compensation plans
not approved by security holders: |
|
|
|
|
|
|
|
|
|
|
|
|
Warrants issued to SXJE, LLC |
|
|
100,000 |
|
|
$ |
2.50 |
|
|
|
|
|
Warrants issued to ViewTrade Financial
and its assigns |
|
|
100,270 |
|
|
$ |
2.05 |
|
|
|
|
|
Options issued to employees |
|
|
30,000 |
|
|
$ |
3.75 |
|
|
|
|
|
Options issued to directors |
|
|
90,000 |
|
|
$ |
3.75 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
581,668 |
|
|
$ |
2.44 |
|
|
|
2,640,602 |
|
|
|
|
|
|
|
|
|
|
|
|
Unregistered Sales of Equity Securities
All of our equity securities sales during 2010 have been previously reported in the Quarterly
Reports on Form 10-Q or in a Current Report on Form 8-K.
33
Repurchases of Equity Securities
During the year ended December 31, 2010, we acquired, by means of net share settlements,
38,034 shares of Graymark common stock, at an average price of $1.08 per share, related to the
vesting of employee restricted stock awards to satisfy withholding tax obligations. In addition,
during the year ended December 31, 2010, we acquired 207,500 shares of Graymark common stock, at an
average price of $1.72 per share, forfeited by employees due to termination of their employment and
pursuant to the terms of their restricted stock award agreements. We do not have any on-going
stock repurchase programs.
|
|
|
Item 6. |
|
Selected Financial Data. |
We are a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and,
accordingly, not required to provide the information required by Item 301 of Regulation S-K with
respect to Selected Financial Data.
|
|
|
Item 7. |
|
Managements 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
Medicines, 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 the Companys testing facilities,
typically by physicians located in the geographical area being served by the diagnostic sleep
testing facility.
As of December 31, 2010, we had an accumulated deficit of approximately $29.2 million and
reported a net loss of approximately $19.1 for the year then ending. We used approximately $2.4
million in cash to fund our
operating activities from continuing operations during the year ending December 31, 2010.
Furthermore, we have a working capital deficit of approximately $20.5 million as of December 31,
2010. We are required to make a $3 million principal payment to Arvest Bank by June 30, 2011 and
we are currently not in compliance with certain covenants required by our lending agreement with
Arvest Bank.
In March 2011, we entered into a loan agreement which provides us up to $1 million. The loan
will be advanced through a series of draws which are subject to our compliance with certain
covenants at the time of each requested draw. In the event that we are unable to obtain debt or
equity financing or we are unable to obtain such financing on terms and conditions acceptable to
us, we may have to cease or severely curtail our operations. This uncertainty raises substantial
doubt regarding our ability to continue as a going concern. Historically, we have been able to
raise the capital necessary to fund our operations and growth. Our consolidated financial
statements do not include any adjustments that might be necessary if we are unable to continue as a
going concern.
34
Discontinued Operations
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 Companys 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 ApothecaryRxs assets
occurred in December 2010. As a result of the sale of ApothecaryRxs 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.
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 Buyer 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 addition, we are required to pay an additional $3.0 million towards
the outstanding balance related to our senior credit facility by June 30, 2011. We are currently
in discussions with our senior lender regarding this payment and our compliance with required
financial covenants.
Generally, 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 will be released,
subject to deduction for any pending claims for indemnification. All remaining funds held in the
Indemnity Escrow Fund will be released in May 2012 (the 18-month anniversary of the final closing
date of the sale), subject to any pending claims for indemnification. Of the $2,000,000 Indemnity
Escrow Fund, $1,000,000 is subject to partial or full recovery by the buyer if the average daily
prescription sales, at the buyers location in Sterling, Colorado over the six-month period after
the purchase does not maintain a certain level of the average daily prescription sales (the
Retention Rate Earnout).
On October 8, 2010, we commenced litigation in U.S. District Court for the District of
Colorado against certain former employees of our retail pharmacy in Sterling, Colorado and their
affiliates. We claimed, among other things, breaches of certain contractual arrangements and
sought monetary damages. On October 13, 2010, a stipulated preliminary injunction was issued in
our favor. On December 6, 2010, we settled the non-competition related litigation with certain
former employees of our retail pharmacy in Sterling, Colorado and their affiliates. As part of the
settlement, we and Walgreens sold assets comprising the long-term care pharmacy business and
certain other assets to certain of the defendants. We also agreed to revoke the preliminary
injunction in return the
defendants agreed to non-competition arrangements acceptable to the Buyer.
Business Operations Evaluation and Reengineering
After the disposition of our pharmacy business, we began an ongoing evaluation of our sleep
related business operations in order to:
|
|
|
generate significant organic revenue growth; |
|
|
|
expand operating margins; |
|
|
|
improve and accelerate cash flow; and |
|
|
|
increase net income and shareholder value. |
35
Significant Organic Revenue Growth. Management believes that we can achieve significant
organic revenue growth by pursuing the following initiatives:
Independent Sleep Care Centers.
Set specific volume goals by month in 2011 for each of our facilities. We are
designing and implementing an incentive pay structure for our sales force to reward them for
achieving and surpassing the volume goals. Furthermore, we will enhance our existing
monitoring process to enable management to follow volume by location on a daily, weekly and
monthly basis to facilitate meeting our volume goals.
We are evaluating and will subsequently reengineer our scheduling process in order to
schedule patients faster, minimize no shows and last minute cancellations, maximize
operating efficiencies by improving tech to patient ratio and maximizing the use of our
existing capacity. We feel our reengineered process will increase the rate at which we
convert positively diagnosed sleep study patients to therapy services and increase the rate
at which we convert therapy service patients to re-supply patients which builds our
recurring revenue patient base.
Hospital Sleep Diagnostic Program Management Agreements.
We continue to identify new hospital-based sleep labs and execute management agreements
with the facilities that have existing diagnostic sleep operations. We believe that working
with facilities that have existing operations ensures that the agreements will be
immediately accretive to our earnings. We have set specific volume goals by month in 2011
for each of our management agreements for 2011. We are designing and implementing an
incentive pay structure for our sales force to reward them for achieving and surpassing
volume goals.
In addition, we plan to make joint presentations with hospital administration to
hospitals physician staff delineating the benefits of the diagnosis and treatment of sleep
disorders particularly obstructive sleep apnea. We believe this will increase the rate at
which we convert positively diagnosed sleep study patients to therapy services and increase
the rate at which we convert therapy service patients to re-supply patients which builds our
recurring revenue patient base.
Expand Operating Margins, Increase Net Income and Enhance Shareholder Value. Management
believes that we can achieve expansion of our operating margins, improved net income and increased
shareholder value by pursuing the following initiatives:
Evaluate, minimize and leverage our existing corporate and support services.
We plan to evaluate and right size our finance, billing, scheduling, human resources,
re-supply service, sales and marketing departments in terms of structure, staffing
requirements, facilities operated and information system integration. We will also evaluate
and reengineer our purchasing function to ensure that we are paying the best prices available for our medical and business supplies and
services.
We plan to consider entering into outsourcing partnerships for certain functions
(re-supply fulfillment and shipping, group purchasing organization).
Improve and Accelerate Cash Flow. Management believes that we can achieve improved and
accelerated cash flow by pursuing the following initiatives:
Network Migration.
During 2011, we will complete our migration from an out-of-network provider to an
in-network provider in all locations where it makes sense from a cost benefit analysis
perspective. We believe that we will more than offset the lower allowable amounts offered
to in-network providers by, lowering our cost to collect, lowering our bad debt write-offs
and accelerating our payment timeframes by being in-network. Additionally, we believe
that by lowering patient out of pocket costs by being in-network and we will also be able
to increase the volume of patients serviced at our independent sleep care centers.
36
Reengineer Scheduling and Billing Functions.
We will evaluate and will subsequently reengineer our scheduling and billing functions
to reduce the time between when our service or supplies are provided and when we receive
payment for those services and supplies (the billing cycle). This will be accomplished by
enhancing our scheduling process to ensure that all required documentation is gathered prior
to services being rendered or supplies being shipped thereby reducing significantly the
number of claims that have to be reworked by the billing department prior to initial billing
or after denial by the payor. We will also review and update our policy related to the
payment of patient deductible and coinsurance amounts prior to services being rendered or
supplies being shipped in order to significantly condense the billing cycle and reduce our
bad debt write-offs.
Acquisitions Growth 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. Acquisitions and the opening of new facilities will also be an integral
part of our growth strategy going forward. We will seek to acquire business operations that can be
tucked 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.
We expect all acquisitions to be accretive to our earnings and fully integrated within ninety (90)
days of closing.
On August 19, 2009, SDC Holdings, one of our subsidiaries, entered into an agreement with
AvastraUSA, Inc. and Avastra Sleep Centres Limited ABN to acquire 100% of the equity of somniTech,
Inc. and somniCare, Inc. (collectively referred to as Somni) and Avastra Eastern Sleep Centers,
Inc. (Eastern) for cash and stock consideration totaling $10.6 million. The Somni acquisition
closed on August 24, 2009 and the Eastern acquisition closed on September 14, 2009. The various
acquisitions that we made since are summarized in the table below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount |
|
Acquisition |
|
|
|
Purchase |
|
|
Financed |
|
Date |
|
Business Acquired (1) |
|
Price |
|
|
By Seller |
|
Sleep Management
Solutions: |
|
|
|
|
|
|
|
|
|
|
September 2009 |
|
Avastra Eastern Sleep Centers,
Inc. (Eastern) |
|
$ |
4,700,000 |
|
|
$ |
|
|
August 2009 |
|
somniTech, Inc. and somniCare,
Inc. (Somni) |
|
|
5,900,000 |
|
|
|
|
|
June 2008 |
|
Sleep
Center of Waco, Ltd., Plano Sleep Center, Ltd. And |
|
|
|
|
|
|
|
|
|
|
Southlake Sleep Center, Ltd.
(Texas Labs) |
|
|
960,000 |
|
|
|
|
|
June 2008 |
|
Nocturna Sleep Center, LLC
(Nocturna) |
|
|
2,172,790 |
|
|
|
726,190 |
|
April 2008 |
|
Roll-up of noncontrolling interests in certain |
|
|
|
|
|
|
|
|
|
|
SMS sleep centers
(Minority) |
|
|
1,616,356 |
|
|
|
|
|
|
|
|
(1) |
|
All of the acquisitions were asset purchases, other than the acquisitions of
somniCare, Inc., somniTech, Inc., Avastra Easter Sleep Centers and Nocturna Sleep
Center, LLC, which were entity purchases. |
Acquisition Goodwill
In connection with the acquisitions during 2009, our SMS operating segment recorded goodwill
of $3,911,109 and intangible assets of $5,446,000. The intangible assets of $5,446,000 recorded
during 2009 consisted of customer relationships with indefinite lives of $3,870,000, customer
relationships of $970,000 (amortizable over 5 to 15 years), trademarks having a value of $221,000
(amortizable over 10 years), covenants not to compete of $195,000 (amortizable over the period of
the covenants not to compete, 3 to 15 years) and payor contracts of $190,000 (amortizable over 15
years).
37
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
|
|
|
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 will be 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 (i.e., sleep center) 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 (i) assessment of current and expected future economic conditions, (ii) trends,
strategies and forecasted cash flows at each business unit and (iii) assumptions similar to those
that market participants would make in valuing our business units, we determined that the carrying
value of goodwill related to our sleep centers located in Oklahoma, Nevada and Texas exceeded their
fair value. In addition, we determined the carrying value our intangible assets associated with
Eastern and certain other intangibles exceeded their fair value. Accordingly, we recorded a
noncash impairment charge, in December 2010, of $7.5 million and $3.2 million, respectively, on
goodwill and other intangible assets. Our evaluation of goodwill and indefinite lived intangible
assets completed during December 2009 resulted in no impairment losses.
Operating Statistics:
The following table summarizes our locations as of December 31, 2010 and 2009:
|
|
|
|
|
|
|
|
|
|
|
Number of Locations |
|
Location Type |
|
2010 |
|
|
2009 |
|
Sleep centers |
|
|
26 |
|
|
|
28 |
|
Managed sleep centers |
|
|
72 |
|
|
|
60 |
|
|
|
|
|
|
|
|
Total |
|
|
98 |
|
|
|
88 |
|
|
|
|
|
|
|
|
The following table summarizes unit sales and other operating statistics for the years ended
December 31, 2010 and 2009:
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
Sleep studies performed |
|
|
18,435 |
|
|
|
13,371 |
|
CPAP set ups performed |
|
|
3,031 |
|
|
|
1,927 |
|
38
Results of Operations
The following table sets forth selected results of our operations for the years ended December
31, 2010 and 2009. The following information was derived and taken from our audited financial
statements appearing elsewhere in this report.
Comparison of 2010 and 2009
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended |
|
|
|
December 31, |
|
|
|
2010 |
|
|
2009 |
|
Net revenues |
|
$ |
22,764,089 |
|
|
$ |
17,571,539 |
|
Cost of services and sales |
|
|
7,144,066 |
|
|
|
5,522,932 |
|
Operating expenses |
|
|
18,615,312 |
|
|
|
14,667,787 |
|
Bad debt expense |
|
|
1,763,736 |
|
|
|
3,768,699 |
|
Impairment of goodwill and intangible assets |
|
|
10,751,997 |
|
|
|
|
|
Impairment of fixed assets |
|
|
762,224 |
|
|
|
|
|
Net other expense |
|
|
1,433,395 |
|
|
|
952,724 |
|
|
|
|
|
|
|
|
Loss from continuing operations, before taxes |
|
|
(17,706,641 |
) |
|
|
(7,340,603 |
) |
Provision for income taxes |
|
|
(166,795 |
) |
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations, net of taxes |
|
|
(17,873,436 |
) |
|
|
(7,340,603 |
) |
Income (loss) from discontinued operations, net of taxes |
|
|
(1,416,083 |
) |
|
|
1,998,901 |
|
|
|
|
|
|
|
|
Net loss |
|
|
(19,289,519 |
) |
|
|
(5,341,702 |
) |
Less: Non-controlling interests |
|
|
(153,513 |
) |
|
|
(153,806 |
) |
|
|
|
|
|
|
|
Net loss attributable to Graymark Healthcare |
|
$ |
(19,136,066 |
) |
|
$ |
(5,187,896 |
) |
|
|
|
|
|
|
|
Discussion of Years Ended December 31, 2010 and 2009
Net revenues increased $5.2 million (a 29.6% increase) to $22.8 million during 2010 from $17.6
million in 2009. This increase was primarily due to:
|
|
|
Revenue from our sleep diagnostic business increased $3.7 million (21%)
compared to 2009. Of this increase, $6.1 million was due to realizing a full year of
operating revenue from the Somni and Eastern acquisitions completed in August and
September of 2009. This increase was offset by lower revenues
from same location operations of $2.4 million. The lower same location revenue was
driven by lower volumes ($1.5 million), lower rates per study ($0.8 million) and lower
revenue from our clinic services ($0.1 million). |
|
|
|
Revenue from our sleep therapy business increased $1.5 million (37%) compared
to 2009. Of this, $1.4 million was due to realizing a full year of operating revenue
from our Somni acquisition completed in August 2009. Additionally, revenue from our
existing therapy business increased $0.6 million driven primarily by an increase in
both set-up and resupply volumes compared to 2009. This was offset by a favorable
adjustment in our reserve for contractual allowances in 2009 of approximately $0.5
million. |
Cost of sales and services increased approximately $1.6 million (a 29.4% increase) to $7.1
million during 2010 from $5.5 million in 2009. This increase was primarily due to:
|
|
|
Our sleep diagnostic cost of services increased $1.9 million and our sleep
therapy cost of sales increased $0.4 million due to realizing a full year of cost of
sales and services from our Somni acquisition which was completed in August 2009. |
39
|
|
|
Cost of services in our existing diagnostic business decreased $0.9 million due
to the lower volume of sleep studies compared to 2009. |
|
|
|
Cost of sales in our existing sleep therapy business increased $0.2 million due
to the growth in that business compared to 2009. |
Cost of sales and services as a percent of net revenues was 31% during 2010 and 2009.
Operating expenses increased $3.9 million (a 26.9% increase) to $18.6 million during 2010 (82%
of revenue), compared with $14.7 million (84% of revenue) in 2009. Operating expenses at our sleep
management operations increased $3.4 million due primarily to the acquisitions of Somni and Eastern
in August and September 2009 which resulted in increased operating expenses of $4.0 million.
Operating expenses in our existing sleep diagnostic and therapy operations decreased approximately
$0.6 million compared to 2009. The decrease in operating expenses in our existing sleep operations
was due to cost reduction initiatives and synergies realized from the integration of Somni and
Eastern. Overhead incurred at the parent-company level, which includes our public-company costs,
increased approximately $0.5 million primarily due to increased professional fees incurred in
conjunction with due diligence performed on a potential acquisition target.
Bad debt expense decreased approximately $2.0 million (a 53% decrease) to $1.8 million (8% of
revenue) during 2010 compared with $3.8 million (22% of revenue) in 2009. During the second
quarter of 2009, we completed our quarterly analysis of the allowance for doubtful accounts based
on historical collection trends using newly available information related to the correlation of the
ultimate collectability of an account and the aging of that account. The effect of this change in
estimate for doubtful accounts was to increase the allowance for doubtful accounts that is netted
against accounts receivable and increase bad debt expenses in 2009 by $2,648,207. The decrease in
bad debt expense resulting from the change in accounting estimate in 2009 was offset by
approximately $0.2 million of increases in bad debt expense in 2010 related operating Somni and
Eastern for a full year in 2010 compared to 3 to 4 months of operations in 2009. The remaining
change is attributable to bad debt experience at our existing sleep center locations.
Impairment of goodwill and intangible assets during the fourth quarter of 2010, we
completed our annual impairment review of goodwill and other intangible assets. Based on our (i)
assessment of current and expected future economic conditions, (ii) trends, strategies and
forecasted cash flows at each business unit and (iii) assumptions similar to those that market
participants would make in valuing our business units, we determined that the carrying value of
goodwill related to our sleep centers located in Oklahoma, Nevada and Texas exceeded their fair
value. In addition, we determined the carrying value our intangible assets associated with Eastern
and certain other intangibles exceeded their fair value. Accordingly, we recorded a noncash
impairment charge, in December 2010, of $7.5 million and $3.2 million, respectively, on goodwill
and other intangible assets. Our evaluation of goodwill and indefinite lived intangible assets
completed during December 2009 resulted in no impairment losses.
Impairment of fixed assets during the third quarter of 2010, we identified impairment
indicators at certain sleep diagnostic facilities and office facilities. The impairment indicators
related to certain sleep diagnostic systems that were no longer compatible with current systems and
assets associated with certain sleep diagnostic and office facilities closed or consolidated into
existing facilities. Accordingly, we performed a recoverability test and an impairment test on
these locations and determined, based on the results of an undiscounted cash flow analysis (level 3
in the fair value hierarchy), that the fair value of the identified assets was less than their
carrying value. As a result, an impairment charge of $762,224 was recorded.
Net other expense represents interest expense on borrowings reduced by interest income earned
on cash and cash equivalents. Net other expense increased approximately $0.5 million during 2010
compared with 2009. The increase is due to interest expense incurred on increased borrowings
related to the acquisition of Somni and Eastern.
40
Income from discontinued operations represents the net income (loss) from the pharmacy
operations of ApothecaryRx. In September 2010, we entered into an agreement to sale substantially
all of the assets of ApothecaryRx. The closing of the sale of ApothecaryRx occurred in December
2010. As a result of the sale of ApothecaryRx, the related assets, liabilities, results of
operations and cash flows of ApothecaryRx have been classified as discontinued operations. In
addition, we have discontinued operations related to our discontinued internet sales
division and discontinued film operations. The results of ApothecaryRx and our other discontinued
operations for the years ended December 31, 2010 and 2009 follows:
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
Revenues |
|
$ |
79,038,856 |
|
|
$ |
89,669,301 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before taxes ApothecaryRx |
|
$ |
(324,092 |
) |
|
$ |
1,985,109 |
|
Income (loss) before taxes other |
|
|
(220,258 |
) |
|
|
6,896 |
|
Income tax (provision) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations of
discontinued operations, net of tax |
|
|
(544,350 |
) |
|
|
1,992,005 |
|
Special (charges) incurred on sale |
|
|
(6,516,613 |
) |
|
|
|
|
Gain recorded on sale |
|
|
5,644,880 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from discontinued operations |
|
$ |
(1,416,083 |
) |
|
$ |
1,992,005 |
|
|
|
|
|
|
|
|
Net revenues and income from operations for ApothecaryRx decreased $10.6 million and $2.5
million, respectively, during 2010 compared with 2009. The decrease in earnings is primarily due
to not operating all stores for a full-year in 2010 as a result of the sale of ApothecaryRx. This
accounted for $9.7 million of the decrease in revenues. The decrease in same store earnings was
primarily due to a continued shift to generic drugs which have a lower average price per
prescription compared to branded drugs.
During 2010, we recorded a special charge of approximately $6.7 million related to certain
estimated costs resulting from the ApothecaryRx Sale. The components of the special charge are as
follows:
|
|
|
|
|
Loss on liquidation of inventory |
|
$ |
2,041,051 |
|
Bad debt expense on remaining accounts receivable |
|
|
3,003,190 |
|
Lease termination costs |
|
|
859,580 |
|
Severance and payroll costs |
|
|
493,303 |
|
Equipment removal and lease termination costs |
|
|
119,489 |
|
|
|
|
|
|
|
|
|
|
Total charge |
|
$ |
6,516,613 |
|
|
|
|
|
The charges noted above were incurred as a result of the following:
|
|
|
We did not sell certain of the front-end merchandise and private-label and
other over the counter drugs as part of the ApothecaryRx Sale. The loss on liquidation
of inventory represents the loss on items that have been liquidated and the write-down
of remaining inventory to expected liquidated values. |
|
|
|
We have recorded a reserve for substantially all outstanding accounts
receivable that have not been collected as of January 31, 2011. Historically, we
collected accounts receivable within 30 days. After the ApothecaryRx sale, we have
seen a significant delay from third-party payers. For example, as of March 15, 2011
the State of Illinois owed us approximately $0.7 million. The payment on this
receivable has been delayed due to underfunding of the States Medicaid program. We
will continue collection efforts on the balances owed and any future receipts will be
recorded as a bad debt recovery in the period collected. |
|
|
|
We incurred certain severance and payroll costs, lease termination costs and
equipment removal costs related to the pharmacy locations which were not assumed by the
buyer. |
Additional charges may be recorded in future periods dependent upon the final resolution of
the items listed above.
Noncontrolling interests were allocated approximately $154,000 of net losses during 2010 and
2009. 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 $18.9 million (83% of approximately $22.8 million in net revenues) during 2010,
compared to a net loss of approximately $5.2 million (30% of approximately $17.8 million in net
revenues) during 2009.
41
Reduction in Cost Base.
As a result of our disposition of ApothecaryRxs independent retail pharmacy business, we
began a company-wide strategic review of our operations. We have begun to implement changes in
operations as discussed above. We believe that we can achieve a material reduction in our cost
base as a result of these changes and begin to generate positive cash flow on a prospective basis
by September 30, 2011.
In addition, we incurred costs in 2010 which we do not believe that will be part of our normal
operations for 2011 based on the restructuring or our operations. We expect that this
restructuring of our operations will be completed by September 30, 2011. We incurred costs of
$454,000 in 2010 which we believe we will not incur in 2011 due to salary reductions ($56,000), and
reduced staffing in marketing ($80,000), accounting ($59,000), billing ($90,000), and human
resources ($127,000) departments. We incurred compensation costs of $359,000 in 2010 for our
President ($112,000), Chief Operating Officer ($165,000) and Vice President of Operations ($81,000)
each of these positions has been eliminated during 2010 or 2011. We also incurred costs of
$789,000 in 2010 which we do not expect to incur in 2011 due to changes in staffing at our sleep
centers ($423,000) and physician staffing ($367,000). We incurred $618,000 in costs in 2010 which
we do not believe we will incur in 2011 due to combining two Oklahoma sleep centers ($120,000),
facility move expenses ($21,000) and renegotiation of leases ($477,000). We also incurred IT
infrastructure investments of $56,000 which we do not expect in 2011. We incurred consulting and
professional service costs of $299,000 in 2010 associated with negotiating and obtaining contracts
with various third party payors ($121,000), fees for tax services related to prior years ($140,000)
upgrading our accounting systems ($9,000) and performing the intangible asset valuation related to
the Somni and East acquisitions ($28,000). We also incurred an expense related to a reserve for
incurred but not yet billed expenses of $60,000.
In 2010, we incurred costs relating to the ApothecaryRx transaction and other potential
transactions which were not consummated. These transactional costs included approximately $688,000
for legal, accounting and other professional fees.
Liquidity and Capital Resources
Our liquidity and capital resources are provided principally through cash generated from
operations, loan proceeds and equity offerings. Our cash and cash equivalents at December 31, 2010
totaled approximately $1.6 million. As of December 31, 2010, we had a working capital deficit of
approximately $20.5 million.
Our operating activities during 2010 used net cash of approximately $3.9 million compared to
operating activities in 2009 that used net cash of approximately $2.7 million. The increase in
cash flows used by operating activities was primarily attributable to an increase in the cash used
from the operating activities of our discontinued operations. Operating activities from our
continuing operations improved by $1.0 million during 2010 compared to 2009. During 2010, our
operating activities from continuing operations included a net loss from continuing operations of
$17.7 million which was increased by the losses from discontinued operations of $1.4 million and
offset by impairment charges of $11.7 million, depreciation and amortization of $1.3 million, bad
debt expense of $1.8 million, and stock-based compensation of $0.4 million.
Our investing activities during 2010 provided net cash of approximately $28.8 million compared
to 2009 during which we used approximately $10.2 million for investing activities. The increase in
the cash provided by investing activities was attributable to the proceeds from the sale of
ApothecaryRx assets which produced $29.3 million.
Our financing activities during 2010 used net cash of $25.2 million compared to 2009 during
which financing activities used $0.6 million. The increase in the cash used by financing
activities is primarily due to increased debt payments. During 2010, we made debt payments from
continuing and discontinued operations totaling $25.2 million compared to total debt payments of
$6.0 million in 2009. During 2009, we received proceeds from debt of approximately $5.4 million.
The debt payments made in 2010 include $22.0 million that were made from the proceeds of the sale
of the assets of ApothecaryRx which is further discussed below.
42
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 Companys subsidiary, ApothecaryRx to Walgreens. ApothecaryRx operated 18 retail
pharmacy stores 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 ApothecaryRxs assets
occurred in December 2010. As a result of the sale of ApothecaryRxs assets, the related assets,
liabilities, results of operations and cash flows of ApothecaryRx have been classified as
discontinued operations.
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 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 Buyer at 17 of our pharmacies with the inventory for the remaining pharmacy being sold
as part of the litigation settlement. Of the proceeds, $22 million was used to reduce outstanding
obligations under our credit facility with Arvest Bank. We are required to pay Arvest Bank an
additional $3.0 million by June 30, 2011. We are currently in discussions with Arvest Bank
regarding this payment and our compliance with required financial covenants.
Generally, on 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 will be released, subject to deduction
for any pending claims for indemnification. All remaining funds held in the Indemnity Escrow Fund,
if any, will be released on the 18-month anniversary of the final closing date of the sale, subject
to any pending claims for indemnification. Of the $2,000,000 Indemnity Escrow Fund, $1,000,000 is
subject to partial or full recovery by the buyer if the average daily prescription sales at the
buyers location in Sterling, Colorado over a six-month period after the purchase does not maintain
percentage certain level of average daily prescription sales (the Retention Rate Earnout).
As of December 31, 2010, we had an accumulated deficit of approximately $29.1 million and
reported a net loss of approximately $19.0 for the year then ending. We used approximately $2.4
million in cash from operating activities of continuing operations during the year ending December
31, 2010. Furthermore, we have a working
capital deficit of approximately $21 million as of December 31, 2010. We are required to make
a $3 million principal payment to Arvest Bank by June 30, 2011 and we are currently not in
compliance with certain covenants required by our lending agreement with Arvest Bank.
Arvest Credit Facility
Effective May 21, 2008, we and each of Oliver Company Holdings, LLC, Roy T. Oliver, The Roy
T. Oliver Revocable Trust, Stanton M. Nelson, Vahid Salalati, Greg Luster, Kevin Lewis, Roger Ely
and, Lewis P. Zeidner (the Guarantors) entered into a Loan Agreement with Arvest Bank (the
Arvest Credit Facility). The Arvest Credit Facility consolidated the prior loan to our
subsidiaries, SDC Holdings and ApothecaryRx in the principal amount of $30 million (referred to as
the Term Loan) and provided an additional credit facility in the principal amount of $15 million
(the Acquisition Line) for total principal of $45 million. The Loan Agreement was subsequently
amended in January 2009 (the Amendment), May 2009, July 2010 and December 2010. As of December
31, 2010, the outstanding principal amount of the Arvest Credit Facility was $22,396,935. See
Loan Agreement below for a description of a recent consent granted by Arvest in March 2011.
Personal Guaranties. The Guarantors unconditionally guarantee payment of our obligations owed
to Arvest Bank and our performance under the Loan Agreement and related documents. The initial
liability of the Guarantors as a group is limited to $15 million of the last portion or dollars of
our obligations collected by Arvest Bank. The liability of the Guarantors under the guaranties
initially was in proportion to their ownership of our common stock shares as a group on a several
and not joint basis. In conjunction with the employment termination of Mr. Luster, we agreed to
obtain release of his guaranty. The Amendment released Mr. Luster from his personal guaranty and
the personal guaranties of the other Guarantors were increased, other than the guaranties of
Messrs. Salalati and Ely. During the third quarter of 2010, Mr. Oliver and Mr. Nelson assumed the
personal guaranty of Mr. Salalati.
43
Furthermore, the Guarantors agreed to not sell, transfer or otherwise dispose of or create,
assume or suffer to exist any pledge, lien, security interest, charge or encumbrance on our common
stock shares owned by them that exceeds, in one or an aggregate of transactions, 20% of the
respective common stock shares owned at May 21, 2008, except after notice to Arvest Bank. Also,
the Guarantors agreed to not sell, transfer or permit to be transferred voluntarily or by operation
of law assets owned by the applicable Guarantor that would materially impair the financial worth of
the Guarantor or Arvest Banks ability to collect the full amount of our obligations.
Maturity Dates. Each advance or tranche of the Acquisition Line will become due on the sixth
anniversary of the first day of the month following the date of advance or tranche (the Tranche
Note Maturity Date). The Term Loan will become due on May 21, 2014. The following table outlines
the contractual due dates of each tranche of debt under the Acquisition Line:
|
|
|
|
|
|
|
|
|
Tranche |
|
Amount |
|
|
Maturity Date |
|
|
|
|
|
|
|
|
|
|
#1 |
|
$ |
1,054,831 |
|
|
|
6/1/2014 |
|
#2 |
|
|
5,217,241 |
|
|
|
7/1/2014 |
|
#3 |
|
|
1,536,600 |
|
|
|
7/1/2014 |
|
#4 |
|
|
1,490,739 |
|
|
|
7/1/2014 |
|
#5 |
|
|
177,353 |
|
|
|
12/1/2014 |
|
#6 |
|
|
4,920,171 |
|
|
|
8/1/2015 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
14,396,935 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Rate. The outstanding principal amounts of Acquisition Line and Term Loan bear
interest at the greater of the prime rate as reported in the Money Rates section of The Wall
Street Journal (the WSJ Prime Rate) or 6% (Floor Rate). Prior to June 30, 2010, the Floor Rate
was 5%. The WSJ Prime Rate is adjusted annually, subject to the Floor Rate, then in effect on May
21 of each year of the Term Loan and the anniversary date of each advance or tranche of the
Acquisition Line. In the event of our default under the terms of the Arvest Credit Facility, the
outstanding principal will bear interest at the per annum rate equal to the greater of 15% or the
WSJ Prime Rate plus 5%.
Interest and Principal Payments. Provided we are not in default, the Term Note is payable in
quarterly payments of accrued and unpaid interest on each September 1, December 1, March 1, and
June 1. Commencing on September 1, 2011, and quarterly thereafter on each December 1, March 1,
June 1 and September 1, we are obligated to make equal payments of principal and interest
calculated on a seven-year amortization of the unpaid principal balance of the Term Note as of June
1, 2011 at the then current WSJ Prime Rate or Floor Rate, and adjusted annually thereafter for any
changes to the WSJ Prime Rate or Floor Rate as provided herein. The entire unpaid principal
balance of the Term Note plus all accrued and unpaid interest thereon will be due and payable on
May 21, 2014.
Furthermore, each advance or tranche of the Acquisition Line is repaid in quarterly payments
of interest only for up to three years and thereafter, principal and interest payments based on a
seven-year amortization until the balloon payment on the Tranche Note Maturity Date. We agreed to
pay accrued and unpaid interest only at the WSJ Prime Rate or Floor Rate in quarterly payments on
each advance or tranche of the Acquisition Line for the first three years of the term of the
advance or tranche commencing three months after the first day of the month following the date of
advance and on the first day of each third month thereafter. Commencing on the third anniversary
of the first quarterly payment date, and each following anniversary thereof, the principal balance
outstanding on an advance or tranche of the Acquisition Line, together with interest at the WSJ
Prime Rate or Floor Rate on the most recent anniversary date of the date of advance, will be
amortized in quarterly payments over a seven-year term beginning on the third anniversary of the
date of advance, and recalculated each anniversary thereafter over the remaining portion of such
seven-year period at the then applicable WSJ Prime Rate or Floor Rate. The entire unpaid principal
balance of the Acquisition Line plus all accrued and unpaid interest thereon will be due and
payable on the respective Tranche Note Maturity Date.
44
Use of Proceeds. All proceeds of the Term Loan were used solely for the funding of the
acquisition and refinancing of the existing indebtedness and loans owed to Intrust Bank, the
refinancing of the existing indebtedness owed to Arvest Bank; and other costs we incurred by Arvest
Bank in connection with the preparation of the loan documents, subject to approval by Arvest Bank.
The proceeds of the Acquisition Line are to be used solely for the funding of up to 70% of
either the purchase price of the acquisition of existing pharmacy business assets or sleep testing
facilities or the startup costs of new sleep centers and other costs incurred by us or Arvest Bank
in connection with the preparation of the Loan Agreement and related documents, subject to approval
by Arvest Bank.
Collateral. Payment and performance of our obligations under the Arvest Credit Facility are
secured by the personal guaranties of the Guarantors and in general our assets. If the Company
sells any assets which are collateral for the Arvest Credit Facility, then subject to certain
exceptions and without the consent of Arvest Bank, such sale proceeds must be used to reduce the
amounts outstanding to Arvest Bank.
Debt Service Coverage Ratio. Based on the latest four rolling quarters, we agreed to
continuously maintain a Debt Service Coverage Ratio of not less than 1.25 to 1. Debt Service
Coverage Ratio is, for any period, the ratio of:
|
|
|
the net income of Graymark Healthcare (i) increased (to the extent deducted in
determining net income) by the sum, without duplication, of our interest expense,
amortization, depreciation, and non-recurring expenses as approved by Arvest, and (ii)
decreased (to the extent included in determining net income and without duplication) by
the amount of minority interest share of net income and distributions to minority
interests for taxes, if any, to |
|
|
|
the annual debt service including interest expense and current maturities of
indebtedness as determined in accordance with generally accepted accounting principles. |
If we acquire another company or its business, the net income of the acquired company and the new
debt service associated with acquiring the company may both be excluded from the Debt Service
Coverage Ratio, at our option.
Compliance with Financial Covenants. As of December 31, 2010, our Debt Service Coverage Ratio
is less than 1.25 to 1 and we do not meet the Minimum Net Worth requirement. Arvest Bank has
waived the Debt Service
Coverage Ratio and Minimum Net Worth requirements through June 30, 2011 assuming we make a $3
million principal payment by June 30, 2011. We expect to raise the funds necessary to make the
principal payment through additional equity or debt financing. There is no assurance that Arvest
Bank will waive Debt Service Coverage Ratio and Minimum Net Worth requirements beyond June 30,
2011. Due to the non-compliance of these waivers and the associated contingent nature of achieving
compliance before June 30, 2011, the associated debt has been classified as current on our
consolidated balance sheet.
Default and Remedies. In addition to the general defaults of failure to perform our
obligations and those of the Guarantors, collateral casualties, misrepresentation, bankruptcy,
entry of a judgment of $50,000 or more, failure of first liens on collateral, default also includes
our delisting by The Nasdaq Stock Market, Inc. In the event a default is not cured within 10 days
or in some case five days following notice of the default by Arvest Bank (and in the case of
failure to perform a payment obligation for three times with notice), Arvest Bank will have the
right to declare the outstanding principal and accrued and unpaid interest immediately due and
payable.
Deposit Account Control Agreement. Effective June 30, 2010, we entered into a Deposit Control
Agreement (Deposit Agreement) with Arvest Bank and Valliance Bank covering the deposit accounts
that we have at Valliance Bank. The Deposit Agreement requires Valliance Bank to comply with
instructions originated by Arvest Bank directing the disposition of the funds held by us at
Valliance Bank without our further consent. Without Arvest Banks consent, we cannot close any of
our deposit accounts at Valliance Bank or open any additional accounts at Valliance Bank. Arvest
Bank may exercise its rights to give instructions to Valliance Bank under the Deposit Agreement
only in the event of an uncured default under the Loan Agreement, as amended.
45
Loan Agreement
On March 16, 2011, we entered into a Loan Agreement with Valiant Investments, LLC, an entity
owned and controlled by Roy T. Oliver one of our controlling shareholders, of up to $1 million. We
intend to use the loan to fund our working capital needs. The loan will be disbursed in amounts
requested by the Company subject to the lenders consent and compliance with other conditions
contained in the Loan Agreement. The loan matures on August 1, 2011. Interest accrues at a rate
of 6% and default interest accrues at a rate of 15%. We are also required to pay 1% of each
advance on the loan as a loan fee. This loan is unsecured and subordinated to our Arvest Bank
facility. The Loan Agreement also contains restrictions on our ability to take action without the
consent of the lender, these include: (i) acquisitions of other businesses, (ii) the sale of all
or substantially all of our assets, (iii) the issuance of common stock or convertible securities
unless the proceeds are to be used to repay the loan in full.
On March 11, 2011, we received the consent of Arvest to obtain this loan and requirements for
payments of interest and principal on this loan and Arvest will waive the debt service coverage
ratio and minimum net worth covenants through December 31, 2011 on the following conditions:
|
|
|
On or before June 30, 2011, Graymark will pay to Arvest the greater of $3
million or one-third of the proceeds of any public equity offering; |
|
|
|
On or before June 30, 2011, Graymark will pay Arvest a fee equal to 0.25% of
the outstanding loan balance as of June 30, 2011; |
|
|
|
If Graymark is not in compliance with the debt service coverage ratio and
minimum net worth covenants on December 31, 2011, Graymark will pay Arvest a fee equal
to 0.50% of the then outstanding balance of the loan (which does not cure any default
in such covenants); |
|
|
|
On June 30, 2011, Graymark will prepay all interest and principal payments due
to Arvest between July 1, 2011 and December 31, 2011; |
|
|
|
On June 30, 2011, if Graymark has received at least $15 million in proceeds
from a public equity offering then Graymark will escrow with Arvest all principal and
interest payments due to Arvest between January 1, 2010 and June 30, 2012; |
|
|
|
Graymark may not repay any amounts on the $1 million loan from Valiant
Investments before August
1, 2011 except that Graymark may repay such loan in full if Graymark has received more
than $10 million in proceeds from a public equity offering and if Graymark has received
less than $10 million from a public equity offering then Graymark will be permitted to
make interest payments only on such loan; and |
|
|
|
The $1 million loan will be subordinated to Arvests credit facility in all
respects. |
Financial Commitments
We do not have any material capital commitments during the next 12 months, but we do have
contractual commitments of approximately $26.0 million for payments on our indebtedness and for
operating lease payments. Included in this amount is $23.7 million related to the classification
of our credit facility as current for financial statement purposes. Although we have not entered
into any definitive arrangements for obtaining additional capital resources, either through
long-term lending arrangements or equity offering, we continue to explore various capital resource
alternatives to replace our long-term bank indebtedness.
Our future commitments under contractual obligations by expected maturity date at December 31,
2010 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
< 1 year |
|
|
1-3 years |
|
|
3-5 years |
|
|
> 5 years |
|
|
Total |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt (1) |
|
$ |
24,149,167 |
|
|
$ |
437,025 |
|
|
$ |
26,894 |
|
|
$ |
|
|
|
$ |
24,613,086 |
|
Operating leases |
|
|
1,597,411 |
|
|
|
2,389,424 |
|
|
|
1,282,358 |
|
|
|
2,489,158 |
|
|
|
7,758,351 |
|
Operating leases, discontinued operations |
|
|
269,454 |
|
|
|
423,313 |
|
|
|
67,101 |
|
|
|
|
|
|
|
759,868 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
26,016,032 |
|
|
$ |
3,249,762 |
|
|
$ |
1,376,353 |
|
|
$ |
2,489,158 |
|
|
$ |
33,131,305 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes principal and interest obligations. |
46
Off-Balance Sheet Arrangements
We had no material off-balance sheet arrangements (as defined in Item 303(a) (4) of Regulation
S-K) as of December 31, 2010 and 2009.
CRITICAL ACCOUNTING POLICIES
The consolidated condensed financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America and include amounts based on
managements prudent judgments and estimates. Actual results may differ from these estimates.
Management believes that any reasonable deviation from those judgments and estimates would not have
a material impact on our consolidated financial position or results of operations. To the extent
that the estimates used differ from actual results, however, adjustments to the statement of
earnings and corresponding balance sheet accounts would be necessary. These adjustments would be
made in future statements. Some of the more significant estimates include revenue recognition,
allowance for contractual adjustments and doubtful accounts, and goodwill and intangible asset
impairment. We use the following methods to determine our estimates:
Revenue recognition Sleep center services and product sales are recognized in the period in
which services and related products are provided to customers and are recorded at net realizable
amounts estimated to be paid by customers and third-party payers. Insurance benefits are assigned
to us and, accordingly, we bill on behalf of our customers. For the business acquired from
somniCare, Inc. and somniTech, Inc. (collectively referred to as Somni) in 2009, we estimate the
net realizable amount based primarily on the contracted rates stated in the contracts we have with
various payors. We have used this method to determine the net revenue for the Somni business since
the date of the acquisition and do not anticipate any future changes to this process. In our
historic business, the business has been predominantly out-of-network and as a result, we have not
had contract rates to use for determining net revenue for a majority of our payors. For this
portion of the business, we perform a quarterly analysis of actual reimbursement from each third
party payor for the most recent 12-months. We conduct this analysis for each of our operating
locations separately to ensure differences in payment rates from various markets
are identified in the analysis. In the analysis, we calculate the percentage actually paid by
each third party payor of the amount billed to determine the applicable amount of net revenue for
each payor at each location. The key assumption in this process is that actual reimbursement
history is a reasonable predictor of the future out-of-network reimbursement for each payor at each
facility. Historically, we consistently used this process to estimate net revenue at the time of
service other than a change in fiscal 2009 to using 12 months of payment history. Prior to that
time, we used nine months of payment history for its quarterly analysis. Although the impact on
the calculation was negligible, we determined a 12-month review eliminates potential seasonal
fluctuations and provides a broader sample of payments for the calculation. During the fourth
quarter of 2010, we migrated much of our historic sleep diagnostic business to an in-network
position. As a result, commencing with the fourth quarter of 2010, the revenue from our historic
sleep diagnostic business was determined using the process utilized in the Somni business. For our
therapy business, we expect to transition to this same process in the first or second quarter of
2011. This change in process and assumptions for our historic business is not expected to have a
material impact on future operating results.
For certain sleep therapy and other equipment sales, reimbursement from third-party payers
occurs over a period of time, typically 10 to 13 months. We recognize revenue on these sales as
payments are earned over the payment period stipulated by the third-party payor.
We have established an allowance to account for contractual adjustments that result from
differences between the amount billed and the expected realizable amount. Actual adjustments that
result from differences between the payment amount received and the expected realizable amount are
recorded against the allowance for contractual adjustments and are typically identified and
ultimately recorded at the point of cash application or when otherwise determined pursuant to our
collection procedures. Revenues are reported net of such adjustments.
47
Due to the nature of the healthcare industry and the reimbursement environment in which we
operate, certain estimates are required to record net revenues and accounts receivable at their net
realizable values at the time products or services are provided. Inherent in these estimates is
the risk that they will have to be revised or updated as additional information becomes available,
which could have a material impact on our operating results and cash flows in subsequent periods.
Specifically, the complexity of many third-party billing arrangements and the uncertainty of
reimbursement amounts for certain services from certain payers may result in adjustments to amounts
originally recorded.
The patient and their third party insurance provider typically share in the payment for our
products and services. The amount patients are responsible for includes co-payments, deductibles,
and amounts not covered due to the provider being out-of-network. Due to uncertainties surrounding
deductible levels and the number of out-of-network patients, we are not certain of the full amount
of patient responsibility at the time of service. Starting in 2010, we implemented a process to
estimate amounts due from patients prior to service and increase collection of those amounts prior
to service. Remaining amounts due from patients are then billed following completion of service.
Cost of Services and Sales Cost of services includes technician labor required to perform
sleep diagnostics, fees associated with interpreting the results of the sleep study and disposable
supplies used in providing sleep diagnostics. Cost of sales includes the acquisition cost of sleep
therapy products sold. Costs of services are recorded in the time period the related service is
provided. Cost of sales is recorded in the same time period that the related revenue is
recognized. If the sale is paid for over a specified period, the product cost associated with that
sale is recognized over that same period. If the product is paid for in one period, the cost of
sale is recorded in the period the product was sold.
Accounts Receivable Accounts receivable are reported net of allowances for contractual
adjustments and doubtful accounts. The majority of our accounts receivable is due from private
insurance carriers, Medicare and Medicaid and other third-party payors, as well as from customers
under co-insurance and deductible provisions.
Third-party reimbursement is a complicated process that involves submission of claims to
multiple payers, each having its own claims requirements. Adding to this complexity, a significant
portion of our business has historically been out-of-network with several payors, which means we do
not have defined contracted reimbursement rates with these payors. For this reason, our systems
reported revenue at a higher gross billed
amount, which we adjusted to an expected net amount based on historic payments. This process
continues in our historic sleep therapy business, but was changed in the fourth quarter of 2010 for
our historic sleep diagnostic business. As a result, the reserve for contractual allowance has
been reduced as our systems now report a larger portion of our business at estimated net contract
rates. As we continue to move more of our business to in-network contracting, the level of reserve
related to contractual allowances is expected to decrease. In some cases, the ultimate collection
of accounts receivable subsequent to the service dates may not be known for several months. As
these accounts age, the risk of collection increases and the resulting reserves for bad debt
expense to reflect this longer payment cycle. We have established an allowance to account for
contractual adjustments that result from differences between the amounts billed to customers and
third-party payers and the expected realizable amounts. The percentage and amounts used to record
the allowance for doubtful accounts are supported by various methods including current and
historical cash collections, contractual adjustments, and aging of accounts receivable.
We offer payment plans to patients for amounts due from them for the sales and services we
provide. For patients with a balance of $500 or less, we allow a maximum of six months for the
patient to pay the amount due. For patients with a balance over $500, we allow a maximum of 12
months to pay the full amount due. The minimum monthly payment amount for both plans is $50 per
month.
48
Accounts are written-off as bad debt using a specific identification method. For amounts due
from patients, we utilize a collections process that includes distributing monthly account
statements. For patients that are not on a payment plan, collection efforts including collection
letters and collection calls begin at 90 days from the initial statement. If the patient is on a
payment program, these efforts begin 30 days after the patient fails to make a planned payment.
For our diagnostic patients, we submit patient receivables to an outside collection agency if the
patient has failed to pay 120 days following service or, if the patient is on a payment plan, they
have failed to make two consecutive payments. For our therapy patients, patient receivables are
submitted to an outside collection agency if payment has not been received between 180 and 270 days
following service depending on the service provided and circumstances of the receivable or, if the
patient is on a payment plan, they have failed to make two consecutive payments. It is our policy
to write-off as bad debt all patient receivables at the time they are submitted to an outside
collection agency. If funds are recovered by our collection agency, the amounts previously
written-off are reversed as a recovery of bad debt. For amounts due from third party payors, it is
our policy to write-off an account receivable to bad debt based on the specific circumstances
related to that claim resulting in a determination that there is no further recourse for collection
of a denied claim from the denying payor.
Included in accounts receivable are earned but unbilled receivables. Unbilled accounts
receivable represent charges for services delivered to customers for which invoices have not yet
been generated by the billing system. Prior to the delivery of services or equipment and supplies
to customers, we perform certain certification and approval procedures to ensure collection is
reasonably assured and that unbilled accounts receivable is recorded at net amounts expected to be
paid by customers and third-party payers. Billing delays, ranging from several weeks to several
months, can occur due to delays in obtaining certain required payer-specific documentation from
internal and external sources, interim transactions occurring between cycle billing dates
established for each customer within the billing system and new sleep centers awaiting assignment
of new provider enrollment identification numbers. In the event that a third-party payer does not
accept the claim for payment, the customer is ultimately responsible.
A summary of the Days Sales Outstanding (DSO) and managements expectations for the years
ended December 31, 2010 and 2009 follows:
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2010 |
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2009 |
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Actual |
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Expected |
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Actual |
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Expected |
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Sleep diagnostic business |
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51.25 |
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50 to 55 |
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51.34 |
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50 to 55 |
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Sleep therapy business |
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52.14 |
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55 to 60 |
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99.76 |
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100 to 105 |
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The primary reason for the decrease in expected DSO for sleep therapy business from 100 to 105
days at December 31, 2009 to 55 to 60 days at December 31, 2010 is the change in accounting method
during 2010 for equipment sales that are paid for over period of time (see Change in Accounting
Method below).
Goodwill and Intangible Assets Goodwill is the excess of the purchase price paid over the
fair value of
the net assets of the acquired business. Goodwill and other indefinitely-lived intangible
assets are not amortized, but are subject to annual impairment reviews, or more frequent reviews if
events or circumstances indicate there may be an impairment of goodwill.
Intangible assets other than goodwill which include customer relationships, customer files,
covenants not to compete, trademarks and payor contracts are amortized over their estimated useful
lives using the straight line method. The remaining lives range from three to fifteen years. We
evaluate the recoverability of identifiable intangible asset whenever events or changes in
circumstances indicate that an intangible assets carrying amount may not be recoverable.
Change in Accounting Method On January 1, 2010, we elected to change our method of revenue
recognition for sleep therapy equipment sales that are paid for over time (rental equipment) to
recognize the revenue for rental equipment over the life of the rental period which typically
ranges from 10 to 13 months. Prior to the business acquisitions made in the 3rd quarter of 2009,
we recognized the total amount of revenue for entire rental equipment period at the inception of
the rental period with an offsetting entry for estimated returns. The entities that were acquired
in 2009 recorded revenue for rental equipment consistent with method being adopted. Recording
revenue for rental equipment over the life of the rental period will provide more accurate interim
information as this method relies less on estimates than the previous method in which potential
rental returns had to be estimated.
We have determined that it is impracticable to determine the cumulative effect of applying
this change retrospectively because historical transactional level records are no longer available
in a manner that would allow for the appropriate calculations for the historical periods presented.
As a result, we will apply the change in revenue recognition for rental equipment on a prospective
basis. As a result of the accounting change, our accumulated deficit increased $213,500, as of
January 1, 2010, from $9,689,471, as originally reported, to $10,082,971.
49
Material Weakness
Internal Controls over Financial Reporting
During the sale of substantially all of the assets of ApothecaryRx, we incurred significant
charges related to the accounts receivable and inventory balances at ApothecaryRx. In addition, we
noted additional control deficiencies that in aggregate with the material special charges incurred
at our subsidiary ApothecaryRx have caused us to conclude that we have a material weakness in our
internal control over financial reporting.
A material weakness is a deficiency, or a combination of control deficiencies, in internal
control over financial reporting such that there is a reasonable possibility that a material
misstatement of the companys annual or interim financial statements will not be prevented or
detected on a timely basis. Although the accounts receivable trends and the inventory physical
counts related to the ApothecaryRx throughout prior periods did not generate unusual results or
cause us to question the validity of the accounts to receivable or inventory balances, we feel that
the significant charges recorded as a result of adjusting the inventory and accounts receivable
amounts to their net realizable value subsequent to the sale of the ApothecaryRx represent a
material weakness in our internal controls over financial reporting.
Since the operations of ApothecaryRx were sold, no remediation efforts are needed related to
those specific control deficiencies. However, we are evaluating the circumstances and potential
changes to entity wide controls to address the other identified control deficiencies.
Recently Adopted and Recently Issued Accounting Guidance
Adopted Guidance
Effective January 1, 2010, we adopted changes issued by the FASB on January 6, 2010, for a
scope clarification to the FASBs previously-issued guidance on accounting for noncontrolling
interests in consolidated financial statements. These changes clarify the accounting and reporting
guidance for noncontrolling interests and changes in ownership interests of a consolidated
subsidiary. An entity is required to deconsolidate a subsidiary
when the entity ceases to have a controlling financial interest in the subsidiary. Upon
deconsolidation of a subsidiary, an entity recognizes a gain or loss on the transaction and
measures any retained investment in the subsidiary at fair value. The gain or loss includes any
gain or loss associated with the difference between the fair value of the retained investment in
the subsidiary and its carrying amount at the date the subsidiary is deconsolidated. In contrast,
an entity is required to account for a decrease in its ownership interest of a subsidiary that does
not result in a change of control of the subsidiary as an equity transaction. The adoption of
these changes had no impact on our consolidated financial statements.
Effective January 1, 2010, we adopted changes issued by the FASB on January 21, 2010, to
disclosure requirements for fair value measurements. Specifically, the changes require a reporting
entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level
2 fair value measurements and describe the reasons for the transfers. The changes also clarify
existing disclosure requirements related to how assets and liabilities should be grouped by class
and valuation techniques used for recurring and nonrecurring fair value measurements. The adoption
of these changes had no impact on our consolidated financial statements.
Effective January 1, 2010, we adopted changes issued by the FASB on February 24, 2010, to
accounting for and disclosure of events that occur after the balance sheet date but before
financial statements are issued or available to be issued, otherwise known as subsequent events.
Specifically, these changes clarified that an entity that is required to file or furnish its
financial statements with the SEC is not required to disclose the date through which subsequent
events have been evaluated. Other than the elimination of disclosing the date through which
management has performed its evaluation for subsequent events, the adoption of these changes had no
impact on our consolidated financial statements.
50
Issued Guidance
In July 2010, the FASB issued changes to the required disclosures about the nature of the
credit risk in an entitys financing receivables, how that risk is incorporated into the allowance
for credit losses, and the reasons for any changes in the allowance. Disclosure is required to be
disaggregated at the level at which an entity calculates its allowance for credit losses. This
change is effective us beginning June 30, 2011. The adoption of this accounting standard is not
expected to have a material impact on our financial position, results of operations, cash flows and
disclosures.
In December 2010, the FASB issued changes as to when a company should perform Step 2 of the
Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The
amendments in this change modify Step 1 of the goodwill impairment test for reporting units with
zero or negative carrying amounts. For those reporting units, an entity is required to perform
Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment
exists. In determining whether it is more likely than not that a goodwill impairment exists, an
entity should consider whether there are any adverse qualitative factors indicating that an
impairment may exist. The qualitative factors are consistent with the existing guidance, which
requires that goodwill of a reporting unit be tested for impairment between annual tests if an
event occurs or circumstances change that would more likely than not reduce the fair value of a
reporting unit below its carrying amount. The amendments in this change are effective for fiscal
years, and interim periods within those years, beginning after December 15, 2010. Early adoption
is not permitted. This change is effective for us beginning January 1, 2011 and is not expected to
have a material impact on our financial position, results of operations, cash flows and
disclosures.
In December 2010, the FASB issued changes to the disclosure requirements for business
combinations. The changes require a public entity to disclose pro forma information for business
combinations that occurred in the current reporting period. The disclosures include pro forma
revenue and earnings of the combined business combinations that occurred during the year had been
as of the beginning of the annual reporting period. If comparative financial statements are
presented, the pro forma revenue and earnings of the combined entity for the comparable prior
reporting period should be reported as though the acquisition date for all business combinations
that occurred during the current year had been as of the beginning of the comparable prior annual
reporting period. The amendments in this update are effective prospectively for business
combinations for which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2010 effective for us beginning January 1,
2011. The adoption of this accounting standard is not expected to have a material impact on our
financial position, results of operations, cash flows and disclosures.
In October 2009, the FASB issued changes to revenue recognition for multiple-deliverable
arrangements. These changes require separation of consideration received in such arrangements by
establishing a selling price hierarchy (not the same as fair value) for determining the selling
price of a deliverable, which will be based on available information in the following order:
vendor-specific objective evidence, third-party evidence, or estimated selling price; eliminate the
residual method of allocation and require that the consideration be allocated at the inception of
the arrangement to all deliverables using the relative selling price method, which allocates any
discount in the arrangement to each deliverable on the basis of each deliverables selling price;
require that a vendor determine its best estimate of selling price in a manner that is consistent
with that used to determine the price to sell the deliverable on a standalone basis; and expand the
disclosures related to multiple-deliverable revenue arrangements. These changes become effective
for us on January 1, 2011. Management has determined that the adoption of these changes will not
have an impact on our consolidated financial statements, as we do not currently have any such
arrangements with our customers.
In January 2010, the FASB issued changes to disclosure requirements for fair value
measurements. Specifically, the changes require a reporting entity to disclose, in the
reconciliation of fair value measurements using significant unobservable inputs (Level 3), separate
information about purchases, sales, issuances, and settlements (that is, on a gross basis rather
than as one net number). These changes become effective for us beginning January 1, 2011. Other
than the additional disclosure requirements, management has determined these changes will not have
an impact on our consolidated financial statements.
51
Cautionary Statement Relating to Forward Looking Information
We have included some forward-looking statements in this section and other places in this
report regarding our expectations. These forward-looking statements involve known and unknown
risks, uncertainties and other factors which may cause our actual results, levels of activity,
performance or achievements, or industry results, to be materially different from any future
results, levels of activity, performance or achievements expressed or implied by these
forward-looking statements. Some of these forward-looking statements can be identified by the use
of forward-looking terminology including believes, expects, may, will, should or
anticipates or the negative thereof or other variations thereon or comparable terminology, or by
discussions of strategies that involve risks and uncertainties. You should read statements that
contain these words carefully because they:
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discuss our future expectations; |
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contain projections of our future operating results or of our future financial
condition; or |
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state other forward-looking information. |
We believe it is important to discuss our expectations; however, it must be recognized that
events may occur in the future over which we have no control and which we are not accurately able
to predict. Readers are cautioned to consider the specific business risk factors described in the
report and not to place undue reliance on the forward-looking statements contained herein, which
speak only as of the date hereof. We undertake no obligation to publicly revise forward-looking
statements to reflect events or circumstances that may arise after the date of this report.
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Item 7A. |
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Quantitative and Qualitative Disclosures about Market Risk. |
We are a smaller reporting entity as defined in Rule 12b-2 of the Exchange Act and as such,
are not required to provide the information required by Item 305 of Regulation S-K with respect to
Quantitative and Qualitative Disclosures about Market Risk.
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Item 8. |
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Financial Statements and Supplementary Data. |
Our financial statements which are prepared in accordance with Regulation S-X are set forth in
this report beginning on page
F-1.
We are a smaller reporting entity as defined in Rule 12b-2 of the Exchange Act and as such,
are not required to provide the information required by Item 302 of Regulation S-K with respect to
Supplementary Financial Information.
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Item 9. |
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Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. |
During 2010 and 2009, there were no disagreements concerning matters of accounting principle
or financial statement disclosure between us and our independent accountants of the type requiring
disclosure hereunder.
52
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Item 9A. |
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Controls and Procedures. |
Disclosure Controls and Procedures
Our management, with the participation of our Principal Executive Officer and Principal
Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as
defined Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of December 31,
2010. Our Principal Executive Officer and Principal Financial Officer are responsible primarily
for establishing and maintaining disclosure controls and procedures designed to ensure that
information required to be disclosed in our reports filed or submitted under the Securities
Exchange Act of 1934, as amended (the AExchange Act@) is recorded, processed,
summarized and reported within the time periods specified in the rules and forms of the U.S.
Securities and Exchange Commission. The controls and procedures are those defined in Rules 13a-15
or 15d-15 under the Securities Exchange Act of 1934. These controls and procedures are designed to
ensure that information required to be disclosed in our reports filed or submitted under the
Exchange Act is accumulated and communicated to our management, including our principal executive
and principal financial officers, or persons performing similar functions, as appropriate to allow
timely decisions regarding required disclosure. Based on such evaluations, our Principal Executive
Officer and Principal Financial Officer concluded that, as of December 31, 2010, our disclosure
controls and procedures were not effective due to the material weakness in internal controls over
financial reporting described below.
Internal Controls over Financial Reporting
Furthermore, our Principal Executive Officer and Principal Financial Officer are responsible
for the design and supervision of our internal controls over financial reporting as defined in Rule
13a-15 of the Securities Exchange Act of 1934. These internal controls over financial reporting
are then effected by and through our board of directors, management and other personnel, to provide
reasonable assurance regarding the reliability of our financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting
principles. These policies and procedures
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(1) |
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pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of our assets; |
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(2) |
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provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made only in
accordance with authorizations of our management and directors; and |
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(3) |
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provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have a material
effect on our financial statements. |
Our Principal Executive Officer and Principal Financial Officer, conducted their evaluation using
the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control Integrated Framework. Based upon their evaluation of the effectiveness of our internal controls over
financial reporting as of December 31, 2010, management, including our Principal Executive Officer
and Principal Accounting Officer, concluded that our internal controls over financial reporting
were not fully effective as of December 31, 2010 due to the material weakness disclosed below, and
reported to our auditors and the audit committee of our board of directors that no changes had
occurred in our internal control over financial reporting during the last fiscal quarter that have
materially affected or are reasonably likely to materially affect our internal control over
financial reporting. In conducting their evaluation of our internal controls over financial
reporting, these executive officers did not discover any fraud that involved management or other
employees who have a significant role in our disclosure controls and procedures and internal
controls over financial reporting. Furthermore, there were no significant changes in our internal
controls over financial reporting, or other factors that could significantly affect our internal
controls over financial reporting subsequent to the date of their evaluation.
53
Material Weakness Internal Controls over Financial Reporting
During the sale of substantially all of the assets of ApothecaryRx, we incurred significant
charges related to the accounts receivable and inventory balances at ApothecaryRx. In addition, we
noted additional control deficiencies that in aggregate with the material special charges incurred
at our subsidiary ApothecaryRx have caused us to conclude that we have a material weakness in our
internal control over financial reporting.
A material weakness is a deficiency, or a combination of control deficiencies, in internal
control over financial reporting such that there is a reasonable possibility that a material
misstatement of the companys annual or interim financial statements will not be prevented or
detected on a timely basis. Although the accounts receivable trends and the inventory physical
counts related to the ApothecaryRx throughout prior periods did not generate unusual results or
cause us to question the validity of the accounts to receivable or inventory balances, we feel that
the significant charges recorded as a result of adjusting the inventory and accounts receivable
amounts to their net realizable value subsequent to the sale of the ApothecaryRx represent a
material weakness in our internal controls over financial reporting.
Since the operations of ApothecaryRx were sold, no remediation efforts are needed related to
that specific control deficiency. However, we are evaluating the circumstances and potential
changes to entity wide controls to address identified control deficiencies.
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Item 9B. |
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Other Information. |
Annual Stockholders Meeting
The 2011 Annual Meeting of Stockholders of Graymark Healthcare, Inc. will be held at 4 p.m. on
May 18, 2011.
PART III
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Item 10. |
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Directors, Executive Officers and Corporate Governance. |
The information required by this item is incorporated herein by reference to our Proxy
Statement for our annual shareholders meeting (the 2010 Proxy Statement).
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Item 11. |
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Executive Compensation. |
The information required by this item is incorporated herein by reference to the 2010 Proxy
Statement.
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Item 12. |
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Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
The information required by this item is incorporated herein by reference to the 2010 Proxy
Statement.
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Item 13. |
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Certain Relationships and Related Transactions, and Director Independence. |
The information required by this item is incorporated herein by reference to the 2010 Proxy
Statement.
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Item 14. |
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Principal Accounting Fees and Services |
The information required by this item is incorporated herein by reference to the 2010 Proxy
Statement.
54
PART IV
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Item 15. |
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Exhibits, Financial Statement Schedules |
(a) Exhibits:
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Exhibit No. |
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Description |
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3.1 |
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Registrants Restated Certificate of Incorporation, incorporated by reference
to Exhibit 3.1.1 of Registrants Quarterly Report on Form 10-Q filed with the U.S.
Securities and Exchange Commission on August 14, 2008. |
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3.2 |
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Registrants Amended and Restated Bylaws, incorporated by reference to Exhibit
3.2 of Registrants Quarterly Report on Form 10-Q as filed with the U.S. Securities and
Exchange Commission on August 14, 2008. |
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4.1 |
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Form of Certificate of Common Stock of Registrant, incorporated by reference to
Exhibit 4.1 of Registrants Registration Statement on Form SB-2 (No. 333-111819) as
filed with the U.S. Securities and Exchange Commission on January 9, 2004. |
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4.2 |
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Form of Amended and Restated Common Stock Purchase Warrant Agreement issued to
SXJE, LLC and dated March 2007, is incorporated by reference to Exhibit 4.2 of the
Registrants Annual Report on Form 10-K filed with the U.S. Securities and Exchange
Commission on March 31, 2010. |
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4.3 |
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Financial Advisor Warrant Agreement issued to ViewTrade Securities, Inc. and
dated June 11, 2009, is incorporated by reference to Exhibit 4.7 of the Registrants
Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on
March 31, 2010. |
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10.1 |
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Graymark Productions, Inc. 2003 Stock Option Plan, incorporated by reference to
Exhibit 10.5 of Registrants Registration Statement on Form SB-2 (No. 333-111819) as
filed with the U.S. Securities and Exchange Commission on January 9, 2004. |
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10.2 |
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Graymark Productions, Inc. 2003 Non-Employee Stock Option Plan, incorporated by
reference to Exhibit 10.6 of Registrants Registration Statement on Form SB-2 (No.
333-111819) as filed with the U.S. Securities and Exchange Commission on January 9,
2004. |
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10.3 |
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Graymark Healthcare, Inc. 2008 Long-term Incentive Plan adopted by Registrant
on the effective date of October 29, 2008, is incorporated by reference to Exhibit 4.1
of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on December 9, 2008. |
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10.3.1 |
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Graymark Healthcare, Inc. 2008 Long-term Incentive Plan, Form of Restricted Stock
Award Agreement, is incorporated by reference to Exhibit 10.3.1 of the Registrants
Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on
March 31, 2010. |
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10.3.2 |
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Graymark Healthcare, Inc. 2008 Long-term Incentive Plan, Form of Stock Option
Agreement, is incorporated by reference to Exhibit 10.3.2 of the Registrants Annual
Report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 31,
2010. |
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10.4 |
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Exchange Agreement between Registrant, SDC Holdings, LLC, SDOC Investors, LLC,
Vahid Salalati, Greg Luster, Kevin Lewis, Roger Ely, ApothecaryRx, LLC, Oliver RX
Investors, LLC, Lewis P. Zeidner, Michael Gold, James A. Cox, and John Frick, dated
October 29, 2007, is incorporated by reference to Registrants Schedule 14 Information
Statement filed with the U.S. Securities and Exchange Commission on December 5, 2007. |
55
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Exhibit No. |
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Description |
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10.5 |
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Registration Rights Agreement between Registrant, Oliver Company Holdings, LLC,
Lewis P. Zeidner, Stanton Nelson, Vahid Salalati, Greg Luster, William R. Oliver, Kevin
Lewis, John B. Frick Revocable Trust, Roger Ely, James A. Cox, Michael Gold, Katrina J.
Martin Revocable Trust, dated January 2, 2008, is incorporated by reference to
Registrants Schedule 14 Information Statement filed with the U.S. Securities and
Exchange Commission on December 5, 2007. |
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10.6 |
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Asset Purchase Agreement among ApothecaryRx, LLC, Rambo Pharmacy, Inc. and
Norman Greenburg, dated January 3, 2008, is incorporated by reference to Exhibit 10.1
of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on January 29, 2008. |
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10.7 |
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Goodwill Protection Agreement between ApothecaryRx, LLC, Rambo Pharmacy, Inc.
and Norman Greenburg, dated January 12, 2008, is incorporated by reference to Exhibit
10.2 of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on January 29, 2008. |
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10.8 |
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Employment Agreement between ApothecaryRx, LLC and Aric Greenburg, dated
January 17, 2008, is incorporated by reference to Exhibit 10.3 of the Registrants |
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Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on
January 29, 2008. |
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10.9 |
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Transition Agreement between ApothecaryRx, LLC, Rambo Pharmacy, Inc. and Norman
Greenburg, dated January 17, 2008, is incorporated by reference to Exhibit 10.4 of the
Registrants Current Report on Form 8-K filed with the U.S. Securities and Exchange
Commission on January 29, 2008. |
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10.10 |
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Lease Agreement between ApothecaryRx, LLC and Rambo Pharmacy, Inc., dated
January 12, 2008, is incorporated by reference to Exhibit 10.5 of the Registrants
Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on
January 29, 2008. |
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10.11 |
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Asset Purchase Agreement between ApothecaryRx, LLC and Thrifty Drug Stores,
Inc., dated February 8, 2008, is incorporated by reference to Exhibit 10.1 of the
Registrants Current Report on Form 8-K filed with the U.S. Securities and Exchange
Commission on March 6, 2008. |
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10.12 |
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Goodwill Protection Agreement between ApothecaryRx, LLC and Thrifty Drug
Stores, Inc., dated February 29, 2008, is incorporated by reference to Exhibit 10.2 of
the Registrants Current Report on Form 8-K filed with the U.S. Securities and Exchange
Commission on March 6, 2008. |
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10.13 |
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Pharmacy Purchase Agreement between ApothecaryRx, LLC, Rehn-Huerbinger Drug
Co., 666 Drug Co., Wilmette-Huerbinger Drug Co., Edward Cox, Simpson Gold,
Lawrence Horwitz, and Steven Feinerman, dated May 2, 2008, is incorporated
by reference to Exhibit 10.1 of the Registrants Current Report on Form 8-K
filed with the U.S. Securities and Exchange Commission on June 6, 2008. |
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10.13.1 |
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First Amendment to Pharmacy Purchase Agreement between ApothecaryRx, LLC,
Rehn-Huerbinger Drug Co., 666 Drug Co., Wilmette-Huerbinger Drug Co., Edward Cox,
Simpson Gold, Lawrence Horwitz, and Steven Feinerman, dated May 23, 2008, is
incorporated by reference to Exhibit 10.7 of the Registrants Current Report on Form
8-K filed with the U.S. Securities and Exchange Commission on June 6, 2008. |
56
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Exhibit No. |
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Description |
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10.13.2 |
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|
Second Amendment to Pharmacy Purchase Agreement between ApothecaryRx, LLC,
Rehn-Huerbinger Drug Co., 666 Drug Co., Wilmette-Huerbinger Drug Co., Edward Cox,
Simpson Gold, Lawrence Horwitz, and Steven Feinerman, dated June 3, 2008, is
incorporated by reference to Exhibit 10.8 of the Registrants Current Report on Form
8-K filed with the U.S. Securities and Exchange Commission on June 6, 2008. |
|
|
|
|
|
|
10.14 |
|
|
Goodwill Protection agreement between ApothecaryRx, LLC, Edward Cox, Simpson
Gold and Lawrence Horwitz, dated June 3, 2008, is incorporated by reference to Exhibit
10.2 of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on June 6, 2008. |
|
|
|
|
|
|
10.15 |
|
|
Employment Agreement between ApothecaryRx, LLC and Lawrence Horwitz, dated
June 3, 2008, is incorporated by reference to Exhibit 10.3 of the Registrants Current
Report on Form 8-K filed with the U.S. Securities and Exchange Commission on June 6,
2008. |
|
|
|
|
|
|
10.16 |
|
|
Employment Agreement between ApothecaryRx, LLC and Steven Feinerman, dated
June 3, 2008, is incorporated by reference to Exhibit 10.4 of the Registrants Current
Report on Form 8-K filed with the U.S. Securities and Exchange Commission on June 6,
2008. |
|
|
|
|
|
|
10.17 |
|
|
Employment Agreement between ApothecaryRx, LLC and Edward Cox, dated June 3,
2008, is incorporated by reference to Exhibit 10.5 of the Registrants Current Report
on Form8-K filed with the U.S. Securities and Exchange Commission on June 6, 2008. |
|
|
|
|
|
|
10.18 |
|
|
Employment Agreement between ApothecaryRx, LLC and Simpson Gold, dated June 3,
2008, is incorporated by reference to Exhibit 10.6 of the Registrants Current Report
on Form 8-K filed with the U.S. Securities and Exchange Commission on June 6, 2008. |
|
|
|
|
|
|
10.19 |
|
|
Purchase Agreement between TCSD of Waco, LLC and Sleep Center of Waco, Ltd.,
dated May 30, 2008, is incorporated by reference to Exhibit 10.3 of the Registrants
Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on
June 13, 2008. |
|
|
|
|
|
|
10.20 |
|
|
Purchase Agreement between Capital Sleep Management, LLC, Plano Sleep Center,
Ltd., and Southlake Sleep Center, Ltd., dated May 30, 2008, is incorporated by
reference to Exhibit 10.2 of the Registrants Current Report on Form 8-K filed with the
U.S. Securities and Exchange Commission on June 13, 2008. |
|
|
|
|
|
|
10.21 |
|
|
Asset Purchase Agreement between SDC Holdings, LLC, Christina Molfetta and
Hanna Friends Trust, dated June 1, 2008, is incorporated by reference to Exhibit 10.1
of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on June 13, 2008. |
|
|
|
|
|
|
10.22 |
|
|
Loan Agreement between Registrant, SDC Holdings, LLC, ApothecaryRx, LLC,
Oliver Company Holdings, LLC, Roy T. Oliver, Stanton M. Nelson, Roy T. Oliver as
Trustee of the Roy T. Oliver Revocable Trust dated June 15, 2004, Vahid Salalati, Greg
Luster, Kevin Lewis, Roger Ely and Lewis P. Zeidner and Arvest Bank, dated May 21,
2008 is incorporated by reference to Exhibit 10.31 of the Registrants
Annual Report on Form 10-K filed with the U.S. Securities and Exchange
Commission on March 31, 2009. |
|
|
|
|
|
|
10.22.1 |
|
|
Amendment to Loan Agreement between Registrant, SDC Holdings, LLC, ApothecaryRx,
LLC, Oliver Company Holdings, LLC, Roy T. Oliver, Stanton M. Nelson, Roy T. Oliver as
Trustee of the Roy T. Oliver Revocable Trust dated June 15, 2004, Vahid Salalati, Greg
Luster, Kevin Lewis, Roger Ely and Lewis P. Zeidner and Arvest Bank, effective May 21,
2008 is incorporated by reference to Exhibit 10.32 of the Registrants Annual Report on
Form 10-K filed with the U.S. Securities and Exchange Commission on March 31, 2009. |
57
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
|
|
10.22.2 |
|
|
Second Amendment to Loan Agreement between Registrant, SDC Holdings, LLC,
ApothecaryRx, LLC, Oliver Company Holdings, LLC, Roy T. Oliver, Stanton M. Nelson, Roy
T. Oliver as Trustee of the Roy T. Oliver Revocable Trust dated June 15, 2004, Vahid
Salalati, Greg Luster, Kevin Lewis, Roger Ely and Lewis P. Zeidner and Arvest Bank,
effective May 21, 2008, is incorporated by reference to Exhibit 10.1 of the
Registrants Quarterly Report on Form 10-Q filed with the U.S. Securities and Exchange
Commission on August 14, 2009. |
|
|
|
|
|
|
10.22.3 |
|
|
Third Amendment to Loan Agreement between Registrant, SDC Holdings, LLC,
ApothecaryRx, LLC, Oliver Company Holdings, LLC, Roy T. Oliver, Stanton M. Nelson, Roy
T. Oliver as Trustee of the Roy T. Oliver Revocable Trust dated June 15, 2004, Vahid
Salalati, Greg Luster, Kevin Lewis, Roger Ely and Lewis P. Zeidner and Arvest Bank,
effective June 30, 2010, is incorporated by reference to the Registrants Registration
Statement on Form S-1 filed with the U.S. Securities and Exchange Commission on
December 30, 2010. |
|
|
|
|
|
|
10.22.4 |
|
|
Amended and Restated Loan Agreement dated December 17, 2010 by and among Graymark
Healthcare, Inc., SDC Holdings, LLC, ApothecaryRx, LLC, Oliver Company Holdings, LLC,
Roy T. Oliver, Stanton M. Nelson, Roy T. Oliver as Trustee of the Roy T. Oliver
Revocable Trust dated June 15, 2004, Kevin Lewis, Roger Ely, Lewis P. Zeidner and
Arvest Bank, is incorporated by reference to the Registrants Registration Statement on
Form S-1 filed with the U.S. Securities and Exchange Commission on March 28, 2011. |
|
|
|
|
|
|
10.23 |
|
|
Stock Sale Agreement dated August 19, 2009 by and among SDC Holdings, LLC,
AvastraUSA, Inc. and Avastra Sleep Centers Limited, is incorporated by reference to
Exhibit 10.1 of the Registrants Current Report on
Form 8-K filed with the U.S.
Securities and Exchange Commission on August 26, 2009. |
|
|
|
|
|
|
10.23.1 |
|
|
First Amendment to Stock Sale Agreement dated August 23, 2009 among SDC Holdings,
LLC, AvastraUSA, Inc. and Avastra Sleep Centers Limited, is incorporated by reference
to Exhibit 10.2 of the Registrants Current Report on Form 8-K filed with the U.S.
Securities and Exchange Commission on August 26, 2009. |
|
|
|
|
|
|
10.23.2 |
|
|
Second Amendment to Stock Sale Agreement dated September 14, 2009 among SDC
Holdings, LLC, AvastraUSA, Inc. and Avastra Sleep Centers Limited, is incorporated by
reference to Exhibit 10.1 of the Registrants Current Report on Form 8-K filed with the
U.S. Securities and Exchange Commission on September 16, 2009. |
|
|
|
|
|
|
10.24 |
|
|
Lock up and Stock Pledge Agreement dated September 14, 2009 among Graymark
Healthcare, Inc., SDC Holdings, LLC, AvastraUSA, Inc. and Avastra Sleep Centers
Limited, is incorporated by reference to Exhibit 10.2 of the Registrants Current
Report on Form 8-K filed with the U.S. Securities and Exchange Commission on September
16, 2009. |
|
|
|
|
|
|
10.25 |
|
|
Settlement Agreement and Release dated September 14, 2009 among Daniel I.
Rifkin, M.D., Graymark Healthcare, Inc., SDC Holdings, LLC, Avastra Sleep Centers
Limited, AvastraUSA, Inc. is incorporated by reference to Exhibit 10.3 of the
Registrants Current Report on Form 8-K/A filed with the U.S. Securities and Exchange
Commission on September 21, 2009. |
58
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
|
|
10.26 |
|
|
Employment Agreement between Registrant and Grant A. Christianson, dated
October 13, 2009, is incorporated by reference to Exhibit 10.2 of the Registrants
Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on
October 14, 2009. |
|
|
|
|
|
|
10.27 |
|
|
Employment Agreement between Registrant and Stanton Nelson, dated October 13,
2009, is incorporated by reference to Exhibit 10.1 of the Registrants Current Report
on Form 8-K filed with the U.S. Securities and Exchange Commission on October 14, 2009. |
|
|
|
|
|
|
10.28 |
|
|
Amended and Restated Employment Agreement among the Registrant, Lewis P.
Zeidner, and ApothecaryRx, LLC, dated October 13, 2009, is incorporated by reference to
Exhibit 10.3 of the Registrants Current Report on Form 8 K filed with the U.S.
Securities and Exchange Commission on October 14, 2009. |
|
|
|
|
|
|
10.29 |
|
|
Employment Agreement between Registrant and Joseph Harroz, Jr., dated December
5, 2008, is incorporated by reference to Exhibit 10.2 of Registrants Current Report on
Form 8-K filed with the U.S. Securities and Exchange Commission on December 9, 2008. |
|
|
|
|
|
|
10.30 |
|
|
Agreement between the Registrant and Joseph Harroz, Jr., dated March 25, 2010,
is incorporated by reference to Exhibit 10.30 of the Registrants Annual Report on Form
10-K filed with the U.S. Securities and Exchange Commission on March 31, 2010. |
|
|
|
|
|
|
10.31 |
|
|
Restricted Stock Award Agreement between the Registrant and Stanton Nelson,
dated March 25, 2010 is incorporated by reference to Exhibit 10.31 of the Registrants
Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on
March 31, 2010. |
|
|
|
|
|
|
10.32 |
|
|
Employment Agreement between the Registrant and Edward M. Carriero, Jr., dated
October 7, 2010, is incorporated by reference to Exhibit 10.3 of the Registrants
Quarterly Report on Form 10-Q filed with the U.S. Securities and Exchange Commission on
November 15, 2010. |
|
|
|
|
|
|
10.33 |
|
|
Asset Purchase Agreement dated September 1, 2010 among Walgreen Co.,
ApothecaryRx, LLC, and, to certain sections only, Graymark Healthcare, Inc., is
incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form
8-K filed with the U.S. Securities and Exchange Commission on September 2, 2010. |
|
|
|
|
|
|
10.33.1 |
|
|
First Amendment to Asset Purchase Agreement dated October 29, 2010 among Walgreen
Co., ApothecaryRx, LLC, and, to certain sections only, Graymark Healthcare, Inc., is
incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form
8-K filed with the U.S. Securities and Exchange Commission on October 29, 2010. |
|
|
|
|
|
|
10.34 |
|
|
Employment Agreement between Registrant and Rick D. Simpson, dated December
5, 2008, is incorporated by reference to Exhibit 10.3 of Registrants Current Report on
Form 8-K filed with the U.S. Securities and Exchange Commission on December 9, 2008. |
|
|
|
|
|
|
10.35 |
|
|
Form of Indemnification Agreement between the Company and each of its
directors and executive officers, is incorporate by reference to Exhibit 10.1 to the
Registrants Current Report on Form 8-K filed with the U.S. Securities and Exchange
Commission on August 24, 2010. |
|
|
|
|
|
|
10.36.1 |
|
|
Loan Agreement dated March 16, 2011 by and between Valiant Investments LLC and
Graymark Healthcare, Inc., is incorporated by reference to Exhibit 10.1 to the
Registrants Current Report with the U.S. Securities and Exchange Commission on Form
8-K filed on March 22, 2011. |
59
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
|
|
10.36.2 |
|
|
Note dated March 16, 2011 issued by Graymark Healthcare, Inc., is incorporated by
reference to Exhibit 10.2 to the Registrants Current Report with the U.S. Securities
and Exchange Commission on Form 8-K filed on March 22, 2011. |
|
|
|
|
|
|
10.36.3 |
|
|
Subordination Agreement dated March 16, 2011 by and among Valiant Investments,
L.L.C., ApothecaryRx, LLC, SDC Holdings LLC and Graymark Healthcare, Inc., in favor of
Arvest Bank, is incorporated by reference to Exhibit 10.3 to the Registrants Current
Report with the U.S. Securities and Exchange Commission on Form 8-K filed on March 22,
2011. |
|
|
|
|
|
|
21 |
+ |
|
Subsidiaries of Registrant. |
|
|
|
|
|
|
23.1 |
+ |
|
Consent of Eide Bailly, LLP |
|
|
|
|
|
|
31.1 |
+ |
|
Certification of Stanton Nelson, Chief Executive Officer of Registrant. |
|
|
|
|
|
|
31.2 |
+ |
|
Certification of Edward M. Carriero, Jr., Chief Financial Officer of Registrant. |
|
|
|
|
|
|
31.3 |
+ |
|
Certification of Grant A. Christianson, Chief Accounting Officer of Registrant. |
|
|
|
|
|
|
32.1 |
+ |
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 of Stanton Nelson, Chief Executive Officer of Registrant. |
|
|
|
|
|
|
32.2 |
+ |
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 of Edward M. Carriero, Chief Financial
Officer of Registrant. |
|
|
|
|
|
|
32.3 |
+ |
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 of Grant A. Christianson, Chief Accounting
Officer of Registrant. |
60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
|
|
|
|
|
GRAYMARK HEALTHCARE, INC.
(Registrant)
|
|
|
By: |
/S/ STANTON NELSON
|
|
|
|
Stanton Nelson |
|
|
|
Chief Executive Officer |
|
|
Date: March 30, 2011
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
Each person whose signature appears below in so signing also makes, constitutes and appoints
Stanton Nelson, Edward M. Carriero, Jr. and Grant A. Christianson, and each of them, his true and
lawful attorney-in-fact, with full power of substitution, for him in any and all capacities, to
execute and cause to be filed with the Securities and Exchange Commission any and all amendments to
this Form 10-K, with exhibits thereto and other documents in connection therewith, and hereby
ratifies and confirms all that said attorney-in-fact or his substitute or substitutes may do or
cause to be done by virtue hereof.
|
|
|
|
|
Signature |
|
Title |
|
Date |
|
/S/ STANTON NELSON
|
|
Chief Executive Officer and
|
|
March 30, 2011 |
|
|
Chairman of the Board |
|
|
|
|
(Principal Executive Officer) |
|
|
|
|
|
|
|
/S/ EDWARD M. CARRIERO, JR.
|
|
Chief Financial Officer
|
|
March 30, 2011 |
|
|
(Principal Financial Officer) |
|
|
|
|
|
|
|
/S/ GRANT A. CHRISTIANSON
|
|
Chief Accounting Officer
|
|
March 30, 2011 |
|
|
(Principal Accounting Officer) |
|
|
|
|
|
|
|
/S/ JOSEPH HARROZ, JR.
|
|
Director
|
|
March 30, 2011 |
|
|
|
|
|
|
|
|
|
|
/S/ SCOTT MUELLER
|
|
Director
|
|
March 30, 2011 |
|
|
|
|
|
|
|
|
|
|
/S/ S. EDWARD DAKIL, M.D.
|
|
Director
|
|
March 30, 2011 |
|
|
|
|
|
|
|
|
|
|
/S/ STEVEN L. LIST
|
|
Director
|
|
March 30, 2011 |
|
|
|
|
|
61
GRAYMARK
HEALTHCARE, INC.
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
|
|
|
|
|
|
|
Page
|
|
|
|
|
F-2
|
|
|
|
|
F-3
|
|
|
|
|
F-4
|
|
|
|
|
F-5
|
|
|
|
|
F-6
|
|
|
|
|
F-7
|
|
F-1
Report
of Independent Registered Public Accounting Firm
To the Audit Committee, Board of Directors,
and Shareholders of Graymark Healthcare, Inc.
Oklahoma City, Oklahoma
We have audited the accompanying consolidated balance sheets of
Graymark Healthcare, Inc. (the Company) as of
December 31, 2010 and 2009, and the related consolidated
statements of operations, shareholders equity and cash
flows for each of the years then ended. Graymark Healthcare,
Inc.s management is responsible for these financial
statements. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included
consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion
on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position
of Graymark Healthcare, Inc. as of December 31, 2010 and
2009, and the results of its operations and its cash flows for
the years then ended, in conformity with accounting principles
generally accepted in the United States of America.
The accompanying financial statements have been prepared
assuming that the Company will continue as a going concern,
which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of operations.
As discussed in Note 2 to the consolidated financial
statements, the Company has suffered significant losses from
operations, anticipates additional losses in the next year and
has insufficient working capital as of December 31, 2010 to
fund the anticipated losses. These conditions raise substantial
doubt about the Companys ability to continue as a going
concern. Managements plans in regard to these matters are
also described in Note 2. The consolidated financial
statements do not include any adjustments that might result from
the outcome of this uncertainty.
/s/ Eide Bailly LLP
Greenwood Village, Colorado
March 28, 2011
F-2
GRAYMARK
HEALTHCARE, INC.
As
of December 31, 2010 and 2009
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
ASSETS
|
Cash and cash equivalents
|
|
$
|
878,796
|
|
|
$
|
1,093,645
|
|
Cash and cash equivalents from discontinued operations
|
|
|
692,261
|
|
|
|
796,961
|
|
Accounts receivable, net of allowances for contractual
adjustments and doubtful accounts of $2,791,906 and $9,772,580,
respectively
|
|
|
2,892,271
|
|
|
|
4,276,628
|
|
Inventories
|
|
|
553,342
|
|
|
|
351,585
|
|
Current assets from discontinued operations
|
|
|
2,093,571
|
|
|
|
15,515,067
|
|
Other current assets
|
|
|
468,486
|
|
|
|
120,388
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
7,578,727
|
|
|
|
22,154,274
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
3,870,514
|
|
|
|
5,318,680
|
|
Intangible assets, net
|
|
|
2,400,756
|
|
|
|
5,871,578
|
|
Goodwill
|
|
|
13,007,953
|
|
|
|
20,516,894
|
|
Other assets from discontinued operations
|
|
|
1,101,013
|
|
|
|
21,087,323
|
|
Other assets
|
|
|
733,589
|
|
|
|
1,137,197
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
28,692,552
|
|
|
$
|
76,085,946
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS EQUITY
|
Liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
942,020
|
|
|
$
|
561,031
|
|
Accrued liabilities
|
|
|
2,357,195
|
|
|
|
1,752,598
|
|
Short-term debt
|
|
|
|
|
|
|
195,816
|
|
Current portion of long-term debt
|
|
|
22,768,781
|
|
|
|
480,201
|
|
Current liabilities from discontinued operations
|
|
|
2,015,277
|
|
|
|
7,890,407
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
28,083,273
|
|
|
|
10,880,053
|
|
|
|
|
|
|
|
|
|
|
Long-term debt, net of current portion
|
|
|
436,850
|
|
|
|
22,215,875
|
|
Liabilities from discontinued operations
|
|
|
|
|
|
|
23,694,319
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
28,520,123
|
|
|
|
56,790,247
|
|
Equity:
|
|
|
|
|
|
|
|
|
Graymark Healthcare shareholders equity:
|
|
|
|
|
|
|
|
|
Preferred stock $0.0001 par value, 10,000,000 authorized;
no shares issued and outstanding
|
|
|
|
|
|
|
|
|
Common stock $0.0001 par value, 500,000,000 shares
authorized; 28,953,611 and 28,989,145 issued and outstanding,
respectively
|
|
|
2,895
|
|
|
|
2,899
|
|
Paid-in capital
|
|
|
29,519,387
|
|
|
|
29,086,750
|
|
Accumulated deficit
|
|
|
(29,218,977
|
)
|
|
|
(9,869,471
|
)
|
|
|
|
|
|
|
|
|
|
Total Graymark Healthcare shareholders equity
|
|
|
303,305
|
|
|
|
19,220,178
|
|
Noncontrolling interest
|
|
|
(130,876
|
)
|
|
|
75,521
|
|
|
|
|
|
|
|
|
|
|
Total equity
|
|
|
172,429
|
|
|
|
19,295,699
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity
|
|
$
|
28,692,552
|
|
|
$
|
76,085,946
|
|
|
|
|
|
|
|
|
|
|
See Accompanying Notes to Consolidated Financial Statements
F-3
GRAYMARK
HEALTHCARE, INC.
For
the Years Ended December 31, 2010 and 2009
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Net Revenues:
|
|
|
|
|
|
|
|
|
Services
|
|
$
|
17,206,634
|
|
|
$
|
13,529,092
|
|
Product sales
|
|
|
5,557,455
|
|
|
|
4,042,447
|
|
|
|
|
|
|
|
|
|
|
|
|
|
22,764,089
|
|
|
|
17,571,539
|
|
|
|
|
|
|
|
|
|
|
Cost of Services and Sales:
|
|
|
|
|
|
|
|
|
Cost of services
|
|
|
5,515,380
|
|
|
|
3,806,582
|
|
Cost of sales
|
|
|
1,628,686
|
|
|
|
1,716,350
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,144,066
|
|
|
|
5,522,932
|
|
|
|
|
|
|
|
|
|
|
Gross Margin
|
|
|
15,620,023
|
|
|
|
12,048,607
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses:
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
17,277,322
|
|
|
|
13,593,655
|
|
Bad debt expense
|
|
|
1,763,736
|
|
|
|
3,768,699
|
|
Impairment of goodwill and intangible assets
|
|
|
10,751,997
|
|
|
|
|
|
Impairment of property and equipment
|
|
|
762,224
|
|
|
|
|
|
Depreciation and amortization
|
|
|
1,337,990
|
|
|
|
1,074,132
|
|
|
|
|
|
|
|
|
|
|
|
|
|
31,893,269
|
|
|
|
18,436,486
|
|
|
|
|
|
|
|
|
|
|
Other (Expense):
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
(1,223,334
|
)
|
|
|
(906,870
|
)
|
Other expense
|
|
|
(10,061
|
)
|
|
|
(45,854
|
)
|
Impairment of equity investment
|
|
|
(200,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net other (expense)
|
|
|
(1,433,395
|
)
|
|
|
(952,724
|
)
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations, before taxes
|
|
|
(17,706,641
|
)
|
|
|
(7,340,603
|
)
|
Provision for income taxes
|
|
|
(166,795
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations, net of taxes
|
|
|
(17,873,436
|
)
|
|
|
(7,340,603
|
)
|
Income (loss) from discontinued operations, net of taxes
|
|
|
(1,416,083
|
)
|
|
|
1,998,901
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
(19,289,519
|
)
|
|
|
(5,341,702
|
)
|
Less: Net income (loss) attributable to noncontrolling interests
|
|
|
(153,513
|
)
|
|
|
(153,806
|
)
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to Graymark Healthcare
|
|
$
|
(19,136,006
|
)
|
|
$
|
(5,187,896
|
)
|
|
|
|
|
|
|
|
|
|
Earnings per common share (basic and diluted):
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing operations
|
|
$
|
(0.61
|
)
|
|
$
|
(0.25
|
)
|
Income from discontinued operations
|
|
|
(0.05
|
)
|
|
|
0.07
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share
|
|
$
|
(0.66
|
)
|
|
$
|
(0.18
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding
|
|
|
28,983,358
|
|
|
|
28,414,508
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of diluted shares outstanding
|
|
|
28,983,358
|
|
|
|
28,414,508
|
|
|
|
|
|
|
|
|
|
|
See Accompanying Notes to Consolidated Financial Statements
F-4
GRAYMARK
HEALTHCARE, INC.
For
the Years Ended December 31, 2010 and 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
Paid-in
|
|
|
Accumulated
|
|
|
Noncontrolling
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Interest
|
|
|
Balances, January 1, 2009
|
|
|
27,719,113
|
|
|
$
|
2,772
|
|
|
$
|
26,937,736
|
|
|
$
|
(4,681,575
|
)
|
|
$
|
284,628
|
|
Issuance of common stock in connection with acquisition
|
|
|
752,795
|
|
|
|
75
|
|
|
|
1,543,925
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
482,133
|
|
|
|
48
|
|
|
|
500,715
|
|
|
|
|
|
|
|
|
|
Stock-based professional services
|
|
|
|
|
|
|
|
|
|
|
104,378
|
|
|
|
|
|
|
|
|
|
Cashless exercise of warrants
|
|
|
35,104
|
|
|
|
4
|
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
Contributions from noncontrolling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41,250
|
|
Distributions to noncontrolling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(96,551
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,187,896
|
)
|
|
|
|
|
Net loss attributable to noncontrolling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(153,806
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2009
|
|
|
28,989,145
|
|
|
|
2,899
|
|
|
|
29,086,750
|
|
|
|
(9,869,471
|
)
|
|
|
75,521
|
|
Stock-based compensation
|
|
|
(35,534
|
)
|
|
|
(4
|
)
|
|
|
432,637
|
|
|
|
|
|
|
|
|
|
Distributions to noncontrolling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(52,884
|
)
|
Change in accounting method
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(213,500
|
)
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(19,136,006
|
)
|
|
|
|
|
Net loss attributable to noncontrolling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(153,513
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2010
|
|
|
28,953,611
|
|
|
$
|
2,895
|
|
|
$
|
29,519,387
|
|
|
$
|
(29,218,977
|
)
|
|
$
|
(130,876
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See Accompanying Notes to Consolidated Financial Statements
F-5
GRAYMARK
HEALTHCARE, INC.
For
the Years Ended December 31, 2010 and 2009
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Operating activities:
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(19,136,006
|
)
|
|
$
|
(5,187,896
|
)
|
Less: Net income (loss) from discontinued operations
|
|
|
(1,416,083
|
)
|
|
|
1,998,901
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing operations
|
|
|
(17,719,923
|
)
|
|
|
(7,186,797
|
)
|
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
1,337,990
|
|
|
|
1,074,132
|
|
Disposal of retired fixed assets
|
|
|
|
|
|
|
77,916
|
|
Net income (loss) attributable to noncontrolling interests
|
|
|
(153,513
|
)
|
|
|
(153,806
|
)
|
Stock-based compensation and professional services
|
|
|
432,633
|
|
|
|
605,141
|
|
Bad debt expense
|
|
|
1,763,736
|
|
|
|
3,768,699
|
|
Change in accounting method
|
|
|
(213,500
|
)
|
|
|
|
|
Impairment charges
|
|
|
11,714,221
|
|
|
|
|
|
Changes in assets and liabilities (net of
acquisitions)
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(379,379
|
)
|
|
|
(622,010
|
)
|
Inventories
|
|
|
(201,757
|
)
|
|
|
(78,463
|
)
|
Other assets
|
|
|
55,510
|
|
|
|
(663,771
|
)
|
Accounts payable
|
|
|
380,989
|
|
|
|
(221,768
|
)
|
Accrued liabilities
|
|
|
604,597
|
|
|
|
2,304
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) operating activities from continuing
operations
|
|
|
(2,378,396
|
)
|
|
|
(3,398,423
|
)
|
Net cash provided by (used in) operating activities from
discontinued operations
|
|
|
(1,539,932
|
)
|
|
|
723,493
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities
|
|
|
(3,918,328
|
)
|
|
|
(2,674,930
|
)
|
|
|
|
|
|
|
|
|
|
Investing activities:
|
|
|
|
|
|
|
|
|
Cash received from acquisitions
|
|
|
|
|
|
|
259,163
|
|
Purchase of businesses
|
|
|
|
|
|
|
(9,056,000
|
)
|
Purchase of property and equipment
|
|
|
(548,529
|
)
|
|
|
(1,117,618
|
)
|
Disposal of property and equipment
|
|
|
124,249
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) investing activities from continuing
operations
|
|
|
(424,280
|
)
|
|
|
(9,914,455
|
)
|
Proceeds from sale of assets from discontinued operations
|
|
|
29,289,874
|
|
|
|
|
|
Net other cash (used in) investing activities from discontinued
operations
|
|
|
(50,054
|
)
|
|
|
(263,336
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities
|
|
|
28,815,540
|
|
|
|
(10,177,791
|
)
|
|
|
|
|
|
|
|
|
|
Financing activities:
|
|
|
|
|
|
|
|
|
Debt proceeds
|
|
|
28,894
|
|
|
|
5,407,901
|
|
Debt payments
|
|
|
(5,200,411
|
)
|
|
|
(2,393,961
|
)
|
Contributions from noncontrolling interests
|
|
|
|
|
|
|
41,250
|
|
Distributions to noncontrolling interests
|
|
|
(52,884
|
)
|
|
|
(96,551
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities from
continuing operations
|
|
|
(5,224,401
|
)
|
|
|
2,958,639
|
|
Net cash (used in) financing activities from discontinued
operations
|
|
|
(19,992,360
|
)
|
|
|
(3,595,622
|
)
|
|
|
|
|
|
|
|
|
|
Net cash (used in) financing activities
|
|
|
(25,216,761
|
)
|
|
|
(636,983
|
)
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents
|
|
|
(319,549
|
)
|
|
|
(13,489,704
|
)
|
Cash and cash equivalents at beginning of year
|
|
|
1,890,606
|
|
|
|
15,380,310
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of year
|
|
|
1,571,057
|
|
|
|
1,890,606
|
|
Cash and cash equivalents of discontinued operations at end of
year
|
|
|
692,261
|
|
|
|
796,961
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents of continuing operations at end of year
|
|
$
|
878,796
|
|
|
$
|
1,093,645
|
|
|
|
|
|
|
|
|
|
|
See Accompanying Notes to Consolidated Financial Statements
F-6
GRAYMARK
HEALTHCARE, INC.
For the
Years Ended December 31, 2010 and 2009
|
|
Note 1
|
Nature of
Business
|
Graymark Healthcare, Inc. (the Company) 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. The Company provides a comprehensive diagnosis
and care management solution for patients suffering from sleep
disorders.
The Company provides diagnostic sleep testing services and care
management solutions for people with chronic sleep disorders. In
addition, the Company sells equipment and related supplies and
components used to treat sleep disorders. The Companys
products and services are used primarily by patients with
obstructive sleep apnea, or OSA. The Companys 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 Medicines (AASM)
preferred method of treatment for obstructive sleep apnea. The
Companys sleep diagnostic facilities also determine the
correct pressure settings for patient treatment with positive
airway pressure. The Company sells CPAP devices and disposable
supplies to patients who have tested positive for sleep apnea
and have had their positive airway pressure determined. There
are noncontrolling interests held in some of the Companys
testing facilities, typically by physicians located in the
geographical area being served by the diagnostic sleep testing
facility.
On September 1, 2010, the Company executed an Asset
Purchase Agreement, which was subsequently amended on
October 29, 2010, providing for the sale of substantially
all of the assets of the Companys subsidiary,
ApothecaryRx, LLC (ApothecaryRx). ApothecaryRx
operated 18 retail pharmacy stores 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
assets occurred in December 2010. As a result of the sale of
ApothecaryRx, the related assets, liabilities, results of
operations and cash flows of ApothecaryRx have been classified
as discontinued operations in the accompanying consolidated
financial statements. See Note 6 Discontinued
Operations.
|
|
Note 2
|
Basis of
Presentation
|
As of December 31, 2010, the Company had an accumulated
deficit of approximately $29.2 million and reported a net
loss of approximately $19.1 for the year then ending. The
Company used approximately $2.4 million in cash from
operating activities of continuing operations during the year
ending December 31, 2010. Furthermore, the Company has a
working capital deficit of approximately $20.5 million as
of December 31, 2010. As noted in Note 10
Borrowings, the Company is required to make a $3 million
principal payment to Arvest Bank by June 30, 2011 and is
not in compliance with certain covenants required by its lending
agreement with Arvest Bank.
Management expects to raise approximately $13.3 million in
a public stock offering by the end of April 2011. From the
proceeds of the offering, the Company will be required to pay
the greater of one-third of the proceeds of the equity offering
or $3 million to Arvest Bank. Management believes that the
Company will begin to generate positive cash flow on a
prospective basis by September 30, 2011. In the event that
the Company is unable to obtain debt or equity financing or the
Company is unable to obtain such financing on terms and
conditions acceptable to it, the Company may have to cease or
severely curtail its operations. This uncertainty raises
substantial doubt regarding the Companys ability to
continue as a going concern. Historically, management has been
able to raise the capital necessary to fund the operation and
growth of the Company. The consolidated financial statements do
not include any adjustments that might be necessary if the
Company is unable to continue as a going concern.
F-7
|
|
Note 3
|
Summary
of Significant Accounting Policies
|
Consolidation The accompanying consolidated
financial statements include the accounts of Graymark
Healthcare, Inc. and its wholly owned, majority owned and
controlled subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation.
Use of estimates The preparation of financial
statements in conformity with generally accepted accounting
principles requires management of the Company to make estimates
and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
Revenue recognition
Sleep center services and product sales are recognized in the
period in which services and related products are provided to
customers and are recorded at net realizable amounts estimated
to be paid by customers and third-party payers. Insurance
benefits are assigned to the Company and, accordingly, the
Company bills on behalf of its customers. For the business
acquired from somniCare, Inc. and somniTech, Inc. (collectively
referred to as Somni) in 2009, the Company estimates
the net realizable amount based primarily on the contracted
rates stated in the contracts the Company has with various
payors. The Company has used this method to determine the net
revenue for the Somni business since the date of the acquisition
and does not anticipate any future changes to this process. In
the Companys historic business, the business has been
predominantly
out-of-network
and as a result, the Company has not had contract rates to use
for determining net revenue for a majority of its payors. For
this portion of the business, the Company performs a quarterly
analysis of actual reimbursement from each third party payor for
the most recent
12-months.
The Company conducts this analysis for each of its operating
locations separately to ensure differences in payment rates from
various markets are identified in the analysis. In the analysis,
the Company calculates the percentage actually paid by each
third party payor of the amount billed to determine the
applicable amount of net revenue for each payor at each
location. The key assumption in this process is that actual
reimbursement history is a reasonable predictor of the future
out-of-network
reimbursement for each payor at each facility. Historically, the
Company has consistently used this process to estimate net
revenue at the time of service other than a change in fiscal
2009 to using 12 months of payment history. Prior to that
time, the Company used nine months of payment history for its
quarterly analysis. Although the impact on the calculation was
negligible, the Company determined a
12-month
review eliminates potential seasonal fluctuations and provides a
broader sample of payments for the calculation. During the
fourth quarter of 2010, the Company migrated much of its
historic sleep diagnostic business to an
in-network
position. As a result, commencing with the fourth quarter of
2010, the revenue from the Companys historic sleep
diagnostic business was determined using the process utilized in
the Somni business. For its therapy business, the Company
expects to transition to this same process in the first or
second quarter of 2011. This change in process and assumptions
for the Companys historic business is not expected to have
a material impact on future operating results.
For certain sleep therapy and other equipment sales,
reimbursement from third-party payers occurs over a period of
time, typically 10 to 13 months. The Company recognizes
revenue on these sales as payments are earned over the payment
period stipulated by the third-party payor.
The Company has established an allowance to account for
contractual adjustments that result from differences between the
amount billed and the expected realizable amount. Actual
adjustments that result from differences between the payment
amount received and the expected realizable amount are recorded
against the allowance for contractual adjustments and are
typically identified and ultimately recorded at the point of
cash application or when otherwise determined pursuant to the
Companys collection procedures. Revenues in the
accompanying consolidated financial statements are reported net
of such adjustments.
Due to the nature of the healthcare industry and the
reimbursement environment in which the Company operates, certain
estimates are required to record net revenues and accounts
receivable at their net realizable values at the time products
or services are provided. Inherent in these estimates is the
risk that they will have to be revised or updated as additional
information becomes available, which could have a material
impact on the Companys operating results and cash flows in
subsequent periods. Specifically, the complexity of many
F-8
third-party billing arrangements and the uncertainty of
reimbursement amounts for certain services from certain payers
may result in adjustments to amounts originally recorded.
The patient and their third party insurance provider typically
share in the payment for the Companys products and
services. The amount patients are responsible for includes
co-payments, deductibles, and amounts not covered due to the
provider being
out-of-network.
Due to uncertainties surrounding deductible levels and the
number of
out-of-network
patients, the Company is not certain of the full amount of
patient responsibility at the time of service. Starting in 2010,
the Company implemented a process to estimate amounts due from
patients prior to service and increase collection of those
amounts prior to service. Remaining amounts due from patients
are then billed following completion of service.
During the years ended December 31, 2010 and 2009, the
Companys revenue payer mix:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Managed care organizations
|
|
|
78
|
%
|
|
|
78
|
%
|
Medicaid / Medicare
|
|
|
16
|
%
|
|
|
18
|
%
|
Private-pay
|
|
|
6
|
%
|
|
|
4
|
%
|
Cost of Services and Sales Cost of services
includes technician labor required to perform sleep diagnostics,
fees associated with interpreting the results of the sleep study
and disposable supplies used in providing sleep diagnostics.
Cost of sales includes the acquisition cost of sleep therapy
products sold. Costs of services are recorded in the time period
the related service is provided. Cost of sales is recorded in
the same time period that the related revenue is recognized. If
the sale is paid for over a specified period, the product cost
associated with that sale is recognized over that same period.
If the product is paid for in one period, the cost of sale is
recorded in the period the product was sold.
Cash and cash equivalents The Company
considers all highly liquid temporary cash investments with an
original maturity of three months or less to be cash equivalents.
Accounts receivable The majority of the
Companys accounts receivable is due from private insurance
carriers, Medicare/Medicaid and other third-party payors, as
well as from patients relating to deductible and coinsurance and
deductible provisions of their health insurance policies.
Third-party reimbursement is a complicated process that involves
submission of claims to multiple payers, each having its own
claims requirements. Adding to this complexity, a significant
portion of the Companys business has historically been
out-of-network
with several payors, which means the Company does not have
defined contracted reimbursement rates with these payors. For
this reason, the Companys systems reported revenue at a
higher gross billed amount, which the Company adjusted to an
expected net amount based on historic payments. This process
continues in the Companys historic sleep therapy business,
but was changed in the fourth quarter of 2010 for the
Companys historic sleep diagnostic business. As a result,
the reserve for contractual allowance has been reduced as our
systems now report a larger portion of our business at estimated
net contract rates. As the Company continues to move more of its
business to
in-network
contracting, the level of reserve related to contractual
allowances is expected to decrease. In some cases, the ultimate
collection of accounts receivable subsequent to the service
dates may not be known for several months. As these accounts
age, the risk of collection increases and the resulting reserves
for bad debt expense to reflect this longer payment cycle. The
Company has established an allowance to account for contractual
adjustments that result from differences between the amounts
billed to customers and third-party payers and the expected
realizable amounts. The percentage and amounts used to record
the allowance for doubtful accounts are supported by various
methods including current and historical cash collections,
contractual adjustments, and aging of accounts receivable.
The Company offers payment plans to patients for amounts due
from them for the sales and services the Company provides. For
patients with a balance of $500 or less, the Company allows a
maximum of six months for the patient to pay the amount due. For
patients with a balance over $500, the Company allows a maximum
of 12 months to pay the full amount due. The minimum
monthly payment amount for both plans is $50 per month.
F-9
Accounts are written-off as bad debt using a specific
identification method. For amounts due from patients, the
Company utilizes a collections process that includes
distributing monthly account statements. For patients that are
not on a payment plan, collection efforts including collection
letters and collection calls begin at 90 days from the
initial statement. If the patient is on a payment program, these
efforts begin 30 days after the patient fails to make a
planned payment. For diagnostic patients, the Company submits
patient receivables to an outside collection agency if the
patient has failed to pay 120 days following service or, if
the patient is on a payment plan, they have failed to make two
consecutive payments. For therapy patients, patient receivables
are submitted to an outside collection agency if payment has not
been received between 180 and 270 days following service
depending on the service provided and circumstances of the
receivable or, if the patient is on a payment plan, they have
failed to make two consecutive payments. It is the
Companys policy to write-off as bad debt all patient
receivables at the time they are submitted to an outside
collection agency. If funds are recovered by a collection
agency, the amounts previously written-off are reversed as a
recovery of bad debt. For amounts due from third party payors,
it is the Companys policy to write-off an account
receivable to bad debt based on the specific circumstances
related to that claim resulting in a determination that there is
no further recourse for collection of a denied claim from the
denying payor.
For the years ended December 31, 2010 and 2009, the amounts
the Company collected in excess of recorded contractual
allowances were $271,195 and $54,600, respectively.
As of December 31, 2010 and 2009, accounts receivable are
reported net of allowances for contractual adjustments and
doubtful accounts as follows:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Allowance for contractual adjustments
|
|
$
|
1,511,330
|
|
|
$
|
5,985,269
|
|
Allowance for doubtful accounts
|
|
|
1,280,576
|
|
|
|
3,787,311
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,791,906
|
|
|
$
|
9,772,580
|
|
|
|
|
|
|
|
|
|
|
The activity in the allowances for contractual adjustments and
doubtful accounts for the years ending December 31, 2010
and 2009 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual
|
|
|
Doubtful
|
|
|
|
|
|
|
Adjustments
|
|
|
Accounts
|
|
|
Total
|
|
|
Balance at December 31, 2008
|
|
$
|
11,627,387
|
|
|
$
|
1,350,238
|
|
|
$
|
12,977,625
|
|
Provisions
|
|
|
35,248,283
|
|
|
|
1,120,492
|
|
|
|
37,186,644
|
|
Write-offs, net of recoveries
|
|
|
(40,890,401
|
)
|
|
|
(1,331,626
|
)
|
|
|
(43,039,896
|
)
|
Change in accounting estimate (see Note 4)
|
|
|
|
|
|
|
2,648,207
|
|
|
|
2,648,207
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2009
|
|
|
5,985,269
|
|
|
|
3,787,311
|
|
|
|
9,772,580
|
|
Provisions
|
|
|
18,502,775
|
|
|
|
1,763,736
|
|
|
|
20,266,511
|
|
Write-offs, net of recoveries
|
|
|
(22,976,714
|
)
|
|
|
(3,757,580
|
)
|
|
|
(26,734,294
|
)
|
Change in accounting method (see Note 4)
|
|
|
|
|
|
|
(512,891
|
)
|
|
|
(512,891
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2010
|
|
$
|
1,511,330
|
|
|
$
|
1,280,576
|
|
|
$
|
2,791,906
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-10
The aging of the Companys accounts receivable, net of
allowances for contractual adjustments and doubtful accounts as
of December 31, 2010 and 2009 follows:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
1 to 60 days
|
|
$
|
1,890,902
|
|
|
$
|
2,262,937
|
|
61 to 90 days
|
|
|
282,807
|
|
|
|
549,234
|
|
91 to 120 days
|
|
|
170,435
|
|
|
|
609,539
|
|
121 to 180 days
|
|
|
67,394
|
|
|
|
244,890
|
|
181 to 360 days
|
|
|
186,310
|
|
|
|
433,178
|
|
Greater than 360 days
|
|
|
294,423
|
|
|
|
176,850
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,892,271
|
|
|
$
|
4,276,628
|
|
|
|
|
|
|
|
|
|
|
In addition to the aging of accounts receivable shown above,
management relies on other factors to determine the
collectability of accounts including the status of claims
submitted to third party payors, reason codes for declined
claims and an assessment of the Companys ability to
address the issue and resubmit the claim and whether a patient
is on a payment plan and making payments consistent with that
plan.
Included in accounts receivable are earned but unbilled
receivables of approximately $129,000 and $797,000 as of
December 31, 2010 and 2009, respectively. Unbilled accounts
receivable represent charges for services delivered to customers
for which invoices have not yet been generated by the billing
system. Prior to the delivery of services or equipment and
supplies to customers, the Company performs certain
certification and approval procedures to ensure collection is
reasonably assured and that unbilled accounts receivable is
recorded at net amounts expected to be paid by customers and
third-party payers. Billing delays can occur due to delays in
obtaining certain required payer-specific documentation from
internal and external sources, interim transactions occurring
between cycle billing dates established for each customer within
the billing system and new sleep centers awaiting assignment of
new provider enrollment identification numbers. In the event
that a third-party payer does not accept the claim for payment,
the customer is ultimately responsible.
Approximately 19% of the Companys accounts receivable are
from Medicare and Medicaid programs and another 56% are due from
major insurance companies. The Company has not experienced
losses due to the inability of these major insurance companies
to meet their financial obligations and does not foresee that
this will change in the near future.
Restricted cash As of December 31, 2010
and 2009, the Company had long-term restricted cash of $236,000
included in other assets in the accompanying consolidated
balance sheets. This amount is pledged as collateral to the
Companys senior bank debt and bank line of credit.
Inventories Inventories are stated at the
lower of cost or market and include the cost of products
acquired for sale. The Company accounts for inventories using
the first in first out method of accounting for
substantially all of its inventories.
Property and equipment Property and equipment
is stated at cost and depreciated using the straight line method
to depreciate the cost of various classes of assets over their
estimated useful lives. At the time assets are sold or otherwise
disposed of, the cost and accumulated depreciation are
eliminated from the asset and depreciation accounts; profits and
losses on such dispositions are reflected in current operations.
Fully depreciated assets are written off against accumulated
depreciation. Expenditures for major renewals and betterments
that extend the useful lives of property and equipment are
capitalized. Expenditures for maintenance and repairs are
charged to expense as incurred.
F-11
The estimated useful lives of the Companys property and
equipment are as follows:
|
|
|
Asset Class
|
|
Useful Life
|
|
Equipment
|
|
5 to 7 years
|
Software
|
|
3 to 7 years
|
Furniture and fixtures
|
|
7 years
|
Leasehold improvements
|
|
25 years or remaining lease period, whichever is shorter
|
Vehicles
|
|
3 to 5 years
|
Goodwill and Intangible Assets Goodwill and
other indefinitely lived intangible assets are not
amortized, but are subject to annual impairment reviews, or more
frequent reviews if events or circumstances indicate there may
be an impairment of goodwill.
Intangible assets other than goodwill which include customer
relationships, customer files, covenants not to compete,
trademarks and payor contracts are amortized over their
estimated useful lives using the straight line method. The
remaining lives range from three to five years. The Company
evaluates the recoverability of identifiable intangible asset
whenever events or changes in circumstances indicate that an
intangible assets carrying amount may not be recoverable.
Deferred Offering Costs The Company defers as
other assets the direct incremental costs of raising capital
until such time as the offering is completed. At the time of the
completion of the offering, the costs are charged against the
capital raised. Should the offering be terminated, deferred
offering costs are charged to operations during the period in
which the offering is terminated.
Equity Investment in Non-Controlled Entity
The Company accounts for its investments in a non-controlled
entity using the cost method which requires the investment to be
recorded at cost plus any related guaranteed debt or other
contingencies. Any earnings are recorded in the period received.
See Note 9 Other Assets for additional
information.
Noncontrolling Interests Noncontrolling
interests in the results of operations of consolidated
subsidiaries represents the noncontrolling shareholders
share of the income or loss of the various consolidated
subsidiaries. The noncontrolling interests in the consolidated
balance sheet reflect the original investment by these
noncontrolling shareholders in these consolidated subsidiaries,
along with their proportional share of the earnings or losses of
these subsidiaries less distributions made to these
noncontrolling interest holders.
Advertising Costs Advertising and sales
promotion costs are expensed as incurred. Advertising expense
for 2010 and 2009, included in continuing operations, was
$356,789 and $109,218, respectively. Advertising expense for
2010 and 2009, included in discontinued operations, was $244,052
and $255,903, respectively.
Acquisition Costs Acquisition costs are
charged directly to expense when incurred.
Legal Issues For asserted claims and
assessments, liabilities are recorded when an unfavorable
outcome of a matter is deemed to be probable and the loss is
reasonably estimable. Management determines the likelihood of an
unfavorable outcome based on many factors such as the nature of
the matter, available defenses and case strategy, progress of
the matter, views and opinions of legal counsel and other
advisors, applicability and success of appeals processes, and
the outcome of similar historical matters, among others. Once an
unfavorable outcome is deemed probable, management weighs the
probability of estimated losses, and the most reasonable loss
estimate is recorded. If an unfavorable outcome of a matter is
deemed to be reasonably possible, then the matter is disclosed
and no liability is recorded. With respect to unasserted claims
or assessments, management must first determine that the
probability that an assertion will be made is likely, then, a
determination as to the likelihood of an unfavorable outcome and
the ability to reasonably estimate the potential loss is made.
Legal matters are reviewed on a continuous basis or sooner if
significant changes in matters have occurred to determine if a
change in the likelihood of an unfavorable outcome or the
estimate of a loss is necessary.
F-12
Income Taxes The Company recognizes deferred
tax assets and liabilities for future tax consequences
attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax bases and tax credit carry-forwards. Deferred tax
assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled.
The effect of deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes
the enactment date. In the event the Company determines that the
deferred tax assets will not be realized in the future, the
valuation adjustment to the deferred tax assets is charged to
earnings in the period in which the Company makes such a
determination.
The Company uses a two-step process to evaluate a tax position.
The first step is to determine whether it is
more-likely-than-not that a tax position will be sustained upon
examination, including the resolution of any related appeals or
litigation based on the technical merits of that position. The
second step is to measure a tax position that meets the
more-likely-than-not threshold to determine the amount of
benefit to be recognized in the financial statements. A tax
position is measured at the largest amount of benefit that is
greater than 50 percent likely of being realized upon
ultimate settlement.
Tax positions that previously failed to meet the
more-likely-than-not recognition threshold should be recognized
in the first subsequent period in which the threshold is met.
Previously recognized tax positions that no longer meet the
more-likely-than-not criteria should be de-recognized in the
first subsequent financial reporting period in which the
threshold is no longer met. The Company reports tax-related
interest and penalties as a component of income tax expense.
Based on all known facts and circumstances and current tax law,
the Company believes that the total amount of unrecognized tax
benefits as of December 31, 2010, is not material to its
results of operations, financial condition or cash flows. The
Company also believes that the total amount of unrecognized tax
benefits as of December 31, 2010, if recognized, would not
have a material effect on its effective tax rate. The Company
further believes that there are no tax positions for which it is
reasonably possible, based on current tax law and policy that
the unrecognized tax benefits will significantly increase or
decrease over the next 12 months producing, individually or
in the aggregate, a material effect on the Companys
results of operations, financial condition or cash flows.
Earnings (loss) per share Basic earnings
(loss) per share is computed by dividing net income (loss) by
the weighted average number of common shares outstanding for the
period. Diluted earnings (loss) per share reflects the potential
dilution that could occur if securities or other contracts to
issue common stock were exercised or converted during the
period. Dilutive securities having an anti-dilutive effect on
diluted earnings (loss) per share are excluded from the
calculation.
The dilutive potential common shares on options and warrants are
calculated in accordance with the treasury stock method, which
assumes that proceeds from the exercise of all options and
warrants are used to repurchase common stock at market value.
The amount of shares remaining after the proceeds are exhausted
represents the potential dilutive effect of the securities.
The following securities were not included in the computation of
diluted earnings (loss) per share from continuing operations or
discontinued operations as their effect would be anti-dilutive:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Stock options and warrants
|
|
|
581,668
|
|
|
|
826,863
|
|
|
|
|
|
|
|
|
|
|
Concentration of credit risk The Company
maintains its cash in bank deposit accounts which, at times, may
exceed federally insured limits. The Company has not experienced
any losses in such accounts and believes it is not exposed to
any significant risk. There were no cash deposits in excess of
FDIC limits as of December 31, 2010. The amount of cash
deposits as of December 31, 2009 in excess of FDIC limits
was approximately $423,000.
Stock options The Company accounts for its
stock option grants using the modified prospective method. Under
the modified prospective method, stock-based compensation cost
is measured at the grant date
F-13
based on the fair value of the award and is recognized as
expense on a straight-line basis over the requisite service
period, which is the vesting period.
Reclassifications Certain amounts presented
in prior years have been reclassified to conform to the current
years presentation.
Recently
Adopted and Recently Issued Accounting Guidance
Adopted
Guidance
Effective January 1, 2010, the Company adopted changes
issued by the FASB on January 6, 2010, for a scope
clarification to the FASBs previously-issued guidance on
accounting for noncontrolling interests in consolidated
financial statements. These changes clarify the accounting and
reporting guidance for noncontrolling interests and changes in
ownership interests of a consolidated subsidiary. An entity is
required to deconsolidate a subsidiary when the entity ceases to
have a controlling financial interest in the subsidiary. Upon
deconsolidation of a subsidiary, an entity recognizes a gain or
loss on the transaction and measures any retained investment in
the subsidiary at fair value. The gain or loss includes any gain
or loss associated with the difference between the fair value of
the retained investment in the subsidiary and its carrying
amount at the date the subsidiary is deconsolidated. In
contrast, an entity is required to account for a decrease in its
ownership interest of a subsidiary that does not result in a
change of control of the subsidiary as an equity transaction.
The adoption of these changes had no impact on the
Companys consolidated financial statements.
Effective January 1, 2010, the Company adopted changes
issued by the FASB on January 21, 2010, to disclosure
requirements for fair value measurements. Specifically, the
changes require a reporting entity to disclose separately the
amounts of significant transfers in and out of Level 1 and
Level 2 fair value measurements and describe the reasons
for the transfers. The changes also clarify existing disclosure
requirements related to how assets and liabilities should be
grouped by class and valuation techniques used for recurring and
nonrecurring fair value measurements. The adoption of these
changes had no impact on the Companys consolidated
financial statements.
Effective January 1, 2010, the Company adopted changes
issued by the FASB on February 24, 2010, to accounting for
and disclosure of events that occur after the balance sheet date
but before financial statements are issued or available to be
issued, otherwise known as subsequent events.
Specifically, these changes clarified that an entity that is
required to file or furnish its financial statements with the
SEC is not required to disclose the date through which
subsequent events have been evaluated. Other than the
elimination of disclosing the date through which management has
performed its evaluation for subsequent events, the adoption of
these changes had no impact on the Companys consolidated
financial statements.
Issued
Guidance
In July 2010, the FASB issued changes to the required
disclosures about the nature of the credit risk in an
entitys financing receivables, how that risk is
incorporated into the allowance for credit losses, and the
reasons for any changes in the allowance. Disclosure is required
to be disaggregated at the level at which an entity calculates
its allowance for credit losses. This change is effective for
the Company beginning June 30, 2011. The adoption of this
accounting standard is not expected to have a material impact on
the Companys financial position, results of operations,
cash flows and disclosures.
In December 2010, the FASB issued changes as to when a company
should perform Step 2 of the Goodwill Impairment Test for
Reporting Units with Zero or Negative Carrying Amounts. The
amendments in this change modify Step 1 of the goodwill
impairment test for reporting units with zero or negative
carrying amounts. For those reporting units, an entity is
required to perform Step 2 of the goodwill impairment test if it
is more likely than not that a goodwill impairment exists. In
determining whether it is more likely than not that a goodwill
impairment exists, an entity should consider whether there are
any adverse qualitative factors indicating that an impairment
may exist. The qualitative factors are consistent with the
existing guidance, which requires that goodwill of a reporting
unit be tested for impairment between annual tests if an event
occurs or circumstances change that would more likely than not
reduce the fair value of a reporting unit below
F-14
its carrying amount. The amendments in this change are effective
for fiscal years, and interim periods within those years,
beginning after December 15, 2010. Early adoption is not
permitted. This change is effective for the Company beginning
January 1, 2011 and is not expected to have a material
impact on the Companys financial position, results of
operations, cash flows and disclosures.
In December 2010, the FASB issued changes to the disclosure
requirements for business combinations. The changes require a
public entity to disclose pro forma information for business
combinations that occurred in the current reporting period. The
disclosures include pro forma revenue and earnings of the
combined business combinations that occurred during the year had
been as of the beginning of the annual reporting period. If
comparative financial statements are presented, the pro forma
revenue and earnings of the combined entity for the comparable
prior reporting period should be reported as though the
acquisition date for all business combinations that occurred
during the current year had been as of the beginning of the
comparable prior annual reporting period. The amendments in this
update are effective prospectively for business combinations for
which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after
December 15, 2010 effective for the Company beginning
January 1, 2011. The adoption of this accounting standard
is not expected to have a material impact on the Companys
financial position, results of operations, cash flows and
disclosures.
In October 2009, the FASB issued changes to revenue recognition
for multiple-deliverable arrangements. These changes require
separation of consideration received in such arrangements by
establishing a selling price hierarchy (not the same as fair
value) for determining the selling price of a deliverable, which
will be based on available information in the following order:
vendor-specific objective evidence, third-party evidence, or
estimated selling price; eliminate the residual method of
allocation and require that the consideration be allocated at
the inception of the arrangement to all deliverables using the
relative selling price method, which allocates any discount in
the arrangement to each deliverable on the basis of each
deliverables selling price; require that a vendor
determine its best estimate of selling price in a manner that is
consistent with that used to determine the price to sell the
deliverable on a standalone basis; and expand the disclosures
related to multiple-deliverable revenue arrangements. These
changes become effective for the Company on January 1,
2011. Management has determined that the adoption of these
changes will not have an impact on the Companys
consolidated financial statements, as the Company does not
currently have any such arrangements with its customers.
In January 2010, the FASB issued changes to disclosure
requirements for fair value measurements. Specifically, the
changes require a reporting entity to disclose, in the
reconciliation of fair value measurements using significant
unobservable inputs (Level 3), separate information about
purchases, sales, issuances, and settlements (that is, on a
gross basis rather than as one net number). These changes become
effective for the Company beginning January 1, 2011. Other
than the additional disclosure requirements, management has
determined these changes will not have an impact on the
Companys consolidated financial statements.
|
|
Note 4
|
Change in
Accounting Method and Accounting Estimate
|
On January 1, 2010, the Company elected to change its
method of revenue recognition for sleep therapy equipment sales
that are paid for over time (rental equipment) to
recognize the revenue for rental equipment over the life of the
rental period which typically ranges from 10 to 13 months.
Prior to the acquisitions of somniTech, Inc., somniCare, Inc.
and Avastra Eastern Sleep Centers, Inc. in the third quarter of
2009, the Company recognized the total amount of revenue for
entire rental equipment period at the inception of the rental
period with an offsetting entry for estimated returns. The
entities that were acquired in 2009 recorded revenue for rental
equipment consistent with method being adopted by the Company.
Recording revenue for rental equipment over the life of the
rental period will provide more accurate interim information as
this method relies less on estimates than the previous method in
which potential rental returns had to be estimated.
The Company has determined that it is impracticable to determine
the cumulative effect of applying this change retrospectively
because historical transactional level records are no longer
available in a manner that would allow for the appropriate
calculations for the historical periods presented. As a result,
the Company will apply the change in revenue recognition for
rental equipment on a prospective basis. As a result of the
F-15
accounting change, the Companys accumulated deficit
increased $213,500, as of January 1, 2010, from $9,869,471,
as originally reported, to $10,082,971. In addition, the
accounts receivable and the related allowance for doubtful
accounts associated with the outstanding rental equipment were
removed and the cost of outstanding rental equipment was
established as rental inventory as detailed below:
|
|
|
|
|
Accounts receivable
|
|
$
|
796,768
|
|
Allowance for doubtful accounts
|
|
|
(512,891
|
)
|
Less: Rental inventory established
|
|
|
70,377
|
|
|
|
|
|
|
Adjustment to accumulated deficit
|
|
$
|
213,500
|
|
|
|
|
|
|
During the second quarter of 2009, the Company completed its
quarterly analysis of the allowance for doubtful accounts based
on historical collection trends for the Companys sleep
management business using newly available information related to
the correlation of the ultimate collectability of an account and
the aging of that account. The effect of this change in estimate
for doubtful accounts was to increase the allowance for doubtful
accounts that is netted against accounts receivable and increase
bad debt expense by $2,648,207. This change in accounting
estimate also increased net loss per basic and diluted share by
$0.09 for the year ended December 31, 2009.
On August 24, 2009, the Company acquired somniTech, Inc.
and somniCare, Inc. (Somni) for a purchase price of
$5.9 million. On September 14, 2009, the Company
acquired Avastra Eastern Sleep Centers, Inc.
(Eastern) for a purchase price of $4.7 million.
The acquisition of Somni and Eastern was based on
managements belief that the acquisitions solidified the
Company as a national leader in the diagnosis and management of
sleep disorders. The acquisition decision was also based on
expected operational benefits resulting from economies of scale
and reduced overall overhead expenses.
The Somni and Eastern acquisitions were recorded by allocating
the cost of the acquisitions to the assets acquired, including
intangible assets and liabilities assumed based on their
estimated fair values at the acquisition date. The excess of the
cost of the acquisitions over the net amounts assigned to the
fair value of the assets acquired, net of liabilities assumed,
was recorded as goodwill, none of which is tax deductible. As of
December 31, 2009, management had completed a preliminary
valuation of the fair values of the assets acquired and
liabilities assumed in the Somni and Eastern acquisitions. In
March 2010, management completed
F-16
the fair value analysis and no adjustments were made to the
amounts recorded at December 31, 2009. The final purchase
allocations for the Somni and Eastern acquisitions were as
follows:
|
|
|
|
|
|
|
|
|
|
|
Somni
|
|
|
Eastern
|
|
|
Cash and cash equivalents
|
|
$
|
225,774
|
|
|
$
|
33,389
|
|
Accounts receivable
|
|
|
1,002,334
|
|
|
|
455,120
|
|
Inventories
|
|
|
78,358
|
|
|
|
6,307
|
|
Other current assets
|
|
|
36,299
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
1,342,765
|
|
|
|
494,816
|
|
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
1,060,362
|
|
|
|
157,109
|
|
Intangible assets
|
|
|
1,455,000
|
|
|
|
3,991,000
|
|
Goodwill
|
|
|
3,747,379
|
|
|
|
163,730
|
|
|
|
|
|
|
|
|
|
|
Total assets acquired
|
|
|
7,605,506
|
|
|
|
4,806,655
|
|
|
|
|
|
|
|
|
|
|
Less: Liabilities assumed:
|
|
|
|
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
|
548,197
|
|
|
|
39,497
|
|
Short-term debt
|
|
|
501,667
|
|
|
|
|
|
Long-term debt
|
|
|
655,642
|
|
|
|
67,158
|
|
|
|
|
|
|
|
|
|
|
Total liabilities assumed
|
|
|
1,705,506
|
|
|
|
106,655
|
|
|
|
|
|
|
|
|
|
|
Net assets acquired
|
|
$
|
5,900,000
|
|
|
$
|
4,700,000
|
|
|
|
|
|
|
|
|
|
|
During 2009, the Company recorded expenses of $497,000 related
to costs incurred in the acquisition of Somni and Eastern. The
acquisition costs were primarily related to legal and
professional fees and other costs incurred in performing due
diligence.
The amounts of Somnis and Easterns revenues and
earnings included in the Companys consolidated statements
of operations for the year ended December 31, 2009, and the
revenue and earnings of the combined entity had the acquisition
date been January 1, 2009, are as follows:
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
Earnings
|
|
|
Actual:
|
|
|
|
|
|
|
|
|
Somni from 8/24/2009 to 12/31/2009
|
|
$
|
3,328,000
|
|
|
$
|
100,000
|
|
|
|
|
|
|
|
|
|
|
Eastern from 9/14/2009 to 12/31/2009
|
|
$
|
690,000
|
|
|
$
|
260,000
|
|
|
|
|
|
|
|
|
|
|
Supplemental Pro Forma:
|
|
|
|
|
|
|
|
|
2009
|
|
$
|
26,009,000
|
|
|
$
|
(3,896,000
|
)
|
|
|
|
|
|
|
|
|
|
Pro forma net income (loss) per common share (basic and diluted)
from net income (loss) attributable to Graymark
|
|
|
|
|
|
|
|
|
Healthcare, Inc.:
|
|
|
|
|
|
|
|
|
2009
|
|
|
|
|
|
$
|
(0.13
|
)
|
|
|
|
|
|
|
|
|
|
The pro forma information is presented for informational
purposes only and is not necessarily indicative of the results
of operations that actually would have been achieved had the
acquisition been consummated as of that time, nor is it intended
to be a projection of future results. Net income (loss) per
share was calculated assuming the common stock issued in the
Eastern acquisition was retroactively issued on January 1,
2009.
|
|
Note 6
|
Discontinued
Operations
|
On September 1, 2010, the Company 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
Companys subsidiary, ApothecaryRx (the ApothecaryRx
Sale). ApothecaryRx operated 18
F-17
retail pharmacy stores 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 assets
occurred in December 2010. As a result of the sale of
ApothecaryRx, the related assets, liabilities, results of
operations and cash flows of ApothecaryRx have been classified
as discontinued operations in the accompanying consolidated
financial statements.
Under the Agreement, the consideration for the ApothecaryRx
assets being purchased and liabilities being 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; the independent valuator valued the Inventory Amount
at approximately $3.8 million. The resulting total Purchase
Price was $29.3 million. Of the Purchase Price, $2,000,000
was deposited in an escrow fund (the Indemnity Escrow
Fund) pursuant to the terms of an indemnity escrow
agreement. All proceeds from the sale of ApothecaryRx were
deposited in a restricted account at Arvest Bank. Of the
proceeds, $22,000,000 was used to reduce outstanding obligations
under the Companys credit facility with Arvest Bank.
Generally, 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 will be released, subject to deduction for any
pending claims for indemnification. All remaining funds held in
the Indemnity Escrow Fund, if any, will be released in May 2012
(the
18-month
anniversary of the final closing date of the sale), subject to
any pending claims for indemnification. Of the $2,000,000
Indemnity Escrow Fund, $1,000,000 is subject to partial or full
recovery by the buyer if the average daily prescription sales at
the buyers location in Sterling, Colorado over a six-month
period after the buyer purchases the ApothecaryRx location in
Sterling, Colorado does not increase by a certain percentage of
the average daily prescription sales by the ApothecaryRx
Sterling, Colorado location (the Retention Rate
Earnout).
During 2010, the Company recorded a special charge of
approximately $6.5 million ($0.22 per share) related to
certain estimated costs resulting from the ApothecaryRx Sale.
The components of the special charge are as follows:
|
|
|
|
|
Loss on liquidation of inventory
|
|
$
|
2,041,051
|
|
Bad debt expense on remaining accounts receivable
|
|
|
3,003,190
|
|
Lease termination costs
|
|
|
859,580
|
|
Severance and payroll costs
|
|
|
493,303
|
|
Equipment removal and lease termination costs
|
|
|
119,489
|
|
|
|
|
|
|
Total charge
|
|
$
|
6,516,613
|
|
|
|
|
|
|
The charges noted above were incurred as a result of the
following:
|
|
|
|
|
The Company did not sell certain of the front-end merchandise
and private-label and other over the counter drugs as part of
the ApothecaryRx Sale. The loss on liquidation of inventory
represents the loss on items that have been liquidated and the
write-down of remaining inventory to expected liquidated values.
|
|
|
|
|
|
The Company has recorded a reserve for substantially all
outstanding accounts receivable that have not been collected as
of January 31, 2011. Historically, the Company has
collected accounts receivable within 30 days. After the
ApothecaryRx sale, the Company has seen a significant delay from
third-party payers. For example, as of March 15, 2011, the
State of Illinois owes the Company approximately
$0.7 million. The payment on this receivable has been
delayed due to underfunding of the States Medicaid
program. The Company will continue collection efforts on the
balances owed and any future receipts will be recorded as a bad
debt recovery in the period collected.
|
F-18
|
|
|
|
|
The Company incurred certain severance and payroll costs, lease
termination costs and equipment removal costs related to the
pharmacy locations which were not assumed by the buyer.
|
Additional charges may be recorded in future periods dependent
upon the final resolution of the items listed above.
The operating results of ApothecaryRx and the Companys
other discontinued operations are summarized below:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Revenues
|
|
$
|
79,038,856
|
|
|
$
|
89,669,301
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before taxes ApothecaryRx
|
|
$
|
(324,092
|
)
|
|
$
|
1,992,005
|
|
Income (loss) before taxes other
|
|
|
(220,258
|
)
|
|
|
6,896
|
|
Income tax (provision)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations of discontinued operations, net of
tax
|
|
|
(544,350
|
)
|
|
|
1,998,901
|
|
Special (charges) incurred on sale
|
|
|
(6,516,613
|
)
|
|
|
|
|
Gain recorded on sale
|
|
|
5,644,880
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from discontinued operations
|
|
$
|
(1,416,083
|
)
|
|
$
|
1,998,901
|
|
|
|
|
|
|
|
|
|
|
As noted above, the Companys other discontinued operations
generated net income (loss) of ($220,258) and $6,896 during the
years ended December 31, 2010 and 2009, respectively.
During the year ended December 31, 2010, other discontinued
operations included a loss from the Companys discontinued
internet sales channel of ($225,948) which was offset by income
from the Companys discontinued film operations of $5,690.
During the year ended December 31, 2009, the Companys
discontinued film operations generated income of $6,896.
The balance sheet items for ApothecaryRx and the Companys
other discontinued operations as of December 31, 2010 and
2009 are summarized below:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Cash and cash equivalents
|
|
$
|
692,261
|
|
|
$
|
796,961
|
|
Accounts receivable, net of allowances
|
|
|
675,501
|
|
|
|
7,421,407
|
|
Inventories
|
|
|
68,267
|
|
|
|
7,882,717
|
|
Indemnity Escrow Fund
|
|
|
1,000,000
|
|
|
|
|
|
Other current assets
|
|
|
349,803
|
|
|
|
210,943
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
2,785,832
|
|
|
|
16,312,028
|
|
|
|
|
|
|
|
|
|
|
Fixed assets, net
|
|
|
101,013
|
|
|
|
992,481
|
|
Indemnity Escrow Fund
|
|
|
1,000,000
|
|
|
|
|
|
Intangible assets, net
|
|
|
|
|
|
|
7,005,704
|
|
Goodwill
|
|
|
|
|
|
|
13,089,138
|
|
|
|
|
|
|
|
|
|
|
Total noncurrent assets
|
|
|
1,101,013
|
|
|
|
21,087,323
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
3,886,845
|
|
|
$
|
37,399,351
|
|
|
|
|
|
|
|
|
|
|
Payables and accrued liabilities
|
|
$
|
2,015,277
|
|
|
$
|
6,107,109
|
|
Current portion of long-term debt
|
|
|
|
|
|
|
1,783,298
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
2,015,277
|
|
|
|
7,890,407
|
|
|
|
|
|
|
|
|
|
|
Long-term debt
|
|
|
|
|
|
|
23,694,319
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
2,015,277
|
|
|
$
|
31,584,726
|
|
|
|
|
|
|
|
|
|
|
F-19
As of December 31, 2010, the balance sheet items from
discontinued operations noted above include inventory, other
current assets, and accounts payable of $68,267, $2,348 and
$13,992, respectively, attributable to the Companys
discontinued internet sales channel. There were no balance sheet
items attributable to the Companys other discontinued
operations as of December 31, 2009.
|
|
Note 7
|
Property
and Equipment
|
Following are the components of property and equipment included
in the accompanying consolidated balance sheets as of
December 31, 2010 and 2009:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Equipment
|
|
$
|
3,283,694
|
|
|
$
|
4,849,083
|
|
Furniture and fixtures
|
|
|
610,929
|
|
|
|
1,066,362
|
|
Software
|
|
|
577,138
|
|
|
|
530,433
|
|
Vehicles
|
|
|
144,410
|
|
|
|
288,646
|
|
Leasehold improvements
|
|
|
1,498,701
|
|
|
|
1,701,927
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,114,872
|
|
|
|
8,436,451
|
|
|
|
|
|
|
|
|
|
|
Accumulated depreciation
|
|
|
(2,143,345
|
)
|
|
|
(2,125,290
|
)
|
Less: Discontinued operations
|
|
|
101,013
|
|
|
|
992,481
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,870,514
|
|
|
$
|
5,318,680
|
|
|
|
|
|
|
|
|
|
|
Depreciation expense for the years ended December 31, 2010
and 2009 was $1,110,224 and $952,432, respectively. Depreciation
expense for the years ended December 31, 2010 and 2009,
included in discontinued operations, was $237,216 and $271,093,
respectively.
During 2010, the Company identified impairment indicators
relating to property and equipment at certain sleep diagnostic
facilities and certain administrative facilities. The impairment
indicators related primarily to sleep diagnostic systems that
were no longer compatible with current systems and assets
associated with sleep diagnostic and office facilities that were
closed or consolidated into other locations. Accordingly, the
Company performed a recoverability test and an impairment test
on these locations and determined, based on the results of an
undiscounted cash flow analysis (level 3 in the fair value
hierarchy), that the fair value of the identified assets was
less than their carrying value. As a result, an impairment
charge of $762,224 for the year ended December 31, 2010 was
recorded as a component of operating expenses in the
accompanying consolidated financial statements. There was no
impairment charge recorded in 2009.
|
|
Note 8
|
Goodwill
and Other Intangibles
|
Changes in the carrying amount of goodwill during the years
ended December 31, 2010 and 2009 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Net
|
|
|
|
Gross
|
|
|
Impairment
|
|
|
Carrying
|
|
|
|
Amount
|
|
|
Losses
|
|
|
Value
|
|
|
January 1, 2009
|
|
$
|
16,605,785
|
|
|
$
|
|
|
|
$
|
16,605,785
|
|
Business acquisitions
|
|
|
3,911,109
|
|
|
|
|
|
|
|
3,911,109
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009
|
|
|
20,516,894
|
|
|
|
|
|
|
|
20,516,894
|
|
Impairment charge
|
|
|
|
|
|
|
(7,508,941
|
)
|
|
|
(7,508,941
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2010
|
|
$
|
20,516,894
|
|
|
$
|
(7,508,941
|
)
|
|
$
|
13,007,953
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010, the Company had approximately
$13.0 million of goodwill resulting from business
acquisitions. Goodwill and intangibles assets with indefinite
lives must be tested for impairment at least once a year.
Carrying values are compared with fair values, and when the
carrying value exceeds the fair value, the carrying value of the
impaired asset is reduced to its fair value. The Company tests
goodwill and
F-20
indefinite-lived intangible assets for impairment on an annual
basis in the fourth quarter or more frequently if management
believes indicators of impairment exist. The performance of the
test involves a two-step process. The first step of the
impairment test involves comparing the fair values of the
applicable reporting units with their aggregate carrying values,
including goodwill. The Company generally determines the fair
value of its reporting units using the income approach
methodology of valuation that includes the discounted cash flow
method as well as other generally accepted valuation
methodologies. If the carrying amount of a reporting unit
exceeds the reporting units fair value, the Company
performs the second step of the impairment test to determine the
amount of impairment loss on goodwill and all related intangible
assets. The second step of the impairment test involves
comparing the implied fair value of the affected reporting
units goodwill with the carrying value of that goodwill.
Based on the Companys (i) assessment of current and
expected future economic conditions, (ii) trends,
strategies and forecasted cash flows at each business unit and
(iii) assumptions similar to those that market participants
would make in valuing the Companys business units, the
Company determined that the carrying value of goodwill related
to the Companys sleep centers located in Oklahoma, Nevada
and Texas exceeded their fair value. In addition, the Company
determined the carrying value of the Companys intangible
assets associated with Eastern and certain other intangibles
exceeded their fair value. Accordingly, the Company recorded a
noncash impairment charge, in December 2010, of
$7.5 million and $3.2 million, respectively, on
goodwill and other intangible assets. The Companys
evaluation of goodwill and indefinite lived intangible assets
completed during 2009 resulted in no impairment losses.
Changes in the carrying amount of intangible assets during the
years ended December 31, 2010 and 2009 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
Impairment
|
|
|
Amortization
|
|
|
|
|
|
|
Amount
|
|
|
Losses
|
|
|
Accumulated
|
|
|
Net
|
|
|
January 1, 2009
|
|
$
|
630,000
|
|
|
$
|
|
|
|
$
|
(82,722
|
)
|
|
$
|
547,278
|
|
Business acquisitions
|
|
|
5,446,000
|
|
|
|
|
|
|
|
|
|
|
|
5,446,000
|
|
Amortization
|
|
|
|
|
|
|
|
|
|
|
(121,700
|
)
|
|
|
(121,700
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009
|
|
|
6,076,000
|
|
|
|
|
|
|
|
(204,422
|
)
|
|
|
5,871,578
|
|
Amortization
|
|
|
|
|
|
|
|
|
|
|
(227,766
|
)
|
|
|
(227,766
|
)
|
Impairment charge
|
|
|
|
|
|
|
(3,243,056
|
)
|
|
|
|
|
|
|
(3,243,056
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2010
|
|
$
|
6,076,000
|
|
|
$
|
(3,243,056
|
)
|
|
$
|
(432,188
|
)
|
|
$
|
2,400,756
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets as of December 31, 2010 and 2009 include
the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Useful
|
|
2010
|
|
|
2009
|
|
|
|
Life
|
|
Carrying
|
|
|
Accumulated
|
|
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
|
|
|
|
(Years)
|
|
Value(1)
|
|
|
Amortization
|
|
|
Net
|
|
|
Value(1)
|
|
|
Amortization
|
|
|
Net
|
|
|
Customer relationships
|
|
Indefinite
|
|
$
|
1,046,000
|
|
|
$
|
|
|
|
$
|
1,046,000
|
|
|
$
|
3,870,000
|
|
|
$
|
|
|
|
$
|
3,870,000
|
|
Customer relationships
|
|
5 - 15
|
|
|
1,139,333
|
|
|
|
(231,333
|
)
|
|
|
908,000
|
|
|
|
1,450,000
|
|
|
|
(111,031
|
)
|
|
|
1,338,969
|
|
Covenants not to compete
|
|
3 - 15
|
|
|
228,000
|
|
|
|
(145,889
|
)
|
|
|
82,111
|
|
|
|
295,000
|
|
|
|
(76,525
|
)
|
|
|
218,475
|
|
Trademark
|
|
10
|
|
|
229,611
|
|
|
|
(38,078
|
)
|
|
|
191,533
|
|
|
|
271,000
|
|
|
|
(12,644
|
)
|
|
|
258,356
|
|
Payor contracts
|
|
15
|
|
|
190,000
|
|
|
|
(16,888
|
)
|
|
|
173,112
|
|
|
|
190,000
|
|
|
|
(4,222
|
)
|
|
|
185,778
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
2,832,944
|
|
|
$
|
(432,188
|
)
|
|
$
|
2,400,756
|
|
|
$
|
6,076,000
|
|
|
$
|
(204,422
|
)
|
|
$
|
5,871,578
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
The carrying value is net of accumulated impairment charges. |
As part of the acquisition of Eastern, the Company acquired a
management services agreement (MSA) under which the
Company provides 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. IMAs responsibilities include
conducting and overseeing the sleep studies, oversight and
management
F-21
of the sleep center clinical staff and facility lease costs
through a
sub-lease of
the facilities from the Company. The MSA has a 10 year
initial term with automatic renewal at the end of that and each
subsequent term. The fee payable under the MSA is renegotiated
at the end of each annual term. For the years ended
December 31, 2010 and 2009, the management fees collected
under the MSA were $2,242,718 and $689,717, respectively, and
are included in services revenue. The MSA is essentially a
contract from which the Company expects to earn cash flow for
the foreseeable future. As a result, the Company considers the
MSA to have an indefinite life. Effective with the annual rate
renegotiation in October 2010, IMA renegotiated the monthly fee
it pays under the MSA from $195,203 to $161,964. As a result,
the Company determined that the carrying value of the MSA was
impaired and accordingly an impairment charge of $2,824,000 was
recorded. As of December 31, 2010 and 2009, the MSA had a
recorded value of $1,046,000 and $3,870,000, respectively.
The MSA was valued (initially and during the 2010 impairment
review) using the multi-period excess earnings method which
utilized expected future cash flows over 10 years plus a
terminal value for years beyond that date, adjusted for a
contributory asset charge, interest, depreciation and
amortization for each year and at the terminal value. These
amounts were then discounted using a cost of capital rate to
determine the net present value of the projected future earnings.
Amortization expense for the years ended December 31, 2010
and 2009 was $227,766 and $121,700, respectively. Amortization
expense for the years ended December 31, 2010 and 2009,
included in discontinued operations, was $710,857 and $842,985,
respectively. Amortization expense for the next five years
related to these intangible assets is expected to be as follows:
|
|
|
|
|
2011
|
|
$
|
156,519
|
|
2012
|
|
|
148,297
|
|
2013
|
|
|
131,853
|
|
2014
|
|
|
131,853
|
|
2015
|
|
|
128,923
|
|
Deferred
Offering Costs
As of December 31, 2010 and 2009, the Company has deferred
offering costs of approximately $435,000 and $176,000,
respectively. The costs have been incurred in conjunction with a
public stock offering that the Company expects to complete in
2011. To the extent that the Company is unsuccessful in
executing the stock offering, the deferred offering costs will
be charged to operations.
Equity
Investment in Non-Controlled Entity
In December 2008, the Company invested in a non-controlled
entity (the Fund) whose purpose is to invest in
Oklahoma based small or rural small business ventures. Such
investment generates tax credits which will be allocated to
investors and can be used to offset Oklahoma state income tax.
The tax credits are available through a rural economic
development fund established by the state of Oklahoma.
The Company invested $200,000 and signed a non-recourse debt
agreement for approximately $1,537,000. The debt agreement is
completely non-recourse to the Company for any amount in excess
of the pledged capital investment of $200,000. As the debt
agreement is non-recourse and has been guaranteed by other
parties, it has not been reflected in the accompanying
consolidated balance sheet.
The Company has provided with documentation from the Fund
referencing tax credits which are available to the Company in
the amount of approximately $400,000. The tax credits expire in
2011. Given the Companys recent operating losses, it is
highly unlikely that the Company will utilize the tax credits.
As a result, management determined in the 4th quarter of
2010 that realization of the Companys $200,000 investment
from proceeds other than utilization of the tax credit was
remote and as a result an impairment charge of $200,000 was
recorded.
F-22
The Companys borrowings as of December 31, 2010 and
2009 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
Rate(1)
|
|
Date
|
|
|
2010
|
|
|
2009
|
|
|
Senior bank debt
|
|
6%
|
|
|
May 2014
|
|
|
$
|
8,000,000
|
|
|
$
|
12,596,375
|
|
Bank line of credit
|
|
6%
|
|
|
June 2014 -
|
|
|
|
14,396,935
|
|
|
|
9,002,341
|
|
|
|
|
|
|
Aug. 2015
|
|
|
|
|
|
|
|
|
|
Sleep center working capital notes payable
|
|
3.25 - 6%
|
|
|
Jul. 2011 -
|
|
|
|
225,124
|
|
|
|
467,835
|
|
|
|
|
|
|
Jan. 2015
|
|
|
|
|
|
|
|
|
|
Notes payable on equipment
|
|
6 - 14%
|
|
|
Apr. 2012 -
|
|
|
|
417,249
|
|
|
|
570,947
|
|
|
|
|
|
|
Dec. 2013
|
|
|
|
|
|
|
|
|
|
Seller financing
|
|
7.6%
|
|
|
Sep. 2012
|
|
|
|
90,662
|
|
|
|
|
|
Notes payable on vehicles
|
|
2.9 -
|
|
|
Nov. 2012 -
|
|
|
|
63,586
|
|
|
|
104,764
|
|
|
|
3.9%
|
|
|
Dec. 2013
|
|
|
|
|
|
|
|
|
|
Insurance premium financing
|
|
2.97
|
|
|
Nov. 2011
|
|
|
|
12,075
|
|
|
|
68,316
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital leases, matured
|
|
|
|
|
|
|
|
|
|
|
|
|
81,314
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total borrowings
|
|
|
|
|
|
|
|
|
23,205,631
|
|
|
|
22,891,892
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term debt
|
|
|
|
|
|
|
|
|
|
|
|
|
(195,816
|
)
|
Current portion of long-term debt
|
|
|
|
|
|
|
|
|
(22,768,781
|
)
|
|
|
(480,201
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt
|
|
|
|
|
|
|
|
$
|
436,850
|
|
|
$
|
22,215,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Effective rate as of December 31, 2010 |
In May 2008 and as amended in May 2009 and July 2010, the
Company entered into a loan agreement with Arvest Bank
consisting of a $30 million term loan (the Term
Loan) and a $15 million line of credit to be used for
future acquisitions (the Acquisition Line);
collectively referred to as the Credit Facility. The
Term Loan was used by the Company to consolidate certain prior
loans to the Companys subsidiaries SDC Holdings LLC
(SDC Holdings) and ApothecaryRx LLC. The Term Loan
and the Acquisition Line bear interest at the greater of the
prime rate as reported in the Wall Street Journal or the floor
rate of 6%. Prior to June 30, 2010, the floor rate was 5%.
The rate on the Term Loan is adjusted annually on May 21.
The rate on the Acquisition Line is adjusted on the anniversary
date of each advance or tranche. The Term Loan matures on
May 21, 2014 and requires quarterly payments of interest
only. Commencing on September 1, 2011, the Company is
obligated to make quarterly payments of principal and interest
calculated on a seven-year amortization based on the unpaid
principal balance on the Term Loan as of June 1, 2011. Each
advance or tranche of the Acquisition Line will become due on
the sixth anniversary of the first day of the month following
the date of the advance or tranche. Each advance or tranche is
repaid in quarterly payments of interest only for three years
and thereafter, quarterly principal and interest payments based
on a seven-year amortization until the balloon payment on the
maturity date of the advance or tranche. The Credit Facility is
collateralized by substantially all of the Companys assets
and is personally guaranteed by various individual shareholders
of the Company. The Company has also agreed to maintain certain
financial covenants including a Debt Service Coverage Ratio of
not less than 1.25 to 1 and Minimum Net Worth, as defined.
As of December 31, 2010, the Companys Debt Service
Coverage Ratio is less than 1.25 to 1 and the Company does not
meet the Minimum Net Worth requirement. Arvest Bank has waived
the Debt Service Coverage Ratio and Minimum Net Worth
requirements through June 30, 2011 assuming the Company
makes a $3 million principal payment by June 30, 2011.
The Company expects to raise the funds necessary to make the
principal payment through additional equity or debt financing
(see Note 2 Basis of Presentation). There is no
assurance that Arvest Bank will waive Debt Service Coverage
Ratio and Minimum Net Worth
F-23
requirements beyond June 30, 2011. Due to the
non-compliance of these waivers and the associated contingent
nature of achieving compliance before June 30, 2011, the
associated debt has been classified as current on the
accompanying consolidated balance sheets.
The Company has entered into various notes payable to banks to
supplement the working capital needs of its individual sleep
centers. The amount owed under these notes at December 31,
2010 of $225,124 bear interest at variable rates ranging from
0.0% to 1.5% above the prime rate as published in the Wall
Street Journal except for one note which bears interest at a
fixed rate of 6.0%. The Company is required to make monthly
payments of principal and interest totaling $29,828. The notes
mature on varying dates from July 2011 to January 2015.
The Company has entered into various notes payable for the
purchase of sleep diagnostic equipment. The balance owed at
December 31, 2010 of $417,249 is comprised of three notes
with that bear interest at fixed rates ranging from 6% to 14%.
The Company is required to make monthly payments of principal
and interest totaling $14,135. The notes mature on varying dates
from April 2012 to December 2013.
As part of the sale of ApothecaryRx assets, the Company retained
one seller financing note payable. The note bears interest at a
fixed rate of 7.6% and matures in September 2012. The Company is
required to make monthly payments of principal and interest of
$4,627. The balance of the note as of December 31, 2009 was
$137,325 and is included in liabilities from discontinued
operations.
The Company has entered various notes payable for the purchase
of vehicles. Under the terms of the notes, the Company is
required to make monthly principal and interest payments
totaling $2,732. The notes mature on various dates from
November 17, 2012 to December 22, 2013.
The Company has entered into a short-term premium financing
arrangement for certain insurance coverage. The financing
arrangement bears interest at 2.97% and matures in November 2011.
At December 31, 2010, future maturities of long-term debt
were as follows:
|
|
|
|
|
2011
|
|
$
|
22,768,781
|
|
2012
|
|
|
244,137
|
|
2013
|
|
|
169,871
|
|
2014
|
|
|
22,842
|
|
2015
|
|
|
|
|
Thereafter
|
|
|
|
|
|
|
Note 11
|
Commitments
and Contingencies
|
Legal
Issues
The Company is exposed to asserted and unasserted legal claims
encountered in the normal course of business. Management
believes that the ultimate resolution of these matters will not
have a material adverse effect on the operating results or the
financial position of the Company. During the years ended
December 31, 2010 and 2009, the Company did not incur any
costs in settlement expenses related to its ongoing asserted and
unasserted legal claims.
Operating
Leases
The Company leases all of the real property used in its business
for office space, retail pharmacy locations and sleep testing
facilities under operating lease agreements. Rent is expensed
consistent with the terms of each lease agreement over the term
of each lease. In addition to minimum lease payments, certain
leases require reimbursement for common area maintenance and
insurance, which are expensed when incurred.
The Companys rental expense for operating leases in 2010
and 2009 was $1,908,322 and $1,558,478, respectively. The
Companys rental expense for operating leases in 2010 and
2009, included in discontinued operations, was $1,024,897 and
$1,232,613, respectively.
F-24
Following is a summary of the future minimum lease payments
under operating leases as of December 31, 2010:
|
|
|
|
|
2011
|
|
$
|
1,866,865
|
|
2012
|
|
|
1,519,991
|
|
2013
|
|
|
1,292,746
|
|
2014
|
|
|
830,094
|
|
2015
|
|
|
519,365
|
|
Thereafter
|
|
|
2,489,158
|
|
|
|
|
|
|
Total
|
|
$
|
8,518,219
|
|
|
|
|
|
|
Significant
Supplier
The Company is dependent on merchandise vendors to provide sleep
disorder related products for resale. The Companys largest
sleep product supplier is Fisher and Paykel Healthcare, which
supplied approximately 39% of the Companys sleep supplies
in the year ended December 31, 2010. In the fiscal year
ended December 31, 2009, the Companys largest sleep
product supplier was Resmed, which supplied approximately 37% of
the Companys sleep supplies. In managements opinion,
if any of these relationships were terminated or if any
contracting party were to experience events precluding
fulfillment of the Companys needs, the Company would be
able to find a suitable alternative supplier, but possibly not
without significant disruption to the Companys business.
This could take a significant amount of time and result in a
loss of customers and revenue, operating and cash flow losses
and may deplete working capital reserves.
The income tax provision for the years ended December 31,
2010 and 2009 consists of:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Current provision
|
|
$
|
166,795
|
|
|
$
|
|
|
Deferred provision (benefit)
|
|
|
998,000
|
|
|
|
(2,273,000
|
)
|
Change in beginning of year valuation allowance
|
|
|
(998,000
|
)
|
|
|
2,273,000
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
166,795
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
Current provision, discontinued operations
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
The Company expensed $110,000 during the year ended
December 31, 2010 for estimated penalties incurred for
filing certain Federal tax returns late. The amount expensed is
included in the income tax provision. There were no estimated
penalties expensed during the year ended December 31, 2009.
F-25
Deferred income tax assets and liabilities as of
December 31, 2010 and 2009 are comprised of:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Deferred income tax assets:
|
|
|
|
|
|
|
|
|
Current:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
$
|
1,664,000
|
|
|
$
|
289,000
|
|
Accrued liabilities
|
|
|
106,000
|
|
|
|
51,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,770,000
|
|
|
|
340,000
|
|
Valuation allowance
|
|
|
(1,770,000
|
)
|
|
|
(57,000
|
)
|
|
|
|
|
|
|
|
|
|
Total current deferred tax assets
|
|
|
|
|
|
|
283,000
|
|
|
|
|
|
|
|
|
|
|
Long-term:
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
4,839,000
|
|
|
|
9,025,000
|
|
Net operating loss carryforwards
|
|
|
4,725,000
|
|
|
|
3,231,000
|
|
State tax credit carryforwards
|
|
|
400,000
|
|
|
|
400,000
|
|
Intangible assets
|
|
|
154,000
|
|
|
|
278,000
|
|
Acquisition costs
|
|
|
38,000
|
|
|
|
104,000
|
|
Stock awards
|
|
|
69,000
|
|
|
|
79,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,225,000
|
|
|
|
13,117,000
|
|
Valuation allowance
|
|
|
(9,849,000
|
)
|
|
|
(12,560,000
|
)
|
|
|
|
|
|
|
|
|
|
Total long-term deferred tax assets
|
|
|
376,000
|
|
|
|
557,000
|
|
Deferred income tax liabilities:
|
|
|
|
|
|
|
|
|
Current:
|
|
|
|
|
|
|
|
|
Tax accounting changes
|
|
|
|
|
|
|
283,000
|
|
|
|
|
|
|
|
|
|
|
Long-term:
|
|
|
|
|
|
|
|
|
Fixed assets, net
|
|
|
376,000
|
|
|
|
557,000
|
|
|
|
|
|
|
|
|
|
|
Deferred tax asset, net
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
The change in the Companys valuation allowance on deferred
tax assets during the years ended December 31, 2010 and
2009 follows:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Beginning valuation allowance
|
|
$
|
12,617,000
|
|
|
$
|
10,344,000
|
|
Change in valuation allowance
|
|
|
(998,000
|
)
|
|
|
2,273,000
|
|
|
|
|
|
|
|
|
|
|
Ending valuation allowance
|
|
$
|
11,619,000
|
|
|
$
|
12,617,000
|
|
|
|
|
|
|
|
|
|
|
The Companys effective income tax rate for continuing
operations differs from the U.S. Federal statutory rate as
follows:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Federal statutory rate
|
|
|
35.0
|
%
|
|
|
35.0
|
%
|
Change in valuation allowance
|
|
|
5.2
|
|
|
|
(43.8
|
)
|
Nondeductible impairment charges
|
|
|
(29.6
|
)
|
|
|
|
|
Other
|
|
|
(9.7
|
)
|
|
|
8.8
|
|
|
|
|
|
|
|
|
|
|
Effective income tax rate
|
|
|
0.9
|
%
|
|
|
|
%
|
|
|
|
|
|
|
|
|
|
At December 31, 2010, the Company had federal and state net
operating loss carryforwards of approximately $13,499,000,
expiring at various dates through 2025. Approximately $3,012,000
of the Companys net operating loss carryforwards are
subject to an annual limitation of approximately $218,000.
F-26
The amount of income taxes the Company pays is subject to
ongoing examinations by federal and state tax authorities. To
date, there have been no reviews performed by federal or state
tax authorities on any of the Companys previously filed
returns. The Companys 2003 and later tax returns are still
subject to examination.
|
|
Note 13
|
Capital
Structure
|
During the year ended December 31, 2009, the holders of
certain placement agent warrants exercised their warrants. These
warrants were exercisable for the purchase of 66,242 shares
of common stock and were issued in connection with our 2008
private placement and convertible note conversion. The warrant
holders elected to use the cashless exercise
provisions and, accordingly, were not required to pay the
exercise price ranging from $1.10 to $5.50 per share. The
Company issued 35,104 shares of common stock pursuant to
these warrant exercises. In connection with this the issuance of
these common stock shares, no underwriting discounts or
commissions were paid or will be paid.
On September 14, 2009, the Company completed the Eastern
acquisition. In connection with this acquisition, the Company
issued 752,795 shares of common stock shares for $1,544,000
(or $2.05 per share) as a portion of the purchase price
consideration. In connection with the issuance of these common
stock shares, no underwriting discounts or commissions were paid
or will be paid.
|
|
Note 14
|
Stock
Options, Grants and Warrants
|
The Company has adopted three stock option plans, the 2008
Long-Term Incentive Plan (the Incentive Plan), the
2003 Stock Option Plan (the Employee Plan) and the
2003 Non-Employee Stock Option Plan (the Non-Employee
Plan).
The Incentive Plan consists of three separate stock incentive
plans, a Non-Executive Officer Participant Plan, an Executive
Officer Participant Plan and a Non-Employee Director Participant
Plan. Except for administration and the category of employees
eligible to receive incentive awards, the terms of the
Non-Executive Officer Participant Plan and the Executive Officer
Participant Plan are identical. The Non-Employee Director Plan
has other variations in terms and only permits the grant of
nonqualified stock options and restricted stock awards. Each
incentive award will be pursuant to a written award agreement.
The number of shares of common stock authorized and reserved
under the Incentive Plan is 3,000,000.
The Employee Plan provides for the issuance of options intended
to qualify as incentive stock options for federal income tax
purposes to our employees, including employees who also serve as
a Company director. The exercise price of options may not be
less than 85% of the fair market value of our common stock on
the date of grant of the option. The Non-Employee Plan provides
for the grant of stock options to the Companys
non-employee directors, consultants and other advisors. The
Companys employees are not eligible to participate in the
Non-Employee Plan. Under the provisions of this plan, the
options do not qualify as incentive stock options for federal
income tax purposes.
The fair value of each option and warrant grant is estimated on
the date of grant using the Black-Scholes option pricing model.
The determination of the fair value of stock-based payment
awards on the date of grant using an option-pricing model is
affected by the Companys stock price as well as
assumptions regarding a number of complex and subjective
variables. These variables include the expected stock price
volatility over the term of the awards, actual and projected
employee stock option exercise behaviors, risk-free interest
rate and expected dividends. Given the Companys limited
trading history and lack of employee option exercise history,
the Company has included the assumptions and variables of
similar companies in the determination of the actual variables
used in the option pricing model. The Company bases the
risk-free interest rate used in the option pricing model on
U.S. Treasury zero-coupon issues. The Company does not
anticipate paying any cash dividends in the foreseeable future
and therefore an expected dividend yield of zero is used in the
option pricing model.
F-27
The assumptions used to value the option and warrant grants are
as follows:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Expected life (in years)
|
|
|
2.5
|
|
|
|
1.0 - 3.5
|
|
Volatility
|
|
|
81
|
%
|
|
|
55
|
%
|
Risk free interest rate
|
|
|
0.4
|
%
|
|
|
0.4 - 2.0
|
%
|
Dividend yield
|
|
|
|
%
|
|
|
|
%
|
Information with respect to stock options and warrants
outstanding follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Exercise
|
|
|
|
Shares
|
|
|
Price
|
|
|
Outstanding at January 1, 2009
|
|
|
590,603
|
|
|
$
|
3.04
|
|
Granted warrants
|
|
|
100,000
|
|
|
|
2.05
|
|
Granted options
|
|
|
232,860
|
|
|
|
3.14
|
|
Exercised warrants
|
|
|
(66,242
|
)
|
|
|
1.65
|
|
Forfeited options
|
|
|
(30,358
|
)
|
|
|
5.24
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2009
|
|
|
826,863
|
|
|
|
2.98
|
|
Granted options
|
|
|
125,000
|
|
|
|
1.18
|
|
Forfeited warrants
|
|
|
(200,000
|
)
|
|
|
2.50
|
|
Forfeited options
|
|
|
(170,195
|
)
|
|
|
4.06
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2010
|
|
|
581,668
|
|
|
$
|
2.44
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options and Warrants
|
|
|
|
Options and Warrants Outstanding
|
|
|
Exercisable
|
|
|
|
Shares
|
|
|
Average
|
|
|
Average
|
|
|
Shares
|
|
|
Average
|
|
|
|
Outstanding
|
|
|
Remaining
|
|
|
Exercise
|
|
|
Outstanding
|
|
|
Exercise
|
|
|
|
at 12/31/10
|
|
|
Life (Years)
|
|
|
Price
|
|
|
at 12/31/10
|
|
|
Price
|
|
|
$1.01 to $3.00
|
|
|
428,130
|
|
|
|
3.4
|
|
|
$
|
1.96
|
|
|
|
344,797
|
|
|
$
|
2.04
|
|
$3.01 to $5.00
|
|
|
152,000
|
|
|
|
2.1
|
|
|
|
3.75
|
|
|
|
152,000
|
|
|
|
3.75
|
|
$5.01 to $7.00
|
|
|
1,538
|
|
|
|
2.6
|
|
|
|
6.50
|
|
|
|
1,538
|
|
|
|
6.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
581,668
|
|
|
|
|
|
|
|
|
|
|
|
498,335
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of the 125,000 and 232,860 options issued in 2010
and 2009 was estimated to be approximately $71,000 and $103,000,
respectively. The value of the options is recorded as
compensation expense or, in the case of non-employee third
parties, as professional services expense over the requisite
service period which equals the vesting period of the options.
Compensation expense related to stock options was $84,000 and
$39,000 during 2010 and 2009, respectively. During 2009, the
Company recorded $14,581 in professional services fees for
options issued to an investor relations firm.
During 2009, the Company issued 100,000 warrants to Viewtrade
for the performance of financial services. The fair value of the
warrants was estimated to be approximately $87,000 and was
recorded as professional services expense over the vesting
period in 2009.
The options and warrants outstanding and options and warrants
exercisable as of December 31, 2010 and 2009 had no
intrinsic value. The intrinsic value is calculated as the
difference between the market value and exercise price of the
shares.
F-28
Information with respect to the Companys restricted stock
awards follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Grant Date
|
|
Unvested Restricted Stock Awards
|
|
Shares
|
|
|
Fair Value
|
|
|
Unvested at December 31, 2008
|
|
|
130,000
|
|
|
$
|
1.60
|
|
Granted
|
|
|
702,669
|
|
|
|
1.94
|
|
Vested
|
|
|
(287,669
|
)
|
|
|
1.96
|
|
Forfeited
|
|
|
(120,000
|
)
|
|
|
1.68
|
|
|
|
|
|
|
|
|
|
|
Unvested at December 31, 2009
|
|
|
425,000
|
|
|
|
1.90
|
|
Granted
|
|
|
210,000
|
|
|
|
1.14
|
|
Vested
|
|
|
(337,500
|
)
|
|
|
1.45
|
|
Forfeited
|
|
|
(207,500
|
)
|
|
|
1.72
|
|
|
|
|
|
|
|
|
|
|
Unvested at December 31, 2010
|
|
|
90,000
|
|
|
$
|
2.44
|
|
|
|
|
|
|
|
|
|
|
During 2010 and 2009, the Company issued 210,000 and 702,669,
respectively, restricted stock grant awards to certain key
employees and directors. The fair value of the restricted stock
grant awards was $239,000 and $1,365,704, respectively, and was
calculated by multiplying the number of restricted shares issued
times the closing share price on the date of issuance. The value
of the stock grants is recorded as compensation over the
requisite service period which equals vesting period of the
stock award. During 2010 and 2009, the Company recorded
compensation expense related to stock grant awards of
approximately $390,000 and $682,000, respectively. As of
December 31, 2010 and 2009, the Company has unrecognized
compensation expense associated with the stock grants, options
and warrants of approximately $464,000 and $754,000,
respectively.
|
|
Note 15
|
Fair
Value Measurements
|
Fair value is the price that would be received from the sale of
an asset or paid to transfer a liability (i.e., an exit price)
in the principal or most advantageous market in an orderly
transaction between market participants. In determining fair
value, the accounting standards established a three-level
hierarchy that distinguishes between (i) market data
obtained or developed from independent sources (i.e., observable
data inputs) and (ii) a reporting entitys own data
and assumptions that market participants would use in pricing an
asset or liability (i.e., unobservable data inputs). Financial
assets and financial liabilities measured and reported at fair
value are classified in one of the following categories, in
order of priority of observability and objectivity of pricing
inputs:
|
|
|
|
|
Level 1 Fair value based on quoted
prices in active markets for identical assets or liabilities.
|
|
|
|
|
|
Level 2 Fair value based on significant
directly observable data (other than Level 1 quoted prices)
or significant indirectly observable data through corroboration
with observable market data. Inputs would normally be
(i) quoted prices in active markets for similar assets or
liabilities, (ii) quoted prices in inactive markets for
identical or similar assets or liabilities or
(iii) information derived from or corroborated by
observable market data.
|
|
|
|
|
|
Level 3 Fair value based on prices or
valuation techniques that require significant unobservable data
inputs. Inputs would normally be a reporting entitys own
data and judgments about assumptions that market participants
would use in pricing the asset or liability.
|
The fair value measurement level for an asset or liability is
based on the lowest level of any input that is significant to
the fair value measurement. Valuation techniques should maximize
the use of observable inputs and minimize the use of
unobservable inputs.
Recurring Fair Value Measurements: The
carrying value of the Companys financial assets and
financial liabilities is their cost, which may differ from fair
value. The carrying value of cash held as demand deposits, money
market and certificates of deposit, accounts receivable,
short-term borrowings, accounts payable and
F-29
accrued liabilities approximated their fair value. The fair
value of the Companys long-term debt, including the
current portion approximated its carrying value. Fair value for
long-term debt was estimated based on quoted market prices of
the identical debt instruments or values of comparable
borrowings.
Nonrecurring Fair Value Measurements: Goodwill
and indefinite-lived intangible assets are tested for possible
impairment as of the beginning of the fourth quarter of each
year. During 2010, management concluded that the carrying values
of goodwill and certain intangible assets at its sleep centers
located in Nevada, Oklahoma and Texas exceeded their respective
fair values. In addition, the carrying value of the
Companys indefinite lived intangible asset and certain
other intangible assets associated with the MSA at Eastern
exceeded their fair value. As a result, the Company recorded
impairment charges totaling $10.8 million to write down the
goodwill and intangible assets to their respective implied fair
values. Also during 2010, the Company identified impairment
indicators relating to property and equipment at certain sleep
diagnostic facilities and certain administrative facilities and
determined that the fair value of the identified assets was less
than their carrying value. As a result, an impairment charge of
$762,224 was recorded during 2010 to write down the property and
equipment to its implied fair value. These nonrecurring fair
value measurements were developed using significant unobservable
inputs (Level 3). The primary valuation technique used was
an income methodology based on managements estimates of
forecasted cash flows for each business unit, with those cash
flows discounted to present value using rates commensurate with
the risks of those cash flows. Assumptions used by management
were similar to those that would be used by market participants
performing valuations of these business units and were based on
analysis of current and expected future economic conditions and
the updated strategic plan for each business unit.
The fair value measurements for the Companys assets
measured at fair value on a nonrecurring basis as of
December 31, 2010 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prices in
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Active
|
|
|
|
|
|
Significant
|
|
|
|
|
|
|
Year
|
|
|
Markets for
|
|
|
Significant Other
|
|
|
Unobservable
|
|
|
|
|
|
|
Ended
|
|
|
Identical
|
|
|
Observable Inputs
|
|
|
Inputs
|
|
|
Total Gains
|
|
Assets
|
|
12/31/2010
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
|
(Losses)
|
|
|
Goodwill
|
|
$
|
13,007,953
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
13,007,953
|
|
|
$
|
(7,508,941
|
)
|
Intangible assets
|
|
|
2,400,756
|
|
|
|
|
|
|
|
|
|
|
|
2,400,756
|
|
|
|
(3,243,056
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(10,751,997
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Note 16
|
Related
Party Transactions
|
On March 16, 2011, the Company executed a promissory note
with Valiant Investments, LLC in the amount of $1,000,000. The
note bears interest at 6%. All accrued interest and principal
are due at the maturity of the Note on August 1, 2011. The
proceeds from the note will be drawn through a series of
advances and will be used for working capital. Valiant
Investments, LLC is controlled by Mr. Roy T. Oliver, one of
the Companys greater than 5% shareholders and affiliates.
The promissory note is subordinate to the Companys credit
facility with Arvest Bank.
As of December 31, 2010 and 2009, the Company had
approximately $0.6 million and $0.7 million on deposit
at Valliance Bank. Valliance Bank is controlled by Mr. Roy
T. Oliver, one of the Companys greater than 5%
shareholders and affiliates. In addition, the Company is
obligated to Valliance Bank under certain sleep center capital
notes totaling approximately $110,000 and $193,000 at
December 31, 2010 and 2009, respectively. The interest
rates on the notes are fixed at 6%. Non-controlling interests in
Valliance Bank are held by Mr. Stanton Nelson, the
Companys chief executive officer and Mr. Joseph
Harroz, Jr., one of the Companys directors.
Mr. Nelson and Mr. Harroz also serve as directors of
Valliance Bank.
The Companys corporate headquarters and offices and the
executive offices of SDC Holdings are occupied under a month to
month lease with Oklahoma Tower Realty Investors, LLC, requiring
monthly rental payments of approximately $7,000. From April 2010
through November 2010, the Company paid a reduced monthly rental
payment of $4,200 per month and prior to April 2010, the monthly
rental payments were $10,300. Mr. Roy T. Oliver, one of the
Companys greater than 5% shareholders and affiliates,
controls
F-30
Oklahoma Tower Realty Investors, LLC (Oklahoma
Tower). During the years ended December 31, 2010 and
2009, the Company incurred approximately $75,000 and $132,000,
respectively, in lease expense under the terms of the lease.
Mr. Stanton Nelson, the Companys chief executive
officer, owns a non-controlling interest in Oklahoma Tower
Realty Investors, LLC.
During 2009, the Company paid Specialty Construction Services,
LLC approximately $255,000, primarily for construction of
leasehold improvements at our Norman, Oklahoma facility.
Non-controlling interests in Specialty Construction Services,
LLC are held by Roy T. Oliver, one of the Companys greater
than 5% shareholders and affiliates, and Mr. Stanton
Nelson, our Chief Executive Officer.
During the year ended December 31, 2009, the Company paid
approximately $24,000 to R.T. Oliver Investments, Inc. for air
travel expenses. Mr. Roy T. Oliver, one of the
Companys greater than 5% shareholders and affiliates,
controls R.T. Oliver Investments, Inc. Mr. Stanton Nelson,
the Companys chief executive officer, owns a
non-controlling interest in R.T. Oliver Investments, Inc.
|
|
Note 17
|
Subsequent
Events
|
Management evaluated all activity of the Company and concluded
that no subsequent events have occurred that would require
recognition in the consolidated financial statements or
disclosure in the notes to the consolidated financial
statements, except the following:
On March 16, 2011, the Company executed a promissory note
with Valiant Investments, LLC in the amount of $1,000,000. The
note bears interest at 6%. All accrued interest and principal
are due at the maturity of the Note on August 1, 2011. The
proceeds from the note will be drawn through a series of
advances and will be used for working capital. Valiant
Investments, LLC is controlled by Mr. Roy T. Oliver, one of
the Companys greater than 5% shareholders and affiliates.
The promissory note is subordinate to the Companys credit
facility with Arvest Bank.
On January 26, 2011, the Companys 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, the Company
received the consent of a majority of its stockholders for this
reverse stock split. The Companys Board of Directors has
the authority to determine the exact ratio of the reverse stock
split. The Company intends to effect the reverse stock split in
connection with the consummation of a planned public stock
offering.
|
|
Note 18
|
Supplemental
Cash Flow Information
|
Cash payments for interest and income taxes and certain noncash
investing and financing activities for the years ended
December 31, 2010 and 2009 follows:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Cash Paid for Interest and Income Taxes:
|
|
|
|
|
|
|
|
|
Interest expense, continuing operations
|
|
$
|
1,230,000
|
|
|
$
|
989,000
|
|
Interest expense, discontinued operations
|
|
|
1,345,000
|
|
|
|
1,453,000
|
|
Income taxes
|
|
|
20,000
|
|
|
|
39,000
|
|
Noncash Investing and Financing Activities:
|
|
|
|
|
|
|
|
|
Common stock and stock options issued in business acquisitions
|
|
$
|
|
|
|
$
|
1,544,000
|
|
F-31
Exhibit Index
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
|
|
3.1 |
|
|
Registrants Restated Certificate of Incorporation, incorporated by reference
to Exhibit 3.1.1 of Registrants Quarterly Report on Form 10-Q filed with the U.S.
Securities and Exchange Commission on August 14, 2008. |
|
|
|
|
|
|
3.2 |
|
|
Registrants Amended and Restated Bylaws, incorporated by reference to Exhibit
3.2 of Registrants Quarterly Report on Form 10-Q as filed with the U.S. Securities and
Exchange Commission on August 14, 2008. |
|
|
|
|
|
|
4.1 |
|
|
Form of Certificate of Common Stock of Registrant, incorporated by reference to
Exhibit 4.1 of Registrants Registration Statement on Form SB-2 (No. 333-111819) as
filed with the U.S. Securities and Exchange Commission on January 9, 2004. |
|
|
|
|
|
|
4.2 |
|
|
Form of Amended and Restated Common Stock Purchase Warrant Agreement issued to
SXJE, LLC and dated March 2007, is incorporated by reference to Exhibit 4.2 of the
Registrants Annual Report on Form 10-K filed with the U.S. Securities and Exchange
Commission on March 31, 2010. |
|
|
|
|
|
|
4.3 |
|
|
Financial Advisor Warrant Agreement issued to ViewTrade Securities, Inc. and
dated June 11, 2009, is incorporated by reference to Exhibit 4.7 of the Registrants
Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on
March 31, 2010. |
|
|
|
|
|
|
10.1 |
|
|
Graymark Productions, Inc. 2003 Stock Option Plan, incorporated by reference to
Exhibit 10.5 of Registrants Registration Statement on Form SB-2 (No. 333-111819) as
filed with the U.S. Securities and Exchange Commission on January 9, 2004. |
|
|
|
|
|
|
10.2 |
|
|
Graymark Productions, Inc. 2003 Non-Employee Stock Option Plan, incorporated by
reference to Exhibit 10.6 of Registrants Registration Statement on Form SB-2 (No.
333-111819) as filed with the U.S. Securities and Exchange Commission on January 9,
2004. |
|
|
|
|
|
|
10.3 |
|
|
Graymark Healthcare, Inc. 2008 Long-term Incentive Plan adopted by Registrant
on the effective date of October 29, 2008, is incorporated by reference to Exhibit 4.1
of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on December 9, 2008. |
|
|
|
|
|
|
10.3.1 |
|
|
Graymark Healthcare, Inc. 2008 Long-term Incentive Plan, Form of Restricted Stock
Award Agreement, is incorporated by reference to Exhibit 10.3.1 of the Registrants
Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on
March 31, 2010. |
|
|
|
|
|
|
10.3.2 |
|
|
Graymark Healthcare, Inc. 2008 Long-term Incentive Plan, Form of Stock Option
Agreement, is incorporated by reference to Exhibit 10.3.2 of the Registrants Annual
Report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 31,
2010. |
|
|
|
|
|
|
10.4 |
|
|
Exchange Agreement between Registrant, SDC Holdings, LLC, SDOC Investors, LLC,
Vahid Salalati, Greg Luster, Kevin Lewis, Roger Ely, ApothecaryRx, LLC, Oliver RX
Investors, LLC, Lewis P. Zeidner, Michael Gold, James A. Cox, and John Frick, dated
October 29, 2007, is incorporated by reference to Registrants Schedule 14 Information
Statement filed with the U.S. Securities and Exchange Commission on December 5, 2007. |
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
|
|
10.5 |
|
|
Registration Rights Agreement between Registrant, Oliver Company Holdings, LLC,
Lewis P. Zeidner, Stanton Nelson, Vahid Salalati, Greg Luster, William R. Oliver, Kevin
Lewis, John B. Frick Revocable Trust, Roger Ely, James A. Cox, Michael Gold, Katrina J.
Martin Revocable Trust, dated January 2, 2008, is incorporated by reference to
Registrants Schedule 14 Information Statement filed with the U.S. Securities and
Exchange Commission on December 5, 2007. |
|
|
|
|
|
|
10.6 |
|
|
Asset Purchase Agreement among ApothecaryRx, LLC, Rambo Pharmacy, Inc. and
Norman Greenburg, dated January 3, 2008, is incorporated by reference to Exhibit 10.1
of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on January 29, 2008. |
|
|
|
|
|
|
10.7 |
|
|
Goodwill Protection Agreement between ApothecaryRx, LLC, Rambo Pharmacy, Inc.
and Norman Greenburg, dated January 12, 2008, is incorporated by reference to Exhibit
10.2 of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on January 29, 2008. |
|
|
|
|
|
|
10.8 |
|
|
Employment Agreement between ApothecaryRx, LLC and Aric Greenburg, dated
January 17, 2008, is incorporated by reference to Exhibit 10.3 of the Registrants
Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on
January 29, 2008. |
|
|
|
|
|
|
10.9 |
|
|
Transition Agreement between ApothecaryRx, LLC, Rambo Pharmacy, Inc. and Norman
Greenburg, dated January 17, 2008, is incorporated by reference to Exhibit 10.4 of the
Registrants Current Report on Form 8-K filed with the U.S. Securities and Exchange
Commission on January 29, 2008. |
|
|
|
|
|
|
10.10 |
|
|
Lease Agreement between ApothecaryRx, LLC and Rambo Pharmacy, Inc., dated
January 12, 2008, is incorporated by reference to Exhibit 10.5 of the Registrants
Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on
January 29, 2008. |
|
|
|
|
|
|
10.11 |
|
|
Asset Purchase Agreement between ApothecaryRx, LLC and Thrifty Drug Stores,
Inc., dated February 8, 2008, is incorporated by reference to Exhibit 10.1 of the
Registrants Current Report on Form 8-K filed with the U.S. Securities and Exchange
Commission on March 6, 2008. |
|
|
|
|
|
|
10.12 |
|
|
Goodwill Protection Agreement between ApothecaryRx, LLC and Thrifty Drug
Stores, Inc., dated February 29, 2008, is incorporated by reference to Exhibit 10.2 of
the Registrants Current Report on Form 8-K filed with the U.S. Securities and Exchange
Commission on March 6, 2008. |
|
|
|
|
|
|
10.13 |
|
|
Pharmacy Purchase Agreement between ApothecaryRx, LLC, Rehn-Huerbinger Drug
Co., 666 Drug Co., Wilmette-Huerbinger Drug Co., Edward Cox, Simpson Gold, Lawrence
Horwitz, and Steven Feinerman, dated May 2, 2008, is incorporated by reference to
Exhibit 10.1 of the Registrants Current Report on Form 8-K filed with the U.S.
Securities and Exchange Commission on June 6, 2008. |
|
|
|
|
|
|
10.13.1 |
|
|
First Amendment to Pharmacy Purchase Agreement between ApothecaryRx, LLC,
Rehn-Huerbinger Drug Co., 666 Drug Co., Wilmette-Huerbinger Drug Co., Edward Cox,
Simpson Gold, Lawrence Horwitz, and Steven Feinerman, dated May 23, 2008, is
incorporated by reference to Exhibit 10.7 of the Registrants Current Report on Form
8-K filed with the U.S. Securities and Exchange Commission on June 6, 2008. |
|
|
|
|
|
|
10.13.2 |
|
|
Second Amendment to Pharmacy Purchase Agreement between ApothecaryRx, LLC,
Rehn-Huerbinger Drug Co., 666 Drug Co., Wilmette-Huerbinger Drug Co., Edward Cox,
Simpson Gold, Lawrence Horwitz, and Steven Feinerman, dated June 3, 2008, is
incorporated by reference to Exhibit 10.8 of the Registrants Current Report
on Form 8-K filed with the U.S. Securities and Exchange Commission on June
6, 2008. |
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
|
|
10.14 |
|
|
Goodwill Protection agreement between ApothecaryRx, LLC, Edward Cox, Simpson
Gold and Lawrence Horwitz, dated June 3, 2008, is incorporated by reference to Exhibit
10.2 of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on June 6, 2008. |
|
|
|
|
|
|
10.15 |
|
|
Employment Agreement between ApothecaryRx, LLC and Lawrence Horwitz, dated
June 3, 2008, is incorporated by reference to Exhibit 10.3 of the Registrants Current
Report on Form 8-K filed with the U.S. Securities and Exchange Commission on June 6,
2008. |
|
|
|
|
|
|
10.16 |
|
|
Employment Agreement between ApothecaryRx, LLC and Steven Feinerman, dated
June 3, 2008, is incorporated by reference to Exhibit 10.4 of the Registrants Current
Report on Form 8-K filed with the U.S. Securities and Exchange Commission on June 6,
2008. |
|
|
|
|
|
|
10.17 |
|
|
Employment Agreement between ApothecaryRx, LLC and Edward Cox, dated June 3,
2008, is incorporated by reference to Exhibit 10.5 of the Registrants Current Report
on Form8-K filed with the U.S. Securities and Exchange Commission on June 6, 2008. |
|
|
|
|
|
|
10.18 |
|
|
Employment Agreement between ApothecaryRx, LLC and Simpson Gold, dated June 3,
2008, is incorporated by reference to Exhibit 10.6 of the Registrants Current Report
on Form 8-K filed with the U.S. Securities and Exchange Commission on June 6, 2008. |
|
|
|
|
|
|
10.19 |
|
|
Purchase Agreement between TCSD of Waco, LLC and Sleep Center of Waco, Ltd.,
dated May 30, 2008, is incorporated by reference to Exhibit 10.3 of the Registrants
Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on
June 13, 2008. |
|
|
|
|
|
|
10.20 |
|
|
Purchase Agreement between Capital Sleep Management, LLC, Plano Sleep Center,
Ltd., and Southlake Sleep Center, Ltd., dated May 30, 2008, is incorporated by
reference to Exhibit 10.2 of the Registrants Current Report on Form 8-K filed with the
U.S. Securities and Exchange Commission on June 13, 2008. |
|
|
|
|
|
|
10.21 |
|
|
Asset Purchase Agreement between SDC Holdings, LLC, Christina Molfetta and
Hanna Friends Trust, dated June 1, 2008, is incorporated by reference to Exhibit 10.1
of the Registrants Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on June 13, 2008. |
|
|
|
|
|
|
10.22 |
|
|
Loan Agreement between Registrant, SDC Holdings, LLC, ApothecaryRx, LLC,
Oliver Company Holdings, LLC, Roy T. Oliver, Stanton M. Nelson, Roy T. Oliver as
Trustee of the Roy T. Oliver Revocable Trust dated June 15, 2004, Vahid Salalati, Greg
Luster, Kevin Lewis, Roger Ely and Lewis P. Zeidner and Arvest Bank, dated May 21, 2008
is incorporated by reference to Exhibit 10.31 of the Registrants Annual Report on Form
10-K filed with the U.S. Securities and Exchange Commission on March 31, 2009. |
|
|
|
|
|
|
10.22.1 |
|
|
Amendment to Loan Agreement between Registrant, SDC Holdings, LLC, ApothecaryRx,
LLC, Oliver Company Holdings, LLC, Roy T. Oliver, Stanton M. Nelson, Roy T. Oliver as
Trustee of the Roy T. Oliver Revocable Trust dated June 15, 2004, Vahid Salalati, Greg
Luster, Kevin Lewis, Roger Ely and Lewis P. Zeidner and Arvest Bank, effective May 21,
2008 is incorporated by reference to Exhibit 10.32 of the Registrants Annual Report on
Form 10-K filed with the U.S. Securities and Exchange Commission on March 31, 2009. |
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
|
|
10.22.2 |
|
|
Second Amendment to Loan Agreement between Registrant, SDC Holdings, LLC,
ApothecaryRx, LLC, Oliver Company Holdings, LLC, Roy T. Oliver, Stanton M. Nelson, Roy
T. Oliver as Trustee of the Roy T. Oliver Revocable Trust dated June 15, 2004, Vahid
Salalati, Greg Luster, Kevin Lewis, Roger Ely and Lewis P. Zeidner and Arvest Bank,
effective May 21, 2008, is incorporated by reference to Exhibit 10.1 of the
Registrants Quarterly Report on Form 10-Q filed with the U.S. Securities and Exchange
Commission on August 14, 2009. |
|
|
|
|
|
|
10.22.3 |
|
|
Third Amendment to Loan Agreement between Registrant, SDC Holdings, LLC,
ApothecaryRx, LLC, Oliver Company Holdings, LLC, Roy T. Oliver, Stanton M. Nelson, Roy
T. Oliver as Trustee of the Roy T. Oliver Revocable Trust dated June 15, 2004, Vahid
Salalati, Greg Luster, Kevin Lewis, Roger Ely and Lewis P. Zeidner and Arvest Bank,
effective June 30, 2010, is incorporated by reference to the Registrants Registration
Statement on Form S-1 filed with the U.S. Securities and Exchange Commission on
December 30, 2010. |
|
|
|
|
|
|
10.22.4 |
|
|
Amended and Restated Loan Agreement dated December 17, 2010 by and among Graymark
Healthcare, Inc., SDC Holdings, LLC, ApothecaryRx, LLC, Oliver Company Holdings, LLC,
Roy T. Oliver, Stanton M. Nelson, Roy T. Oliver as Trustee of the Roy T. Oliver
Revocable Trust dated June 15, 2004, Kevin Lewis, Roger Ely, Lewis P. Zeidner and
Arvest Bank, is incorporated by reference to the Registrants Registration Statement on
Form S-1 filed with the U.S. Securities and Exchange Commission on March 28, 2011. |
|
|
|
|
|
|
10.23 |
|
|
Stock Sale Agreement dated August 19, 2009 by and among SDC Holdings, LLC,
AvastraUSA, Inc. and Avastra Sleep Centers Limited, is incorporated by reference to
Exhibit 10.1 of the Registrants Current Report on
Form 8-K filed with the U.S.
Securities and Exchange Commission on August 26, 2009. |
|
|
|
|
|
|
10.23.1 |
|
|
First Amendment to Stock Sale Agreement dated August 23, 2009 among SDC Holdings,
LLC, AvastraUSA, Inc. and Avastra Sleep Centers Limited, is incorporated by reference
to Exhibit 10.2 of the Registrants Current Report on Form 8-K filed with the U.S.
Securities and Exchange Commission on August 26, 2009. |
|
|
|
|
|
|
10.23.2 |
|
|
Second Amendment to Stock Sale Agreement dated September 14, 2009 among SDC
Holdings, LLC, AvastraUSA, Inc. and Avastra Sleep Centers Limited, is incorporated by
reference to Exhibit 10.1 of the Registrants Current Report on Form 8-K filed with the
U.S. Securities and Exchange Commission on September 16, 2009. |
|
|
|
|
|
|
10.24 |
|
|
Lock up and Stock Pledge Agreement dated September 14, 2009 among Graymark
Healthcare, Inc., SDC Holdings, LLC, AvastraUSA, Inc. and Avastra Sleep Centers
Limited, is incorporated by reference to Exhibit 10.2 of the Registrants Current
Report on Form 8-K filed with the U.S. Securities and Exchange Commission on September
16, 2009. |
|
|
|
|
|
|
10.25 |
|
|
Settlement Agreement and Release dated September 14, 2009 among Daniel I.
Rifkin, M.D., Graymark Healthcare, Inc., SDC Holdings, LLC, Avastra Sleep Centers
Limited, AvastraUSA, Inc. is incorporated by reference to Exhibit 10.3 of the
Registrants Current Report on Form 8-K/A filed with the U.S. Securities and Exchange
Commission on September 21, 2009. |
|
|
|
|
|
|
10.26 |
|
|
Employment Agreement between Registrant and Grant A. Christianson, dated
October 13, 2009, is incorporated by reference to Exhibit 10.2 of the Registrants
Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on
October 14, 2009. |
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
|
|
10.27 |
|
|
Employment Agreement between Registrant and Stanton Nelson, dated October 13,
2009, is incorporated by reference to Exhibit 10.1 of the Registrants Current Report
on Form 8-K filed with the U.S. Securities and Exchange Commission on October 14, 2009. |
|
|
|
|
|
|
10.28 |
|
|
Amended and Restated Employment Agreement among the Registrant, Lewis P.
Zeidner, and ApothecaryRx, LLC, dated October 13, 2009, is incorporated by reference to
Exhibit 10.3 of the Registrants Current Report on Form 8 K filed with the U.S.
Securities and Exchange Commission on October 14, 2009. |
|
|
|
|
|
|
10.29 |
|
|
Employment Agreement between Registrant and Joseph Harroz, Jr., dated December
5, 2008, is incorporated by reference to Exhibit 10.2 of Registrants Current Report on
Form 8-K filed with the U.S. Securities and Exchange Commission on December 9, 2008. |
|
|
|
|
|
|
10.30 |
|
|
Agreement between the Registrant and Joseph Harroz, Jr., dated March 25, 2010,
is incorporated by reference to Exhibit 10.30 of the Registrants Annual Report on Form
10-K filed with the U.S. Securities and Exchange Commission on March 31, 2010. |
|
|
|
|
|
|
10.31 |
|
|
Restricted Stock Award Agreement between the Registrant and Stanton Nelson,
dated March 25, 2010 is incorporated by reference to Exhibit 10.31 of the Registrants
Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on
March 31, 2010. |
|
|
|
|
|
|
10.32 |
|
|
Employment Agreement between the Registrant and Edward M. Carriero, Jr., dated
October 7, 2010, is incorporated by reference to Exhibit 10.3 of the Registrants
Quarterly Report on Form 10-Q filed with the U.S. Securities and Exchange Commission on
November 15, 2010. |
|
|
|
|
|
|
10.33 |
|
|
Asset Purchase Agreement dated September 1, 2010 among Walgreen Co.,
ApothecaryRx, LLC, and, to certain sections only, Graymark Healthcare, Inc., is
incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form
8-K filed with the U.S. Securities and Exchange Commission on September 2, 2010. |
|
|
|
|
|
|
10.33.1 |
|
|
First Amendment to Asset Purchase Agreement dated October 29, 2010 among Walgreen
Co., ApothecaryRx, LLC, and, to certain sections only, Graymark Healthcare, Inc., is
incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form
8-K filed with the U.S. Securities and Exchange Commission on October 29, 2010. |
|
|
|
|
|
|
10.34 |
|
|
Employment Agreement between Registrant and Rick D. Simpson, dated December
5, 2008, is incorporated by reference to Exhibit 10.3 of Registrants Current Report on
Form 8-K filed with the U.S. Securities and Exchange Commission on December 9, 2008. |
|
|
|
|
|
|
10.35 |
|
|
Form of Indemnification Agreement between the Company and each of its
directors and executive officers, is incorporate by reference to Exhibit 10.1 to the
Registrants Current Report on Form 8-K filed with the U.S. Securities and Exchange
Commission on August 24, 2010. |
|
|
|
|
|
|
10.36.1 |
|
|
Loan Agreement dated March 16, 2011 by and between Valiant Investments LLC and
Graymark Healthcare, Inc., is incorporated by reference to Exhibit 10.1 to the
Registrants Current Report on Form 8-K filed with the U.S. Securities and Exchange
Commission on March 22, 2011. |
|
|
|
|
|
|
10.36.2 |
|
|
Note dated March 16, 2011 issued by Graymark Healthcare, Inc., is incorporated by
reference to Exhibit 10.2 to the Registrants Current Report with the U.S. Securities
and Exchange Commission on Form 8-K filed on March 22, 2011. |
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
|
|
10.36.3 |
|
|
Subordination Agreement dated March 16, 2011 by and among Valiant Investments,
L.L.C., ApothecaryRx, LLC, SDC Holdings LLC and Graymark Healthcare, Inc., in favor of
Arvest Bank, is incorporated by reference to Exhibit 10.3 to the Registrants Current
Report with the U.S. Securities and Exchange Commission on Form 8-K filed on March 22,
2011. |
|
|
|
|
|
|
21+ |
|
|
Subsidiaries of Registrant. |
|
|
|
|
|
|
23.1+ |
|
|
Consent of Eide Bailly, LLP |
|
|
|
|
|
|
31.1+ |
|
|
Certification of Stanton Nelson, Chief Executive Officer of Registrant. |
|
|
|
|
|
|
31.2+ |
|
|
Certification of Edward M. Carriero, Jr., Chief Financial Officer of Registrant. |
|
|
|
|
|
|
31.3+ |
|
|
Certification of Grant A. Christianson, Chief Accounting Officer of
Registrant. |
|
|
|
|
|
|
32.1+ |
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 of Stanton Nelson, Chief Executive Officer of
Registrant. |
|
|
|
|
|
|
32.2+ |
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 of Edward M. Carriero, Chief Financial
Officer of Registrant. |
|
|
|
|
|
|
32.3+ |
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 of Grant A. Christianson, Chief Accounting
Officer of Registrant. |