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Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2011
o | 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)
OKLAHOMA | 20-0180812 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | 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)
Oklahoma City, Oklahoma 73102
(Address of principal executive offices)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act 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.
þ Yes
o No
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).
þ Yes
o No
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.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller reporting company þ | |||
(Do not check if a smaller reporting company) |
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes þ No
As of August 12, 2011, 14,871,613 shares of the registrants common stock, $0.0001 par value, were
outstanding.
GRAYMARK HEALTHCARE, INC.
FORM 10-Q
For the Quarter Ended June 30, 2011
FORM 10-Q
For the Quarter Ended June 30, 2011
TABLE OF CONTENTS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the captions Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations, and Item 1A. Risk Factors, 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 adoption of, 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.
i
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. | Graymark Healthcare, Inc. Consolidated Condensed Financial Statements. |
The consolidated condensed financial statements included in this report have been prepared by
us pursuant to the rules and regulations of the Securities and Exchange Commission. The
Consolidated Condensed Balance Sheets as of June 30, 2011 and December 31, 2010, the Consolidated
Condensed Statements of Operations for the three month and six month periods ended June 30, 2011
and 2010, and the Consolidated Condensed Statements of Cash Flows for the six months ended June 30,
2011 and 2010, have been prepared without audit. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or omitted pursuant to those
rules and regulations, although we believe that the disclosures are adequate to make the
information presented not misleading. It is suggested that these consolidated condensed financial
statements be read in conjunction with the financial statements and the related notes thereto
included in our latest annual report on Form 10-K.
The consolidated condensed statements for the unaudited interim periods presented include all
adjustments, consisting of normal recurring adjustments, necessary to present a fair statement of
the results for such interim periods. Because of the influence of seasonal and other factors on
our operations, net earnings for any interim period may not be comparable to the same interim
period in the previous year or necessarily indicative of earnings for the full year.
1
Table of Contents
GRAYMARK HEALTHCARE, INC.
Consolidated Condensed Balance Sheets
(Unaudited)
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
ASSETS |
||||||||
Cash and cash equivalents |
$ | 6,592,884 | $ | 639,655 | ||||
Accounts
receivable, net of allowances for contractual adjustments and doubtful accounts of $2,834,076 and $2,791,906, respectively |
2,837,793 | 2,597,848 | ||||||
Inventories |
536,429 | 553,342 | ||||||
Current assets from discontinued operations |
2,191,487 | 3,349,567 | ||||||
Other current assets |
1,571,436 | 438,315 | ||||||
Total current assets |
13,730,029 | 7,578,727 | ||||||
Property and equipment, net |
3,151,790 | 3,642,847 | ||||||
Intangible assets, net |
1,239,889 | 1,313,756 | ||||||
Goodwill |
12,844,223 | 12,844,223 | ||||||
Other assets from discontinued operations |
73,440 | 2,579,410 | ||||||
Other assets |
289,542 | 733,589 | ||||||
Total assets |
$ | 31,328,913 | $ | 28,692,552 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Liabilities: |
||||||||
Accounts payable |
$ | 589,188 | $ | 909,983 | ||||
Accrued liabilities |
2,223,840 | 2,263,907 | ||||||
Current portion of long-term debt |
19,687,662 | 22,768,781 | ||||||
Current liabilities from discontinued operations |
956,025 | 2,140,602 | ||||||
Total current liabilities |
23,456,715 | 28,083,273 | ||||||
Long-term debt, net of current portion |
306,085 | 436,850 | ||||||
Total liabilities |
23,762,800 | 28,520,123 | ||||||
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;
14,531,613 and 7,238,403 issued and outstanding, respectively |
1,453 | 724 | ||||||
Paid-in capital |
39,424,437 | 29,521,558 | ||||||
Accumulated deficit |
(31,637,113 | ) | (29,218,977 | ) | ||||
Total Graymark Healthcare shareholders equity (deficit) |
7,788,777 | 303,305 | ||||||
Noncontrolling interest |
(222,664 | ) | (130,876 | ) | ||||
Total equity (deficit) |
7,566,113 | 172,429 | ||||||
Total liabilities and shareholders equity |
$ | 31,328,913 | $ | 28,692,552 | ||||
See Accompanying Notes to Consolidated Condensed Financial Statements
2
Table of Contents
GRAYMARK HEALTHCARE, INC.
Consolidated Condensed Statements of Operations
For the Three Months Ended June 30, 2011 and 2010
(Unaudited)
2011 | 2010 | |||||||
Net Revenues: |
||||||||
Services |
$ | 3,143,390 | $ | 4,108,597 | ||||
Product sales |
1,265,763 | 1,416,668 | ||||||
4,409,153 | 5,525,265 | |||||||
Cost of Services and Sales: |
||||||||
Cost of services |
1,292,960 | 1,404,281 | ||||||
Cost of sales |
388,660 | 294,831 | ||||||
1,681,620 | 1,699,112 | |||||||
Gross Margin |
2,727,533 | 3,826,153 | ||||||
Operating Expenses: |
||||||||
Selling, general and administrative |
3,133,739 | 3,615,158 | ||||||
Bad debt expense |
122,980 | 541,994 | ||||||
Depreciation and amortization |
277,534 | 333,762 | ||||||
3,534,253 | 4,490,914 | |||||||
Other (Expense): |
||||||||
Interest expense, net |
(325,367 | ) | (286,455 | ) | ||||
Other expense |
(7,005 | ) | | |||||
Net other (expense) |
(332,372 | ) | (286,455 | ) | ||||
Income (loss) from continuing operations, before taxes |
(1,139,092 | ) | (951,216 | ) | ||||
(Provision) benefit for income taxes |
(3,498 | ) | 16,502 | |||||
Income (loss) from continuing operations, net of taxes |
(1,142,590 | ) | (934,714 | ) | ||||
Income (loss) from discontinued operations, net of taxes |
542,342 | 801,478 | ||||||
Net income (loss) |
(600,248 | ) | (133,236 | ) | ||||
Less: Net income (loss) attributable to noncontrolling interests |
(18,378 | ) | 6,072 | |||||
Net income (loss) attributable to Graymark Healthcare |
$ | (581,870 | ) | $ | (139,308 | ) | ||
Earnings per common share (basic and diluted): |
||||||||
Net income (loss) from continuing operations |
$ | (0.13 | ) | $ | (0.13 | ) | ||
Income from discontinued operations |
0.06 | 0.11 | ||||||
Net income (loss) per share |
$ | (0.07 | ) | $ | (0.02 | ) | ||
Weighted average number of common shares outstanding |
8,787,853 | 7,246,080 | ||||||
Weighted average number of diluted shares outstanding |
8,787,853 | 7,246,080 | ||||||
See Accompanying Notes to Consolidated Condensed Financial Statements
3
Table of Contents
GRAYMARK HEALTHCARE, INC.
Consolidated Condensed Statements of Operations
For the Six Months Ended June 30, 2011 and 2010
(Unaudited)
For the Six Months Ended June 30, 2011 and 2010
(Unaudited)
2011 | 2010 | |||||||
Net Revenues: |
||||||||
Services |
$ | 6,100,994 | $ | 8,195,973 | ||||
Product sales |
2,512,140 | 2,655,718 | ||||||
8,613,134 | 10,851,691 | |||||||
Cost of Services and Sales: |
||||||||
Cost of services |
2,515,904 | 2,856,881 | ||||||
Cost of sales |
797,356 | 695,166 | ||||||
3,313,260 | 3,552,047 | |||||||
Gross Margin |
5,299,874 | 7,299,644 | ||||||
Operating Expenses: |
||||||||
Selling, general and administrative |
6,722,989 | 8,147,949 | ||||||
Bad debt expense |
240,828 | 780,893 | ||||||
Depreciation and amortization |
557,474 | 665,822 | ||||||
7,521,291 | 9,594,664 | |||||||
Other (Expense): |
||||||||
Interest expense, net |
(674,944 | ) | (570,686 | ) | ||||
Other expense |
(9,234 | ) | | |||||
Net other (expense) |
(684,178 | ) | (570,686 | ) | ||||
Income (loss) from continuing operations, before taxes |
(2,905,595 | ) | (2,865,706 | ) | ||||
Provision for income taxes |
(6,996 | ) | (1,004 | ) | ||||
Income (loss) from continuing operations, net of taxes |
(2,912,591 | ) | (2,866,710 | ) | ||||
Income (loss) from discontinued operations, net of taxes |
391,373 | 1,267,727 | ||||||
Net income (loss) |
(2,521,218 | ) | (1,598,983 | ) | ||||
Less: Net income (loss) attributable to noncontrolling interests |
(103,082 | ) | (34,727 | ) | ||||
Net income (loss) attributable to Graymark Healthcare |
$ | (2,418,136 | ) | $ | (1,564,256 | ) | ||
Earnings per common share (basic and diluted): |
||||||||
Net income (loss) from continuing operations |
$ | (0.35 | ) | $ | (0.39 | ) | ||
Income from discontinued operations |
0.05 | 0.17 | ||||||
Net income (loss) per share |
$ | (0.30 | ) | $ | (0.22 | ) | ||
Weighted average number of common shares outstanding |
8,017,408 | 7,252,919 | ||||||
Weighted average number of diluted shares outstanding |
8,017,408 | 7,252,919 | ||||||
See Accompanying Notes to Consolidated Condensed Financial Statements
4
Table of Contents
GRAYMARK HEALTHCARE, INC.
Consolidated Condensed Statements of Cash Flows
For the Six Months Ended June 30, 2011 and 2010
(Unaudited)
2011 | 2010 | |||||||
Operating activities: |
||||||||
Net income (loss) |
$ | (2,418,136 | ) | $ | (1,564,256 | ) | ||
Less: Net income (loss) from discontinued operations |
391,373 | 1,267,727 | ||||||
Net income (loss) from continuing operations |
(2,809,509 | ) | (2,831,983 | ) | ||||
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities: |
||||||||
Depreciation and amortization |
557,474 | 665,822 | ||||||
Noncontrolling interests |
(103,082 | ) | (34,727 | ) | ||||
Stock-based compensation, net of cashless vesting |
42,812 | 348,437 | ||||||
Bad debt expense |
240,828 | 780,893 | ||||||
Changes in assets and liabilities - |
||||||||
Accounts receivable |
(480,773 | ) | (31,150 | ) | ||||
Inventories |
16,913 | (187,223 | ) | |||||
Other assets |
(689,074 | ) | (219,529 | ) | ||||
Accounts payable |
(320,795 | ) | 199,984 | |||||
Accrued liabilities |
(40,067 | ) | (357,032 | ) | ||||
Net cash (used in) operating activities from continuing operations |
(3,585,273 | ) | (1,666,508 | ) | ||||
Net cash provided by operating activities from discontinued operations |
370,846 | 2,187,172 | ||||||
Net cash provided by (used in) operating activities |
(3,214,427 | ) | 520,664 | |||||
Investing activities: |
||||||||
Purchase of property and equipment |
(10,439 | ) | (77,009 | ) | ||||
Disposal of property and equipment |
17,889 | 68,003 | ||||||
Net cash provided by (used in) investing activities from continuing operations |
7,450 | (9,006 | ) | |||||
Net cash provided by (used in) investing activities from discontinued
operations |
2,500,000 | (29,164 | ) | |||||
Net cash provided by (used in) investing activities |
2,507,450 | (38,170 | ) | |||||
Financing activities: |
||||||||
Issuance of common stock and warrants |
8,877,814 | | ||||||
Debt proceeds |
1,000,000 | 12,614 | ||||||
Debt payments |
(3,211,884 | ) | (350,883 | ) | ||||
Purchase of noncontrolling interests |
(5,724 | ) | | |||||
Distributions to noncontrolling interests |
| (7,000 | ) | |||||
Net cash provided by (used in) financing activities from continuing operations |
6,660,206 | (345,269 | ) | |||||
Net cash (used in) financing activities from discontinued operations |
| (758,639 | ) | |||||
Net cash provided by (used in) financing activities |
6,660,206 | (1,103,908 | ) | |||||
Net change in cash and cash equivalents |
5,953,229 | (621,414 | ) | |||||
Cash and cash equivalents at beginning of period |
639,655 | 959,252 | ||||||
Cash and cash equivalents at end of period |
$ | 6,592,884 | $ | 337,838 | ||||
Cash Paid for Interest and Income Taxes: |
||||||||
Interest expense, continuing operations |
$ | 695,000 | $ | 583,000 | ||||
Interest expense, discontinued operations |
$ | 1,000 | $ | 658,000 | ||||
Income taxes, continuing operations |
$ | | $ | 14,000 | ||||
Income taxes, discontinued operations |
$ | | $ | 18,000 | ||||
Noncash Investing and Financing Activities: |
||||||||
Common stock issued as payment for debt |
$ | 1,000,000 | $ | | ||||
See Accompanying Notes to Consolidated Condensed Financial Statements
5
Table of Contents
GRAYMARK HEALTHCARE, INC.
Notes to Consolidated Condensed Financial Statements
For the Periods Ended June 30, 2011 and 2010
Note 1 Nature of Business
Graymark Healthcare, Inc. (the Company) is organized in Oklahoma and 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, or 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 supplies to patients who have tested positive for sleep apnea and have had their
positive airway pressure determined. There are noncontrolling interest holders in some of the
Companys testing facilities, who are typically physicians in the geographical area being served by
the diagnostic sleep testing facility.
In May 2011 and December 2010, the Company executed the sale of substantially all of the
assets of the Companys subsidiaries, Nocturna East, Inc. (East) and ApothecaryRx, LLC
(ApothecaryRx), respectively. East operated the Management Services Agreement (MSA) under
which the Company provided certain services to the sleep centers owned by Independent Medical
Practices (IMA) including billing and collections, trademark rights, non-clinical sleep center
management services, equipment rental fees, general management services, legal support and
accounting and bookkeeping services. 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. As a result of the sale of East and ApothecaryRx, the related assets,
liabilities, results of operations and cash flows of East and ApothecaryRx have been classified as
discontinued operations in the accompanying consolidated condensed financial statements.
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 had a working capital deficit of
approximately $20.5 million as of December 31, 2010. At that time, there was substantial doubt
about the Companys ability to continue as a going concern.
During May 2011 and June 2011, the Company raised a total of $8.9 million in net proceeds from
a private and public offering of common stock and warrants. As of June 30, 2011, the Company had
cash and cash equivalents of $6.6 million and total equity of $7.6 million. The $6.6 million in
cash and cash equivalents, as of June 30, 2011, is significantly more than managements projected
cash needs for the next twelve months of approximately $3.9 million. As a result, the substantial
doubt about the Companys ability to continue as a going concern has been eliminated.
As of June 30, 2011, the Companys Debt Service Coverage Ratio is less than 1.25 to 1 which is
ratio required by the Companys loan agreement with Arvest Bank (see Note 6). The Company has
obtained a waiver from Arvest Bank for the Debt Service Coverage Ratio through December 31, 2011.
Since the waiver does not extend past twelve months from June 30, 2011, the associated debt with
Arvest Bank has been classified as current in the accompanying condensed consolidated balance
sheets.
6
Table of Contents
On June 3, 2011, the Company executed a reverse stock split of the Companys common stock in a
ratio of 1-for-4 (see Note 8). The effect of the reverse split reduced the Companys outstanding
common stock shares from 34,126,022 to 8,531,506 shares as of the date of the reverse split. The
accompanying condensed consolidated financial statements give effect to the reverse split as of the
first date presented.
Note 3 Summary of Significant Accounting Policies
For a complete list of the Companys significant accounting policies, please see the Companys
Annual Report on Form 10-K for the year ending December 31, 2010.
Interim Financial Information The unaudited consolidated condensed financial statements
included herein have been prepared in accordance with generally accepted accounting principles for
interim financial statements and with Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted in the United States
of America (GAAP) for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring adjustments) considered necessary for a fair
presentation have been included. Operating results for the three months and six months ended June
30, 2011 are not necessarily indicative of results that may be expected for the year ended December
31, 2011. The consolidated condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Companys Form 10-K for the
year ended December 31, 2010. The December 31, 2010 consolidated condensed balance sheet was
derived from audited financial statements.
Reclassifications Certain amounts presented in prior years have been reclassified to
conform to the current years presentation including the assets, liabilities, results of operations
and cash flows of East and ApothecaryRx which are reflected as discontinued operations.
Consolidation The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned, majority owned and controlled subsidiaries. All significant
inter-company 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 its sleep
diagnostic business, 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 business acquired from somniCare, Inc. and
somniTech, Inc. (Somni) business since the date of the acquisition in 2009 and for the Companys
remaining sleep diagnostic business since the fourth quarter of 2010. The Company does not
anticipate any future changes to this process. In the Companys historic sleep therapy 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. 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. The key assumption in this process is that actual reimbursement
history is a reasonable predictor of the future reimbursement for each payor at each facility.
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. The Company expects to transition its historic sleep therapy
business to the same process currently used for its sleep diagnostic business by the end of 2011.
This change in process and assumptions for the Companys historic sleep therapy business is not
expected to have a material impact on future operating results.
7
Table of Contents
For certain sleep therapy and other equipment sales, reimbursement from third-party payers
occur 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 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.
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 revenue from the sale is recognized over a specified period, the product cost
associated with that sale is recognized over that same period. If the revenue from a product sale
is recognized in one period, the cost of sale is recorded in the period the product was sold.
Restricted cash As of June 30, 2011 and December 31, 2010, the Company had long-term
restricted cash of approximately $236,000 included in other assets in the accompanying condensed
consolidated balance sheets. This amount is pledged as collateral to the Companys senior bank
debt and bank line of credit.
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, compared to the same periods in 2010, 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 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.
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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.
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 six months ended June 30, 2011 and 2010, the amounts the Company collected in excess
of recorded contractual allowances were approximately $117,000 and $306,000, respectively. These
amounts reflect the amount of actual cash received in excess of the original contractual amount
recorded at the time of service.
Accounts receivable are reported net of allowances for contractual adjustments and doubtful
accounts as follows:
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Allowance for contractual adjustments |
$ | 1,726,377 | $ | 1,676,618 | ||||
Allowance for doubtful accounts |
1,107,699 | 1,115,288 | ||||||
Total |
$ | 2,834,076 | $ | 2,791,906 | ||||
The activity in the allowances for contractual adjustments and doubtful accounts for the six
months ending June 30, 2011 follows:
Contractual | Doubtful | |||||||||||
Adjustments | Accounts | Total | ||||||||||
Balance at December 31, 2010 |
$ | 1,676,618 | $ | 1,115,288 | $ | 2,791,906 | ||||||
Provisions |
2,367,631 | 240,828 | 2,608,459 | |||||||||
Write-offs, net of recoveries |
(2,317,872 | ) | (248,417 | ) | (2,566,289 | ) | ||||||
Balance at June 30, 2011 |
$ | 1,726,377 | $ | 1,107,699 | $ | 2,834,076 | ||||||
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The aging of the Companys accounts receivable, net of allowances for contractual adjustments
and doubtful accounts as of June 30, 2011 and December 31, 2010 follows:
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
1 to 60 days |
$ | 1,702,235 | $ | 1,890,902 | ||||
61 to 90 days |
357,878 | 282,807 | ||||||
91 to 120 days |
243,159 | 170,435 | ||||||
121 to 180 days |
292,829 | 67,394 | ||||||
181 to 360 days |
241,692 | 186,310 | ||||||
Greater than 360 days |
| | ||||||
Total |
$ | 2,837,793 | $ | 2,597,848 | ||||
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 $102,000
and $129,000 as of June 30, 2011 and December 31, 2010, 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.
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 during the fourth
quarter, 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. The
Company evaluates the recoverability of identifiable intangible assets whenever events or changes
in circumstances indicate that an intangible assets carrying amount may not be recoverable.
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.
Recently Adopted and Recently Issued Accounting Guidance
Adopted Guidance
On January 1, 2011, the Company adopted changes issued by the Financial Accounting Standards
Board (FASB) 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. The adoption of these
changes had no impact on the Companys consolidated financial statements, as the Company does not
currently have any such arrangements with its customers.
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On January 1, 2011, the Company adopted changes issued by the FASB 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). The adoption of these changes had no impact on the Companys
consolidated financial statements.
On January 1, 2011, the Company adopted changes issued by the FASB to the testing of goodwill
for impairment. These changes require an entity to perform all steps in the test for a reporting
unit whose carrying value is zero or negative if it is more likely than not (more than 50%) that a
goodwill impairment exists based on qualitative factors. This will result in the elimination of an
entitys ability to assert that such a reporting units goodwill is not impaired and additional
testing is not necessary despite the existence of qualitative factors that indicate otherwise.
Based on the most recent impairment review of the Companys goodwill (2010 fourth quarter), the
adoption of these changes had no impact on the Companys consolidated financial statements.
On January 1, 2011, the Company adopted changes issued by the FASB to the disclosure of pro
forma information for business combinations. These changes clarify that if a public entity
presents comparative financial statements, the entity should disclose revenue and earnings of the
combined entity as though the business combination that occurred during the current year had
occurred as of the beginning of the comparable prior annual reporting period only. Also, the
existing supplemental pro forma disclosures were expanded to include a description of the nature
and amount of material, nonrecurring pro forma adjustments directly attributable to the business
combination included in the reported pro forma revenue and earnings. The adoption of these changes
had no impact on the Companys consolidated financial statements.
Issued Guidance
In July 2011, the FASB issued Presentation and Disclosure of Patient Service Revenue,
Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities
(ASU 2011-07), which requires healthcare organizations that perform services for patients for which
the ultimate collection of all or a portion of the amounts billed or billable cannot be determined
at the time services are rendered to present all bad debt expense associated with patient service
revenue as an offset to the patient service revenue line item in the statement of operations. The
ASU also requires qualitative disclosures about the Companys policy for recognizing revenue and
bad debt expense for patient service transactions and quantitative information about the effects of
changes in the assessment of collectability of patient service revenue. This ASU is effective for
fiscal years beginning after December 15, 2011, and will be adopted by the Company in the first
quarter of 2012. The Company is currently assessing the potential impact the adoption of this ASU
will have on its consolidated results of operations and consolidated financial position.
Note 4 Discontinued Operations
On May 10, 2011, the Company executed an Asset Purchase Agreement (Agreement) with Daniel I.
Rifkin, M.D., P.C. pursuant to which we sold substantially all of the assets of the Companys
subsidiary, Nocturna East, Inc. (East) for $2,500,000. In conjunction with the sale of East
assets, the Management Services Agreement (MSA) under which the Company provided certain services
to the sleep centers owned by Independent Medical Practices (IMA) including billing and
collections, trademark rights, non-clinical sleep center management services, equipment rental
fees, general management services, legal support and accounting and bookkeeping services was
terminated. The Companys decision to sell the assets of East was primarily based on managements
determination that the operations of East no longer fit into the Companys strategic plan of
providing a full continuum of care to patients due to significant regulatory barriers that limit
the Companys ability to sell CPAP devices and other supplies at the East locations. As a result
of the sale of East, the related assets, liabilities, results of operations and cash flows of East
have been classified as discontinued operations in the accompanying consolidated financial
statements.
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Table of Contents
On September 1, 2010, the Company executed an Asset Purchase Agreement, which was subsequently
amended on October 29, 2010, (as amended, the Agreement) pursuant to which we sold substantially
all of the assets of the Companys subsidiary, ApothecaryRx (the ApothecaryRx Sale).
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.
Under the Agreement, the consideration for the ApothecaryRx assets sold and liabilities
assumed was $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 was 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 purchased the ApothecaryRx location in Sterling, Colorado did not increase
by a certain percentage of the average daily prescription sales of ApothecaryRxs Sterling,
Colorado location during a period prior to the closing (the Retention Rate Earnout). The
six-month period has passed and there was no adjustment as a result of the Retention Rate Earnout.
The operating results of East, ApothecaryRx and the Companys other discontinued operations
(discontinued internet sales division and discontinued film operations) for the six months ended
June 30, 2011 and 2010 are summarized below:
2011 | 2010 | |||||||
Revenues: |
||||||||
East |
$ | 566,874 | $ | 1,171,217 | ||||
ApothecaryRx |
(134,708 | ) | 43,836,051 | |||||
Other |
(1,184 | ) | 193 | |||||
$ | 430,982 | $ | 45,007,461 | |||||
Income (loss) from discontinued
operations, before taxes: |
||||||||
East |
$ | 28,652 | $ | 403,370 | ||||
ApothecaryRx |
(363,314 | ) | 884,180 | |||||
Other |
(8,689 | ) | (19,823 | ) | ||||
Gain recorded on sale of East |
734,724 | | ||||||
Income tax (provision) |
| | ||||||
Income (loss) from discontinued operations |
$ | 391,373 | $ | 1,267,727 | ||||
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Table of Contents
The balance sheet items for the Companys discontinued operations as of June 30, 2011 and
December 31, 2010 are summarized below:
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Cash and cash equivalents |
$ | 25,811 | $ | 931,402 | ||||
Accounts receivable, net of allowances |
| 969,924 | ||||||
Inventories |
68,438 | 68,267 | ||||||
Indemnity Escrow Fund |
2,000,000 | 1,000,000 | ||||||
Other current assets |
97,238 | 379,974 | ||||||
Total current assets |
2,191,487 | 3,349,567 | ||||||
Fixed assets, net |
73,440 | 328,680 | ||||||
Indemnity Escrow Fund |
| 1,000,000 | ||||||
Intangible assets, net |
| 1,087,000 | ||||||
Goodwill |
| 163,730 | ||||||
Total noncurrent assets |
73,440 | 2,579,410 | ||||||
Total assets |
$ | 2,264,927 | $ | 5,928,977 | ||||
Payables and accrued liabilities |
$ | 956,025 | $ | 2,140,602 | ||||
Note 5 Goodwill and Other Intangibles
The carrying amount of goodwill as of June 30, 2011 and December 31, 2010 follows:
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Gross amount |
$ | 16,950,734 | $ | 16,950,734 | ||||
Accumulated impairment losses |
(4,106,511 | ) | (4,106,511 | ) | ||||
Carrying value |
$ | 12,844,223 | $ | 12,844,223 | ||||
Goodwill and intangible 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 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 goodwill impairment test to determine the
amount of impairment loss. The second step of the goodwill impairment test involves comparing the
implied fair value of the affected reporting units goodwill with the carrying value of that
goodwill.
The carrying amount of intangible assets as of June 30, 2011 and December 31, 2010 follows:
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Gross amount |
$ | 2,085,000 | $ | 2,085,000 | ||||
Accumulated impairment losses |
(365,945 | ) | (365,945 | ) | ||||
Carrying value |
$ | 1,719,055 | $ | 1,719,055 | ||||
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Intangible assets as of June 30, 2011 and December 31, 2010 include the following:
Useful | June 30, 2011 | December 31, | ||||||||||||||||
Life | Carrying | Accumulated | 2010 | |||||||||||||||
(Years) | Value | Amortization | Net | Net | ||||||||||||||
Customer relationships |
8 15 | $ | 1,139,333 | $ | (275,484 | ) | $ | 863,849 | $ | 908,000 | ||||||||
Trademark |
10 15 | 229,611 | (49,127 | ) | 180,484 | 191,533 | ||||||||||||
Covenants not to compete |
3 15 | 160,111 | (131,333 | ) | 28,778 | 41,111 | ||||||||||||
Payor contracts |
15 | 190,000 | (23,222 | ) | 166,778 | 173,112 | ||||||||||||
Total |
$ | 1,719,055 | $ | (479,166 | ) | $ | 1,239,889 | $ | 1,313,756 | |||||||||
Amortization expense for the three months ended June 30, 2011 and 2010 was approximately
$37,000 and $52,000, respectively. Amortization expense for the six months ended June 30, 2011 and
2010 was approximately $74,000 and $104,000, respectively. Amortization expense for the next five
years related to these intangible assets is expected to be as follows:
Twelve months ended June 30, |
||||
2012 |
$ | 126,000 | ||
2013 |
133,000 | |||
2014 |
123,000 | |||
2015 |
123,000 | |||
2016 |
119,000 |
Note 6 Borrowings
The Companys long-term debt as of June 30, 2011 and December 31, 2010 are as follows:
Maturity | June 30, | December 31, | ||||||||||
Rate (1) | Date | 2011 | 2010 | |||||||||
Senior bank debt |
6% | May 2014 | $ | 5,000,000 | $ | 8,000,000 | ||||||
Bank line of credit |
6% | Aug. 2015 | 14,396,935 | 14,396,935 | ||||||||
Notes payable on equipment |
6 14% | April 2012 Dec. 2013 | 344,992 | 417,249 | ||||||||
Sleep center notes payable |
3.75 8.75% | July 2011 Jan. 2015 | 128,523 | 225,124 | ||||||||
Seller financing |
7.65% | Sept. 2012 | 65,961 | 90,662 | ||||||||
Notes payable on vehicles |
7.5% | Nov. 2012 Dec. 2013 | 51,259 | 63,586 | ||||||||
Insurance premium financing |
2.97% | Nov. 2011 | 6,076 | 12,075 | ||||||||
Total borrowings |
19,993,747 | 23,205,631 | ||||||||||
Less: Current portion of long-term debt |
(19,687,662 | ) | (22,768,781 | ) | ||||||||
Long-term debt |
$ | 306,085 | $ | 436,850 | ||||||||
(1) | Effective rate as of June 30, 2011 |
At June 30, 2011, future maturities of long-term debt were as follows:
Twelve months ended June 30, |
||||
2012 |
$ | 19,688,000 | ||
2013 |
207,000 | |||
2014 |
88,000 | |||
2015 |
11,000 | |||
2016 |
| |||
Thereafter |
|
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Table of Contents
In May 2008 and as amended in May 2009, July 2010 and December 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%. 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, as defined.
As of June 30, 2011, the Companys Debt Service Coverage Ratio is less than 1.25 to 1. In
June 2011, the Company prepaid approximately $1.1 million in principal and interest to Arvest Bank
and as a result, Arvest Bank has waived the Debt Service Coverage Ratio requirement through
December 31, 2011. The prepayment represents all principal and interest payments due to Arvest
Bank between July 1, 2011 and December 31, 2011. The prepayment is reflected in other current
assets on the accompanying condensed consolidated balance sheets. The prepayment will be recorded
as interest expense and a reduction of principal in accordance with the loan agreement. There is
no assurance that Arvest Bank will waive the Debt Service Coverage Ratio requirement beyond
December 31, 2011. Since the waiver does not extend past twelve months from June 30, 2011, the
associated debt with Arvest Bank has been classified as current in the accompanying condensed
consolidated balance sheets.
Note 7 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 three months and six months ended June 30, 2011 and 2010, the Company did not
incur any material costs or settlement expenses related to its ongoing asserted and unasserted
legal claims.
Note 8 Capital Structure
In June 2011, the Company completed a public offering of 6,000,000 common stock shares and
warrants exercisable for the purchase of 6,700,000 shares for gross proceeds of $8,400,000 or $1.40
per combination of one share of common stock and a warrant to purchase one share of common stock.
The underwriter of the offering received sales commissions of $420,350 (5% of the gross proceeds),
a corporate finance fee of $168,140 (2% of the gross proceeds) and a legal and other expense
allowance of $116,094 (1.4% of the gross proceeds). In conjunction with the offering, each
investor received a warrant to purchase one share of common stock for each share of common stock
purchased. The amount received for the warrants has been included in additional paid-in capital in
the accompanying condensed consolidated balance sheets. The warrants are exercisable for the
purchase of one share of common stock for $1.50 beginning June 20, 2011 and on or before June 20,
2016. The Company incurred $824,603 in expenses directly associated with the offering. These
expenses have been reflected as a reduction in additional paid-in capital in the accompanying
consolidated condensed balance sheets.
In conjunction with the offering, the underwriter had an option to purchase an additional
700,000 shares of the Companys common stock and warrants to purchase 700,000 shares of the
Companys common stock solely to cover over-allotments. The underwriter exercised the full
over-allotment option with respect to the warrants in conjunction with the initial closing in June
2011 and the Company received $7,000 for the purchase of such warrants. In July 2011, the Company
received $472,600 in gross proceeds from the sale of 340,000 over-allotment
shares that the underwriter purchased directly from the Company. The net proceeds of the
over-allotment were $439,518.
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Table of Contents
In May 2011, the Company executed subscription agreements with existing accredited investors
or their affiliates to sell 1,293,103 shares of the Companys common stock in a private placement.
The proceeds of the private placement were approximately $3 million ($2.32 per share). The
proceeds included $2 million in cash and $1 million from the conversion of the Valiant Note. In
conjunction with the private placement, each investor received a warrant to purchase one share of
common stock for each common share purchased pursuant to the subscription agreement. The warrants
are exercisable for the purchase of one share of common stock for $1.80 beginning November 4, 2011
and on or before May 4, 2014.
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 our shareholders for this reverse stock split. On May 18, 2011, the Companys
Board of Directors resolved to effect the reverse stock split of our common stock in a ratio of
1-for-4 effective after the close of business on June 3, 2011. The Company executed the reverse
stock split to regain compliance with the continued listing standards of the Nasdaq Capital Market.
The effect of the reverse split reduced the Companys outstanding common stock shares from
34,126,022 to 8,531,506 shares as of the date of the reverse split.
Note 9 Fair Value Measurements
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 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 market prices of similar debt instruments and
values of comparable borrowings.
Note 10 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. 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. In May 2011, the Valiant Note
was converted to common stock in conjunction with a private placement stock offering. During the
six months ended June 30, 2011, the Company incurred approximately $5,000 in interest expense on
the Valiant Note.
As of June 30, 2011, the Company had approximately $6.3 million on deposit at Valliance Bank.
Valliance Bank is controlled by Mr. Roy T. Oliver, one of our greater than 5% shareholders and
affiliates. In addition, the Company is obligated to Valliance Bank under certain sleep center
capital notes totaling approximately $104,000 and $110,000 at June 30, 2011 and December 31, 2010,
respectively. The interest rates on the notes are fixed and range from 4.25% to 8.75%.
Non-controlling interests in Valliance Bank are held by Mr. Stanton Nelson, the Companys chief
executive officer and Mr. Joseph Harroz, Jr., a director of the Company. 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 60-month lease with Oklahoma Tower Realty Investors, LLC, requiring monthly rental
payments of approximately $10,000. Mr. Roy T. Oliver, one of our greater than 5% shareholders and
affiliates, controls Oklahoma Tower Realty Investors, LLC (Oklahoma Tower). During the six
months ended June 30, 2011 and 2010, the Company incurred approximately $60,000 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.
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Note 11 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:
In conjunction with public offering executed in June 2011, the underwriter had an option to
purchase an additional 700,000 shares of the Companys common stock solely to cover
over-allotments. The underwriter exercised the full over-allotment options with respect to the
warrants and in June 2011 in connection with the initial closing of the public offering, the
Company received $7,000 for the warrants issued in the over-allotment. In July 2011, the Company
received $472,600 in gross proceeds from the 340,000 shares of common stock that the underwriter
purchased directly from the Company upon exercise of the over-allotment option. The net proceeds
of the sale of these shares were $439,518.
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Item 2. | 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.
As of June 30, 2011, we operated 101 sleep diagnostic and therapy centers in 9 states; 24 of
which are located in our facilities with the remaining centers operated under management
agreements. There are certain noncontrolling interest holders in some of our testing facilities,
who are typically physicians in the geographical area being served by the diagnostic sleep testing
facility.
Our sleep management solution is driven by our clinical approach to managing sleep disorders.
Our clinical model is led by our staff of medical directors who are board-certified physicians in
sleep medicine, who oversee the entire life cycle of a sleep disorder from initial referral through
continuing care management. Our approach to managing the care of our patients diagnosed with OSA
is a key differentiator for us. We believe our overall patient CPAP usage compliance rate, as
articulated by the Medicare Standard of compliance requirements, is approximately 80%, compared to
a national compliance rate of approximately 50%. Five key elements support our clinical approach:
| Referral: Our medical directors, who are board-certified physicians in sleep medicine, have forged strong relationships with referral sources, which include primary care physicians, as well as physicians from a wide variety of other specialties and dentists. |
| Diagnosis: We own and operate sleep testing clinics that diagnose the full range of sleep disorders including OSA, insomnia, narcolepsy and restless legs syndrome. |
| CPAP Device Supply: We sell CPAP devices, which are used to treat OSA. |
| Re-Supply: We offer a re-supply program for our patients and other CPAP users to obtain the required disposable components for their CPAP devices that must be replaced on a regular basis. |
| Care Management: We provide continuing care to our patients led by our medical directors who are board-certified physicians in sleep medicine and their staff. |
Our clinical approach increases the long-term compliance of our patients, and enables us to
manage a patients sleep disorder care throughout the life cycle of the disorder, thereby allowing
us to generate a long-term, recurring revenue stream. We generate revenues via three primary
sources: providing the diagnostic tests and related studies for sleep disorders through our sleep
diagnostic centers, the sale of CPAP devices, and the ongoing re-supply of components of the CPAP
device that need to be replaced. In addition, as a part of our ongoing care management program, we
monitor the patients sleep disorder and as the patients medical condition changes, we are paid
for additional diagnostic tests and studies.
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In addition, we believe that our clinical approach to comprehensive patient care, provides
higher quality of care and achieves higher patient compliance. We believe that higher compliance
rates are directly correlated to higher revenue generation per patient compared to our competitors
through increased utilization of our resupply or PRSP program and a greater likelihood of full
reimbursement from federal payors and those commercial carriers who have adopted federal payor
standards.
Public Offering and Private Placement Offering
In June 2011, we completed a public offering of 6,000,000 shares of common stock and warrants
exercisable for the purchase of 6,700,000 shares for gross proceeds of $8,400,000 or $1.40 per
combination of one share of common stock and a warrant to purchase one share of common stock. The
underwriter of the offering received sales commissions of $420,350 (5% of the gross proceeds), a
corporate finance fee of $168,140 (2% of the gross proceeds) and a legal and other expense
allowance of $116,094 (1.4% of the gross proceeds). In conjunction with the offering, each
investor received a warrant to purchase one share of common stock for each share of common stock
purchased. The warrants are exercisable for the purchase of one share of common stock for $1.50
beginning June 20, 2011 and on or before June 20, 2016. We incurred $824,603 in expenses directly
associated with the offering.
In conjunction with the offering, the underwriter had an option to purchase an additional
700,000 shares of our common stock and warrants to purchase 700,000 shares of our common stock
solely to cover over-allotments. The underwriter exercised the full over-allotment option with
respect to the warrants in June 2011 in connection with the initial closing and we received $7,000
for the purchase of such warrants. In July 2011, we received $472,600 in gross proceeds from the
sale of 340,000 over-allotment shares that the underwriter purchased directly from us. The net
proceeds of the over-allotment were $439,518.
In May 2011, we executed subscription agreements with existing accredited investors or their
affiliates to sell 1,293,103 shares of the Companys common stock in a private placement. The
proceeds of the private placement were approximately $3 million ($2.32 per share). The proceeds
included $2 million in cash and $1 million from the conversion of the Valiant Note. In conjunction
with the private placement, each investor received a warrant to purchase one share of common stock
for each common share purchased pursuant to the subscription agreement. The warrants are
exercisable for the purchase of one share of common stock for $1.80 beginning November 4, 2011 and
on or before May 4, 2014.
Reverse Stock Split
On January 26, 2011, our Board of Directors approved a reverse stock split in one of five
ratios, namely 1 for 2, 3, 4, 5 or 6. On February 1, 2011, we received the consent of a majority
of our shareholders for this reverse stock split. On May 18, 2011, our Board of Directors resolved
to effect the reverse stock split of our common stock in a ratio of 1-for-4 effective after the
close of business on June 3, 2011. We executed the reverse stock split to regain compliance with
the continued listing standards of the Nasdaq Capital Market. The Nasdaq Capital Market requires
issuers to maintain a $1.00 minimum bid price. In determining a reverse stock split ratio of
1-for-4, the Board of Directors considered the continued listing standards of the Nasdaq Capital
Markets, considered a ratio that would allow us to achieve long-term compliance with the listing
standards and which allowed us to have a number of outstanding shares to have sufficient trading
volume. Our Board of Directors determined that a ratio of 1-for-4 was the best balance of these
various factors. The effect of the reverse split reduced our outstanding common stock shares from
34,126,022 to 8,531,506 shares as of the date of the reverse split.
Basis of Presentation
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 from operating activities of continuing operations during the year ending December
31, 2010. Furthermore, we had a working capital deficit of approximately $20.5 million as of
December 31, 2010. At that time, there was substantial doubt about our ability to continue as a
going concern.
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During May 2011 and June 2011, we raised a total of $8.9 million in net proceeds from a
private and public offering of common stock and warrants. As of June 30, 2011, we had cash and
cash equivalents of $6.6 million and total equity of $7.6 million. The $6.6 million in cash and
cash equivalents, as of June 30, 2011, is significantly more than our projected cash needs for the
next twelve months of approximately $3.9 million. As a result, the substantial doubt about our
ability to continue as a going concern has been eliminated.
As of June 30, 2011, our Debt Service Coverage Ratio is less than 1.25 to 1 which is ratio
required by our loan agreement with Arvest Bank. We have obtained a waiver from Arvest Bank for
the Debt Service Coverage Ratio through December 31, 2011. Since the waiver does not extend past
twelve months from June 30, 2011, the associated debt with Arvest Bank has been classified as
current in our consolidated balance sheets.
Discontinued Operations
In May 2011, we executed an Asset Purchase Agreement (Agreement) with Daniel I. Rifkin,
M.D., P.C. providing for the sale of substantially all of the assets of our subsidiary, Nocturna
East, Inc. (East) for $2,500,000. In conjunction with the sale of East assets, the Management
Services Agreement (MSA) under which the Company provided certain services to the sleep centers
owned by Independent Medical Practices (IMA) including billing and collections, trademark rights,
non-clinical sleep center management services, equipment rental fees, general management services,
legal support and accounting and bookkeeping services will be terminated. Our decision to sell the
assets of East was primarily based on our determination that the operations of East no longer fit
into our strategic plan of providing a full continuum of care to patients due to significant
regulatory barriers that limit our ability to sell CPAP devices and other supplies at the East
locations. As a result of the sale of East, the historical assets, and liabilities, results of
operations and cash flows of East have been classified as discontinued operations for financial
statement reporting purposes.
On September 1, 2010, we executed an Asset Purchase Agreement, which was subsequently amended
on October 29, 2010, (as amended, the Agreement) providing for the sale of substantially all of
the assets of the 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.
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 was 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 did not increase by a certain
percentage of the average daily prescription sales by the ApothecaryRx Sterling, Colorado location
(the Retention Rate Earnout). The six-month period has passed and there was no adjustment as a
result of the
Retention Rate Earnout.
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Results of Operations
The following table sets forth selected results of our operations for the three months and six
months ended June 30, 2011 and 2010. The following information was derived and taken from our
unaudited financial statements appearing elsewhere in this report.
Comparison of the Three Month and Six Month Periods Ended June 30, 2011 and 2010
For the Three Months Ended | For the Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net Revenues: |
||||||||||||||||
Services |
$ | 3,143,390 | $ | 4,108,597 | $ | 6,100,994 | $ | 8,195,973 | ||||||||
Product sales |
1,265,763 | 1,416,668 | 2,512,140 | 2,655,718 | ||||||||||||
4,409,153 | 5,525,265 | 8,613,134 | 10,851,691 | |||||||||||||
Cost of services |
1,292,960 | 1,404,281 | 2,515,904 | 2,856,881 | ||||||||||||
Cost of sales |
388,660 | 294,831 | 797,356 | 695,166 | ||||||||||||
Selling, general and administrative |
3,133,739 | 3,615,158 | 6,722,989 | 8,147,949 | ||||||||||||
Bad debt expense |
122,980 | 541,994 | 240,828 | 780,893 | ||||||||||||
Depreciation and amortization |
277,534 | 333,762 | 557,474 | 665,822 | ||||||||||||
Net other expense |
332,372 | 286,455 | 684,178 | 570,686 | ||||||||||||
Loss from continuing
operations, before taxes |
(1,139,092 | ) | (951,216 | ) | (2,905,595 | ) | (2,865,706 | ) | ||||||||
Provision for income taxes |
(3,498 | ) | 16,502 | (6,996 | ) | (1,004 | ) | |||||||||
Loss from continuing
operations, net of taxes |
(1,142,590 | ) | (934,714 | ) | (2,912,591 | ) | (2,866,710 | ) | ||||||||
Discontinued operations, net of taxes |
542,342 | 801,478 | 391,373 | 1,267,727 | ||||||||||||
Net loss |
(600,248 | ) | (133,236 | ) | (2,521,218 | ) | (1,598,983 | ) | ||||||||
Less: Noncontrolling interests |
(18,378 | ) | 6,072 | (103,082 | ) | (34,727 | ) | |||||||||
Net loss attributable to
Graymark Healthcare |
$ | (581,870 | ) | $ | (139,308 | ) | $ | (2,418,136 | ) | $ | (1,564,256 | ) | ||||
Discussion of Three Month Periods Ended June 30, 2011 and 2010
Services revenues decreased $1.0 million (a 23.5% decrease) during the three months ended June
30, 2011 compared with the second quarter of 2010. The decline in revenues from sleep diagnostic
services compared to the second quarter of 2010 was comprised of:
| $0.3 million due to lower volumes; and |
| $0.7 million due to lower average revenue per sleep study performed. |
While we saw a significant improvement in volume versus the first quarter of the current year,
volumes compared to the second quarter of 2010 were lower. We have seen a reduction in our average
rate per sleep study due to the shift during the second half of 2010 to more in-network contracts
for sleep diagnostic services. This coupled with a reduction in Medicare reimbursement and other,
out-of-network rate reductions contributed to our lower average rate per sleep study compared to
the second quarter of 2010.
Product revenues from our sleep therapy business decreased $0.2 million (a 10.7% decrease)
during the three months ended June 30, 2011 compared with the second quarter of 2010. The decrease
was due to a $0.3 million reduction in revenue from the initial set-up of CPAP devices, partially
offset by a $0.1 million increase in revenue from our re-supply business. The reduction in CPAP
set-up revenues was a combination of slightly lower volumes, driven by the lower sleep study
volumes which were partially offset by improved conversion rates from
sleep study to CPAP set-up, and a reduction in average revenue per set-up performed. The increase
in supply revenue was driven by the continued growth of our recurring re-supply revenue stream.
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During the first quarter of 2011 we focused on driving referral volume in our sleep diagnostic
centers by making several key management changes in our sales team and implementing new sales
incentive initiatives. These changes and initiatives produced significantly higher sleep study
volumes in March 2011 and continuing into the second quarter.
Cost of services decreased $0.1 million (a 7.9% decrease) during the three months ended June
30, 2011 compared with the second quarter of 2010. The decrease in cost of services was primarily
due to decreased sleep study volumes and operational efficiencies including a decrease in
technician labor cost per sleep study performed and the renegotiation and resulting reduction of
professional interpretation fees.
Cost of services as a percent of services was 41.1% and 34.2% during the three months ended
June 30, 2011 and 2010, respectively. The increase in cost of services as a percent of service
revenue was primarily due to lower average reimbursement related to our sleep diagnostic services
which was partially offset by operational efficiencies.
Cost of sales from our sleep therapy business increased $0.1 million during the three months
ended June 30, 2011 compared with the second quarter of 2010. The increase was due to an
adjustment of approximately $0.1 million in the second quarter of 2010 to reflect the appropriate
cost of sales and inventory levels for in-service equipment. Net of that adjustment, cost of sales
from our therapy business would have been flat compared to the second quarter of 2010.
Cost of sales as a percent of product sales was 30.7% and 20.8% during the three months ended
June 30, 2011 and 2010, respectively. The increase in cost of sales as a percent of product sales
was due to the previously described adjustment in the second quarter of 2010 (accounting for 6% of
the variance) as well as lower average reimbursement for both CPAP set-ups and supply sales.
Selling, general and administrative expenses decreased $0.5 million (a 13.3% decrease) to $3.1
million or 71.1% of revenue from $3.6 million or 65.4% of revenue during the three months ended
June 30, 2011, compared with the second quarter of 2010. The decrease in selling, general and
administrative expenses was primarily due to:
| a decrease in operating expenses in our sleep diagnostic business of $0.4 million compared to the second quarter of 2010 primarily due to the implementation of several cost reduction initiatives including staff reductions related to the centralization of billing, renegotiating of facility leases and consolidation of non-profitable facilities during the last quarter of 2010 and the first quarter of 2011. |
| an increase in operating expense in our sleep therapy business of $0.1 million as we expanded our infrastructure in order to gain operating efficiencies and prepare for continued growth in this business unit; and |
| a decrease in overhead incurred at the parent-company level of $0.2 million due to reductions in executive labor expenses related to staff reductions and reduced legal and other professional fee expenses. |
Bad debt expense decreased $0.4 million (a 77.3% decrease) to $0.1 million or 2.8% of revenue
from $0.5 million or 9.8% of revenue during the three months ended June 30, 2011, compared with the
second quarter of 2010. The decrease is primarily due to improvements in the overall aging and
collection efforts related to open accounts receivable balances compared with the second quarter of
2010 which are largely related to our migration from out-of-network providers to in-network
providers.
Depreciation and amortization represents the depreciation expense associated with our fixed
assets and the amortization attributable to our intangible assets. Depreciation and amortization
decreased $0.1 million (a 16.8% decrease) during the three months ended June 30, 2011 compared to
the second quarter of 2010. The decrease is primarily due to the fixed asset impairment of $0.8
million recorded in the third quarter of 2010 which reduced the
overall asset base and depreciation rates.
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Net other expense represents interest expense on borrowings reduced by interest income earned
on cash and cash equivalents. Net other expense increased approximately $46,000 (a 16.0% increase)
during the three months ended June 30, 2011 compared with the second quarter of 2010. The increase
is related to interest expense on debt that was moved from discontinued operations to continuing
operations.
Income from discontinued operations represents the net income (loss) from the operations of
East and ApothecaryRx. In May 2011 and December 2010, we completed the sale of substantially all
of the assets of East and ApothecaryRx, respectively. As a result, the related assets,
liabilities, results of operations and cash flows of East and ApothecaryRx have been classified as
discontinued operations. In addition, we have discontinued operations related to our
discontinued internet sales division and discontinued film operations. The results of
East, ApothecaryRx and our other discontinued operations for the three months ended June 30, 2011
and 2010 follows:
2011 | 2010 | |||||||
Revenues: |
||||||||
East |
$ | 80,982 | $ | 585,608 | ||||
ApothecaryRx |
(68,495 | ) | 22,142,612 | |||||
Other |
(1,184 | ) | 193 | |||||
$ | 11,303 | $ | 22,728,413 | |||||
Income (loss) from discontinued
operations, before taxes: |
||||||||
East |
$ | (35,057 | ) | $ | 220,390 | |||
ApothecaryRx |
(156,348 | ) | 599,021 | |||||
Other |
(977 | ) | (17,933 | ) | ||||
Gain recorded on sale of East |
734,724 | | ||||||
Income tax (provision) |
| | ||||||
Income (loss) from discontinued operations |
$ | 542,342 | $ | 801,478 | ||||
Noncontrolling interests were allocated approximately $18,000 of net loss during the three
months ended June 30, 2011 compared with the second quarter of 2010 when noncontrolling interests
were allocated approximately $6,000 in net income. 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 $0.6 million (13% of approximately $4.4 million in net revenues) during the second
quarter of 2011, compared to a net loss of approximately $0.1 million (3% of approximately $5.5
million in net revenues) during the second quarter of 2010.
Discussion of Six Month Periods Ended June 30, 2011 and 2010
Services revenues decreased $2.1 million (a 25.6% decrease) during the six months ended June
30, 2011 compared with the first six months of 2010. The decline in revenues from sleep diagnostic
services at existing locations compared to the first six months of 2010 was comprised of:
| $0.9 million due to lower volumes; |
| $1.2 million due to lower average revenue per sleep study performed; and |
During the first quarter of 2011, we incurred a series of severe weather events at our
locations in Kansas, Iowa, South Dakota, Oklahoma and Texas in January and February of 2011 which
negatively impacted our volumes in those months. As a result of the severe weather, several of our
labs were forced to close on multiple days during those months, contributing to reduced volumes in
the first half of 2011. We have seen a reduction in our average rate per sleep study due to the
shift late in 2010 and early 2011 to more in-network contracts for sleep diagnostic
services. This coupled with a reduction in Medicare reimbursement and other, out-of-network
rate reductions contributed to our lower average rate per sleep study compared to the first six
months of 2010.
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Table of Contents
Product revenues from our sleep therapy business decreased $0.1 million (a 5.4% decrease)
during the six months ended June 30, 2011 compared with the first six months of 2010. The decrease
was due to $0.3 million in lower set-up revenue driven by a combination of lower volumes due to
lower sleep study volumes which was partially offset by improved conversion rates, and lower
average reimbursement per set-up, offset by a $0.2 million increase in supply revenues reflecting
the continued growth of our re-supply business.
During the first and second quarter of 2011 we focused on driving referral volume in our sleep
diagnostic centers by making several key management changes in our sales team and implementing new
sales incentive initiatives in the first quarter. These changes and initiatives produced
significantly higher sleep study volumes in March and through the second quarter of 2011 and we
expect that trend to continue through the balance of 2011.
Cost of services decreased $0.3 million (an 11.9% decrease) to $2.5 million from $2.8 million
during the six months ended June 30, 2011 compared with the first six months of 2010. The decrease
in cost of services was primarily due to decreased sleep study volumes and operational efficiencies
including a decrease in technician labor cost per sleep study performed and the renegotiation and
resulting reduction of professional interpretation fees.
Cost of services as a percent of services was 41.2% and 34.9% during the six months ended June
30, 2011 and 2010, respectively. The increase in cost of services as a percent of services was
primarily due to lower average reimbursement related to our sleep diagnostic services which was
partially offset by operational efficiencies.
Cost of sales from our sleep therapy business increased $0.1 million during the six months
ended June 30, 2011 compared with the first six months of 2010. The increase was due to an
adjustment of approximately $0.1 million in the second quarter of 2010 to reflect the appropriate
cost of sales and inventory levels for in-service equipment. Net of that adjustment, cost of sales
from our therapy business would have been flat compared to the first half of 2010.
Cost of sales as a percent of product sales was 31.7% and 26.2% during the six months ended
June 30, 2011 and 2010, respectively. The increase in cost of sales as a percent of product sales
was due to the previously described adjustment in the second quarter of 2010 (accounting for 3.2%
of the 5.5% variance) as well as lower average reimbursement for both set-ups and supply sales.
Selling, general and administrative expenses decreased $1.4 million (a 17.5% decrease) to $6.7
million or 78% of revenue from $8.1 million or 75% of revenue during the six months ended June 30,
2011, compared with the first six months of 2010. The decrease in selling, general and
administrative expenses was primarily due to:
| a decrease in operating expenses in our sleep diagnostic business of $1.0 million compared to the first six months of 2010 primarily due to the implementation of several cost reduction initiatives including staff reductions, renegotiating of facility leases and consolidation of non-profitable facilities during the last three quarters of 2010 and the first quarter of 2011; |
| an increase in operating expense in our sleep therapy business of $0.3 million as we expanded our infrastructure in order to gain operating efficiencies and prepare for continued growth in this business unit; and |
| a decrease in overhead incurred at the parent-company level due to decreased stock option expense of $0.3 million and $0.4 million related to reductions in executive labor expenses due to staff reductions and lower legal and other professional fees. |
Bad debt expense decreased $0.5 million (a 69.2% decrease) to $0.2 million or 7.2% of revenue
from $0.7 million or 6.1% of revenue during the six months ended June 30, 2011, compared with the
first six months of 2010. The decrease is primarily due to improvements in the overall aging and
collection efforts related to open accounts receivable balances compared with the first six months
of 2010 which are largely related to our migration from out-of-network providers to in-network
providers.
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Depreciation and amortization represents the depreciation expense associated with our fixed
assets and the amortization attributable to our intangible assets. Depreciation and amortization
decreased $0.1 million (a 16.3% decrease) during the six months ended June 30, 2011 compared to the
first six months of 2010. The decrease is primarily due to the fixed asset impairment of $0.8
million recorded in the third quarter of 2010 which reduced the overall asset base and depreciation
rates.
Net other expense represents interest expense on borrowings reduced by interest income earned
on cash and cash equivalents. Net other expense increased $0.1 million (a 19.9% increase) during
the six months ended June 30, 2011 compared with the first six months of 2010. The increase is
related to interest expense on debt that was moved from discontinued operations to continuing
operations.
Income from discontinued operations represents the net income (loss) from the operations of
East and ApothecaryRx. In May 2011 and December 2010, we completed the sale of substantially all
of the assets of East and ApothecaryRx, respectively. As a result, the related assets,
liabilities, results of operations and cash flows of East and ApothecaryRx have been classified as
discontinued operations. In addition, we have discontinued operations related to our
discontinued internet sales division and discontinued film operations. The results of
East, ApothecaryRx and our other discontinued operations for the six months ended June 30, 2011 and
2010 follows:
2011 | 2010 | |||||||
Revenues: |
||||||||
East |
$ | 566,874 | $ | 1,171,217 | ||||
ApothecaryRx |
(134,708 | ) | 43,836,051 | |||||
Other |
(1,184 | ) | 193 | |||||
$ | 430,982 | $ | 45,007,461 | |||||
Income (loss) from discontinued
operations, before taxes: |
||||||||
East |
$ | 28,652 | $ | 403,370 | ||||
ApothecaryRx |
(363,314 | ) | 884,180 | |||||
Other |
(8,689 | ) | (19,823 | ) | ||||
Gain recorded on sale of East |
734,724 | | ||||||
Income tax (provision) |
| | ||||||
Income (loss) from discontinued operations |
$ | 391,373 | $ | 1,267,727 | ||||
Noncontrolling interests were allocated approximately $103,000 and $35,000 of net loss during
the six months ended June 30, 2011 and 2010, respectively. Noncontrolling interests are the equity
ownership interests in our SDC Holdings subsidiaries that are not wholly-owned.
Net income (loss) attributable to Graymark Healthcare. Our operations resulted in a net loss
of approximately $2.4 million (40% of approximately $8.6 million in net revenues) during the six
months ended June 30, 2011, compared to a net loss of approximately $1.6 million (19% of
approximately $10.9 million in net revenues) during the first six months of 2010.
Liquidity and Capital Resources
Generally our liquidity and capital resources needs are funded from operations, loan proceeds
and equity offerings. As of June 30, 2011, our liquidity and capital resources included cash and
cash equivalents of $6.6 million and working capital deficit of $9.7 million. As of December 31,
2010, our liquidity and capital resources included cash and cash equivalents of $1.6 million and a
working capital deficit of $20.5 million.
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Cash used in operating activities from continuing operations was $3.6 million during the six
months ended June 30, 2011 compared to $1.7 million for the first six months of 2010. During the
six months ended June 30, 2011, the primary uses of cash from operating activities from continuing
operations were cash required to fund losses from continuing operations (net non-cash adjustments)
of $2.1 million, a net reduction of accounts payable
and accrued liabilities totaling $0.3 million, and an increase in accounts receivable and
other assets totaling $1.2 million. During the six months ended June 30, 2010, the primary uses of
cash from operating activities from continuing operations were cash required to fund losses from
continuing operations (net of non-cash adjustments) of $1.1 million, increase in inventories of
$0.2 million and an increase in other assets of $0.2 million. The primary sources of cash from
operating activities from continuing operations during the second quarter of 2010 was a net
increase in accounts payable and accrued liabilities of $0.2 million.
Cash provided by discontinued operations for the six months ended June 30, 2011 was $0.3
million compared to $2.2 million for the first six months of 2010.
Net cash provided by investing activities from continuing operations during the six months
ended June 30, 2011 was approximately $7,000 compared to the first six months of 2010 when
investing activities from continuing operations used approximately $9,000.
Net cash provided by investing activities from discontinued operations during the six months
ended June 30, 2011 was $2.5 million compared to the first six months of 2010 when we used
approximately $29,000. In May 2011, we sold substantially all of the assets of East for $2.5
million.
Net cash provided by financing activities from continuing operations during the six months
ended June 30, 2011 was $6.7 million compared to net cash used in financing activities of $0.3
million during the first six months of 2010. During the six months ended June 30, 2011, we raised
$6.9 million and $2.0 million in a public offering and private placement offering, respectively.
We also received $1.0 million in proceeds from our credit facility with Valiant Investments, LLC
which was subsequently repaid with common stock in conjunction with the private placement. During
the six months ended June 30, 2011, we made debt payments of $3.2 million. During the six months
ended June 30, 2010, the primary use of cash from financing activities from continuing operations
was debt payments totaling $0.3 million.
Net cash used in financing activities from discontinued operations during the six months ended
June 30, 2010 was $0.8 million.
On the 12-month anniversary of the final closing date of the sale of ApothecaryRx (December
2011), 50% of the funds held in the Indemnity Escrow Fund (currently $1.0 million) 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 (June 2012), subject to any pending claims for indemnification. Of
the $2,000,000 Indemnity Escrow Fund, $1,000,000 was 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 purchased the ApothecaryRx location in Sterling, Colorado did not
increase by a certain percentage of the average daily prescription sales of ApothecaryRxs
Sterling, Colorado location during a period prior to the closing (the Retention Rate Earnout).
The six-month period has passed and there was no adjustment as a result of the Retention Rate
Earnout.
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.
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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.
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.
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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 were 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 June 30, 2011, the Companys Debt Service Coverage
Ratio is less than 1.25 to 1. In June 2011, the Company prepaid approximately $1.1 million in
principal and interest to Arvest Bank and as a result, Arvest Bank has waived the Debt Service
Coverage Ratio requirement through December 31, 2011. The prepayment represents all principal and
interest payments due to Arvest Bank between July 1, 2011 and December 31, 2011. The prepayment is
reflected in other current assets on our consolidated balance sheets. The prepayment will be
recorded as interest expense and a reduction of principal in accordance with the loan agreement.
There is no assurance that Arvest Bank will waive the Debt Service Coverage Ratio requirement
beyond December 31, 2011. Since the waiver does not extend past twelve months from June 30, 2011,
the associated debt with Arvest Bank has been classified as current in our consolidated balance
sheets.
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.
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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
used the loan proceeds to fund our working capital needs. We fully advanced the loan during the
second quarter of 2011 and in May 2011, we repaid the loan with common stock as part of our private
placement offering.
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 (we made a $3 million payment to Arvest on May 12, 2011); |
| 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 (we paid this fee on 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 (we made this prepayment in the amount of $1.1 million on June 30, 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, 2012 and June 30, 2012 (our public offering did not exceed $15 million); |
| 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 Valiant Investments loan is subordinated to Arvests credit facility in all respects. |
Financial Commitments
Our future commitments under contractual obligations by expected maturity date at June 30,
2011 are as follows:
< 1 year | 1-3 years | 3-5 years | > 5 years | Total | ||||||||||||||||
Long-term debt (1) |
$ | 20,875,731 | $ | 310,176 | $ | 10,679 | $ | | $ | 21,196,586 | ||||||||||
Operating leases |
1,213,983 | 2,100,668 | 904,655 | 2,296,236 | 6,515,542 | |||||||||||||||
Operating leases, discontinued operations |
272,367 | 330,558 | 23,188 | | 626,113 | |||||||||||||||
$ | 22,362,081 | $ | 2,741,402 | $ | 938,522 | $ | 2,296,236 | $ | 28,338,241 | |||||||||||
(1) | Includes principal and interest obligations. |
Our uses of cash for the next twelve months will be principally for working capital needs and
debt service as we do not have any material capital expenditures planned, however, we do have
contractual commitments of approximately $22.3 million for payments on our indebtedness and for
operating lease payments.
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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. For a complete discussion of all our significant accounting policies
please see our 2010 annual report on Form 10-K. 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 our sleep diagnostic business, 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
business acquired from somniCare, Inc. and somniTech, Inc. (Somni) business since the date of the
acquisition in 2009 and for our remaining sleep diagnostic business since the fourth quarter of
2010. We do not anticipate any future changes to this process. In our historic sleep therapy
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. 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. The key assumption in this process is that actual reimbursement history is a
reasonable predictor of the future reimbursement for each payor at each facility. 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. We
expect to transition our historic sleep therapy business to the same process currently used for our
sleep diagnostic business by the end of 2011. This change in process and assumptions for our
historic sleep therapy 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
occur 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.
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.
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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 revenue from the sale is recognized over a specified period, the product cost
associated with that sale is recognized over that same period. If the revenue from a product sale
is recognized 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, compared to the same periods in 2010, 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 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.
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.
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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 follows:
June 30, 2011 | December 31, 2010 | |||||||||||||||
Actual | Expected | Actual | Expected | |||||||||||||
Sleep diagnostic business |
49.45 | 45 to 50 | 48.62 | 50 to 55 | ||||||||||||
Sleep therapy business |
67.79 | 55 to 60 | 51.30 | 55 to 60 |
We decreased our expected DSO for sleep diagnostic business from 50 to 55 days at December 31,
2010 to 45 to 50 days at June 30, 2011 as a result of continued improvement in our collection
process related to amounts due from patients. We anticipate that the expected DSO for our sleep
diagnostic business will continue to decrease in the future. The DSO for our sleep therapy
business was inflated at June 30, 2011 as a result of timing issues related to our collections. We
have also experienced an increase in the level of past due receivables in our sleep therapy
business. We are currently investigating the cause of the in the increase in DSO and we expect to
return to the expected range by September 30, 2011.
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 assets whenever events or changes in
circumstances indicate that an intangible assets carrying amount may not be recoverable.
Recently Adopted and Recently Issued Accounting Guidance
Adopted Guidance
On January 1, 2011, we adopted changes issued by the Financial Accounting Standards Board
(FASB) 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. The adoption of these changes had no impact on our
consolidated financial statements, as we do not currently have any such arrangements with its
customers.
On January 1, 2011, we adopted changes issued by the FASB 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). The adoption of these changes had no impact on our consolidated financial
statements.
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On January 1, 2011, we adopted changes issued by the FASB to the testing of goodwill for
impairment.
These changes require an entity to perform all steps in the test for a reporting unit whose
carrying value is zero or negative if it is more likely than not (more than 50%) that a goodwill
impairment exists based on qualitative factors. This will result in the elimination of an entitys
ability to assert that such a reporting units goodwill is not impaired and additional testing is
not necessary despite the existence of qualitative factors that indicate otherwise. Based on the
most recent impairment review of our goodwill (2010 fourth quarter), the adoption of these changes
had no impact on our consolidated financial statements.
On January 1, 2011, we adopted changes issued by the FASB to the disclosure of pro forma
information for business combinations. These changes clarify that if a public entity presents
comparative financial statements, the entity should disclose revenue and earnings of the combined
entity as though the business combination that occurred during the current year had occurred as of
the beginning of the comparable prior annual reporting period only. Also, the existing
supplemental pro forma disclosures were expanded to include a description of the nature and amount
of material, nonrecurring pro forma adjustments directly attributable to the business combination
included in the reported pro forma revenue and earnings. The adoption of these changes had no
impact on our consolidated financial statements.
Issued Guidance
In July 2011, the FASB issued Presentation and Disclosure of Patient Service Revenue,
Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities
(ASU 2011-07), which requires healthcare organizations that perform services for patients for which
the ultimate collection of all or a portion of the amounts billed or billable cannot be determined
at the time services are rendered to present all bad debt expense associated with patient service
revenue as an offset to the patient service revenue line item in the statement of operations. The
ASU also requires qualitative disclosures about the our policy for recognizing revenue and bad debt
expense for patient service transactions and quantitative information about the effects of changes
in the assessment of collectability of patient service revenue. This ASU is effective for fiscal
years beginning after December 15, 2011, and will be adopted by us in the first quarter of 2012.
We are currently assessing the potential impact the adoption of this ASU will have on its
consolidated results of operations and consolidated financial position.
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, business plans or
objectives, levels of activity, performance or achievements, or industry results, to be materially
different from any future results, business plans or objectives, 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
| discuss our future expectations; |
| contain projections of our future operating results or of our future financial condition; or |
| 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 this
report and our Annual Report on Form 10-K and not to place undue reliance on the forward-looking
statements contained in this report or our Annual Report, which speak only as of the date of this
report or the date of our Annual Report. 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 3. | 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.
Item 4. | Controls and Procedures. |
Evaluation of 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 in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the
Exchange Act)), as of June 30, 2011. Disclosure controls and procedures are designed to ensure
that information required to be disclosed by the Company in the reports it files or submits under
the Exchange Act is recorded, processed, summarized and reported on a timely basis and that such
information is accumulated and communicated to management, including the Principal Executive
Officer and Principal Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. Based on this evaluation, our Principal Executive Officer and Principal
Financial Officer concluded that these disclosure controls and procedures are effective.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2011 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
Material Weakness
Internal Controls over Financial Reporting
During the fourth quarter of 2010 and as part of the sale of ApothecaryRx assets, 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 ApothecaryRx caused us to conclude that we had 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 assets represented
a material weakness in our internal controls over financial reporting.
Since the operations of ApothecaryRx were sold, no remediation efforts were needed related to
those specific control deficiencies. However, due to the significance of the ApothecaryRx special
charges, we began an evaluation of the circumstances and potential changes to our entity wide
controls to address the other identified control deficiencies. The evaluation of entity wide
controls is still in process. We have not identified any additional material weaknesses or
significant deficiencies, but we have identified areas of improvement to eliminate identified
control deficiencies, including enhancing the level of documentation and testing of our internal
controls over financial reporting.
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PART II. OTHER INFORMATION
Item 1. | Legal Proceedings. |
In the normal course of business, we may become involved in litigation or in legal
proceedings. Except as described above, we are not aware of any such litigation or legal
proceedings, that we believe will have, individually or in the aggregate, a material adverse effect
on our business, financial condition and results of operations.
Item 1A. | Risk Factors. |
There have been no material changes from the risk factors previously disclosed in our 2010
Annual Report on Form 10-K.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
Unregistered Sales of Equity Securities
We do not have anything to report under this Item.
Repurchases of Equity Securities
We do not have anything to report under this Item.
Item 3. | Defaults Upon Senior Securities. |
We do not have anything to report under this Item.
Item 4. | (Removed and Reserved). |
Item 5. | Other Information. |
We do not have anything to report under this Item.
Item 6. | Exhibits. |
(a) Exhibits:
Exhibit No. | Description | |||
3.1 | Certificate of Amendment to the Registrants Restated Certificate of
Incorporation is incorporated by reference to Exhibit 3.1.1 to the Registrants
Registration Statement on Form S-1 filed with the U.S. Securities and Exchange
Commission on May 7, 2011. |
|||
4.4 | Form of Warrant to Purchase Common Stock issued pursuant to the Underwriting
Agreement dated June 14, 2011 is incorporated by reference to Exhibit 4.1 to the
Registrants Current Report with the U.S. Securities and Exchange Commission on Form
8-K filed on May 15, 2011. |
|||
10.1 | Form of Subscription Agreement dated April 30, 2011 by and between each of
Graymark Healthcare, Inc., and each of MTV Investments, LP, Black Oak II, LLC, TLW
Securities, LLC and Valiant Investments, LLC, 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 May 5, 2011. |
|||
10.2 | Form of Warrant Agreement dated May 4, 2011 issued to each of MTV Investments,
LP, Black Oak II, LLC, TLW Securities, LLC and Valiant Investments, LLC, 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 May 5, 2011. |
|||
31.1 | Certification of Stanton Nelson, Chief Executive Officer of Registrant
(furnished herewith). |
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Exhibit No. | Description | |||
31.2 | Certification of Edward M. Carriero, Jr., Chief Financial Officer of Registrant
(furnished herewith). |
|||
31.3 | Certification of Grant A. Christianson, Chief Accounting Officer of Registrant
(furnished herewith). |
|||
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 (furnished herewith). |
|||
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, Jr., Chief Financial
Officer of Registrant (furnished herewith). |
|||
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 (furnished herewith). |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
GRAYMARK HEALTHCARE, INC. (Registrant) |
||||
By: | /s/ STANTON NELSON | |||
Stanton Nelson | ||||
Chief Executive Officer (Principal Executive Officer) |
||||
Date: August 12, 2011 |
By: | /s/ EDWARD M. CARRIERO, JR. | |||
Edward M. Carriero, Jr. | ||||
Chief Financial Officer (Principal Financial Officer) |
||||
Date: August 12, 2011 |
By: | /s/ GRANT A. CHRISTIANSON | |||
Grant A. Christianson | ||||
Chief Accounting Officer (Principal Accounting Officer) |
||||
Date: August 12, 2011 |
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