##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D. C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2008
 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.
  OKLAHOMA
(State or other jurisdiction of 
incorporation or organization)
    
    20-0180812
(I.R.S. Employer
Identification No.)
 210 Park Avenue, Ste. 1350
Oklahoma City, Oklahoma 73102   (405) 601-5300








þ o




Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer o
    
    Smaller reporting company þ(Do not check if a smaller reporting company)


o þ












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##### 



GRAYMARK HEALTHCARE, INC
  Part I. Financial InformationItem 1. Consolidated Condensed Financial Statements (Unaudited)
    
    
    1a) Balance Sheets
    
    
    2b) Statements of Operations
    
    
    3c) Statements of Operations
    
    
    4d) Statements of Cash Flows
    
    
    5e) Notes to Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    27Item 4. Controls and Procedures and Item 4T. Controls and Procedures
    
    
    27Part II. Other InformationItem 1. Legal Proceedings
    
    
    28Item 1A. Risk Factors
    
    
    28Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    28Item 3. Defaults Upon Senior Securities
    
    
    29Item 4. Submission of Matters to a Vote of Security Holders
    
    
    29Item 5. Other Information
    
    
    29Item 6. Exhibits
    
    
    29SIGNATURES
    
    
    30EX-31.1EX-31.2EX-32.1EX-32.2
     -i-




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Graymark Healthcare, Inc. Consolidated Condensed Financial Statements
   -1-




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GRAYMARK HEALTHCARE, INC.
 
 Consolidated Condensed Balance Sheets
(Unaudited)
 September 30,
    
    
    December 31,2008
    
    
    2007ASSETSCash and cash equivalents
    
    $
    17,556,341
    
    
    $
    2,072,866Accounts receivable, net of allowance for sales adjustments and
doubtful accounts of $13,756,980 and $5,946,788, respectively
    
    
    13,577,255
    
    
    
    6,485,267Inventories
    
    
    8,580,706
    
    
    
    4,238,670Other current assets
    
    
    124,449
    
    
    
    133,791Total current assets
    
    
    39,838,751
    
    
    
    12,930,594Property and equipment, net
    
    
    4,488,316
    
    
    
    2,069,685Intangible assets, net
    
    
    8,472,693
    
    
    
    5,609,326Goodwill
    
    
    29,694,923
    
    
    
    20,247,905Other assets
    
    
    110,700
    
    
    
    275,127Total assets
    
    $
    82,605,383
    
    
    $
    41,132,637LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Accounts payable
    
    $
    6,497,407
    
    
    $
    4,423,324Accrued liabilities
    
    
    5,163,839
    
    
    
    2,474,404Short-term debt
    
    
    865,739
    
    
    
    13,993,015Current portion of long-term debt
    
    
    3,715,940
    
    
    
    2,394,512Total current liabilities
    
    
    16,242,925
    
    
    
    23,285,255Long-term debt, net of current portion
    
    
    43,200,516
    
    
    
    15,354,584Total liabilities
    
    
    59,443,441
    
    
    
    38,639,839Minority interests
    
    
    458,487
    
    
    
    629,916Shareholders 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; 27,569,106 and 22,190,400 issued and outstanding
at September 30, 2008 and December 31, 2007, respectively
    
    
    2,757
    
    
    
    2,219Paid-in capital
    
    
    26,832,001
    
    
    
    7,286,636Accumulated deficit
    
    
    (4,131,303
    )
    
    
    (5,425,973
    )Total shareholders equity
    
    
    22,703,455
    
    
    
    1,862,882Total liabilities and shareholders equity
    
    $
    82,605,383
    
    
    $
    41,132,637
  -2-




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##### Table of Contents



GRAYMARK HEALTHCARE, INC.
 
 Consolidated Condensed Statements of Operations
For the Three Months Ended September 30, 2008 and 2007
(Unaudited)
 2008
    
    
    2007Revenues:Product sales
    
    $
    23,510,086
    
    
    $
    11,522,639Services
    
    
    3,973,904
    
    
    
    2,143,26227,483,990
    
    
    
    13,665,901Costs and Expenses:Cost of sales
    
    
    17,383,849
    
    
    
    8,734,458Cost of services
    
    
    1,553,107
    
    
    
    995,362Selling, general and administrative
    
    
    6,843,086
    
    
    
    3,184,333Depreciation and amortization
    
    
    424,980
    
    
    
    216,24126,205,022
    
    
    
    13,130,394Income from continuing operations
    
    
    1,278,968
    
    
    
    535,507Other Income (Expense):Interest expense, net
    
    
    (576,244
    )
    
    
    (498,232
    )Net income before minority interests and provision for income taxes
    
    
    702,724
    
    
    
    37,275Minority interests
    
    
    28,595
    
    
    
    (167,952
    )Net income (loss) before provision for income taxes
    
    
    731,319
    
    
    
    (130,677
    )Provision for income taxes
    
    
    (277,901
    )
    
    
    Net income (loss) from continuing operations
    
    
    453,418
    
    
    
    (130,677
    )Income from discontinued operations
    
    
    87,696
    
    
    
    Net income (loss)
    
    $
    541,114
    
    
    $
    (130,677
    )Net earnings per common share (basic and diluted):Net income (loss) from continuing operations
    
    $
    0.02
    
    
    $
    (0.01
    )Income from discontinued operations
    
    
    
    
    
    
    Net earnings (loss) per share
    
    $
    0.02
    
    
    $
    (0.01
    )Average common shares outstanding
    
    
    27,508,924
    
    
    
    20,400,000Dilutive effect of stock warrants and options
    
    
    452,000
    
    
    
    Average common shares outstanding assuming dilution
    
    
    27,960,924
    
    
    
    20,400,000
  -3-




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##### Table of Contents



GRAYMARK HEALTHCARE, INC.
 
 Consolidated Condensed Statements of Operations
For the Nine months Ended September 30, 2008 and 2007
(Unaudited)
 2008
    
    
    2007Revenues:Product sales
    
    $
    60,167,242
    
    
    $
    27,983,943Services
    
    
    9,633,269
    
    
    
    5,364,33469,800,511
    
    
    
    33,348,277Costs and Expenses:Cost of sales
    
    
    44,822,711
    
    
    
    21,251,831Cost of services
    
    
    3,716,269
    
    
    
    2,082,212Selling, general and administrative
    
    
    16,202,116
    
    
    
    7,839,974Depreciation and amortization
    
    
    1,092,678
    
    
    
    524,95665,833,774
    
    
    
    31,698,973Income from continuing operations
    
    
    3,966,737
    
    
    
    1,649,304Other Income (Expense):Interest expense, net
    
    
    (1,602,338
    )
    
    
    (1,255,159
    )Net income before minority interests and provision for income taxes
    
    
    2,364,399
    
    
    
    394,145Minority interests
    
    
    (590,282
    )
    
    
    (459,324
    )Net income (loss) before provision for income taxes
    
    
    1,774,117
    
    
    
    (65,179
    )Provision for income taxes
    
    
    (598,164
    )
    
    
    Net income (loss) from continuing operations
    
    
    1,175,953
    
    
    
    (65,179
    )Income from discontinued operations
    
    
    118,717
    
    
    
    Net income (loss)
    
    $
    1,294,670
    
    
    $
    (65,179
    )Net earnings per common share (basic and diluted):Net income (loss) from continuing operations
    
    $
    0.05
    
    
    $
    Income from discontinued operations
    
    
    
    
    
    
    Net earnings (loss) per share
    
    $
    0.05
    
    
    $
    Average common shares outstanding
    
    
    25,310,579
    
    
    
    20,400,000Dilutive effect of stock warrants
    
    
    452,000
    
    
    
    Average common shares outstanding assuming dilution
    
    
    25,762,579
    
    
    
    20,400,000
  -4-




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##### Table of Contents



GRAYMARK HEALTHCARE, INC.
 
 Consolidated Condensed Statements of Cash Flows
For the Nine months Ended September 30, 2008 and 2007
(Unaudited)
 2008
    
    
    2007Operating activities:Net income (loss)
    
    $
    1,294,670
    
    
    $
    (65,179
    )Adjustments to reconcile net income to
net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    1,092,678
    
    
    
    524,956Minority interests
    
    
    590,282
    
    
    
    459,324Minority interests in discontinued operations
    
    
    97,653
    
    
    
    Stock option compensation
    
    
    231,000
    
    
    
    Changes in assets and liabilities, net of acquisitions Accounts receivable
    
    
    (6,374,366
    )
    
    
    (3,077,383
    )Inventories
    
    
    (688,506
    )
    
    
    (622,905
    )Other assets
    
    
    173,769
    
    
    
    (108,115
    )Accounts payable
    
    
    2,074,083
    
    
    
    2,349,899Accrued liabilities
    
    
    2,689,435
    
    
    
    1,458,571Net cash provided by operating activities
    
    
    1,180,698
    
    
    
    919,168Investing activities:Cash received from acquisitions
    
    
    3,000
    
    
    
    396,138Deposit on acquisition
    
    
    
    
    
    
    1,310,500Purchase of businesses
    
    
    (11,156,165
    )
    
    
    (21,933,685
    )Purchase of property and equipment
    
    
    (742,789
    )
    
    
    (671,665
    )Net cash used in investing activities
    
    
    (11,895,954
    )
    
    
    (20,898,712
    )Financing activities:Issuance of common stock
    
    
    15,988,547
    
    
    
    Capital contributions
    
    
    
    
    
    
    2,990,000Debt proceeds
    
    
    13,334,539
    
    
    
    19,010,162Debt payments
    
    
    (2,882,636
    )
    
    
    (784,218
    )Distributions to minority interests
    
    
    (241,719
    )
    
    
    (408,636
    )Net cash provided by financing activities
    
    
    26,198,731
    
    
    
    20,807,308Net change in cash and cash equivalents
    
    
    15,483,475
    
    
    
    827,764Cash and cash equivalents at beginning of period
    
    
    2,072,866
    
    
    
    805,220Cash and cash equivalents at end of period
    
    $
    17,556,341
    
    
    $
    1,632,984Noncash Investing and Financing Activities:Seller-financing of acquisitions
    
    $
    4,228,000
    
    
    $
    2,730,000Common stock issued to pay-off convertible debt
    
    $
    750,000
    
    
    $
    Common stock and stock options issued to purchase business
    
    $
    960,000
    
    
    $
    Common stock issued to purchase minority interests
    
    $
    1,616,000
    
    
    $
    Cash Paid for Interest and Income Taxes:Interest expense
    
    $
    1,392,000
    
    
    $
    1,094,000Income taxes
    
    $
    
    
    
    $
    
  -5-




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##### Table of Contents



GRAYMARK HEALTHCARE, INC.
 
 Notes to Consolidated Condensed Financial Statements
 For the Periods Ended September 30, 2008 and 2007
     Interim Financial Information
 Consolidation
 Use of estimates
 Revenue recognition
   -6-




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##### Table of Contents



Accounts receivable
  Goodwill and Intangible Assets
  Discontinued Operations
 -7-




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##### Table of Contents



Recent Accounting Pronouncements
 SFAS 141(R) and SFAS 160 Business
Combinations Business Combinations Noncontrolling Interests in Consolidated Financial Statements  an Amendment of ARB No.
51
 
    
    that assets acquired and liabilities assumed be measured at fair value as of the acquisition
date,
    
    that liabilities related to contingent consideration be recognized at the acquisition date
and remeasured at fair value in each subsequent reporting period,
    
    that acquisition-related costs be expensed as incurred, and
    
    that income be recognized if the fair value of the net assets acquired exceeds the fair value
of the consideration transferred.
  SFAS 157 Fair Value
Measurements
   AmountAcquisition
    
    Business
    
    Purchase
    
    Financed byDate
    
    Acquired
    
    Price
    
    SellerApothecary:January 12, 2008
    
    Rambo Drug (Rambo)
    
    $
    2,558,564
    
    
    $
    1,020,215February 29, 2008
    
    Thrifty White Store 726 (Thrifty)
    
    
    824,910
    
    
    
    99,444March 26, 2008
    
    Newts Pharmacy (Newts)
    
    
    1,381,066
    
    
    
    486,209March 26, 2008
    
    Professional Pharmacy (Professional)
    
    
    942,809
    
    
    
    263,100June 1, 2008
    
    Parkway Drug (Parkway)
    
    
    7,360,998
    
    
    
    1,489,814SDC:April 15, 2008
    
    Minority interests in sleep centers (Minority)
    
    
    1,616,356
    
    
    
    June 1, 2008
    
    Sleep Center of Waco, Ltd.,June 1, 2008
    
    Plano Sleep Center, Ltd. andJune 1, 2008
    
    Southlake Sleep Center, Ltd. (Texas Labs)
    
    
    960,000
    
    
    
    June 1, 2008
    
    Nocturna Sleep Center, LLC (Nocturna)
    
    
    2,172,790
    
    
    
    726,190
  -8-




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##### Table of Contents



Rambo
    
    
    Thrifty
    
    
    Newts
    
    
    Professional
    
    
    ParkwayCash
    
    $
    1,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    2,000Accounts receivable
    
    
    7,027
    
    
    
    
    
    
    
    3,626
    
    
    
    1,412
    
    
    
    13,706Inventory
    
    
    350,537
    
    
    
    161,950
    
    
    
    395,546
    
    
    
    398,982
    
    
    
    2,346,569Total current assets
    
    
    358,564
    
    
    
    161,950
    
    
    
    399,172
    
    
    
    400,394
    
    
    
    2,362,275Property and equipment
    
    
    33,683
    
    
    
    
    
    
    
    7,500
    
    
    
    5,000
    
    
    
    113,812Intangible assets
    
    
    973,990
    
    
    
    662,960
    
    
    
    462,209
    
    
    
    162,415
    
    
    
    1,062,636Goodwill
    
    
    1,192,327
    
    
    
    
    
    
    
    512,185
    
    
    
    375,000
    
    
    
    3,822,275Net assets acquired
    
    $
    2,558,564
    
    
    $
    824,910
    
    
    $
    1,381,066
    
    
    $
    942,809
    
    
    $
    7,360,998
  Minority
    
    
    Texas Labs
    
    
    NocturnaAccounts receivable
    
    $
    
    
    
    $
    481,187
    
    
    $
    210,664Total current assets
    
    
    
    
    
    
    481,187
    
    
    
    210,664Property and equipment
    
    
    
    
    
    
    1,707,978
    
    
    
    289,651Intangible assets
    
    
    
    
    
    
    
    
    
    
    150,000Goodwill
    
    
    998,712
    
    
    
    881,244
    
    
    
    1,522,475Total assets acquired
    
    
    998,712
    
    
    
    3,070,409
    
    
    
    2,172,790Minority interest in net
tangible assets
    
    
    617,644
    
    
    
    
    
    
    
    Less: debt assumed
    
    
    
    
    
    
    (2,110,409
    )
    
    
    Net assets acquired
    
    $
    1,616,356
    
    
    $
    960,000
    
    
    $
    2,172,790
  2008Pro forma:Net sales
    
    $
    84,477,000Net income
    
    $
    2,253,000
    Apothecary
    
    
    SDC
    
    
    TotalDecember 31, 2007
    
    $
    7,044,551
    
    
    $
    13,203,354
    
    
    $
    20,247,905Business acquisitions
    
    
    5,901,787
    
    
    
    2,403,719
    
    
    
    8,305,506Business acquisitions  contingent consideration
    
    
    142,800
    
    
    
    
    
    
    
    142,800Purchase of minority interests
    
    
    
    
    
    
    998,712
    
    
    
    998,712September 30, 2008
    
    $
    13,089,138
    
    
    $
    16,605,785
    
    
    $
    29,694,923
 -9-




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##### Table of Contents



December 31,Useful
    
    
    September 30, 2008
    
    
    2007Life
    
    
    Gross
    
    
    Accumulated(Years)
    
    
    Amount
    
    
    Amortization
    
    
    Net
    
    
    NetApothecary:Customer files
    
    
    15
    
    
    $
    7,483,136
    
    
    $
    (598,881
    )
    
    $
    6,884,255
    
    
    $
    4,357,127Covenants not to compete
    
    
    3  5
    
    
    
    1,469,244
    
    
    
    (445,250
    )
    
    
    1,023,994
    
    
    
    801,532SDC:Customer relationships
    
    
    15
    
    
    
    480,000
    
    
    
    (53,334
    )
    
    
    426,666
    
    
    
    450,667Trademark
    
    
    15
    
    
    
    50,000
    
    
    
    (1,111
    )
    
    
    48,889
    
    
    
    Covenants not to compete
    
    
    3
    
    
    
    100,000
    
    
    
    (11,111
    )
    
    
    88,889
    
    
    
    Total
    
    
    
    
    
    $
    9,582,380
    
    
    $
    (1,109,687
    )
    
    $
    8,472,693
    
    
    $
    5,609,326
  Year ended September 30,2009
    
    $
    893,0002010
    
    
    821,0002011
    
    
    798,0002012
    
    
    703,0002013
    
    
    570,000
   Maturity
    
    
    September 30,
    
    
    December 31,Rate (1)
    
    
    Date
    
    
    2008
    
    
    2007Apothecary:Senior bank debt
    
    
    5
    %
    
    May 2014
    
    $
    17,403,625
    
    
    $
    Bank line of credit
    
    
    5
    %
    
    July 2014
    
    
    5,217,541
    
    
    
    Bank line of credit, matured
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,905,000Seller financing
    
    
    4.1  7.25
    %
    
    July 2009  June 2011
    
    
    5,423,661
    
    
    
    3,385,241
 -10-




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##### Table of Contents



Maturity
    
    
    September 30,
    
    
    December 31,Rate (1)
    
    
    Date
    
    
    2008
    
    
    2007Non-compete agreements
    
    
    0.0  7.65
    %
    
    Dec. 2009  May 2013
    
    
    1,142,556
    
    
    
    784,23529,187,383
    
    
    
    16,074,476SDC:Senior bank debt
    
    
    5
    %
    
    May 2014
    
    
    12,582,730
    
    
    
    11,960,000Bank line of credit
    
    
    5
    %
    
    June 2014
    
    
    4,055,798
    
    
    
    Bank line of credit, matured
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    438,386Notes payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    862,971Seller financing
    
    
    5
    %
    
    June 2009
    
    
    734,126
    
    
    
    Sleep center working capital notes
    
    
    6.0  8.0
    %
    
    Apr. 2010  Aug. 2012
    
    
    800,950
    
    
    
    728,552Short-term equipment leases
    
    
    
    
    
    Sept. 2009
    
    
    131,613
    
    
    
    149,629Capital leases
    
    
    11.0 - 17.0
    %
    
    Nov. 2010 - Oct. 2011
    
    
    179,577
    
    
    
    Notes payable on vehicles
    
    
    3.0
    %
    
    June 2013
    
    
    110,018
    
    
    
    28,09718,594,812
    
    
    
    14,167,635Total borrowings
    
    
    
    
    
    
    
    
    
    
    47,782,195
    
    
    
    31,742,111Less:Short-term debt
    
    
    
    
    
    
    
    
    
    
    (865,739
    )
    
    
    (13,993,015
    )Current portion of long-term debt
    
    
    
    
    
    
    
    
    
    
    (3,715,940
    )
    
    
    (2,394,512
    )Long-term debt
    
    
    
    
    
    
    
    
    
    $
    43,200,516
    
    
    $
    15,354,584
 
 (1)
    
    Effective rate as of September 30, 2008  Year ended September 30,2009
    
    $
    3,715,9402010
    
    
    2,490,7922011
    
    
    2,082,6512012
    
    
    5,121,0662013
    
    
    5,235,492Thereafter
    
    
    28,270,515
     -11-




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##### Table of Contents



Year ended September 30,2009
    
    $
    2,035,8882010
    
    
    1,769,9532011
    
    
    1,305,7392012
    
    
    931,9782013
    
    
    626,134Thereafter
    
    
    1,599,456Total
    
    $
    8,269,148
          -12-




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##### Table of Contents



AverageExerciseShares
    
    
    PriceOutstanding at December 31, 2007
    
    
    1,064,650
    
    
    $
    7.15Granted  warrants
    
    
    202,500
    
    
    
    1.47Granted  options
    
    
    155,000
    
    
    
    4.03Exercised
    
    
    (291,150
    )
    
    
    (2.70
    )Forfeited
    
    
    
    
    
    
    Outstanding at September 30, 2008
    
    
    1,131,000
    
    
    $
    6.84
    Three Months Ending
    
    
    Nine months EndingSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Sales to external customers:Apothecary
    
    $
    22,757,053
    
    
    $
    11,032,785
    
    
    $
    58,132,214
    
    
    $
    26,774,673SDC
    
    
    4,726,937
    
    
    
    2,633,116
    
    
    
    11,668,297
    
    
    
    6,573,604Total
    
    $
    27,483,990
    
    
    $
    13,665,901
    
    
    $
    69,800,511
    
    
    $
    33,348,277Segment operating profit (loss):Apothecary
    
    $
    189,156
    
    
    $
    (148,872
    )
    
    $
    375,790
    
    
    $
    (217,226
    )SDC
    
    
    507,627
    
    
    
    18,195
    
    
    
    1,407,616
    
    
    
    152,047Discontinued operations
    
    
    87,696
    
    
    
    
    
    
    
    118,717
    
    
    
    Other
    
    
    (243,365
    )
    
    
    
    
    
    
    (607,453
    )
    
    
    Total
    
    $
    541,114
    
    
    $
    (130,677
    )
    
    $
    1,294,670
    
    
    $
    (65,179
    )
 -13-




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##### Table of Contents



September 30,
    
    
    December 31,2008
    
    
    2007Segment assets:Apothecary
    
    $
    39,848,060
    
    
    $
    21,583,680SDC
    
    
    29,027,234
    
    
    
    18,730,505Discontinued operations
    
    
    290,607
    
    
    
    335,507Other
    
    
    13,439,482
    
    
    
    482,945Total
    
    $
    82,605,383
    
    
    $
    41,132,637
 -14-




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Overview
     Apothecary Operating Segment
  -15-




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##### Table of Contents



SDC Operating Segment
    -16-




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##### Table of Contents



Acquisitions
  -17-




---



##### Table of Contents



AmountAcquisition
    
    Business
    
    Purchase
    
    Financed byDate
    
    Acquired
    
    Price
    
    SellerApothecary:January 12, 2008
    
    Rambo Pharmacy (Rambo)
    
    $
    2,558,564
    
    
    $
    1,020,215February 29, 2008
    
    Thrifty White Store 726 (Thrifty)
    
    
    824,910
    
    
    
    99,444March 26, 2008
    
    Newts Pharmacy (Newts)
    
    
    1,381,066
    
    
    
    486,209March 26, 2008
    
    Professional Pharmacy (Professional)
    
    
    942,809
    
    
    
    263,100June 1, 2008
    
    Parkway Drug (Parkway)
    
    
    7,360,998
    
    
    
    1,489,814SDC:April 15, 2008
    
    Minority interests in sleep centers (Minority)
    
    
    1,616,356
    
    
    
    617,644June 1, 2008
    
    Sleep Center of Waco, Ltd.,June 1, 2008
    
    Plano Sleep Center, Ltd. andJune 1, 2008
    
    Southlake Sleep Center, Ltd. (Texas Labs)
    
    
    960,000
    
    
    
    June 1, 2008
    
    Nocturna Sleep Center, LLC (Nocturna)
    
    
    2,172,790
    
    
    
    726,190
 Impairment of Acquisition Goodwill
  
    
    a significant adverse change in legal factors or in business climate,
 
    
    unanticipated competition, or
 
    
    an adverse action or assessment by a regulator.
 i.e.
 Results of Operations
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##### Table of Contents



Comparison of the Three-Month and Nine-Month Periods Ended September 30, 2008 and 2007
 Consolidated Totals
 For the Three Months Ended
    
    
    For the Nine months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net revenues
    
    $
    27,483,990
    
    
    $
    13,665,901
    
    
    $
    69,800,511
    
    
    $
    33,348,277Cost of sales and services
    
    
    18,936,956
    
    
    
    9,729,820
    
    
    
    48,538,980
    
    
    
    23,334,043Operating expenses
    
    
    7,268,066
    
    
    
    3,400,574
    
    
    
    17,294,794
    
    
    
    8,364,930Operating income
    
    
    1,278,968
    
    
    
    535,507
    
    
    
    3,966,737
    
    
    
    1,649,304Net other (expense)
    
    
    (576,244
    )
    
    
    (498,232
    )
    
    
    (1,602,338
    )
    
    
    (1,255,159
    )Net income before minority interests and
provision for income taxes
    
    
    702,724
    
    
    
    37,275
    
    
    
    2,364,399
    
    
    
    394,145Minority interests
    
    
    28,595
    
    
    
    (167,952
    )
    
    
    (590,282
    )
    
    
    (459,324
    )Provision for income taxes
    
    
    (277,901
    )
    
    
    
    
    
    
    (598,164
    )
    
    
    Net income (loss) from continuing
operations
    
    
    453,418
    
    
    
    (130,677
    )
    
    
    1,175,953
    
    
    
    (65,179
    )Income from discontinued operations
    
    
    87,696
    
    
    
    
    
    
    
    118,717
    
    
    
    Net income (loss)
    
    $
    541,114
    
    
    $
    (130,677
    )
    
    $
    1,294,670
    
    
    $
    (65,179
    )
 Discussion of Three Month Periods Ended September 30, 2008 and 2007
 Net revenues
 
    
    the seven acquisitions made by our Apothecary operating segment during the three months ended
December 31, 2007 and the nine months ended September 30, 2008 resulted in an increase in
revenue of $11.9 million and
 
    
    the two acquisitions made by our SDC operating segment in June 2008 resulted in an increase
of revenue of $1.1 million related to the three months of operations in the 3rd quarter of
2008. See the Segment Analysis, below, for additional information.
 Cost of sales and services
 
    
    the seven acquisitions made by our Apothecary operating segment during the three months ended
December 31, 2007 and the nine months ended September 30, 2008 resulted in an increase in cost
of sales and services of $8.8 million and
 
    
    the two acquisitions made by our SDC operating segment in June 2008 resulted in an increase
of cost of sales and services of $0.5 million related to the three months of operations in the
3rd quarter of 2008. See the Segment Analysis, below, for additional information.
 Operating expenses
 Net other expense
 -19-




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##### Table of Contents



Minority interests
 Provision for income taxes
 Income from discontinued operations
 Net Income or Loss.
 Discussion of Nine Month Periods Ended September 30, 2008 and 2007
 Net revenues
 
    
    the seven acquisitions made by our Apothecary operating segment during the three months ended
December 31, 2007 and the nine months ended September 30, 2008 which resulted in an increase
in revenue of $32.6 million,
 
    
    the two acquisitions made by our SDC operating segment in June 2008 resulted in an increase
of revenue of $1.3 million related to the four months of operations in the first nine months
of 2008 and
 
    
    the acquisition made by our SDC operating segment on January 31, 2007 resulted in an increase
of revenue of $1.0 million related to nine months of operations in 2008 versus eight months in
the 1st nine months of 2007. See the Segment Analysis below, for additional information.
 Cost of sales and services
 
    
    the seven acquisitions made by our Apothecary operating segment during the three months ended
December 31, 2007 and the nine months ended September 30, 2008 which resulted in an increase
in cost of sales and services of $24.9 million,
 
    
    the two acquisitions made by our SDC operating segment in June 2008 resulted in an increase
of cost of sales and services of $0.6 million related to the four months of operations in the
first nine months of 2008 and
 
    
    the acquisition made by our SDC operating segment on January 31, 2007 resulted in an increase
of cost of sales and services of $0.3 million related to nine months of operations in 2008
versus eight months in the 1st nine months of 2007. See the Segment Analysis, below, for
additional information.
 Operating expenses
 -20-




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##### Table of Contents



Net other expense
 Minority interests
 Provision for income taxes
 Income from discontinued operations
 Net income
 Apothecary Operating Segment
 For the Three Months Ended
    
    
    For the Nine months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net revenues
    
    $
    22,757,053
    
    
    $
    11,032,785
    
    
    $
    58,132,214
    
    
    $
    26,774,673Cost of sales
    
    
    17,265,508
    
    
    
    8,547,346
    
    
    
    44,479,151
    
    
    
    20,761,258Operating expenses
    
    
    4,804,213
    
    
    
    2,393,745
    
    
    
    12,113,566
    
    
    
    5,657,997Operating income
    
    
    687,332
    
    
    
    91,694
    
    
    
    1,539,497
    
    
    
    355,418Net other (expense)
    
    
    (382,242
    )
    
    
    (240,566
    )
    
    
    (972,556
    )
    
    
    (572,644
    )Net income (loss) before provision for
income taxes
    
    $
    305,090
    
    
    $
    (148,872
    )
    
    $
    566,941
    
    
    $
    (217,226
    )
 Discussion of Three Month Periods Ended September 30, 2008 and 2007
 Net revenues
 Cost of sales
 -21-




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##### Table of Contents



Operating expenses
 
    
    approximately $2.2 million in additional expenses associated with new pharmacy locations,
 
    
    $0.1 million in increased costs at existing (or same store) locations and
 
    
    $0.1 million in increased operational overhead.
 Net other expense
 Net income or loss before provision for income taxes.
 Discussion of Nine Month Periods Ended September 30, 2008 and 2007
 Net revenues
 Cost of sales
 Operating expenses
 
    
    approximately $5.9 million in additional expenses associated with new pharmacy locations,
 
    
    $0.1 million in increased costs at existing (or same store) locations and
 
    
    $0.5 million in increased operational overhead.
 Net other expense
 -22-




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##### Table of Contents



Net income or loss before provision for income taxes.
 SDC Operating Segment
 For the Three Months Ended
    
    
    For the Nine months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net revenues
    
    $
    4,726,937
    
    
    $
    2,633,116
    
    
    $
    11,668,297
    
    
    $
    6,573,604Cost of sales and services
    
    
    1,671,448
    
    
    
    1,182,474
    
    
    
    4,059,829
    
    
    
    2,572,785Operating expenses
    
    
    1,995,699
    
    
    
    1,006,829
    
    
    
    4,163,099
    
    
    
    2,706,933Operating income
    
    
    1,059,790
    
    
    
    443,813
    
    
    
    3,445,369
    
    
    
    1,293,886Net other (expense)
    
    
    (269,632
    )
    
    
    (257,666
    )
    
    
    (731,469
    )
    
    
    (682,515
    )Net income before minority interests
and provision for income taxes
    
    
    790,158
    
    
    
    186,147
    
    
    
    2,713,900
    
    
    
    611,371Minority interests
    
    
    28,595
    
    
    
    (167,952
    )
    
    
    (590,282
    )
    
    
    (459,324
    )Net income (loss) before provision for
income taxes
    
    $
    818,753
    
    
    $
    18,195
    
    
    $
    2,123,618
    
    
    $
    152,047
 Discussion of Three Month Periods Ended September 30, 2008 and 2007
 Net revenues
 
    
    the acquisition of Nocturna and Texas Labs on June 1, 2008 resulted in an increase in net
revenues of approximately $1.1 million and
 
    
    an increase in the number of sleep studies performed, in existing locations, in the 3rd
quarter of 2008, compared with the same period in 2007, resulted in an increase in net
revenues of approximately $1.0 million.
 Cost of sales and services
  Operating expenses
 Net other expense
 Minority interests
 -23-




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##### Table of Contents



Net income or loss before provision for income taxes
 Discussion of Nine Month Periods Ended September 30, 2008 and 2007
 Net revenues
 
    
    the acquisition of our sleep operations on January 31, 2007 that resulted in only eight
months of operations during the first nine months of 2007, compared with nine months of
operations ended September 30, 2008, resulted in an increase in net revenues of approximately
$1.0 million,
 
    
    the acquisition of Nocturna and Texas Labs on June 1, 2008 resulted in an increase in net
revenues of approximately $1.3 million and
 
    
    an increase in the number of sleep studies performed, in existing locations, in the eight
months ended September 30, 2008, compared with the same period in 2007, resulted in an
increase in net revenues of approximately $2.8 million.
 Cost of sales and services
 
    
    the acquisition of our sleep operations on January 31, 2007, which resulted in only eight
months of operations during the first nine months of 2007, compared with nine months of
operations ended
September 30, 2008, resulted in an increase in cost of sales and services of approximately $0.3
million,
 
    
    the acquisition of Nocturna and Texas Labs on June 1, 2008 resulted in an increase in cost of
sales and services of approximately $0.6 million and
 
    
    an increase in the number of sleep studies performed, in existing locations, in the eight
months ended September 30, 2008, compared with the same period in 2007, resulted in an
increase in cost of sales and services of approximately $0.6 million.
  Operating expenses
 Net other expense
 -24-




---



##### Table of Contents



Minority interests
 Net income or loss before provision for income taxes
 Liquidity and Capital Resources
      Financial Commitments
  -25-




---



##### Table of Contents



<1 year
    
    
    1-3 years
    
    
    3-5 years
    
    

>  5 years
    
    
    TotalShort-term debt
    
    $
    865,739
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    865,739Long-term debt
    
    
    6,208,790
    
    
    
    8,918,086
    
    
    
    13,766,335
    
    
    
    30,267,755
    
    
    
    59,160,966Operating leases
    
    
    2,035,888
    
    
    
    3,075,692
    
    
    
    1,558,112
    
    
    
    1,599,456
    
    
    
    8,269,148$
    9,110,417
    
    
    $
    11,993,778
    
    
    $
    15,324,447
    
    
    $
    31,867,211
    
    
    $
    68,295,853
   Revenue recognition
      Accounts Receivable
  Goodwill and Intangible Assets
  Recent Accounting Pronouncements
 SFAS 141(R) and SFAS 160 Business
Combinations Business Combinations Noncontrolling Interests in Consolidated Financial Statements  an Amendment of ARB No.
51
 
    
    that assets acquired and liabilities assumed be measured at fair value as of the acquisition
date,
 
    
    that liabilities related to contingent consideration be recognized at the acquisition date
and remeasured at fair value in each subsequent reporting period,
 
    
    that acquisition-related costs be expensed as incurred, and
 
    
    that income be recognized if the fair value of the net assets acquired exceeds the fair value
of the consideration transferred.
  SFAS 157 Fair Value
Measurements
 -26-




---



##### Table of Contents



Cautionary Statement Relating to Forward Looking Information
  
    
    discuss our future expectations;
 
    
    contain projections of our future operating results or of our future financial condition; or
 
    
    state other forward-looking information.
  
 Item 3. Quantitative and Qualitative Disclosures about Market Risk.
  
 Item 4. Controls and Procedures and Item 4T. Controls and Procedures.
   
    
    pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of our assets,
 
    
    provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting
principles, and that our receipts and expenditures are being made only in accordance with
authorizations of our management and directors; and
 -27-




---



##### Table of Contents




    
    provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of our assets that could have a material effect on our
financial statements.
  Accounts Receivable Billing and Reporting at SDC Holding
  
    
    our billing system was aging the accounts receivable based on date of billing rather than
date of service and
 
    
    lack of appropriate collection procedures needed to identify and follow-up on insurance
company and patient receivables that are not collected in a timely manner.
  
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  -28-




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##### Table of Contents



Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
  Exhibit No.
    
    Description3.1.1
    
    Registrants Restated Certificate of Incorporation, incorporated by
reference to Exhibit 3.1 of Registrants Registration Statement on Form SB-2 (No.
333-111819) as filed with the Commission on January 2, 2004.3.2
    
    Registrants Bylaws, incorporated by reference to Exhibit 3.2 of Registrants
Registration Statement on Form SB-2 (No. 333-111819) as filed with the Commission on
January 9, 2004.4.1
    
    Form of Certificate of Common Stock of Registrant, incorporated by reference
to Exhibit 4.1 of Registrants Registration Statement on Form SB-2 (No. 333-111819) as
filed with the Commission on January 9, 2004.4.2
    
    Stock Option Agreement between E. Peter Hoffman, Jr. and Registrant ,
incorporated by reference to Exhibit A of Exhibit 10.8 of Registrants Registration
Statement on Form SB-2 (No. 333-111819) as filed with the Commission on January 9,
2004.4.3
    
    Form of Common Stock Purchase Warrant Agreement attached as Exhibit A-1 to
the Form of Senior Promissory Note dated August 5, 2005, incorporated by reference to
Exhibit 4.2 of Form 8-K filed with the Commission on August 11, 2005.4.4
    
    Form of Common Stock Purchase Warrant Agreement attached as Exhibit A-2 to
the Form of Senior Promissory Note dated August 5, 2005, incorporated by reference to
Exhibit 4.3 of Form 8-K filed with the Commission on August 11, 2005.4.5
    
    Form of Common Stock Purchase Warrant Agreement attached as Exhibit A-1 to
the Form of Senior Promissory Note dated October 24, 2005, incorporated by reference
to Exhibit 4.2 of Form 8-K filed with the Commission on November 1, 2005.
 -29-




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##### Table of Contents



Exhibit No.
    
    Description4.6
    
    Form of Common Stock Purchase Warrant Agreement attached as Exhibit A-2 to the
Form of Senior Promissory Note dated October 24, 2005, incorporated by reference to
Exhibit 4.3 of Form 8-K filed with the Commission on November 1, 2005.31.1
    
    Certification of Stanton Nelson, Chief Executive Officer of Registrant.31.2
    
    Certification of Rick D. Simpson, Chief Financial Officer and Controller of
Registrant.32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 of Stanton Nelson, Chief Executive Officer of
Registrant.32.2
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 of Rick D. Simpson, Chief Financial Officer
and Controller of Registrant.
 
 SIGNATURES
  GRAYMARK HEALTHCARE, INC.(Registrant)By:
    
    /s/ STANTON NELSON

Stanton NelsonChief Executive OfficerDate: November 11, 2008By:
    
    /s/ RICK D. SIMPSON

Rick D. SimpsonChief Financial Officer and ControllerDate: November 11, 2008
 -30-