e10vq

GRAYMARK HEALTHCARE, INC.
FORM 10-Q
For the Quarter Ended September 30, 2008

TABLE OF CONTENTS


Part I. Financial Information
Item 1. Consolidated Condensed Financial Statements (Unaudited)			1
a) Balance Sheets			2
b) Statements of Operations			3
c) Statements of Operations			4
d) Statements of Cash Flows			5
e) Notes to Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
Item 3. Quantitative and Qualitative Disclosures about Market Risk			27
Item 4. Controls and Procedures and Item 4T. Controls and Procedures			27

Part II. Other Information
Item 1. Legal Proceedings			28
Item 1A. Risk Factors			28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			28
Item 3. Defaults Upon Senior Securities			29
Item 4. Submission of Matters to a Vote of Security Holders			29
Item 5. Other Information			29
Item 6. Exhibits			29

SIGNATURES			30
EX-31.1
EX-31.2
EX-32.1
EX-32.2

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

Certain statements under the captions and “Item 2. Management’s 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 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, including SDC Holdings LLC and ApothecaryRx LLC, and their executive officers and directors.

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GRAYMARK HEALTHCARE, INC.

Consolidated Condensed Statements of Cash Flows
For the Nine months Ended September 30, 2008 and 2007
(Unaudited)


	2008			2007
Operating 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			524,956
Minority interests		590,282			459,324
Minority 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			2,349,899
Accrued liabilities		2,689,435			1,458,571

Net cash provided by operating activities		1,180,698			919,168


Investing activities:
Cash received from acquisitions		3,000			396,138
Deposit on acquisition		—			1,310,500
Purchase 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		—			2,990,000
Debt proceeds		13,334,539			19,010,162
Debt payments		(2,882,636	)		(784,218	)
Distributions to minority interests		(241,719	)		(408,636	)

Net cash provided by financing activities		26,198,731			20,807,308

Net change in cash and cash equivalents		15,483,475			827,764
Cash and cash equivalents at beginning of period		2,072,866			805,220

Cash and cash equivalents at end of period	$	17,556,341		$	1,632,984

Noncash Investing and Financing Activities:
Seller-financing of acquisitions	$	4,228,000		$	2,730,000

Common 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		$	1,094,000

Income taxes	$	—		$	—

See Accompanying Notes to Consolidated Condensed Financial Statements

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GRAYMARK HEALTHCARE, INC.

Notes to Consolidated Condensed Financial Statements

For the Periods Ended September 30, 2008 and 2007

Note 1 – Nature of Business

Graymark Healthcare, Inc. (the “Company”) is organized in Oklahoma. Prior to December 31, 2007, the Company was named Graymark Productions, Inc. and was an independent producer and distributor of film entertainment content. On December 31, 2007, the Company completed the acquisition of ApothecaryRx, LLC, (“ApothecaryRx”) and SDC Holdings, LLC (“SDC Holdings”), collectively referred to as the “Graymark Acquisition.” For financial reporting purposes, ApothecaryRx and SDC Holding were considered the acquiring entities and historical financial statements prior to December 31, 2007 reflect the activities of ApothecaryRx and SDC Holdings as adjusted for the effect of the recapitalization which occurred at the date of the Graymark Acquisition. Activities of Graymark Productions, Inc. prior to the acquisition date are no longer reflected in the historical financial statements as Graymark Productions was considered to be the acquired entity. In conjunction with the Graymark Acquisition, the Company suspended all operations related to its film production activities.

Note 2 – Summary of Significant Accounting Policies

For a complete list of the Company’s significant accounting policies, please see the Company’s Annual Report on Form 10-K for the year ending December 31, 2007.

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 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 and nine months ended September 30, 2008 are not necessarily indicative of results that may be expected for the year ended December 31, 2008. The consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2007. The December 31, 2007 consolidated condensed balance sheet was derived from audited financial statements.

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 –

Pharmacy product sales from the Company’s ApothecaryRx operating segment are recorded at the time the customer takes possession of the merchandise. Customer returns are immaterial and are recorded at the time merchandise is returned.

Sleep center services and product sales from the Company’s SDC operating segment 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. The Company has established an allowance to account for sales adjustments that result from differences between the amount billed and the expected realizable amount.

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Actual adjustments that result from differences between the payment amount received and the expected realizable amount are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company’s 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. 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.

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, 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, 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 labs 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.

We perform analysis to evaluate the net realizable value of accounts receivable on a quarterly basis. Specifically, we consider historical realization data, accounts receivable aging trends, other operating trends and relevant business conditions. Because of continuing changes in the healthcare industry and third-party reimbursement, it is possible that our estimates could change, which could have a material impact on our operating results and cash flows.

Accounts receivable – Accounts receivable are reported net of allowances for sales adjustments, rental returns and uncollectible accounts of $13,756,980 and $5,946,788 as of September 30, 2008 and December 31, 2007, respectively. The majority of the Company’s accounts receivable is due from Medicare, private insurance carriers and other third-party payors, as well as from customers under co-insurance and deductible provisions.

The Company’s allowance for sales adjustments and uncollectible accounts is primarily attributable to the Company’s SDC operating segment. Third-party reimbursement is a complicated process that involves submission of claims to multiple payers, each having its own claims requirements. In some cases, the ultimate collection of accounts receivable subsequent to the service dates may not be known for several months. The Company has established an allowance to account for sales 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, sales adjustments, and aging of accounts receivable.

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 consist primarily of customer files and covenants not to compete are amortized over their estimated useful lives. The remaining lives range from three to fifteen years. The Company evaluates the recoverability of identifiable intangible asset whenever events or changes in circumstances indicate that an intangible asset’s carrying amount may not be recoverable.

Discontinued Operations – In conjunction with the Graymark Acquisition, management of the Company elected to discontinue its film production and distribution operations. The income and expense from the ongoing marketing and distribution of the Company’s films is accounted for as discontinued operations.

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Recent Accounting Pronouncements

SFAS 141(R) and SFAS 160 – In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141 (Revised), “Business Combinations” (“SFAS 141 (R)”), replacing SFAS No. 141, “Business Combinations” (“SFAS 141”), and SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements – an Amendment of ARB No. 51” (“SFAS 160”). SFAS 141(R) retains the fundamental requirements of SFAS 141, and broadens its scope by applying the acquisition method to all transactions and other events in which one entity obtains control over one or more other businesses, and requires, among other things,

•		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 160 establishes accounting and reporting standards for noncontrolling interests (i.e., minority interests) in a subsidiary, including changes in a parent’s ownership interest in a subsidiary and requires, among other things, that noncontrolling interests in subsidiaries be classified as a separate component of equity. Except for the presentation and disclosure requirements of SFAS 160, which are to be applied retrospectively for all periods presented, SFAS 141 (R) and SFAS 160 are to be applied prospectively in financial statements issued for fiscal years beginning after December 15, 2008. We are assessing the impact SFAS 160 will have on our consolidated financial statements and anticipate that shareholders’ equity will increase by the minority interest in our subsidiaries.

SFAS 157 – In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. The Company adopted this Statement on January 1, 2008 and the initial adoption of this Statement did not have a material impact on its financial position, results of operations, or cash flows.

Note 3 – Acquisitions

During the nine months ended September 30, 2008, the Company’s Apothecary and SDC operating segments made the following acquisitions:

Amount

Acquisition

Business

Purchase

Financed by

Date

Acquired

Price

Seller

Apothecary:

January 12, 2008

Rambo Drug (“Rambo”)

2,558,564

1,020,215

February 29, 2008

Thrifty White Store 726 (“Thrifty”)

824,910

99,444

March 26, 2008

Newt’s Pharmacy (“Newt’s”)

1,381,066

486,209

March 26, 2008

Professional Pharmacy (“Professional”)

942,809

263,100

June 1, 2008

Parkway Drug (“Parkway”)

7,360,998

1,489,814

SDC:

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. and

June 1, 2008

Southlake Sleep Center, Ltd. (“Texas Labs”)

960,000

—

June 1, 2008

Nocturna Sleep Center, LLC (“Nocturna”)

2,172,790

726,190

The results of operations from the businesses acquired have been included in the Company’s consolidated condensed statements of operations prospectively from the date of acquisition. Purchase accounting was used to account for all of these acquisitions. Below is the purchase price allocation used to record each of these purchases:

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Apothecary:


	Rambo		Thrifty		Newt’s		Professional		Parkway
Cash	$	1,000	$	—	$	—	$	—	$	2,000
Accounts receivable		7,027		—		3,626		1,412		13,706
Inventory		350,537		161,950		395,546		398,982		2,346,569

Total current assets		358,564		161,950		399,172		400,394		2,362,275


Property and equipment		33,683		—		7,500		5,000		113,812
Intangible assets		973,990		662,960		462,209		162,415		1,062,636
Goodwill		1,192,327		—		512,185		375,000		3,822,275

Net assets acquired	$	2,558,564	$	824,910	$	1,381,066	$	942,809	$	7,360,998

SDC:


	Minority		Texas Labs			Nocturna
Accounts receivable	$	—	$	481,187		$	210,664

Total current assets		—		481,187			210,664

Property and equipment		—		1,707,978			289,651
Intangible assets		—		—			150,000
Goodwill		998,712		881,244			1,522,475

Total assets acquired		998,712		3,070,409			2,172,790
Minority interest in net tangible assets		617,644		—			—
Less: debt assumed		—		(2,110,409	)		—

Net assets acquired	$	1,616,356	$	960,000		$	2,172,790

The following unaudited pro forma combined results of operations for the nine months ended September 30, 2008 have been prepared as if the 2008 acquisitions had occurred on January 1, 2008:


	2008
Pro forma:
Net sales	$	84,477,000

Net income	$	2,253,000

The pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that date, nor is it intended to be a projection of future results.

Note 4 – Goodwill and Other Intangibles

Changes in the carrying amount of goodwill by operating segment during the nine months ended September 30, 2008 were as follows:


	Apothecary		SDC		Total
December 31, 2007	$	7,044,551	$	13,203,354	$	20,247,905

Business acquisitions		5,901,787		2,403,719		8,305,506
Business acquisitions – contingent consideration		142,800		—		142,800
Purchase of minority interests		—		998,712		998,712

September 30, 2008	$	13,089,138	$	16,605,785	$	29,694,923

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As of September 30, 2008, the Company had $29.7 million of goodwill resulting from business acquisitions and other purchases. Goodwill and intangibles assets with indefinite lives must be tested for impairment at least once a year. Carrying values are compared with fair values, and when the carrying value exceeds the fair value, the carrying value of the impaired asset is reduced to its fair value. The Company tests goodwill 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 unit’s 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 unit’s goodwill with the carrying value of that goodwill.

Intangible assets as of September 30, 2008 and December 31, 2007 include the following:


										December 31,
	Useful		September 30, 2008							2007
	Life		Gross		Accumulated
	(Years)		Amount		Amortization			Net		Net
Apothecary:
Customer files		15	$	7,483,136	$	(598,881	)	$	6,884,255	$	4,357,127
Covenants not to compete		3 – 5		1,469,244		(445,250	)		1,023,994		801,532
SDC:
Customer relationships		15		480,000		(53,334	)		426,666		450,667
Trademark		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

Amortization expense for the three months ended September 30, 2008 and 2007 was approximately $210,000 and $114,000, respectively. Amortization expense for the nine months ended September 30, 2008 and 2007 was approximately $611,000 and $283,000, respectively. Amortization expense for the next five years related to these intangible assets is expected to be as follows:


Year ended September 30,
2009	$	893,000
2010		821,000
2011		798,000
2012		703,000
2013		570,000

Note 5 – Borrowings

The Company’s borrowings by operating segment as of September 30, 2008 and December 31, 2007 are as follows:


				Maturity	September 30,		December 31,
	Rate (1)			Date	2008		2007
Apothecary:
Senior bank debt		5	%	May 2014	$	17,403,625	$	—
Bank line of credit		5	%	July 2014		5,217,541		—
Bank line of credit, matured						—		11,905,000
Seller financing		4.1 – 7.25	%	July 2009 – June 2011		5,423,661		3,385,241

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				Maturity	September 30,			December 31,
	Rate (1)			Date	2008			2007
Non-compete agreements		0.0 – 7.65	%	Dec. 2009 – May 2013		1,142,556			784,235

						29,187,383			16,074,476

SDC:
Senior bank debt		5	%	May 2014		12,582,730			11,960,000
Bank line of credit		5	%	June 2014		4,055,798			—
Bank line of credit, matured						—			438,386
Notes payable						—			862,971
Seller financing		5	%	June 2009		734,126			—
Sleep center working capital notes		6.0 – 8.0	%	Apr. 2010 – Aug. 2012		800,950			728,552
Short-term equipment leases		—		Sept. 2009		131,613			149,629
Capital leases		11.0 - 17.0	%	Nov. 2010 - Oct. 2011		179,577			—
Notes payable on vehicles		3.0	%	June 2013		110,018			28,097

						18,594,812			14,167,635

Total borrowings						47,782,195			31,742,111
Less:
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

At September 30, 2008, future maturities of long-term debt were as follows:


Year ended September 30,
2009	$	3,715,940
2010		2,490,792
2011		2,082,651
2012		5,121,066
2013		5,235,492
Thereafter		28,270,515

As of September 30, 2008, the Company had availability under its $15 million bank line of credit of approximately $5.7 million. As of September 30, 2008, the Company had one outstanding letter of credit obligation in the amount of $500,000 which was issued as collateral for payment of a seller financing obligation.

Note 6 – Operating Leases

The Company leases all of the real property used in its business for office space, retail pharmacy locations and sleep testing facilities under operating lease agreements. Rent is expensed as paid consistent with the terms of each lease agreement over the term of each lease. In addition to minimum lease payments, certain leases require reimbursement for common area maintenance and insurance, which are expensed when incurred.

The Company’s minimum rental expense for operating leases for the three months ended September 30, 2008 and 2007 was $523,195 and $234,302, respectively. The Company’s minimum rental expense for operating leases for the nine months ended September 30, 2008 and 2007 was $1,184,522 and $546,996, respectively.

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Following is a summary of the future minimum lease payments under operating leases as of September 30, 2008:


Year ended September 30,
2009	$	2,035,888
2010		1,769,953
2011		1,305,739
2012		931,978
2013		626,134
Thereafter		1,599,456

Total	$	8,269,148

Note 7 – Income Taxes

Prior to December 31, 2007, the taxable income and expenses of ApothecaryRx and SDC Holdings (collectively, the reporting entity for financial reporting purposes) flowed through and was reported at the member level.

Note 8 – Capital Structure

On June 4, 2008, the Company completed a private placement of common stock and issued 3,344,447 shares of common stock. The proceeds of the private placement offering were $15,050,047 ($4.50 per share). There were no offering costs incurred.

On June 1, 2008, the Company issued 130,435 shares of common stock in conjunction with the purchase of Texas Labs. The common stock shares issued were valued at $900,000 ($6.90 per share). In connection with the purchase of Texas Labs, the Company issued common stock options exercisable for the purchase of 35,000 common stock shares for $5.00 each.

On April 15, 2008, the Company concluded a private placement of common stock and issued 404,089 shares of common stock to certain minority interest holders in subsidiaries of SDC Holdings. The shares were issued at a price of $4.00 per share.

On January 11, 2008, the Company concluded a private placement of common stock and issued 599,999 shares of common stock (2,999,996 shares before effect of reverse stock split – see Note 9). The net proceeds of the private placement offering were $938,500 ($1.56 per share) after deduction of $111,500 in offering costs. In conjunction with the private placement, the Company issued common stock purchase warrants exercisable for the purchase of 90,000 common stock shares for $1.93 each.

During January 2008, in conjunction with the closing of the Company’s private placement of common stock, the Company paid-off one of its convertible notes for $750,000 in cash and exchanged the remaining convertible note for 750,000 shares of the Company’s common stock (3,750,000 shares before effect of reverse stock split – see Note 9). In connection with the exchange of shares, the Company issued common stock purchase warrants exercisable for the purchase of 112,500 common stock shares for $1.10 each.

During 2008, certain placement agent warrant holders exercised their warrants. These warrants were exercisable for the purchase of 291,150 common stock shares and were issued in connection with our 2003 and 2008 private placement offerings and convertible note conversion. The warrant holders elected to use the “cashless exercise” provisions and, accordingly, were not required to pay the exercise price ranging from $1.10 to $5.50 per share. We issued 149,723 common stock shares, $0.0001 par value, pursuant to these warrant exercises.

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Note 9 – Reverse Stock Split

On March 13, 2008, the Company’s board of directors approved a reverse split of the Company’s common stock at a ratio of 1 – 5 shares. The effective date of the reverse split was April 11, 2008. The effect of the reverse split was a reduction of our outstanding common stock shares from 117,701,997 to 23,540,399 shares, subject to adjustment for elimination of fractional shares. All references to shares in the consolidated condensed financial statements and the accompanying notes, including but not limited to the number of shares and per share amounts, unless otherwise noted, have been adjusted to reflect the reverse split retroactively. Previously awarded options and warrants to purchase shares of the Company’s common stock have also been retroactively adjusted to reflect the stock split.

Note 10 – Stock Options and Warrants

Information with respect to stock options and warrants outstanding follows:


				Average
				Exercise
	Shares			Price
Outstanding at December 31, 2007		1,064,650		$	7.15
Granted – warrants		202,500			1.47
Granted – options		155,000			4.03
Exercised		(291,150	)		(2.70	)
Forfeited		—			—

Outstanding at September 30, 2008		1,131,000		$	6.84

Note 11 – Segment Information

The Company operates in two reportable business segments: Apothecary and SDC. The Apothecary operating segment operates retail pharmacy stores throughout the central United States. The SDC operating segment operates sleep diagnostic testing labs in Nevada, Oklahoma and Texas. The Company’s film production and distribution activities are included in discontinued operations. The Company’s remaining operations that primarily involve administrative activities associated with operating as a public company are identified as “Other.” Included in segment assets identified as “Other” is approximately $13.5 million in cash and cash equivalents held at the consolidated level to fund future acquisitions and other capital needs of the Apothecary and SDC operating segments.

Reportable business segment information follows:


	Three Months Ending						Nine months Ending
	September 30,						September 30,
	2008			2007			2008			2007
Sales to external customers:
Apothecary	$	22,757,053		$	11,032,785		$	58,132,214		$	26,774,673
SDC		4,726,937			2,633,116			11,668,297			6,573,604

Total	$	27,483,990		$	13,665,901		$	69,800,511		$	33,348,277


Segment operating profit (loss):
Apothecary	$	189,156		$	(148,872	)	$	375,790		$	(217,226	)
SDC		507,627			18,195			1,407,616			152,047
Discontinued operations		87,696			—			118,717			—
Other		(243,365	)		—			(607,453	)		—

Total	$	541,114		$	(130,677	)	$	1,294,670		$	(65,179	)

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

Overview

Graymark Healthcare, Inc. (“Graymark”) is organized in Oklahoma. Prior to December 31, 2007, we were named Graymark Productions, Inc. and an independent producer and distributor of film entertainment content. On January 2, 2008, we completed the acquisition of ApothecaryRx, LLC, (“ApothecaryRx”) and SDC Holdings, LLC (“SDC Holdings”), collectively referred to as the “Graymark Acquisition.” For financial reporting purposes, Graymark was deemed acquired by ApothecaryRx and SDC Holdings and, accordingly, the historical financial statements prior to December 31, 2007 are those of ApothecaryRx and SDC Holdings as adjusted for the effect of the Graymark Acquisition. The activities of Graymark prior to the Graymark Acquisition are no longer reflected in the historical financial statements as it was considered to be the acquired entity. Goodwill of $5,426,815 was recorded as a result of the Graymark Acquisition reflecting the fair market value of the outstanding common stock and liabilities assumed in excess of Graymark’s identifiable assets at the date of the Graymark Acquisition. In conjunction with the Graymark Acquisition, all motion picture production operations were discontinued.

On March 13, 2008, our board of directors approved a reverse split of our common stock at a ratio of 1 – 5 shares. The effective date of the reverse split was April 11, 2008. The effect of the reverse split was a reduction of our outstanding common stock shares from 117,701,997 to 23,540,399 shares, subject to adjustment for elimination of fractional shares.

ApothecaryRx is organized in Oklahoma and began its operations on July 3, 2006. Through ApothecaryRx, we acquire and operate independent retail pharmacy stores selling prescription drugs and a small assortment of general merchandise including diabetic merchandise, over the counter drugs, beauty products and cosmetics, seasonal merchandise, greeting cards, and convenience foods. We operate stores in Colorado, Illinois, Minnesota, Missouri and Oklahoma. We expect to expand our operations to additional states in the future, primarily in the central United States. The results of operations from our retail pharmacy locations are included in our “Apothecary” operating segment.

SDC Holdings is organized in Oklahoma and began its operations on February 1, 2007. Through SDC Holdings, we provide diagnostic sleep testing services and treatment for sleep disorders at sleep diagnostic testing labs in Nevada, Oklahoma and Texas. Our products and services are used primarily by patients with obstructive sleep apnea. These labs 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 obstructive sleep apnea. Positive airway pressure provided by sleep/personal ventilation (or “CPAP”) equipment is the American Academy of Sleep Medicines preferred method of treatment for obstructive sleep apnea. Our sleep diagnostic facilities also determine the correct pressure settings for patient treatment with positive airway pressure. We sell CPAP equipment and supplies to patients who have tested positive for sleep apnea and have had their positive airway pressure determined. The CPAP equipment is a medical device and can only be dispensed pursuant to a physician’s prescription. There are minority ownership interests in our testing facilities. Many of the minority owners are physicians in the geographical area being served by the diagnostic sleep testing facility. The results of operations from our sleep diagnostic testing labs are included in our “SDC” operating segment.

Apothecary Operating Segment

As of September 30, 2008, we owned and operated 18 retail pharmacies located in Colorado, Illinois, Missouri, Minnesota, and Oklahoma. We acquire financially successful independently-owned retail pharmacies from long-term owners that are approaching retirement. Our acquired pharmacies have successfully maintained market share due to the convenient proximity to health care providers and services, high customer service levels, longevity in the community, competitive pricing and supportive services and products such as compounded pharmaceuticals, durable medical equipment, and assisted and group living deliveries. Our acquired and target acquisition stores are in mid-size, economically-stable communities. We believe that a significant amount of the value of the acquired pharmacies resides in their name and key staff relationships in the community. Following acquisition, we maintain the historic store name and key staff personnel.

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In our Apothecary operating segment, we derive our revenue primarily from the retail sale of prescription drugs, non-prescription over-the-counter drugs and health related products. We are unlike traditional full-line retail pharmacies in that most of our stores offer a very limited amount of what is known as “front-end” merchandise (that is, cosmetics, gift and sundry items and photographic development services). Two of our 18 pharmacies provide pharmaceutical compounded prescriptions. Compounded pharmaceuticals are physician prescribed and are specifically mixed and blended from bulk chemicals for patients’ treatment; generally for conditions that the attending physician deems are not effectively treated by manufactured pharmaceuticals available in standard formats or dosages or to which the patient has some form of sensitivity. Our pharmacies are generally located within or near hospitals and major medical complexes, and cater to patients of those healthcare providers. Other than some compounded prescriptions, our pharmacy services do not typically include intravenous infusion and injectable medications that are offered by hospital or home infusion pharmacies.

Following their acquisition, all of our pharmacies are converted to a standardized computer platform. The computer platform we use is commercially available and represents modest investment but it allows for standardized pricing models, comparison of site metrics, low cost training and ease of reporting. Our pharmacy computer system profiles customer medical and other relevant information, supplies customers with information concerning their drug purchases for income tax and insurance purposes and prepares prescription labels and receipts. The computer platform also expedites transactions with third-party plans by electronically transmitting prescription information directly to the third-party plan and providing on-line adjudication. At the time a prescription is filled, on-line adjudication confirms customer eligibility, prescription coverage, pricing and co-payment requirements and automatically bills the respective plan. On-line adjudication also reduces losses from rejected claims and eliminates a portion of the administrative burden related to the billing and collection of receivables and related costs.

Our pharmacy front-end merchandising strategy is to provide a limited selection of competitively priced branded drugstore healthcare products and gift items, unlike the larger pharmacy chains that carry a variety of non-healthcare products. To further enhance customer service and loyalty, we attempt to maintain a consistent in-stock position in our offered healthcare merchandise. We offer primarily brand name healthcare care products, including over-the-counter items, and some gift product items.

SDC Operating Segment

As of September 30, 2008, we operated 14 sleep diagnosis centers in Nevada, Oklahoma and Texas. Each sleep center located in Nevada and Oklahoma is owned by a limited liability company and each of the sleep centers located in Texas is owned by a limited partnership. Some of the limited liability companies and limited partnerships are not wholly-owned by us. We are the manager of each limited liability company and the general partner of each limited partnership.

At these sleep centers, we conduct sleep studies to determine whether the patients referred to us suffer from sleep disorders and if so the severity of their condition. Our facilities are designed to diagnose and assist in the treatment of the full range of sleep disorders (there are currently over 80 different possible diagnoses of sleep disorders); however, the most common referral to our facilities is Obstructive Sleep Apnea (“OSA”). If a patient is determined to suffer from obstructive sleep apnea, the patient and the patient’s referring physician are offered a comprehensive sleep program. This includes diagnosis, titration procedure (that is, the process of determining the optimal pressure to prescribe for the Continuous Positive Airway Pressure, or CPAP device), and therapeutic intervention. This offering provides a one-stop-shop approach to servicing patient’s needs. The principal sleep disorder products we currently market are personal non-invasive ventilation support systems and the associated disposable supplies that are used in the treatment of obstructive sleep apnea to prevent temporary airway closure during sleep.

Obstructive sleep apnea is considered to be one of the most common sleep problems. OSA, is a condition that causes the soft tissue in the rear of the throat to narrow and repeatedly close during sleep. Oxygen deficiency, elevated blood pressure and increased heart rate associated with OSA are related to increased risk of cardiovascular morbidity, stroke and heart attack. Additionally, OSA may result in excessive daytime sleepiness, reduced cognitive functions, including memory loss, lack of concentration, depression and irritability. According to National Heart, Lung and Blood Institute of the National Institutes of Health, approximately 80% of people in the United States who

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suffer from sleep apnea remain undiagnosed. Increased awareness of OSA among doctors and patients in recent years is expected to continue fueling growth of the OSA diagnostic and treatment market at an annual rate of 15% to 20%.

The diagnosis of obstructive sleep apnea typically requires monitoring a patient during sleep. During overnight testing, which usually takes place in a clinical setting, respiratory parameters and sleep patterns are monitored along with other vital signs, providing information about the quality of an individual’s sleep. At the end of 2005, it was estimated that there were approximately 3,000 sleep laboratories and centers in the United States.

Continuous positive airway pressure therapy, commonly referred to as CPAP therapy, has evolved as the primary method for the treatment of obstructive sleep apnea, in part because it is less invasive and more cost-effective than surgery. Unlike surgery, which may only result in reduced snoring, CPAP therapy actually reduces or eliminates the occurrence of obstructive sleep apnea. During this therapy, a patient sleeps with a nasal or facial mask connected by a tube to a small portable airflow generator that delivers room air at a predetermined continuous positive pressure. The continuous air pressure acts as a pneumatic splint to keep the patient’s upper airway open and unobstructed. As a result, the cycle of airway closures that leads to the disruption of sleep and other symptoms that characterize obstructive sleep apnea, is prevented or dramatically reduced.

CPAP is generally not a cure but a therapy for managing the chronic condition of obstructive sleep apnea, and therefore, must be used on a daily basis as long as treatment is required. Patient compliance has been a major factor in the efficacy of CPAP treatment. Early generations of CPAP units provided limited patient comfort and convenience. More recently, product innovations to improve patient comfort and compliance have been developed.

The primary product we sell is a continuous positive airway pressure systems, commonly referred to as CPAP systems, that consist of a compact flow generator connected to a dual-port, air-filled cushion face mask and are used as therapy for obstructive sleep apnea. The face mask is attached to a single-patient use positive end expiratory pressure valve designed to maintain positive airway pressure with the objective of increasing patient comfort and acceptance of the treatment. The CPAP systems provide a non-invasive and more comfortable way for treating obstructive sleep apnea.

CPAP flow generators are electro-mechanical devices that deliver continuous positive airway pressure through a nasal or full face mask to a patient suffering from obstructive sleep apnea in order to keep the patient’s airway open during sleep. Given the importance of patient compliance in treating obstructive sleep apnea, the products are easy to use, lightweight, small and quiet, making them relatively unobtrusive at the bedside. The latest generation of these products are self-adjusting CPAP devices that use pattern recognition technology to respond to changes in breathing patterns, as individual patient needs change. It is the responsibility of the physician prescribing the CPAP to determine the appropriate type of device that we will supply for each patient.

For patients with more severe or complex obstructive sleep apnea, the bi-level CPAP is available. These electro-mechanical devices allow inspiratory and expiratory pressures to be independently adjusted.

Acquisitions

On January 2, 2008, the Graymark Acquisition was completed. Although the Graymark Acquisition was completed on January 2, 2008, we accounted for the Graymark Acquisition as though it occurred on December 31, 2007 because our shareholders approved the Graymark Acquisition in December 2007 and effectively consummated the associate change in control. As part of the Graymark Acquisition, we delivered 20,400,000 shares of our common stock (102,000,000 shares before effect of reverse stock split) to the former equity interest owners of ApothecaryRx and SDC Holdings. Roy T. Oliver and Stanton Nelson received 6,775,146 and 2,572,236 shares of common stock, respectively, (33,875,730 and 12,861,180 shares, respectively, before effect of reverse stock split) as a result of their direct and indirect equity ownership interests in ApothecaryRx and SDC Holdings. Prior to the Graymark Acquisition, Mr. Nelson served on our Board of Directors and Mr. Oliver was one of our greater than 10% shareholders.

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During the nine months ended September 30, 2008, our Apothecary and SDC operating segments completed the following acquisitions:


				Amount
Acquisition	Business	Purchase		Financed by
Date	Acquired	Price		Seller
Apothecary:
January 12, 2008	Rambo Pharmacy (“Rambo”)	$	2,558,564	$	1,020,215
February 29, 2008	Thrifty White Store 726 (“Thrifty”)		824,910		99,444
March 26, 2008	Newt’s Pharmacy (“Newt’s”)		1,381,066		486,209
March 26, 2008	Professional Pharmacy (“Professional”)		942,809		263,100
June 1, 2008	Parkway Drug (“Parkway”)		7,360,998		1,489,814
SDC:
April 15, 2008	Minority interests in sleep centers (“Minority”)		1,616,356		617,644
June 1, 2008	Sleep Center of Waco, Ltd.,
June 1, 2008	Plano Sleep Center, Ltd. and
June 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

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

•

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

•

unanticipated competition, or

•

an adverse action or assessment by a regulator.

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

Results of Operations

The following table sets forth selected results of our operations for the three and nine months ended September 30, 2008. We operate in two reportable business segments: Apothecary and SDC. The Apothecary operating segment includes the operations of our retail pharmacy stores. The SDC operating segment includes the operations from our sleep diagnostic testing labs and related equipment sales. Our film production and distribution activities are included as discontinued operations. The following information was derived and taken from our unaudited financial statements appearing elsewhere in this report.

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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 Ended
	September 30,						September 30,
	2008			2007			2008			2007
Net revenues	$	27,483,990		$	13,665,901		$	69,800,511		$	33,348,277
Cost of sales and services		18,936,956			9,729,820			48,538,980			23,334,043
Operating expenses		7,268,066			3,400,574			17,294,794			8,364,930

Operating income		1,278,968			535,507			3,966,737			1,649,304
Net 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			394,145
Minority 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 increased $13.8 million during the three months ended September 30, 2008 compared with the 3rd quarter of 2007. The increase in net revenues was primarily due to:

•

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 increased $9.2 million during the three months ended September 30, 2008 compared with the 3rd quarter of 2007. The increase in cost of sales and services was primarily due to:

•

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 increased $3.9 million during the three months ended September 30, 2008, compared with the 3rd quarter of 2007. The increase in operating expenses was partly due to the acquisitions made by our Apothecary operating segment which resulted in an increase in operating expenses of $2.2 million. In addition, operating expenses at our SDC operating segment increased $1.0 million due to additional overhead needed to support increased operations and an increase in the allowance for doubtful accounts. Included in the consolidated operating expenses is approximately $0.4 million of overhead incurred at the parent-company level that includes our a public-company costs. See the “Segment Analysis” below, for additional information.

Net other expense increased approximately $78,000 during the three months ended September 30, 2008, compared with the 3rd quarter of 2007. The increase in net other expense was primarily due to an increase in

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interest expense resulting from an increase in borrowings which was offset by a reduction in the interest rate paid on our borrowings and an increase in interest income.

Minority interests decreased approximately $197,000 during the three months ended September 30, 2008 compared with the 3rd quarter of 2007. The minority interests are the equity ownership interests in our SDC subsidiaries that are not wholly-owned. The decrease in minority interests was primarily due to the minority interests share of additional allowances for sales adjustments and doubtful accounts, and the minority interests we purchased in April 2008, which was offset by the increased net income of our SDC subsidiaries attributable to the equity ownership interests we do not own.

Provision for income taxes was approximately $278,000 during the three months ended September 30, 2008. During the 3rd quarter of 2007, we were classified as a partnership for federal and state income tax purposes and were not subject to income tax.

Income from discontinued operations was approximately $88,000 during the three months ended September 30, 2008 and represents the net income from our film operations that were discontinued on January 1, 2008.

Net Income or Loss. Our operations results achieved net income of approximately $541,000 (2.0% of approximately $27.4 million of net revenues) during the third quarter of 2008, compared to a net loss of approximately $131,000 (on net revenues of approximately $13.7 million) during the 2007 third quarter.

Discussion of Nine Month Periods Ended September 30, 2008 and 2007

Net revenues increased $36.4 million during the nine months ended September 30, 2008 compared with the same period in 2007. The increase in net revenues was primarily due to:

•

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 increased $25.2 million during the nine months ended September 30, 2008, compared with the same period in 2007. The increase in cost of sales and services was primarily due to:

•

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 increased $8.9 million during the nine months ended September 30, 2008 compared with the same period in 2007. The increase in operating expenses was partly due to the acquisitions made by our Apothecary operating segment which resulted in an increase in operating expenses of $5.9 million. In addition, operating expenses at our SDC operating segment increased $1.5 million due to additional overhead required to support increased operations and an increase in the allowance for doubtful accounts. Included in the consolidated

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operating expenses is approximately $0.9 million of overhead incurred at the Graymark level which includes the costs of being a public company. See the “Segment Analysis” below, for additional information.

Net other expense increased approximately $347,000 during the nine months ended September 30, 2008, compared with the same period in 2007. The increase in net other expense was primarily due to an increase in borrowings resulting from the acquisitions made by our Apothecary and SDC operating segments, which was offset by a reduction in the interest rate paid on our borrowings and an increase in interest income.

Minority interests increased approximately $131,000 during the nine months ended September 30, 2008 compared with the same period in 2007. The minority interests are the equity ownership interests in our SDC subsidiaries that are not wholly-owned. The increase in minority interests was primarily due to the increased net income of our SDC subsidiaries attributable to the equity ownership interests we do not own, which was offset by the minority interests share in additional allowances for sales adjustment and doubtful accounts, and the amount of minority interest ownerships we purchased in April 2008.

Provision for income taxes was approximately $598,000 during the nine months ended September 30, 2008. During the first nine months of 2007, our operations were conducted limited liability companies that were classified as partnerships for federal and state income tax purposes and were not subject to income tax.

Income from discontinued operations was approximately $119,000 during the nine months ended September 30, 2008 and represent the net income from our film operations which were discontinued on January 1, 2008.

Net income was approximately $1.3 million (1.9% of approximately $69.8 million of net revenues) during the first nine months of 2008, compared to a net loss of approximately $65,000 (on net revenues of approximately $33.3 million) during the 2007 first nine months.

Apothecary Operating Segment


	For the Three Months Ended						For the Nine months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Net revenues	$	22,757,053		$	11,032,785		$	58,132,214		$	26,774,673
Cost of sales		17,265,508			8,547,346			44,479,151			20,761,258
Operating expenses		4,804,213			2,393,745			12,113,566			5,657,997

Operating income		687,332			91,694			1,539,497			355,418
Net 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 increased $11.7 million during the three months ended September 30, 2008 compared with the 3rd quarter of 2007. During the three months ended September 30, 2008, we operated 18 pharmacy locations. During the three months ended September 30, 2007, we operated 8 to 10 pharmacy locations. The increase in our pharmacy locations resulted in an increase in net revenues of $11.9 million. Revenues during the three months ended September 30, 2008 from existing (or same store) pharmacy locations decreased $0.2 million compared with the 3rd quarter of 2007. The decrease in same store revenues was primarily due to an opportunity in 2007 to resupply one of our clinic clients with a sizable amount of vaccines which did not repeat in 2008 and an increase in the percentage of generic drug prescriptions that have a lower average price per prescription. This was partially offset by an increase in the volume of prescriptions filled.

Cost of sales increased $8.7 million during the three months ended September 30, 2008, compared with the 3rd quarter of 2007. This increase was primarily due to the increase in pharmacy locations operated in 2008.

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Cost of sales as a percentage of net revenues was 76% and 77%, respectively, during each of the three months ended September 30, 2008 and 2007.

Operating expenses increased $2.4 million during the three months ended September 30, 2008, compared with the 3rd quarter of 2007. This increase was primarily due to:

•

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 increased approximately $142,000 during the three months ended September 30, 2008 compared with the 3rd quarter of 2007. The increase in net interest expenses was primarily due to the increase in borrowings associated with acquisitions. Total borrowings for our Apothecary operating segment were approximately $29.2 million and $15.3 million at September 30, 2008 and 2007, respectively.

Net income or loss before provision for income taxes. Our Apothecary operating segment operations resulted in net income before provision for income taxes of approximately $306,000 (1.3% of approximately $22.8 million of net revenues) during the third quarter of 2008, compared to a net loss before provision for income taxes of approximately $149,000 (on net revenues of approximately $11.0 million) during the 2007 third quarter.

Discussion of Nine Month Periods Ended September 30, 2008 and 2007

Net revenues increased $31.4 million during the nine months ended September 30, 2008 compared with the same period in 2007. During the nine months ended September 30, 2008, we operated 12 pharmacy locations until February 29, 2008 when we acquired the customer files from another pharmacy which were incorporated into our existing facilities and until March 26, 2008 when we acquired two pharmacy locations for a total of 14 locations until June 1, 2008 when we acquired four additional pharmacy locations for a total of 18 locations. During the nine months ended September 30, 2007, we operated 5 to 10 pharmacy locations. The increase in our pharmacy locations resulted in an increase in net revenues of $32.6 million. Revenues during the nine months ended September 30, 2008 from existing (or same store) pharmacy locations decreased $1.2 million compared with the same period in 2007. The decrease in same store revenues is primarily due to an opportunity in 2007 to resupply one of our clinic clients with a sizable amount of vaccines which did not repeat in 2008, a reduction in the ongoing level of vaccine purchases from this same client and an increase in the percentage of generic drug prescriptions which have a lower average price per prescription. This was partially offset by an increase in the volume of prescriptions filled.

Cost of sales increased $23.7 million during the nine months ended September 30, 2008, compared with the same period in 2007. This increase was primarily due to the increase in pharmacy locations operated in 2008. Cost of sales as a percentage of net revenues was 77% and 78%, respectively, during each of the nine months ended September 30, 2008 and 2007.

Operating expenses increased $6.5 million during the nine months ended September 30, 2008, compared with the same period in 2007. This increase was primarily due to:

•

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 increased approximately $400,000 during the nine months ended September 30, 2008, compared to the same period in 2007. The increase in net interest expenses was primarily due to the increase in

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borrowings resulting from pharmacy acquisitions. Total borrowings for our Apothecary operating segment were approximately $29.2 million and $15.3 million at September 30, 2008 and 2007, respectively.

Net income or loss before provision for income taxes. Our Apothecary operating segment operations resulted in net income before provision for income taxes of approximately $567,000 (1.0% of approximately $58.1 million of net revenues) during the first nine months of 2008, compared to a net loss before provision of income taxes of approximately $217,000 (on net revenues of approximately $26.8 million) during the 2007 first nine months.

SDC Operating Segment


	For the Three Months Ended						For the Nine months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Net revenues	$	4,726,937		$	2,633,116		$	11,668,297		$	6,573,604
Cost of sales and services		1,671,448			1,182,474			4,059,829			2,572,785
Operating expenses		1,995,699			1,006,829			4,163,099			2,706,933

Operating income		1,059,790			443,813			3,445,369			1,293,886
Net 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			611,371
Minority 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 increased $2.1 million during the three months ended September 30, 2008, compared with the 3rd quarter of 2007. This increase was primarily due to:

•

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 increased approximately $0.5 million during the three months ended September 30, 2008 compared with the 3rd quarter of 2007. This increase was primarily due to the acquisition of Nocturna and Texas Labs on June 1, 2008 resulted in an increase in cost of sales and services of approximately $0.5 million.

Cost of sales and services as a percent of net revenues was 35% and 45% during the three months ended September 30, 2008 and 2007, respectively. This decrease was primarily due to the increase in number of sleep studies that were performed at existing locations without substantial increase in staffing levels.

Operating expenses increased approximately $1.0 million during the three months ended September 30, 2008, compared with the 3rd quarter of 2007. The increase in operating expenses was primarily due to additional overhead needed to support increased operations and an increase in the allowance for doubtful accounts.

Net other expense increased approximately $12,000 during the three months ended September 30, 2008 compared with the 3rd quarter of 2007. The increase in net other expenses is primarily an increase in interest expense resulting from an increase in the total borrowings for our SDC operating segment which was offset by a reduction in the interest rate paid on borrowings.

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subsidiaries that are not wholly-owned. The decrease in minority interests was primarily due to the minority interests share of additional allowances for sales adjustments and doubtful accounts, and the minority interests we purchased in April 2008, which was offset by the increased net income of our SDC subsidiaries attributable to the equity ownership interests we do not own.

Net income or loss before provision for income taxes of our SDC operating segment was approximately $818,000 (17% of approximately $4.7 million of net revenues) during the third quarter of 2008, compared to a net income before provision for income taxes of approximately $18,000 (0.7% of approximately $2.6 million net revenues) during the 2007 third quarter.

Discussion of Nine Month Periods Ended September 30, 2008 and 2007

Net revenues increased $5.1 million during the nine months ended September 30, 2008, compared with the same period in 2007. This increase was primarily due to:

•

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 increased approximately $1.5 million during the nine months ended September 30, 2008 compared with the same period 2007. This increase was primarily due to:

•

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

•

Cost of sales and services as a percent of net revenues was 35% and 39% during the nine months ended September 30, 2008 and 2007, respectively. This decrease was primarily due to the increase in number of sleep studies that were performed at existing locations without substantial increase in staffing levels.

Operating expenses increased approximately $1.5 million during the nine months ended September 30, 2008, compared with the same period in 2007. This increase was primarily due to an increase in operating expenses associated with having nine months of operation in the first half of 2008 versus only eight months in the 1st nine months of 2007. In addition, there was an increase in overhead associated with increased operations and the allowance for doubtful accounts.

Net other expense increased approximately $49,000 during the nine months ended September 30, 2008, compared with the same period in 2007. The increase in net other expenses was primarily due to an increase in the total borrowings for our SDC operating segment, which was offset by a reduction in the interest rate paid on borrowings.

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Minority interests increased approximately $131,000 during the nine months ended September 30, 2008, compared with the same period in 2007. The minority interests are the equity ownership interests in our SDC subsidiaries that are not wholly-owned. The increase in minority interests was primarily due to the increased net income of our SDC subsidiaries attributable to the equity ownership interests we do not own, which was offset by the minority interests share in additional allowances for sales adjustment and doubtful accounts, and the amount of minority interest ownerships we purchased in April 2008.

Net income or loss before provision for income taxes of our SDC operating segment was approximately $2,124,000 (18% of approximately $11.7 million of net revenues) during the nine months of 2008, compared to a net income before provision for income taxes of approximately $152,000 (2.3% of approximately $6.6 million net revenues) during the first nine months of 2007.

Liquidity and Capital Resources

Our liquidity and capital resources are provided principally through cash generated from operations, loan proceeds and equity offerings. Our cash and cash equivalents at September 30, 2008 totaled approximately $17.6 million. As of September 30, 2008, we had working capital of approximately $23.6 million.

Our operating activities during the nine months ended September 30, 2008 provided net cash of approximately $1,181,000 compared to operating activities in the first nine months of 2007 that provided approximately $919,000. The increase in cash flows used by operating activities was primarily attributable to increases in net income adjusted for non-cash items, accounts payable and accrued liabilities which was offset by an increase in accounts receivable and inventories. During the nine months ended September 30, 2008, our operating activities included net income of $1,294,670 which was increased by depreciation and amortization of $1,092,678, minority interests of $590,282, minority interests in discontinued operations of $97,653 and stock option compensation of $231,000.

Our investing activities during the nine months ended September 30, 2008 used net cash of approximately $11.9 million compared to the 1st nine months of 2007 during which we used approximately $20.9 million for investing activities. The decrease in the cash used in investing activities was attributable to a decrease in the amount of our business acquisitions. During the nine months ended September 30, 2008, we used $11.2 million for the purchases of businesses compared to $21.9 million in the 1st nine months of 2007.

Our financing activities during the nine months ended September 30, 2008 provided net cash of approximately $26.2 million compared to the 1st nine months of 2007 during which financing activities provided approximately $20.8 million. The increase in net cash provided by financing activities was due to proceeds from the issuance of common stock of $15.6 million, which was offset by a reduction in the amount of debt proceeds. Debt proceeds were $13.3 million during the nine months ended September 30, 2008, compared with debt proceeds of $19.0 million during the 1st nine months of 2007. Debt payments were $2.9 million during the nine months ended September 30, 2008, compared with debt payments of $0.8 million during the 1st nine months of 2007.

We expect to meet our obligations as they become due through available cash and funds generated from our operations, supplemented as necessary by debt financing. We expect to generate positive working capital through our operations. However, there are no assurances that we will be able to either achieve a level of revenues adequate to generate sufficient cash flow from operations or obtain additional financing through debt financing to support our capital commitments and working capital requirements. Our principal capital commitments during the next 12 months primarily involve payments of our indebtedness and lease obligations of approximately $9.1 million as of September 30, 2008.

Financial Commitments

We do not have any capital commitments that we cannot meet with our current capital resources. We expect to meet our obligations as they become due through available cash and funds generated from our operations supplemented as necessary by debt financing. We neither have any plans nor anticipate the need to raise additional

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equity capital during the next 12 months; however, we may receive additional funds from the exercise of outstanding warrants and stock options, the exercise of which is generally not within our control.

Our future commitments under contractual obligations by expected maturity date at September 30, 2008 are as follows:


	<1 year		1-3 years		3-5 years		> 5 years		Total
Short-term debt	$	865,739	$	—	$	—	$	—	$	865,739
Long-term debt		6,208,790		8,918,086		13,766,335		30,267,755		59,160,966
Operating 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

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 management’s 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 2007 annual report on Form 10-K. Some of the more significant estimates include revenue recognition, allowance for sales adjustments and doubtful accounts, and goodwill and intangible asset impairment. We use the following methods to determine our estimates:

Revenue recognition –

Pharmacy product sales from our Apothecary operating segment are recorded at the time the customer takes possession of the merchandise. Customer returns are immaterial and are recorded at the time merchandise is returned.

Sleep center services and product sales from our SDC operating segment 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. We have established an allowance to account for sales 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 sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to our 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 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. 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.

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 labs 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.

Accounts Receivable – Accounts receivable are reported net of allowances for sales adjustments, rental returns and doubtful accounts. The majority of our accounts receivable is due from Medicare, private insurance carriers and other third-party payors, as well as from customers under co-insurance and deductible provisions.

Our allowance for sales adjustments and doubtful accounts is primarily attributable to our SDC operating segment. Third-party reimbursement is a complicated process that involves submission of claims to multiple payers, each having its own claims requirements. In some cases, the ultimate collection of accounts receivable subsequent to the service dates may not be known for several months. We have established an allowance to account for sales 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, sales adjustments, and aging of accounts receivable.

Intangible assets other than goodwill which consist primarily of customer files and covenants not to compete are amortized over their estimated useful lives. The remaining lives range from three to fifteen years. We evaluate the recoverability of identifiable intangible asset whenever events or changes in circumstances indicate that an intangible asset’s carrying amount may not be recoverable.

Recent Accounting Pronouncements

SFAS 141(R) and SFAS 160 – In December 2007, the FASB issued SFAS No. 141 (Revised), “Business Combinations” (“SFAS 141 (R)”), replacing SFAS No. 141, “Business Combinations” (“SFAS 141”), and SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements – an Amendment of ARB No. 51” (“SFAS 160”). SFAS 141(R) retains the fundamental requirements of SFAS 141, and broadens its scope by applying the acquisition method to all transactions and other events in which one entity obtains control over one or more other businesses, and requires, among other things,

•

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 – In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. We adopted this Statement on January 1, 2008 and the initial adoption of this Statement did not have a material impact on our financial position, results of operations, or cash flows.

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Cautionary Statement Relating to Forward Looking Information

We have included some forward-looking statements in this section and other places in this report regarding our expectations. These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, levels of activity, performance or achievements, or industry results, to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Some of these forward-looking statements can be identified by the use of forward-looking terminology including “believes,” “expects,” “may,” “will,” “should” or “anticipates” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategies that involve risks and uncertainties. You should read statements that contain these words carefully because they

•

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.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Management does not believe that there is any material market risk exposure with respect to derivative or other financial instruments that would require disclosure under this item.

Item 4. Controls and Procedures and Item 4T. Controls and Procedures.

Our Chief Executive Officer and Chief Financial Officer are responsible primarily for establishing and maintaining disclosure controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the U.S. Securities and Exchange Commission. The controls and procedures are those defined in Rules 13a-15 or 15d-15 under the Securities Exchange Act of 1934. These controls and procedures are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Furthermore, our Chief Executive Officer and Chief Financial Officer are responsible for the design and supervision of our internal controls over financial reporting as defined in Rule 13a-15 of the Securities Exchange Act of 1934. These internal controls over financial reporting are then effected by and through our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. These policies and procedures

•

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

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•

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.

Our Chief Executive Officer and Chief Financial Officer conducted their evaluation using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework. Based upon their evaluation of the effectiveness of our disclosure controls and procedures and the internal controls over financial reporting as of the last day of the period covered by this report, concluded that our disclosure controls and procedures and internal controls over financial reporting were not fully effective as of the last day of the period covered by this report due to the material weakness noted below. We reported to our auditors and board of directors that, other than the changes taken to remediate the material weakness noted below, no change occurred in our disclosure controls and procedures and internal control over financial reporting occurred during the period covered by this report that would materially affect or is reasonably likely to materially affect our disclosure controls and procedures or internal control over financial reporting. In conducting their evaluation of our disclosure controls and procedures and internal controls over financial reporting, these executive officers did not discover any fraud that involved management or other employees who have a significant role in our disclosure controls and procedures and internal controls over financial reporting. Furthermore, there were no significant changes, other than the material weakness noted below, in our disclosure controls and procedures, internal controls over financial reporting, or other factors that could significantly affect our disclosure controls and procedures or internal controls over financial reporting subsequent to the date of their evaluation.

Accounts Receivable Billing and Reporting at SDC Holding

Our processing and recording of accounts receivable, the associated third-party billings and the estimate of contractual allowances at SDC Holding are key determinants of material revenues and expenses in our financial statements. Subsequent to the close of our reporting period ending June 30, 2008, we identified the following weaknesses in our controls and procedures:

•

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.

We have remediated the billing system issue by adding the flexibility to properly age accounts receivable which provides management with the needed information to properly monitor the level of accounts receivable and monitor the estimate of contractual allowances. In addition, we have implemented additional internal review procedures to monitor the timely follow-up on aged receivables and the effectiveness of our collection efforts. Our remediation efforts were completed during the third quarter of 2008. During the fourth quarter of 2008, we will continue to monitor our internal controls over this area.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We do not have any legal proceedings to report.

Item 1A. Risk Factors

There have been no material changes from the risk factors previously disclosed in our 2007 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During 2008, the holders of certain placement agent warrants exercised their warrants. These warrants were exercisable for the purchase of 291,150 common stock shares and were issued in connection with our 2003 and 2008 private placements and convertible note conversion. The warrant holders elected to use the “cashless exercise” provisions and, accordingly, were not required to pay the exercise price ranging from $1.10 to $5.50 per share. We

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issued 149,723 common stock shares, $0.0001 par value, pursuant to these warrant exercises. In connection with this the issuance of these common stock shares, no underwriting discounts or commissions were paid or will be paid. The common stock shares were sold without registration under the Securities Act of 1933, as amended, in reliance on the registration exemption afforded by Regulation D and more specifically Rule 506 of Regulation D. It is believed that each warrant holder qualified as an accredited investor within the meaning of Rule 501(a) of Regulation D.

Item 3. Defaults Upon Senior Securities

We do not have any thing to report under this Item.

Item 4. Submission of Matters to a Vote of Security Holders

We do not have any thing to report under this Item.

Item 5. Other Information.

We do not have any thing to report under this Item.

Item 6. Exhibits

(a) Exhibits:


Exhibit No.		Description

3.1.1		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.

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


	September 30,			December 31,
	2008			2007
ASSETS
Cash and cash equivalents	$	17,556,341		$	2,072,866
Accounts receivable, net of allowance for sales adjustments and doubtful accounts of $13,756,980 and $5,946,788, respectively		13,577,255			6,485,267
Inventories		8,580,706			4,238,670
Other current assets		124,449			133,791

Total current assets		39,838,751			12,930,594

Property and equipment, net		4,488,316			2,069,685
Intangible assets, net		8,472,693			5,609,326
Goodwill		29,694,923			20,247,905
Other assets		110,700			275,127

Total assets	$	82,605,383		$	41,132,637


LIABILITIES AND SHAREHOLDERS’ EQUITY

Liabilities:
Accounts payable	$	6,497,407		$	4,423,324
Accrued liabilities		5,163,839			2,474,404
Short-term debt		865,739			13,993,015
Current portion of long-term debt		3,715,940			2,394,512

Total current liabilities		16,242,925			23,285,255
Long-term debt, net of current portion		43,200,516			15,354,584

Total liabilities		59,443,441			38,639,839

Minority interests		458,487			629,916
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; 27,569,106 and 22,190,400 issued and outstanding at September 30, 2008 and December 31, 2007, respectively		2,757			2,219
Paid-in capital		26,832,001			7,286,636
Accumulated deficit		(4,131,303	)		(5,425,973	)

Total shareholders’ equity		22,703,455			1,862,882

Total liabilities and shareholders’ equity	$	82,605,383		$	41,132,637


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

Total	$	82,605,383	$	41,132,637


	GRAYMARK HEALTHCARE, INC.
	(Registrant)

	By:	/s/ STANTON NELSON Stanton Nelson
		Chief Executive Officer

Date: November 11, 2008
	By:	/s/ RICK D. SIMPSON Rick D. Simpson
		Chief Financial Officer and Controller
Date: November 11, 2008

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þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


OKLAHOMA (State or other jurisdiction of incorporation or organization)		20-0180812 (I.R.S. Employer Identification No.)


	2008			2007
Revenues:
Product sales	$	23,510,086		$	11,522,639
Services		3,973,904			2,143,262

		27,483,990			13,665,901


Costs and Expenses:
Cost of sales		17,383,849			8,734,458
Cost of services		1,553,107			995,362
Selling, general and administrative		6,843,086			3,184,333
Depreciation and amortization		424,980			216,241


		26,205,022			13,130,394


Income from continuing operations		1,278,968			535,507

Other Income (Expense):
Interest expense, net		(576,244	)		(498,232	)

Net income before minority interests and provision for income taxes		702,724			37,275
Minority 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			20,400,000
Dilutive effect of stock warrants and options		452,000			—

Average common shares outstanding assuming dilution		27,960,924			20,400,000