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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2013

For the transition period from                      to                     

Commission File Number: 001-34171

GRAYMARK HEALTHCARE, INC.

(Exact name of registrant as specified in its charter)

204 N. Robinson Avenue, Ste. 400

Oklahoma City, Oklahoma 73102

(Address of principal executive offices)

(405) 601-5300

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     x  Yes     ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    ¨  Yes    x  No

As of August 14, 2013, 163,203,276 shares of the registrant’s common stock, $0.0001 par value, were outstanding.

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GRAYMARK HEALTHCARE, INC.

FORM 10-Q

For the Quarter Ended June 30, 2013

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

Certain statements under the captions “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” Certain, but not necessarily all, of such forward-looking statements can be identified by the use of forward-looking terminology such as “anticipates,” “believes,” “expects,” “may,” “will,” or “should” or other variations thereon, or by discussions of strategies that involve risks and uncertainties. Our actual results or industry results may be materially different from any future results expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially include general economic and business conditions; our ability to implement our business strategies; competition; availability of key personnel; increasing operating costs; unsuccessful promotional efforts; changes in brand awareness; acceptance of new product offerings; and adoption of, changes in, or the failure to comply with, and government regulations.

Throughout this report the first personal plural pronoun in the nominative case form “we” and its objective case form “us”, its possessive and the intensive case forms “our” and “ourselves” and its reflexive form “ourselves” refer collectively to Graymark Healthcare, Inc. and its subsidiaries and “Sleep Management Solutions,” or “SMS,” refers to our sleep centers and related service and supply business.

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PART I. FINANCIAL INFORMATION

The consolidated condensed financial statements included in this report have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission. The Consolidated Condensed Balance Sheets as of June 30, 2013 and December 31, 2012, the Consolidated Condensed Statements of Operations for the three and six month periods ended June 30, 2013 and 2012, and the Consolidated Condensed Statements of Cash Flows for the three and six months ended June 30, 2013 and 2012, have been prepared without audit. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures are adequate to make the information presented not misleading. It is suggested that these consolidated condensed financial statements be read in conjunction with the financial statements and the related notes thereto included in our latest annual report on Form 10-K.

The consolidated condensed statements for the unaudited interim periods presented include all adjustments, consisting of normal recurring adjustments, necessary to present a fair statement of the results for such interim periods. The results for any interim period may not be comparable to the same interim period in the previous year or necessarily indicative of earnings for the full year.

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GRAYMARK HEALTHCARE, INC.

Consolidated Condensed Balance Sheets

(Unaudited)

See Accompanying Notes to Consolidated Condensed Financial Statements

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GRAYMARK HEALTHCARE, INC.

Consolidated Condensed Statements of Operations

For the Three Months Ended June 30, 2013 and 2012

(Unaudited)

See Accompanying Notes to Consolidated Condensed Financial Statements

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GRAYMARK HEALTHCARE, INC.

Consolidated Condensed Statements of Operations

For the Six Months Ended June 30, 2013 and 2012

(Unaudited)

See Accompanying Notes to Consolidated Condensed Financial Statements

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GRAYMARK HEALTHCARE, INC.

Consolidated Condensed Statements of Cash Flows

For the Six Months Ended June 30, 2013 and 2012

(Unaudited)

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 June 30, 2013 and 2012

Note 1 – Nature of Business

Graymark Healthcare, Inc. (the “Company”) is organized under the laws of the state of Oklahoma and is a provider of care management solutions to the sleep disorder market based in the United States. The Company provides a comprehensive diagnosis and care management solution for patients suffering from sleep disorders.

The Company provides diagnostic sleep testing services and care management solutions for people with chronic sleep disorders. In addition, the Company sells equipment and related supplies and components used to treat sleep disorders. The Company’s products and services are used primarily by patients with obstructive sleep apnea, or OSA. The Company’s sleep centers provide monitored sleep diagnostic testing services to determine sleep disorders in the patients being tested. The majority of the sleep testing is to determine if a patient has OSA. A continuous positive airway pressure, or CPAP, device is the American Academy of Sleep Medicine’s (“AASM”) preferred method of treatment for obstructive sleep apnea. The Company’s sleep diagnostic facilities also determine the correct pressure settings for patient treatment with positive airway pressure. The Company sells CPAP devices and disposable supplies to patients who have tested positive for sleep apnea and have had their positive airway pressure determined. There are noncontrolling interests held in some of the Company’s testing facilities, typically by physicians located in the geographical area being served by the diagnostic sleep testing facility.

On July 22, 2013, the Company acquired 100% of the interests in Foundation Surgery Affiliates, LLC (“FSA”) and Foundation Surgical Hospital Affiliates, LLC (“FSHA”) (collectively “Foundation”) from Foundation Healthcare Affiliates, LLC (“FHA”) in exchange for 114,500,000 shares of the Company’s common stock and promissory note in the amount of $2,000,000. The effective date of the Foundation acquisition was July 1, 2013. For financial reporting purposes, the transaction will be recorded as a reverse merger and Foundation will be considered the accounting acquirer. As a result of the reverse merger, the Company’s historical operating results will only include the results of Foundation.

The Company intends to operate the Foundation businesses along with its existing sleep management solutions business. FSA and FSHA own and manage ambulatory surgery centers (“ASC” or “ASCs”) and surgical hospitals with facilities located in Louisiana, Maryland, New Jersey, Ohio, Oklahoma, Pennsylvania and Texas. Foundation typically owns a minority ownership in its facilities with ownership ranging from 10% to 28%. However, Foundation does own over 51% in two of its larger hospitals located in San Antonio and El Paso, Texas. The Foundation facilities collectively offer a portfolio of specialties ranging from relatively intensive specialties such as orthopedics and neurosurgery to low-surgery-intensive specialties such as pediatric ENT (tubes / adenoids), pain management and gastroenterology. The Foundation facilities are located in freestanding buildings or medical office buildings.

As of June 30, 2013, the Company had an accumulated deficit of $61.8 million and reported a net loss of $4.2 million for the six months ended June 30, 2013. In addition, the Company used $0.5 million in cash from operating activities from continuing operations during the six months ended June 30, 2013. Management expects the new combined entity to generate positive cash flow; however the Company’s legacy Graymark business has a significant working capital deficiency. As of June 30, 2013, the Company had a working capital deficiency of $5.1 million (excluding short-term debt and current portion of long-term debt of $18.6 million). In addition, the Company’s lenders have placed restrictions on the amount of cash the Company can transfer from Foundation to the Company’s parent entity or it’s sleep business subsidiaries. The Company has significantly delayed payments to it’s vendors and service providers as a result of the working capital deficiency. Management expects to negotiate discounts and/or payment plans with many of the Company’s vendors and service providers; however, there is no assurance that some of them will not take legal action against the Company which could have a negative impact on the Company’s liquidity.

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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, 2012.

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 in accordance with Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months and six months ended June 30, 2013 are not necessarily indicative of results that may be expected for the year ended December 31, 2013. 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, 2012. The December 31, 2012 consolidated condensed balance sheet was derived from audited financial statements.

Consolidation – The accompanying consolidated condensed 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.

Reclassifications – Certain amounts presented in prior years have been reclassified to conform to the current year’s presentation. Such reclassifications had no effect on net loss.

Use of estimates – The preparation of financial statements in conformity with generally accepted accounting principles requires management of the Company to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Revenue recognition – Sleep center services and product sales are recognized in the period in which services and related products are provided to customers and are recorded at net realizable amounts estimated to be paid by customers and third-party payors. Insurance benefits are assigned to the Company and, accordingly, the Company bills on behalf of its customers. For its sleep diagnostic business and acquired therapy business, the Company estimates the net realizable amount based primarily on the contracted rates stated in the contracts the Company has with various payors or for payors without contracts, historic payment trends. In addition, the Company, on a monthly basis, calculates the historic payments received from all payors at each location to determine if an incremental contractual reserve is necessary and if so, the amount of that reserve. The Company does not anticipate any future changes to this process. In the Company’s historic sleep therapy business, the business has been predominantly out-of-network and as a result, the Company has not had contract rates to use for determining net revenue for a majority of its payors. For this portion of the business, the Company performs a monthly analysis of actual reimbursement from each third party payor for the most recent 12-months. In the analysis, the Company calculates the percentage actually paid by each third party payor of the amount billed to determine the applicable amount of net revenue for each payor. The key assumption in this process is that actual reimbursement history is a reasonable predictor of the future reimbursement for each payor at each facility.

For certain sleep therapy and other equipment sales, reimbursement from third-party payors is earned over a period of time, typically 10 to 13 months. The Company recognizes revenue on these sales as amounts are earned over the payment period stipulated by the third-party payor.

The Company has established an allowance to account for contractual adjustments that result from differences between the amount billed and the expected realizable amount. Actual adjustments that result from differences between the payment amount received and the expected realizable amount are recorded against the allowance for contractual adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company’s collection procedures. Revenues in the accompanying consolidated condensed financial statements are reported net of such adjustments.

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Due to the nature of the healthcare industry and the reimbursement environment in which the Company operates, certain estimates are required to record net revenues and accounts receivable at their net realizable values at the time products or services are provided. Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available, which could have a material impact on the Company’s operating results and cash flows in subsequent periods. Specifically, the complexity of many third-party billing arrangements and the uncertainty of reimbursement amounts for certain services from certain payors may result in adjustments to amounts originally recorded.

The patient and their third party insurance provider typically share in the payment for the Company’s products and services. The amount patients are responsible for includes co-payments, deductibles, and amounts not covered due to the provider being out-of-network. Due to uncertainties surrounding deductible levels and the number of out-of-network patients, the Company is not certain of the full amount of patient responsibility at the time of service. The Company estimates amounts due from patients prior to service and attempts to collect those amounts prior to service. Remaining amounts due from patients are then billed following completion of service.

Cost of Services and Sales – Cost of services includes technician labor required to perform sleep diagnostics, fees associated with interpreting the results of the sleep study and disposable supplies used in providing sleep diagnostics. Cost of sales includes the acquisition cost of sleep therapy products sold. Costs of services are recorded in the time period the related service is provided. Cost of sales is recorded in the same time period that the related revenue is recognized. If the revenue from the sale is recognized over a specified period, the product cost associated with that sale is recognized over that same period. If the revenue from a product sale is recognized in one period, the cost of sale is recorded in the period the product was sold.

Restricted cash – As of June 30, 2013 and December 31, 2012, the Company had long-term restricted cash of approximately $236,000 included in other assets in the accompanying consolidated condensed balance sheets. This amount is pledged as collateral to the Company’s senior bank debt. On July 22, 2013, the Company’s senior lender applied the restricted cash against the principle balance owed by the Company.

Accounts receivable – The majority of the Company’s accounts receivable is due from private insurance carriers, Medicare/Medicaid and other third-party payors, as well as from patients relating to deductible and coinsurance provisions of their health insurance policies.

Third-party reimbursement is a complicated process that involves submission of claims to multiple payors, each having its own claims requirements. Adding to this complexity, a significant portion of the Company’s historic therapy business has been out-of-network with several payors, which means the Company does not have defined contracted reimbursement rates with these payors. For this reason, the Company’s systems report this revenue at a higher gross billed amount, which the Company adjusts to an expected net amount based on historic payments. As the Company continues to move more of its business to in-network contracting, the level of reserve related to contractual allowances is expected to decrease. In some cases, the ultimate collection of accounts receivable subsequent to the service dates may not be known for several months. As these accounts age, the risk of collection increases and the resulting reserves for bad debt expense reflect this longer payment cycle. The Company has established an allowance to account for contractual adjustments that result from differences between the amounts billed to customers and third-party payors and the expected realizable amounts. The percentage and amounts used to record the allowance for doubtful accounts are supported by various methods including current and historical cash collections, contractual adjustments, and aging of accounts receivable.

The Company offers payment plans of up to three months to patients for amounts due from them for the sales and services the Company provides. The minimum monthly payment amount for is calculated based on the down payment and the remaining balance divided by the number of months the patient has to pay the balance.

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Accounts are written-off as bad debt using a specific identification method. For amounts due from patients, the Company utilizes a collections process that includes distributing monthly account statements. For patients that are not on a payment plan, collection efforts including collection letters and collection calls begin once the balance becomes the responsibility of the patient. If the patient is on a payment program, these efforts begin within 30 days of the patient failing to make a planned payment. Beginning in the fourth quarter of 2012, all patient responsibility accounts are forwarded to a contracted Extended Business Office (“EBO”). The EBO prepares and mails all patient account statements and follow up with patients via phone calls and letters to collect amounts due prior to them being turned over for collection. For diagnostic patients, the Company submits patient receivables to an outside collection agency if the patient has failed to pay 120 days following service or, if the patient is on a payment plan, they have failed to make two consecutive payments. For therapy patients, patient receivables are submitted to an outside collection agency if payment has not been received between 180 and 240 days following service depending on the service provided and circumstances of the receivable or, if the patient is on a payment plan, they have failed to make two consecutive payments. It is the Company’s policy to write-off as bad debt all patient receivables at the time they are submitted to an outside collection agency. If funds are recovered by a collection agency, the amounts previously written-off are accounted for as a recovery of bad debt. For amounts due from third party payors, it is the Company’s policy to write-off an account receivable to bad debt based on the specific circumstances related to that claim resulting in a determination that there is no further recourse for collection of a denied claim from the denying payor.

For the six months ended June 30, 2013 and 2012, the amounts the Company collected in excess of (less than) recorded contractual allowances were approximately ($27,000) and $73,000, respectively. These amounts reflect the amount of actual cash received in excess of (less than) the original contractual allowance recorded at the time of service.

Accounts receivable are reported net of allowances for contractual adjustments and doubtful accounts as follows:

The activity in the allowances for contractual adjustments and doubtful accounts for the six months ending June 30, 2013 follows:

The aging of the Company’s accounts receivable, net of allowances for contractual adjustments and doubtful accounts as of June 30, 2013 and December 31, 2012 follows:

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In addition to the aging of accounts receivable shown above, management relies on other factors to determine the collectability of accounts including the status of claims submitted to third party payors, reason codes for declined claims and an assessment of the Company’s ability to address the issue and resubmit the claim and whether a patient is on a payment plan and making payments consistent with that plan.

Included in accounts receivable are earned but unbilled receivables of approximately $90,588 and $179,000 as of June 30, 2013 and December 31, 2012, respectively. Unbilled accounts receivable represent charges for services delivered to customers for which invoices have not yet been generated by the billing system. Prior to the delivery of services or equipment and supplies to customers, the Company performs certain certification and approval procedures to ensure collection is reasonably assured and that unbilled accounts receivable is recorded at net amounts expected to be paid by customers and third-party payors. Billing delays can occur due to delays in obtaining certain required payor-specific documentation from internal and external sources, interim transactions occurring between cycle billing dates established for each customer within the billing system and new sleep centers awaiting assignment of new provider enrollment identification numbers. In the event that a third-party payor does not accept the claim for payment, the customer is ultimately responsible.

Goodwill and Intangible Assets – Goodwill is the excess of the purchase price paid over the fair value of the net assets of the acquired business. Goodwill and other indefinitely-lived intangible assets are not amortized, but are subject to annual impairment reviews during the fourth quarter, or more frequent reviews if events or circumstances indicate there may be an impairment of goodwill.

Intangible assets other than goodwill which include customer relationships, customer files, covenants not to compete, trademarks and payor contracts are amortized over their estimated useful lives using the straight line method. The remaining lives range from three to fifteen years. The Company evaluates the recoverability of identifiable intangible assets annually during the fourth quarter, or more frequently if events or circumstances indicate there may be an impairment of intangible assets.

Loss per share – Basic loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted loss per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted during the period. Dilutive securities having an anti-dilutive effect on diluted loss per share are excluded from the calculation.

Recently Adopted and Recently Issued Accounting Guidance

Adopted Guidance

On January 1, 2013, the Company adopted changes issued by the Financial Accounting Standards Board (FASB) to the testing of indefinite-lived intangible assets for impairment, similar to the goodwill changes adopted in September 2011. These changes provide an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (more than 50%) that the fair value of an indefinite-lived intangible asset is less than its carrying amount. Such qualitative factors may include the following: macroeconomic conditions; industry and market considerations; cost factors; overall financial performance; and other relevant entity-specific events. If an entity elects to perform a qualitative assessment and determines that an impairment is more likely than not, the entity is then required to perform the existing two-step quantitative impairment test, otherwise no further analysis is required. An entity also may elect not to perform the qualitative assessment and, instead, proceed directly to the two-step quantitative impairment test. Notwithstanding the adoption of these changes, management plans to proceed directly to the two-step quantitative test for the Company’s indefinite-lived intangible assets. The adoption of these changes had no impact on the Company’s consolidated financial statements.

On January 1, 2013, the Company adopted changes issued by the FASB to the disclosure of offsetting assets and liabilities. These changes require an entity to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The enhanced disclosures will enable users of an entity’s financial statements to understand and evaluate the effect or potential effect of master netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. The adoption of these changes had no impact on the Company’s consolidated financial statements.

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Issued Guidance

In February 2013, the FASB issued changes to the accounting for obligations resulting from joint and several liability arrangements. These changes require an entity to measure such obligations for which the total amount of the obligation is fixed at the reporting date as the sum of (i) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors, and (ii) any additional amount the reporting entity expects to pay on behalf of its co-obligors. An entity will also be required to disclose the nature and amount of the obligation as well as other information about those obligations. Examples of obligations subject to these requirements are debt arrangements and settled litigation and judicial rulings. These changes become effective for the Company on January 1, 2014. Management has determined that the adoption of these changes will not have an impact on the consolidated financial statements, as the Company does not currently have any such arrangements.

Note 3 – Discontinued Operations

On September 1, 2010, the Company executed an Asset Purchase Agreement, which was subsequently amended on October 29, 2010, (as amended, the “Agreement”) pursuant to which we sold substantially all of the assets of the Company’s subsidiary, ApothecaryRx, LLC (“ApothecaryRx”). ApothecaryRx operated 18 retail pharmacy stores selling prescription drugs and a small assortment of general merchandise, including diabetic merchandise, non-prescription drugs, beauty products and cosmetics, seasonal merchandise, greeting cards and convenience foods. As a result of the sale of ApothecaryRx, the related assets, liabilities, results of operations and cash flows of ApothecaryRx have been classified as discontinued operations in the accompanying consolidated condensed financial statements.

The operating results of ApothecaryRx and the Company’s other discontinued operations (discontinued internet sales division and discontinued film operations) for the six months ended June 30, 2013 and 2012 are summarized below:

The balance sheet items for discontinued operations are summarized below:

As noted above, the Company’s other discontinued operations generated net income (loss) of $14,306 and ($34,449) during the six months ended June 30, 2013 and 2012, respectively, which was attributable to the Company’s discontinued film operations. The Company’s discontinued internet sales division did not have any net income (loss) during the six months ended June 30, 2013 and 2012.

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Note 4 – Other Assets

On October 1, 2012 the Company entered into a purchase agreement to acquire 100% of the membership interests of Midwest Sleep Specialists (“MSS”) located in Kansas City, Missouri, for a purchase price of $720,000. The membership interests of MSS are currently held by Dr. Steven Hull, the Company’s chief medical officer. Under the agreement, the purchase price was to be paid in semi-monthly installments of $15,000 commencing on October 18, 2012 and ending on September 30, 2014 (the “Transfer Date”). Under the agreement, the membership interests would not be transferred to the Company until the final payment was made on the Transfer Date. Prior to the Transfer Date, the Company did not have any control over the operation of MSS. In addition, the Company was not obligated to continue to make the semi-monthly payments and could rescind the agreement at any time. As a result, the Company would not record the MSS purchase until the Transfer Date. As of June 30, 2013, the Company has incurred cumulative semi-monthly payments of $300,000. In July 2013, the Company exercised its right to rescind the agreement. As a result, the installment payments made to date were written-off and are reflected as a write-down of deferred purchase consideration in the accompanying consolidated condensed income statement. As of December 31, 2012, the cumulative installment payments were included in other assets in the accompanying consolidated condensed balance sheet.

Note 5 – Borrowings

The Company’s long-term debt as of June 30, 2013 and December 31, 2012 are as follows:

At June 30, 2013, future maturities of long-term debt were as follows:

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On August 31, 2012, December 31, 2012, March 1, 2013 and April 2, 2013, the Company executed promissory notes with Mr. Roy T. Oliver in the amount of $1,184,808, $351,710, $485,082 and 351,710, respectively, for a total of $2,373,310. The interest rate on the notes is 8% and the maturity date of the notes is July 31, 2013. All principal and interest outstanding are due on the maturity date. Mr. Oliver is one of the Company’s greater than 5% shareholders and affiliates. The promissory notes are subordinate to the Company’s credit facility with Arvest Bank. The Company used the proceeds from the notes to fund its payment obligations to Arvest Bank. On July 22, 2013, the Company converted all amounts owed to Mr. Oliver into shares of the Company’s common stock. See “Note 10 – Subsequent Events” for additional information.

On July 22, 2013, the Company’s subsidiaries, SDC Holdings, LLC and ApothecaryRx, LLC (collectively the “Borrowers”), the Company and Mr. Stanton Nelson (the “Guarantor” and the Company’s chief executive officer) entered into a Second Amended and Restated Loan Agreement (the “New Loan Agreement”) and an Amended and Restated Promissory Note (the “New Note”) with Arvest Bank. The Company, Borrowers, Guarantor and other guarantors previously entered into the Amended and Restated Loan Agreement dated effective December 17, 2010, as amended by the First Amendment to Loan Agreement dated January 1, 2012, the Second Amendment to Loan Agreement dated effective June 30, 2012, and the Third Amendment to Loan Agreement dated effective October 12, 2012 (the “Prior Agreement”). Under the Prior Agreement, the Company and Borrowers were indebted to Arvest Bank under the Amended and Restated Promissory Note, in the original principal amount of $15,000,000 dated June 30, 2010 and the Second Amended and Restated Promissory Note, in the original principal amount of $30,000,000.00, dated June 30, 2010 (the “Prior Notes”). Arvest Bank, the Company, the Borrowers and the Guarantor have agreed to restructure the loan evidenced by the Prior Notes and the Prior Agreement. As of July 22, 2013, the outstanding principal amount of the New Note was $10,691,262.

Personal Guaranty. Under the New Loan Agreement, the Guarantor unconditionally guarantees payment of Borrower’s obligations owed to Arvest Bank and Borrower’s performance under the New Loan Agreement and related documents. Guarantor’s liability is limited to $2,919,000.

Maturity Dates. The maturity date of the New Note is December 31, 2013.

Interest Rate. The outstanding principal amount of the New Note bears interest at the greater of the prime rate as reported in the “Money Rates” section of The Wall Street Journal (the “WSJ Prime Rate”) or 6% (“Floor Rate”).

Interest and Principal Payments. Provided the Borrowers are not in default, the New Note is payable in monthly payments of accrued and unpaid interest. The entire unpaid principal balance of the New Note plus all accrued and unpaid interest thereon will be due and payable on December 31, 2013.

Use of Proceeds. All proceeds of the New Note were used solely for the refinancing of the existing indebtedness owed to Arvest Bank; and other costs the Company incurred by Arvest Bank in connection with the preparation of the loan documents, subject to approval by Arvest Bank.

Collateral. Payment and performance of our obligations under the Arvest Credit Facility are collateralized by the assets of the Borrowers and the limited personal guaranty of the Guarantor. If we sell any assets which are collateral for the New Note, then subject to certain exceptions and without the consent of Arvest Bank, such sale proceeds must be used to reduce the amounts outstanding to Arvest Bank.

Default and Remedies. In addition to the general defaults of failure to perform our obligations and those of the Guarantor, default also includes collateral casualties, misrepresentation, bankruptcy, entry of a judgment of $50,000 or more, or failure of first liens on collateral. In the event a default is not cured within 10 days or in some case five days following notice of the default by Arvest Bank (and in the case of failure to perform a payment obligation for three times with notice), Arvest Bank will have the right to declare the outstanding principal and accrued and unpaid interest immediately due and payable.

Deposit Account Control Agreement. The Company has entered into a Deposit Control Agreement (“Deposit Agreement”) with Arvest Bank and Valliance Bank covering the deposit accounts that we have at Valliance Bank. The Deposit Agreement requires Valliance Bank to comply with instructions originated by Arvest Bank directing the disposition of the funds held by us at Valliance Bank without our further consent. Without Arvest Bank’s consent, we cannot close any of our deposit accounts at Valliance Bank or open any additional accounts at Valliance Bank. Arvest Bank may exercise its rights to give instructions to Valliance Bank under the Deposit Agreement only in the event of an uncured default under the Loan Agreement, as amended.

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Debt Service Coverage Ratio. Based on the latest four rolling quarters, the Company has agreed to continuously maintain a “Debt Service Coverage Ratio” of not less than 1.25 to 1. Debt Service Coverage Ratio is, for any period, the ratio of:

If we acquire another company or its business, the net income of the acquired company and the new debt service associated with acquiring the company may both be excluded from the Debt Service Coverage Ratio, at our option.

Positive EBITDA. Beginning on March 31, 2013, and on the last day of each quarter thereafter, the Company’s EBITDA (“earnings before interest, taxes, depreciation and amortization”) must be positive for such immediately ended quarter. “Positive EBITDA” for any period means the net income for that period: (a) plus the following for such period to the extent deducted in calculating such net income, without duplication: (i) interest expense, (ii) all income tax expense; (iii) depreciation and amortization expense; and (iv) non-cash charges constituting intangible impairment charges, equity compensation and fixed asset impairment charges; (b) but, and in all cases, excluding from the calculation of EBITDA: (i) any extraordinary items (as determined in accordance with GAAP); and (ii) onetime or non-recurring gains or losses associated with the sale or disposition of any business, asset, contract or lease.

Compliance with Financial Covenants. Arvest Bank has waived the financial covenants related to the Company’s Debt Service Coverage Ratio, Positive EBITDA and minimum net worth through December 31, 2013 which is the maturity date of the New Note.

Note 6 – Restructuring Charges

On January 7, 2013, the Company implemented a plan to close four of its sleep diagnostic facilities (two of the locations also had therapy facilities). The facilities were located in Oklahoma and Texas and were closed because the revenue from the facilities had not met expectations and was not adequate to offset the fixed operating costs of the locations. Two of the facilities were operated through January 11, 2013 and two of the facilities were operated through January 31, 2013. The Company recorded restructuring charges of $0.9 million in connection with the closure of these facilities which included $0.8 million for lease termination costs with respect to the remaining lease obligations for the facilities and $0.1 million for other exit costs including severance payments to affected employees and other write-downs. All cash payments related to the severance costs were paid during the first quarter of 2013. The cash payments for the remaining lease obligations will continue for the life of the respective leases which extend through January 2018.

Restructuring charges during the three and six months ended June 30, 2013 were $898,832 and $399,617 respectively. There were no restructuring charges during 2012.

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During the six months ended June 30, 2013, the activity in the accruals for restructuring charges established for lease termination and other exit costs were as follows:

Note 7 – Commitments and Contingencies

Legal Issues: The Company is exposed to asserted and unasserted legal claims encountered in the normal course of business. Management believes that the ultimate resolution of these matters will not have a material adverse effect on the operating results or the financial position of the Company. During the six months ended June 30, 2013 and 2012, the Company did not incur any material costs or settlement expenses related to its ongoing asserted and unasserted legal claims.

Note 8 – Fair Value Measurements

Recurring Fair Value Measurements: The carrying value of the Company’s financial assets and financial liabilities is their cost, which may differ from fair value. The carrying value of cash held as demand deposits, money market and certificates of deposit, accounts receivable, short-term borrowings, accounts payable and accrued liabilities approximated their fair value. At June 30, 2013, the fair value of the Company’s long-term debt, including the current portion was determined to be $10 million. The fair value of the Company’s debt was valued using Level 3 inputs. At June 30, 2012 the Company’s long-term debt, including the current portion approximated its carrying value.

Note 9 – Related Party Transactions

On October 1, 2012 the Company entered into a purchase agreement to acquire 100% of the membership interests of Midwest Sleep Specialists (“MSS”) located in Kansas City, Missouri, for a purchase price of $720,000. The membership interests of MSS are currently held by Dr. Steven Hull, the Company’s chief medical officer. Under the agreement, the purchase price was to be paid in semi-monthly installments of $15,000 commencing on October 18, 2012 and ending on September 30, 2014 (the “Transfer Date”). Under the agreement, the membership interests would not be transferred to the Company until the final payment was made on the Transfer Date. Prior to the Transfer Date, the Company did not have any control over the operation of MSS. In addition, the Company was not obligated to continue to make the semi-monthly payments and could rescind the agreement at any time. As a result, the Company would not record the MSS purchase until the Transfer Date. As of June 30, 2013, the Company has incurred cumulative semi-monthly payments of $300,000. In July 2013, the Company exercised its right to rescind the agreement. As a result, the installment payments made to date were written-off and are reflected as a write-down of deferred purchase consideration in the accompanying condensed consolidated income statement. As of December 31, 2012, the cumulative installment payments were included in other assets in the accompanying condensed consolidated balance sheet.

On October 1, 2012 the Company entered into a management services agreement with MSS to provide certain administrative staffing and other support to the back office operations of MSS. MSS is owned by Dr. Steven Hull, our Chief Medical Officer. The term of the management services agreement is five years and renews automatically for successive five year periods unless either party provides 90 day written notice of termination. Prior to the current agreement, the Company provided similar services to MSS under other arrangements. The total management fees received from MSS during the six months ended June 30, 2013 and 2012 were approximately $129,000 and $156,000, respectively.

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On August 31, 2012, December 31, 2012, March 1, 2013 and April 2, 2013, the Company executed promissory notes with Mr. Roy T. Oliver in the amount of $1,184,808, $351,710, $485,082 and $351,710, respectively, for a total of $2,373,310. The interest rate on the notes is 8% and the maturity dates of the notes are July 31, 2013. All principal and interest outstanding are due on the maturity date. Mr. Oliver is one of the Company’s greater than 5% shareholders and affiliates. The promissory notes are subordinate to the Company’s credit facility with Arvest Bank. The Company used the proceeds from the notes to fund its payment obligations to Arvest Bank.

As of June 30, 2013 and December 31, 2012, the Company had $11,000 and $33,000, respectively, on deposit at Valliance Bank. Valliance Bank is controlled by Mr. Roy T. Oliver, one of our greater than 5% shareholders and affiliates. In addition, the Company is obligated to Valliance Bank under certain sleep center capital notes totaling approximately $44,000 and $56,000 at June 30, 2013 and December 31, 2012, respectively. The interest rates on the notes are fixed at 6.0%. Non-controlling interests in Valliance Bank are held by Mr. Stanton Nelson, the Company’s chief executive officer and Mr. Joseph Harroz, Jr., a director of the Company. Mr. Nelson and Mr. Harroz also serve as directors of Valliance Bank.

In March 2012, the Company executed a lease agreement with City Place, LLC (“City Place”) for the Company’s new corporate headquarters and offices. Under the lease agreement, the Company pays monthly rent of $17,970 from April 1, 2012 to June 30, 2014; $0.00 from July 1, 2014 to January 31, 2015 and $17,970 from February 1, 2015 to March 31, 2017 plus additional payments for allocable basic expenses of City Place; the lease expires on March 31, 2017. As part of the lease agreement, City Place paid $450,000 to offset a portion of the costs the Company incurred to build-out the office space. Non-controlling interests in City Place are held by Roy T. Oliver, one of the Company’s greater than 5% shareholders and affiliates, and Mr. Stanton Nelson, the Company’s Chief Executive Officer. During the six months ending June 30, 2013, the Company incurred approximately $42,000 in lease expense under the terms of the lease. As of June 30, 2013 and December 31, 2012, the Company has accrued but unpaid rent to City Place of approximately $216,000 and $108,000, respectively.

The Company’s previous corporate headquarters and offices were occupied under a month to month lease with Oklahoma Tower Realty Investors, LLC, requiring monthly rental payments of approximately $7,000. Mr. Roy T. Oliver, one of our greater than 5% shareholders and affiliates, controls Oklahoma Tower Realty Investors, LLC (“Oklahoma Tower”). During the six months ended June 30, 2012, the Company incurred approximately $32,000 in lease expense under the terms of the lease. In addition, during six months ended June 30, 2013 and 2012, the Company paid Oklahoma Tower approximately $10,000 and $21,000, respectively, for employee parking under a month to month agreement

Note 10 – Subsequent Events

Management evaluated all activity of the Company and concluded that no material subsequent events have occurred that would require recognition in the consolidated financial statements or disclosure in the notes to the consolidated financial statements, except the following:

Foundation Transaction – On July 22, 2013, the Company acquired 100% of the interests in Foundation Surgery Affiliates, LLC and Foundation Surgical Hospital Affiliates, LLC (collectively “Foundation”) from Foundation Healthcare Affiliates, LLC (“FHA”) in exchange for 114,500,000 shares of the Company’s common stock and promissory note in the amount of $2,000,000, of which $250,000 was paid on July 24, 2013. The effective date of the Foundation acquisition was July 1, 2013. For financial reporting purposes, the transaction will be recorded as a reverse merger and Foundation will be considered the accounting acquirer. As a result of the reverse merger, the Company’s historical operating results will only include the results of Foundation.

The initial accounting for the Foundation transaction has not been completed as it will require the completion of audits for FSA and FSHA. In addition, the Company must complete a fair value analysis of its assets and liabilities as of July 1, 2013 in order to record the reverse merger transaction. As a result of the initial accounting being incomplete, the following disclosures have been omitted:

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Arvest Debt – On July 22, 2013, the Company’s subsidiaries, SDC Holdings, LLC and ApothecaryRx, LLC (collectively the “Borrowers”), the Company and Mr. Stanton Nelson (the “Guarantor” and the Company’s chief executive officer) entered into a Second Amended and Restated Loan Agreement (the “New Loan Agreement”) and an Amended and Restated Promissory Note (the “New Note”) with Arvest Bank. The Company, Borrowers, Guarantor and other guarantors previously entered into the Amended and Restated Loan Agreement dated effective December 17, 2010, as amended by the First Amendment to Loan Agreement dated January 1, 2012, the Second Amendment to Loan Agreement dated effective June 30, 2012, and the Third Amendment to Loan Agreement dated effective October 12, 2012 (the “Prior Agreement”). Under the Prior Agreement, the Company and Borrowers are indebted to Arvest Bank under the Amended and Restated Promissory Note, in the original principal amount of $15,000,000 dated June 30, 2010 and the Second Amended and Restated Promissory Note, in the original principal amount of $30,000,000.00, dated June 30, 2010 (the “Prior Notes”). Arvest Bank, the Company, the Borrowers and the Guarantor have agreed to restructure the loan evidenced by the Prior Notes and the Prior Agreement. As of July 22, 2013, the outstanding principal amount of the New Note was $10,691,262. See “Note 5 – Borrowings” for additional information about the Arvest Debt.

Arvest Loan Participation – On July 22, 2013, in conjunction with the New Loan Agreement with Arvest Bank, the Company entered into a Participation Agreement with Arvest Bank in which we purchased a $6,000,000 participation in the New Note from Arvest Bank in exchange for 13,333,333 shares of the Company’s common stock. The Company purchased the participation in the last $6,000,000 of the principle amount due under the Arvest credit facility.

Roy T. Oliver Note – On July 22, 2013, the Company issued a promissory note in the original principal amount of $5,648,290 in favor of Roy T. Oliver (the “Oliver Note”). The principal amount of the Oliver Note represents the amount Mr. Oliver, a Guarantor under the Prior Agreement, paid to Arvest Bank in full satisfaction of his limited guaranty. Mr. Oliver is not a guarantor of the New Note.

The Oliver Note bears interest at an annual rate of 8.0% and is unsecured and subordinated to the New Loan Agreement. In the event the Company defaults on the Oliver Note, and the event of default is not cured in a timely manner, the lender has the right to declare the outstanding principal and accrued and unpaid interest immediately due and payable. Events of default under the Oliver Note include the failure of the Company to pay the Oliver Note when due, the Company’s assignment for the benefit of creditors or admission of its inability to pay debts as they become due, the commencement of bankruptcy or similar proceedings by or against the Company. or an event of default occurs under the Loan Agreement. The Oliver Note matures on July 31, 2013 provided that, if the New Loan Agreement as in effect on such maturity date does not permit the Company to repay the Oliver Note, then the maturity date is continued until such time as the Arvest loan is refinanced or the provisions of the Loan Agreement permits repayment.

Oliver Debt Conversion – On August 31, 2012, December 31, 2012, March 1, 2013, April 1, 2013 and July 22, 2013, the Company executed promissory notes with Mr. Roy T. Oliver in the amount of $1,184,808, $351,710, $485,082, $351,470 and $5,648,290, respectively, for a total of $8,021,360 (collectively referred to as the “Oliver Notes”). The Company used the proceeds from the notes to fund its payment obligations to Arvest Bank. On July 22, 2013, the Company issued Mr. Oliver 17,970,295 shares of common stock for full satisfaction of the Oliver Notes including principal and accrued interest owed thereon of $114,263.

Preferred Interest Financing Transaction – On March 13, 2013, the Company’s wholly-owned subsidiary, Foundation Health Enterprises, LLC (“FHE”) initiated a private placement offering for up to $15,960,000. The offering is comprised of 152 units (“FHE Unit”). Each FHE Unit is being offered at $105,000 and entitles the purchaser to one (1) Class B membership interest in FHE, valued at $100,000, and 10,000 shares of the Company’s common stock, valued at $5,000. On July 22, 2013, FHE and the Company completed the sale of 68 FHE Units for total consideration received was $7,140,000.

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The FHE Units provide for a cumulative preferred annual return of 9% on the amount allocated to the Class B membership interests. The FHE Units will be redeemed by FHE in four annual installments beginning in July 2014. The first three installments shall be in the amount of $10,000 per FHE Unit and the fourth installment will be in the amount of the unreturned capital contribution and any undistributed preferred distributions. The FHE Units are convertible at the election of the holder at any time prior to the complete redemption into restricted common shares of the Company at a conversion price of $2.00 per share.

The proceeds from the FHE Units allocated to the Class B membership units were used to fund a portion of the Tyche Transaction described below.

Tyche Transaction – On March 31, 2013, the Company and its wholly-owned subsidiary, TSH Acquisition, LLC (“TSH”) entered into an Asset Purchase Agreement (the “Tyche Agreement”) with Tyche Health Enterprises, LLC (“Tyche”) which was subsequently amended on March 31, 2013 and July 22, 2013. The Tyche Agreement provides for the purchase of the preferred membership interests that Tyche owns in certain subsidiaries of FSHA and FSA under a Membership Interest Purchase Agreement, dated July 17, 2007, between Tyche and Foundation Surgery Holdings, L.L.C. (“FSH”), Foundation Weightwise Holdings, L.L.C. (nka FSHA), Foundation Healthcare Affiliates, L.L.C. (“FHA”) as well as the right to various equity interest in the affiliates of FSH, FSA and FHA (collectively “Foundation”).

The transactions under the Tyche Agreement were closed on July 22, 2013. Under the Tyche Agreement, TSH purchased from Tyche (i) all of Tyche’s right, title and interest in the Membership Interest Purchase Agreement; (ii) all of Tyche’s right, title and interest in the preferred and common membership interest in FSH and the right to various equity interests in the affiliates of FSH; (iii) all of Tyche’s right, title and interest in the preferred and common membership interest in FSHA and the right to various equity interest in the affiliates of FSHA; and (iv) all of Tyche’s right, title and interest in any preferred or non-preferred ownership interest in any Foundation entities that have been acquired as a result of the Membership Interest Purchase Agreement.

Under the Tyche Agreement, TSH paid $11,102,372 in cash to Tyche and Tyche related entities and TSH issued promissory notes totaling $2,339,905 to Tyche and Tyche related entities for total consideration of $13,442,277. The promissory notes bear interest at annual rate of 11.5% and mature on August 1, 2013 with all principal and interest being due at that time. On August 1, 2013, the Company paid-off two of the promissory notes totaling $474,305. Management is in the process of extending the terms on the remaining note in the amount of $1,865,600.

As further consideration for the Tyche Agreement, the Company issued Tyche and certain Tyche related entities warrants for the purchase of the Company’s common stock. The warrants issued included:

Valliance Loan Agreement – On July 22, 2013, the Company’s subsidiary, FHE executed a loan agreement and a promissory note in the amount of $5,100,000 payable to Valliance Bank. The note bears interest at annual rate of 10% and FHE is required to make quarterly payments of interest beginning on October 15, 2013. FHE is required to make one principal payment of $728,571 on August 15, 2014. The note matures on July 22, 2015 at which time all outstanding principal and accrued interest is due. The proceeds of the note, net of a $100,000 loan origination fee, were used to help fund FHE’s purchase of the preferred interests of FHA and FSHA from Tyche. The loan agreement requires FHE to prepay a portion of the loan upon the completion of a sale of FSHA’s equity interest in a hospital located in Sherman, TX. The promissory note is secured by the Company’s equity interests in TSH Acquisition, LLC. Valliance Bank is controlled by Mr. Roy T. Oliver, one of our greater than 5% shareholders and affiliates. Non-controlling interests in Valliance Bank are held by Mr. Stanton Nelson, the Company’s chief executive officer and Mr. Joseph Harroz, Jr., a director of the Company. Mr. Nelson and Mr. Harroz also serve as directors of Valliance Bank.

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Restructuring Plan – During July 2013, the Company closed four of its sleep diagnostic and therapy facilities and implemented a plan to close a fifth location. The facilities are located in Oklahoma and Georgia and are being closed because the revenue from these facilities has not met expectations and is not adequate to offset the fixed operating costs of these locations.

The Company expects to record restructuring charges in connection with the closure of these facilities with respect to the remaining lease obligations for the facilities, severance payments to affected employees and other write-downs. The remaining lease obligations and severance payments are estimated to be approximately $132,000 and $56,000, respectively, and will be recorded in the third quarter of 2013. All cash payments related to the severance costs are expected to be paid during the third quarter of 2013. The cash payments for the remaining lease obligations will continue for the life of the respective leases which extend through September 2014.

On July 17, 2013, the Company implemented a plan to sell certain sleep diagnostic and therapy facilities. The facilities identified as held for sale were selected because the revenue from these facilities have not met expectations and are not adequate to offset fixed operating costs. If a sale of these facilities cannot be achieved within an acceptable time frame, then these facilities will be closed. The time frame for achieving a sale or closing the site ranges from July 31, 2013 to August 31, 2013. The facilities identified are located in Oklahoma, Texas, Nevada, Kansas, Missouri and Iowa.

As a result of identifying these sites as held for sale, the related assets, liabilities, results of operations and cash flows of the identified sites will be classified as discontinued operations in the Company’s consolidated financial statements for periods after June 30, 2013.

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Company Overview

Graymark Healthcare, Inc. is organized under the laws of the State of Oklahoma and is a provider of care management solutions to the sleep disorder market with independent sleep care centers and hospital sleep diagnostic programs operated in the United States. We provide comprehensive diagnosis and care management solutions for patients suffering from sleep disorders.

We provide diagnostic sleep testing services and care management solutions, or SMS, for people with chronic sleep disorders. In addition, we provide therapy services (delivery and set up of CPAP equipment together with training related to the operation and maintenance of CPAP equipment) and the sale of related disposable supplies and components used to maintain the CPAP equipment. Our products and services are used primarily by patients with obstructive sleep apnea, or OSA. Our sleep centers provide monitored sleep diagnostic testing services to determine sleep disorders in the patients being tested. The majority of the sleep testing is to determine if a patient has OSA. A continuous positive airway pressure, or CPAP, device is the American Academy of Sleep Medicine’s, or AASM’s, preferred method of treatment for obstructive sleep apnea. Our sleep diagnostic facilities also determine the correct pressure settings for patient CPAP devices via titration testing. We sell CPAP devices and disposable supplies to patients who have tested positive for sleep apnea and have had their positive airway pressure determined.

Foundation Transaction

On July 22, 2013, we acquired 100% of the interests in Foundation Surgery Affiliates, LLC (“FSA”) and Foundation Surgical Hospital Affiliates, LLC (“FSHA”) (collectively “Foundation”) from Foundation Healthcare Affiliates, LLC (“FHA”) in exchange for 114,500,000 shares of the Company’s common stock and promissory note in the amount of $2,000,000, of which $250,000 was paid on July 24, 2013. The effective date of the Foundation acquisition was July 1, 2013. For financial reporting purposes, the transaction will be recorded as a reverse merger and Foundation will be considered the accounting acquirer. As a result of the reverse merger, our historical operating results will only include the results of Foundation.

The Company intends to operate the Foundation businesses along with its existing sleep management solutions business. FSA and FSHA own and manage ambulatory surgery centers (“ASC” or “ASCs”) and surgical hospitals with facilities located in Louisiana, Maryland, New Jersey, Ohio, Oklahoma, Pennsylvania and Texas. Foundation typically owns a minority ownership in its facilities with ownership ranging from 10% to 28%. However, Foundation does own over 51% in two of its larger hospitals located in San Antonio and El Paso, Texas. The Foundation facilities collectively offer a portfolio of specialties ranging from relatively intensive specialties such as orthopedics and neurosurgery to low-surgery-intensive specialties such as pediatric ENT (tubes / adenoids), pain management and gastroenterology. The Foundation facilities are located in freestanding buildings or medical office buildings.

Sleep Business Overview

As of June 30, 2013, we operated 88 sleep diagnostic and therapy centers in 10 states; 20 of which are located in our facilities with the remaining centers operated under management agreements. There are certain noncontrolling interest holders in some of our testing facilities, who are typically physicians in the geographical area being served by the diagnostic sleep testing facility.

Our sleep management solution is driven by our clinical approach to managing sleep disorders. Our clinical model is led by our staff of medical directors who are board-certified physicians in sleep medicine, who oversee the entire life cycle of a sleep disorder from initial referral through continuing care management. Our approach to managing the care of our patients diagnosed with OSA is a key differentiator for us. We believe our overall patient CPAP usage compliance rate, as articulated by the Medicare Standard of compliance requirements, is approximately 80%, compared to a national compliance rate of approximately 50%. Five key elements support our clinical approach:

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Our clinical approach increases the long-term compliance of our patients, and enables us to manage a patient’s sleep disorder care throughout the life cycle of the disorder, thereby allowing us to generate a long-term, recurring revenue stream. We generate revenues via three primary sources: providing the diagnostic tests and related studies for sleep disorders through our sleep diagnostic centers, the sale of CPAP devices, and the ongoing re-supply of components of the CPAP device that need to be replaced. In addition, as a part of our ongoing care management program, we monitor the patient’s sleep disorder and as the patient’s medical condition changes, we are paid for additional diagnostic tests and studies.

In addition, we believe that our clinical approach to comprehensive patient care provides higher quality of care and achieves higher patient compliance. We believe that higher compliance rates are directly correlated to higher revenue generation per patient compared to our competitors through increased utilization of our resupply or PRSP program and a greater likelihood of full reimbursement from federal payors and those commercial carriers who have adopted federal payor standards.

Restructuring Plan

During July 2013, we closed four of our sleep diagnostic and therapy facilities and implemented a plan to close a fifth location. The facilities are located in Oklahoma and Georgia and are being closed because the revenue from these facilities has not met expectations and is not adequate to offset the fixed operating costs of these locations.

We expect to record restructuring charges in connection with the closure of these facilities with respect to the remaining lease obligations for the facilities, severance payments to affected employees and other write-downs. The remaining lease obligations and severance payments are estimated to be approximately $132,000 and $56,000, respectively, and will be recorded in the third quarter of 2013. All cash payments related to the severance costs are expected to be paid during the third quarter of 2013. The cash payments for the remaining lease obligations will continue for the life of the respective leases which extend through September 2014.

On July 17, 2013, we implemented a plan to sell certain sleep diagnostic and therapy facilities. The facilities identified as held for sale were selected because the revenue from these facilities have not met expectations and are not adequate to offset fixed operating costs. If a sale of these facilities cannot be achieved within an acceptable time frame, then these facilities will be closed. The time frame for achieving a sale or closing the site ranges from July 31, 2013 to August 31, 2013. The facilities identified are located in Oklahoma, Texas, Nevada, Kansas, Missouri and Iowa.

As a result of identifying these sites as held for sale, the related assets, liabilities, results of operations and cash flows of the identified sites will be classified as discontinued operations in our consolidated financial statements for periods beginning after June 30, 2013.

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Liquidity Overview

As of June 30, 2013, we had an accumulated deficit of $61.8 million and reported a net loss of $4.2 million for the six months ended June 30, 2013. In addition, we used $0.5 million in cash from operating activities from continuing operations during the six months ended June 30, 2013. On July 22, 2013, we acquired 100% of the interests in Foundation Surgery Affiliates, LLC and Foundation Surgical Hospital Affiliates, LLC (collectively “Foundation”) in exchange for 114.5 million shares of our common stock and a demand note payable for $2 million, of which $250,000 was paid on July 24, 2013. We expect the new combined entity to generate positive cash flow; however our legacy Graymark business has a significant working capital deficiency. As of June 30, 2013, we had a working capital deficiency of $5.1 million (excluding short-term debt and current portion of long-term debt of $18.6 million). In addition, our lenders have placed restrictions on the amount of cash we can transfer from Foundation to our parent entity or our sleep business subsidiaries. We have significantly delayed payments to our vendors and service providers as a result of our working capital deficiency. We expect to negotiate discounts and/or payment plans with many of our vendors and service providers; however, there is no assurance that some of them will not take legal action against us which could have a negative impact on our liquidity. See “Liquidity and Capital Resources” for additional information.

Future Focus of Graymark

In conjunction with the Foundation transaction and restructuring plan, we expect to significantly curtail our existing sleep diagnostic and therapy business and focus on the Foundation business plan and acquisition opportunities that will be synergistic with the Foundation business.

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Results of Operations

The following table sets forth selected results of our operations for the three and six months ended June 30, 2013 and 2012. The following information was derived and taken from our unaudited financial statements appearing elsewhere in this report.

Comparison of the Three and Six Month Periods Ended June 30, 2013 and 2012

Discussion of Three Month Periods Ended June 30, 2013 and 2012

Services revenues declined $1.4 million or 42.9% during the three months ended June 30, 2013 compared with the second quarter of 2012. Our sleep diagnostic services are performed in two environments, our independent diagnostic testing facilities (“IDTF”) and at contracted client locations (“Hospital/Outreach”). For studies performed in our IDTF locations, we generally bill third-party payors for the sleep study. In our Hospital/ Outreach locations, we are paid a contracted fee per study performed. In our more rural outreach locations, our contracted rates are typically higher due to the additional costs associated with servicing more remote locations. Our urban hospital agreements tend to be at a lower rate due to the reimbursement environment and lower costs to serve. The decrease in revenues from sleep diagnostic services during the second quarter of 2013 compared to the second quarter of 2012 was due to a $0.9 million decrease at our IDTF locations and a $0.5 million decrease at our Hospital/Outreach locations.

The $0.9 million decline in IDTF revenues compared to the second quarter of 2012 was due to the following:

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The $0.5 million decrease in Hospital/Outreach revenues during the three months ended June 30, 2013 compared to the second quarter of 2012 was due to the following:

Product sales revenues from our sleep therapy business decreased $0.5 million or 44.7% during the three months ended June 30, 2013 compared with the second quarter of 2012. The decrease was due to a $0.3 million reduction in revenue from the initial set-up of CPAP devices and a $0.2 million decrease in revenue from supply sales.

The reduction in CPAP set-up revenues was due to a $0.3 million reduction related to lower set-up volumes compared to the second quarter of 2012, partially offset by a $0.1 million increase in revenues due to a higher overall average revenue per set-up compared to the second quarter of 2012. The reduced volumes were driven by a combination of lower sleep study volumes at our IDTF locations and product supply shortages resulting from our inability to obtain additional credit from some of our vendors in the second quarter of 2013. The increase in rate is primarily due to changes in both product and payor mix.

Cost of services decreased $0.5 million or 33.0% during the three months ended June 30, 2013 compared with the second quarter of 2012. The decrease in cost of services is due to a $0.6 million decrease due to the lower volume of sleep studies performed offset by an increase in the average cost per study of $0.1 million compared to the second quarter of 2012. Lower volumes unfavorably impacts technician labor efficiency resulting in the higher costs per study.

Cost of services as a percent of service revenue was 50.9% and 43.4% during the three months ended June 30, 2013 and 2012, respectively. The increase in the cost of service as a percent of revenue is primarily due to the decrease in volumes. The utilization efficiency of our sleep technician staff is reduced at lower volume levels as it becomes more difficult to maximize the ratio of technicians to patients. As a result, we are not able to reduce labor costs at the same rate as revenue related to lost volume, increasing our cost of service percentage.

Cost of sales from our sleep therapy business decreased $0.1 million or 35.9% during the three months ended June 30, 2013 compared with the second quarter of 2012 due primarily to lower volumes of both set-ups and supply sales. In addition, cost of sales as a percent of product sales was 40.7% and 35.1% during the three months ended June 30, 2013 and 2012, respectively. The increase in the cost of sales percentage was due to an overall average higher cost per supply item driven in part by lost discounts and pricing advantages due to our credit standing with our vendors and the mix of products sold.

Selling, general and administrative expenses decreased $1.2 million or 32.1% to $2.6 million from $3.8 million during the three months ended June 30, 2013, compared with the second quarter of 2012. The decrease in selling, general and administrative expenses was primarily due to:

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Bad debt expense decreased $0.2 million during the three months ended June 30, 2013, compared with the second quarter of 2012. Bad debt as a percent of revenue was 4.8% and 8.2% for the second quarter of 2013 and 2012, respectively. The decrease in bad debt expense was due to a combination of improved collections related to contracting with an Extended Business Office (EBO) to manage our collection processes related to patient receivables allowing internal staff to focus on third party collections, new processes designed to increase the amount of patient portion of service fees collected at the time of service and a shift in our sleep study volume to more hospital/outreach business which has a shorter collection cycle and lower collection risk.

Write-down of deferred purchase consideration represents the deferred purchase price payments for the membership interests of Midwest Sleep Specialists (“MSS”). On October 1, 2012, we entered into a purchase agreement to acquire 100% of the membership interests of MSS located in Kansas City, Missouri, for a purchase price of $720,000. Under the agreement, the purchase price was to be paid in semi-monthly installments of $15,000 commencing on October 18, 2012 and ending on September 30, 2014 (the “Transfer Date”). Under the agreement, the membership interests would not be transferred to us until the final payment is made on the Transfer Date. We were not obligated to continue to make the semi-monthly payments and could rescind the agreement at any time. We exercised this right in July 2013 and as a result the cumulative semi-monthly payments, totaling $300,000, which had been capitalized and included in other assets in our consolidated balance sheets, were charged to operating expense.

Impairment of goodwill – Based on our sleep study trends and forecasted cash flows at each business unit, we determined that impairment indicators existed during the second quarter of 2012. Based on assumptions similar to those that market participants would make in valuing our business units, we determined that the carrying value of goodwill related to our sleep centers exceeded their fair value. Accordingly, in June 2012, we recorded a noncash impairment charge on goodwill of $3.0 million. We did not have a goodwill impairment charge in the second quarter of 2013.

Restructuring charges resulted in income or a credit of $0.5 million during the three months ended June 30, 2013. On January 7, 2013, we implemented a plan to close four of its sleep diagnostic facilities (two of the locations also had therapy facilities). The facilities were located in Oklahoma and Texas and were closed because the revenue from the facilities had not met expectations and was not adequate to offset the fixed operating costs of the locations. Two of the facilities were operated through January 11, 2013 and two of the facilities were operated through January 31, 2013. We recorded restructuring charges of $0.9 million in connection with the closure of these facilities which included $0.8 million for lease termination costs with respect to the remaining lease obligations for the facilities and $0.1 million for other exit costs including severance payments to affected employees and other write-downs. In the second quarter of 2013, we were able to successfully negotiate a lease termination agreement with one of the facilities. As a result of this agreement, we adjusted our restructuring charge in the second quarter to reflect this reduction in future lease liability. We did not have restructuring charges in the second quarter of 2012.

Depreciation and amortization represents the depreciation expense associated with our fixed assets and the amortization attributable to our intangible assets. Depreciation and amortization decreased $0.1 million compared to the second quarter of 2012. The decrease was primarily due to the elimination of amortization as a result of the impairment recorded against our intangible assets during the fourth quarter of 2012.

Net other expense represents interest expense on borrowings reduced by interest income earned on cash and cash equivalents. Net other expense was flat during the three months ended June 30, 2013 compared with the second quarter of 2012.

Discontinued operations represent the net income (loss) from the operations of East, ApothecaryRx and our other discontinued operations. In May 2011 and December 2010, we completed the sale of substantially all of the assets of East and ApothecaryRx, respectively. As a result, the related assets, liabilities, results of operations and cash flows of East and ApothecaryRx have been classified as discontinued operations. In addition, we have discontinued operations related to our discontinued internet sales division and discontinued film operations. During the second quarter of 2013, the income from discontinued operations is primarily due to a decrease in our estimate for future potential lease liabilities at our former ApothecaryRx locations that have outstanding lease obligations.

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Noncontrolling interests were allocated approximately $84,000 and $49,000 of net loss during the three months ended June 30, 2013 and 2012, respectively. Noncontrolling interests are the equity ownership interests in our SDC Holdings subsidiaries that are not wholly-owned.

Net income (loss) attributable to Graymark Healthcare. Our operations resulted in a net loss of approximately $1.6 million during the second quarter of 2013, compared to a net loss of approximately $5.3 million during the second quarter of 2012.

Discussion of Six Month Periods Ended June 30, 2013 and 2012

Services revenues declined $2.7 million or 40.6% during the six months ended June 30, 2013 compared with the first half of 2012. Our sleep diagnostic services are performed in two environments, our independent diagnostic testing facilities (“IDTF”) and at contracted client locations (“Hospital/Outreach”). For studies performed in our IDTF locations, we generally bill third-party payors for the sleep study. In our Hospital/ Outreach locations, we are paid a contracted fee per study performed. In our more rural outreach locations, our contracted rates are typically higher due to the additional costs associated with servicing more remote locations. Our urban hospital agreements tend to be at a lower rate due to the reimbursement environment and lower costs to serve. The decrease in revenues from sleep diagnostic services during the first six months of 2013 compared to the first six months of 2012 was due to a $1.9 million decrease at our IDTF locations, a $0.7 million decrease at our Hospital/Outreach locations and a $0.1 million decrease in clinic and other revenues.

The $1.9 million decline in IDTF revenues compared to the first six months of 2012 was due to the following:

The $0.7 million decrease in Hospital/Outreach revenues during the six months ended June 30, 2013 compared to the first half of 2012 was due to the following:

The $0.1 million decrease in clinic and other revenues is due to the closing of our clinic operations in 2012 and lower fees from other service agreements.

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Product sales revenues from our sleep therapy business decreased $0.7 million or 31.5% during the six months ended June 30, 2013 compared with the first six months of 2012. The decrease was due to a $0.4 million reduction in revenue from the initial set-up of CPAP devices and a $0.3 million decrease in revenue from supply sales.

The reduction in CPAP set-up revenues was due to a $0.5 million reduction related to lower set-up volumes compared to the second quarter of 2012, partially offset by a $0.1 million increase in revenues due to a higher overall average revenue per set-up compared to the first six months of 2012. The reduced volumes were driven by a combination of lower sleep study volumes at our IDTF locations and product supply shortages resulting from our inability to obtain additional credit from some of our vendors in the second quarter of 2013. The increase in rate is primarily due to changes both product and payor mix.

The reduction in CPAP supply revenue was due to lower supply volumes compared to the first six months of 2012 due to a combination of lower set-up volumes and product supply shortages resulting from tour credit standing with vendors in the second quarter of 2013.

Cost of services decreased $0.9 million or 31.1% during the six months ended June 30, 2013 compared with the first six months of 2012. The decrease in cost of services is due to a $1.0 million decrease due to the lower volume of sleep studies performed offset by an increase in the cost per study totaling $0.1 million compared to the second quarter of 2012. Lower volumes unfavorably impacts technician labor efficiency, resulting in the higher costs per study.

Cost of services as a percent of service revenue was 48.5% and 41.8% during the six months ended June 30, 2013 and 2012, respectively. The increase in the cost of service as a percent of revenue is primarily due to the decrease in volumes. The utilization efficiency of our sleep technician staff is reduced at lower volume levels as it becomes more difficult to maximize the ratio of technicians to patients. As a result, we are not able to reduce labor costs at the same rate as revenue related to lost volume, increasing our cost of service percentage.

Cost of sales from our sleep therapy business decreased $0.2 million or 28.3% during the six months ended June 30, 2013 compared with the first six months of 2012 due primarily to lower volumes of both set-ups and supply sales. In addition, cost of sales as a percent of product sales was 39.1% and 37.4% during the six months ended June 30, 2013 and 2012, respectively. The increase in the cost of sales percentage was due to an overall average higher cost per supply item driven in part by lost discounts and pricing advantages due to our credit standing with certain vendors in the second quarter of 2013 and the mix of products sold.

Selling, general and administrative expenses decreased $2.1 million or 28.7% to $5.3 million from $7.4 million during the six months ended June 30, 2013, compared with the first six months of 2012. The decrease in selling, general and administrative expenses was primarily due to:

Bad debt expense decreased $0.4 million during the six months ended June 30, 2013, compared with the first six months of 2012. Bad debt as a percent of revenue was 5.5% and 7.5% for the first six months of 2013 and 2012, respectively. The decrease in bad debt expense was due to a combination of improved collections related to contracting with an Extended Business Office (EBO) to manage our collection processes related to patient receivables allowing internal staff to focus on third party collections, new processes designed to increase the amount of patient portion of service fees at the time of service and a shift in our sleep study volume to more hospital/outreach business which has a shorter collection cycle and lower collection risk.

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Write-down of deferred purchase consideration represents the deferred purchase price payments for the membership interests of Midwest Sleep Specialists (“MSS”). On October 1, 2012, we entered into a purchase agreement to acquire 100% of the membership interests of MSS located in Kansas City, Missouri, for a purchase price of $720,000. Under the agreement, the purchase price was to be paid in semi-monthly installments of $15,000 commencing on October 18, 2012 and ending on September 30, 2014 (the “Transfer Date”). Under the agreement, the membership interests would not be transferred to us until the final payment is made on the Transfer Date. We were not obligated to continue to make the semi-monthly payments and could rescind the agreement at any time. We exercised this right in July 2013 and as a result the cumulative semi-monthly payments, totaling $300,000, which were formerly included in other assets in our consolidated balance sheets, were charged to operating expense.

Impairment of goodwill – Based on our sleep study trends and forecasted cash flows at each business unit, we determined that impairment indicators existed during the second quarter of 2012. Based on assumptions similar to those that market participants would make in valuing our business units, we determined that the carrying value of goodwill related to our sleep centers exceeded their fair value. Accordingly, in June 2012, we recorded a noncash impairment charge on goodwill of $3.0 million. We did not have a goodwill impairment charge in the first half of 2013.

Restructuring charges were $0.4 million during the six months ended June 30, 2013. On January 7, 2013, we implemented a plan to close four of our sleep diagnostic facilities (two of the locations also had therapy facilities). The facilities were located in Oklahoma and Texas and were closed because the revenue from the facilities had not met expectations and was not adequate to offset the fixed operating costs of the locations. Two of the facilities were operated through January 11, 2013 and two of the facilities were operated through January 31, 2013. We recorded restructuring charges of $0.9 million in connection with the closure of these facilities which included $0.8 million for lease termination costs with respect to the remaining lease obligations for the facilities and $0.1 million for other exit costs including severance payments to affected employees and other write-downs. In the second quarter of 2013, we were able to successfully negotiate a lease termination agreement with one of the facilities. As a result of this agreement, we adjusted our restructuring charge $0.5 million in the second quarter to reflect this reduction in future lease liability. We did not have restructuring charges in the second quarter of 2012.

Depreciation and amortization represents the depreciation expense associated with our fixed assets and the amortization attributable to our intangible assets. Depreciation and amortization decreased $0.1 million compared to the first six months of 2012. The decrease was primarily due to the elimination of amortization as a result of the impairment recorded against our intangible assets during the fourth quarter of 2012.

Net other expense represents interest expense on borrowings reduced by interest income earned on cash and cash equivalents. Net other expense was flat during the six months ended June 30, 2013 compared with the first six months of 2012.

Discontinued operations represent the net income (loss) from the operations of East, ApothecaryRx and our other discontinued operations. In May 2011 and December 2010, we completed the sale of substantially all of the assets of East and ApothecaryRx, respectively. As a result, the related assets, liabilities, results of operations and cash flows of East and ApothecaryRx have been classified as discontinued operations. In addition, we have discontinued operations related to our discontinued internet sales division and discontinued film operations. During the first six months of 2013, the income from discontinued operations is primarily due to a decrease in our estimate for future potential lease liabilities at our former ApothecaryRx locations that have outstanding lease obligations.

Noncontrolling interests were allocated approximately $132,000 and $93,000 of net loss during the six months ended June 30, 2013 and 2012, respectively. Noncontrolling interests are the equity ownership interests in our SDC Holdings subsidiaries that are not wholly-owned.

Net income (loss) attributable to Graymark Healthcare. Our operations resulted in a net loss of approximately $4.2 million during the first six months of 2013, compared to a net loss of approximately $7.2 million during the first six months of 2012.

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Liquidity and Capital Resources

Generally our liquidity and capital resource needs are funded from operations, loan proceeds and equity offerings. As of June 30, 2013, our liquidity and capital resources included cash and cash equivalents of $0.1 million and working capital deficit of $23.7 million. As of December 31, 2012, our liquidity and capital resources included cash and cash equivalents of $0.3 million and working capital deficit of $20.2 million.

Cash used in operating activities from continuing operations was $0.5 million during the six months ended June 30, 2013 compared to $2.7 million for the first six months of 2012. During the six months ended June 30, 2013, the primary uses of cash from operating activities from continuing operations were cash required to fund losses from continuing operations (net of non-cash adjustments) of $3.6 million. The primary sources of cash from operating activities from continuing operations during the first six months of 2013 were increases in accounts payable, accrued liabilities and other liabilities totaling $1.9 million and decreases in accounts receivable, inventories and other assets totaling $1.3 million. During the six months ended June 30, 2012, the primary uses of cash from operating activities from continuing operations were cash required to fund losses from continuing operations (net of non-cash adjustments) of $2.8 million and an increase in accounts receivable and other assets totaling $1.1 million. The primary sources of cash from operating activities from continuing operations in the first six months of 2012 was a net increase in accounts payable and accrued liabilities of $1.2 million.

Cash provided by discontinued operations for the six months ended June 30, 2013 was $0.2 million compared to the first six months of 2012 when discontinued operations provided $0.7 million which included $1.0 million received from the final proceeds of the ApothecaryRx Indemnity Escrow Fund

Net cash provided by investing activities from continuing operations during the six months ended June 30, 2013 was approximately $30,000 compared to the first six months of 2012 when investing activities from continuing operations used $1.0 million. Investing activities during the first six months of 2012 were primarily related to the purchase of leasehold improvements and sleep equipment for new sleep labs and leasehold improvements at our corporate office location.

There were no investing activities from discontinued operations during the six months ended June 30, 2013 and 2012.

Net cash provided by financing activities from continuing operations during the six months ended June 30, 2013 was $0.1 million compared to the first six months of 2012 when financing activities from continuing operations used $0.8 million. During the six months ended June 30, 2013 and 2012, we made debt payments of $0.7 million and $1.0 million, respectively. During the six months ended June 30, 2013 and 2012, we received $0.8 and $0.2 million, respectively, in debt proceeds.

As of June 30, 2013, we had an accumulated deficit of $61.8 million and reported a net loss of $4.2 million for the six months ended June 30, 2013. In addition, we used $0.5 million in cash from operating activities from continuing operations during the six months ended June 30, 2013. On July 22, 2013, we acquired 100% of the interests in Foundation Surgery Affiliates, LLC and Foundation Surgical Hospital Affiliates, LLC (collectively “Foundation”) in exchange for 114.5 million shares of our common stock and a demand note payable for $2 million, of which $250,000 was paid on July 24, 2013. We expect the new combined entity to generate positive cash flow; however our legacy Graymark business has a significant working capital deficiency. As of June 30, 2013, we had a working capital deficiency of $5.1 million (excluding short-term debt and current portion of long-term debt of $18.6 million). In addition, our lenders have placed restrictions on the amount of cash we can transfer from Foundation to our parent entity or our sleep business subsidiaries. We have significantly delayed payments to our vendors and service providers as a result of our working capital deficiency. We expect to negotiate discounts and/or payment plans with many of our vendors and service providers; however, there is no assurance that some of them will not take legal action against us which could have a negative impact on our liquidity.

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Arvest Credit Facility

On July 22, 2013, our subsidiaries, SDC Holdings, LLC and ApothecaryRx, LLC (collectively the “Borrowers”), we and Mr. Stanton Nelson (the “Guarantor” and our chief executive officer) entered into a Second Amended and Restated Loan Agreement (the “New Loan Agreement”) and an Amended and Restated Promissory Note (the “New Note”) with Arvest Bank. We, the Borrowers, the Guarantor and other guarantors previously entered into the Amended and Restated Loan Agreement dated effective December 17, 2010, as amended by the First Amendment to Loan Agreement dated January 1, 2012, the Second Amendment to Loan Agreement dated effective June 30, 2012, and the Third Amendment to Loan Agreement dated effective October 12, 2012 (the “Prior Agreement”). Under the Prior Agreement, we and the Borrowers were indebted to Arvest Bank under the Amended and Restated Promissory Note, in the original principal amount of $15,000,000 dated June 30, 2010 and the Second Amended and Restated Promissory Note, in the original principal amount of $30,000,000, dated June 30, 2010 (the “Prior Notes”). Arvest Bank, we, the Borrowers and the Guarantor have agreed to restructure the loan evidenced by the Prior Notes and the Prior Agreement. As of July 22, 2013, the outstanding principal amount of the New Note was $10,691,262.

Personal Guaranty. Under the New Loan Agreement, the Guarantor unconditionally guarantees payment of Borrower’s obligations owed to Arvest Bank and Borrower’s performance under the New Loan Agreement and related documents. Guarantor’s liability is limited to $2,919,000.

Maturity Dates. The maturity date of the New Note is December 31, 2013.

Interest Rate. The outstanding principal amount of the New Note bears interest at the greater of the prime rate as reported in the “Money Rates” section of The Wall Street Journal (the “WSJ Prime Rate”) or 6% (“Floor Rate”).

Interest and Principal Payments. Provided the Borrowers are not in default, the New Note is payable in monthly payments of accrued and unpaid interest. The entire unpaid principal balance of the New Note plus all accrued and unpaid interest thereon will be due and payable on December 31, 2013.

Use of Proceeds. All proceeds of the New Note were used solely for the refinancing of the existing indebtedness owed to Arvest Bank; and other costs we were incurred by Arvest Bank in connection with the preparation of the loan documents, subject to approval by Arvest Bank.

Collateral. Payment and performance of our obligations under the Arvest Credit Facility are secured by the assets of the Borrowers and the limited personal guaranty of the Guarantor. If we sell any assets which are collateral for the New Note, then subject to certain exceptions and without the consent of Arvest Bank, such sale proceeds must be used to reduce the amounts outstanding to Arvest Bank.

Default and Remedies. In addition to the general defaults of failure to perform our obligations and those of the Guarantor, default also includes collateral casualties, misrepresentation, bankruptcy, entry of a judgment of $50,000 or more, or failure of first liens on collateral. In the event a default is not cured within 10 days or in some case five days following notice of the default by Arvest Bank (and in the case of failure to perform a payment obligation for three times with notice), Arvest Bank will have the right to declare the outstanding principal and accrued and unpaid interest immediately due and payable.

Deposit Account Control Agreement. We have entered into a Deposit Control Agreement (“Deposit Agreement”) with Arvest Bank and Valliance Bank covering the deposit accounts that we have at Valliance Bank. The Deposit Agreement requires Valliance Bank to comply with instructions originated by Arvest Bank directing the disposition of the funds held by us at Valliance Bank without our further consent. Without Arvest Bank’s consent, we cannot close any of our deposit accounts at Valliance Bank or open any additional accounts at Valliance Bank. Arvest Bank may exercise its rights to give instructions to Valliance Bank under the Deposit Agreement only in the event of an uncured default under the Loan Agreement, as amended.

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Debt Service Coverage Ratio. Based on the latest four rolling quarters, the Company has agreed to continuously maintain a “Debt Service Coverage Ratio” of not less than 1.25 to 1. Debt Service Coverage Ratio is, for any period, the ratio of:

If we acquire another company or its business, the net income of the acquired company and the new debt service associated with acquiring the company may both be excluded from the Debt Service Coverage Ratio, at our option.

Positive EBITDA. Beginning on March 31, 2013, and on the last day of each quarter thereafter, the Company’s EBITDA (“earnings before interest, taxes, depreciation and amortization”) must be positive for such immediately ended quarter. “Positive EBITDA” for any period means the net income for that period: (a) plus the following for such period to the extent deducted in calculating such net income, without duplication: (i) interest expense, (ii) all income tax expense; (iii) depreciation and amortization expense; and (iv) non-cash charges constituting intangible impairment charges, equity compensation and fixed asset impairment charges; (b) but, and in all cases, excluding from the calculation of EBITDA: (i) any extraordinary items (as determined in accordance with GAAP); and (ii) onetime or non-recurring gains or losses associated with the sale or disposition of any business, asset, contract or lease.

Compliance with Financial Covenants. Arvest Bank has waived the financial covenants related to the Company’s Debt Service Coverage Ratio, Positive EBITDA and minimum net worth through December 31, 2013 which is the maturity date of the New Note.

Arvest Loan Participation

On July 22, 2013, in conjunction with the New Loan Agreement with Arvest Bank, we entered into a Participation Agreement with Arvest Bank in which we purchased a $6,000,000 participation in the New Note from Arvest Bank in exchange for 13,333,333 shares of the Company’s common stock. We purchased the participation in the last $6,000,000 of the principle amount due under the Arvest credit facility.

Roy T. Oliver Note

On July 22, 2013, we issued a promissory note in the original principal amount of $5,648,290 in favor of Roy T. Oliver (the “Oliver Note”). The principal amount of the Oliver Note represents the amount Mr. Oliver, a Guarantor under the Prior Agreement, paid to Arvest Bank in full satisfaction of his limited guaranty. Mr. Oliver is not a guarantor of the New Note.

The Oliver Note bears interest at an annual rate of 8.0% and is unsecured and subordinated to the New Loan Agreement. In the event the Company defaults on the Oliver Note, and the event of default is not cured in a timely manner, the lender has the right to declare the outstanding principal and accrued and unpaid interest immediately due and payable. Events of default under the Oliver Note include the failure of the Company to pay the Oliver Note when due, the Company’s assignment for the benefit of creditors or admission of its inability to pay debts as they become due, the commencement of bankruptcy or similar proceedings by or against the Company. or an event of default occurs under the Loan Agreement. The Oliver Note matures on July 31, 2013 provided that, if the New Loan Agreement as in effect on such maturity date does not permit the Company to repay the Oliver Note, then the maturity date is continued until such time as the Arvest loan is refinanced or the provisions of the Loan Agreement permits repayment.

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Oliver Debt Conversion

On August 31, 2012, December 31, 2012, March 1, 2013, April 1, 2013 and July 22, 2013, we executed promissory notes with Mr. Roy T. Oliver in the amount of $1,184,808, $351,710, $485,082, $351,470 and $5,648,290, respectively, for a total of $8,021,360 (collectively referred to as the “Oliver Notes”). The Company used the proceeds from the notes to fund its payment obligations to Arvest Bank. On July 22, 2013, the Company issued Mr. Oliver 17,970,295 shares of common stock for full satisfaction of the Oliver Notes including principal and accrued interest owed thereon of $114,263.

Preferred Interest Financing Transaction

On March 13, 2013, our wholly-owned subsidiary, Foundation Health Enterprises, LLC (“FHE”) initiated a private placement offering for up to $15,960,000. The offering is comprised of 152 units (“FHE Unit”). Each FHE Unit is being offered at $105,000 and entitles the purchaser to one (1) Class B membership interest in FHE, valued at $100,000, and 10,000 shares of the Company’s common stock, valued at $5,000. On July 22, 2013, FHE and the Company completed the sale of 68 FHE Units for total consideration received was $7,140,000.

The FHE Units provide for a cumulative preferred annual return of 9% on the amount allocated to the Class B membership interests. The FHE Units will be redeemed by FHE in four annual installments beginning in July 2014. The first three installments shall be in the amount of $10,000 per FHE Unit and the fourth installment will be in the amount of the unreturned capital contribution and any undistributed preferred distributions. The FHE Units are convertible at the election of the holder at any time prior to the complete redemption into restricted common shares of the Company at a conversion price of $2.00 per share.

The proceeds from the FHE Units allocated to the Class B membership units were used to fund a portion of the Tyche Transaction described below.

Tyche Transaction

On March 31, 2013, we and our wholly-owned subsidiary, TSH Acquisition, LLC (“TSH”) entered into an Asset Purchase Agreement (the “Tyche Agreement”) with Tyche Health Enterprises, LLC (“Tyche”) which was subsequently amended on March 31, 2013 and July 22, 2013. The Tyche Agreement provides for the purchase of the preferred membership interests that Tyche owns in certain subsidiaries of FSHA and FSA under a Membership Interest Purchase Agreement, dated July 17, 2007, between Tyche and Foundation Surgery Holdings, L.L.C. (“FSH”), Foundation Weightwise Holdings, L.L.C. (nka FSHA), Foundation Healthcare Affiliates, L.L.C. (“FHA”) as well as the right to various equity interest in the affiliates of FSH, FSA and FHA (collectively “Foundation”).

The transactions under the Tyche Agreement were closed on July 22, 2013. Under the Tyche Agreement, TSH purchased from Tyche (i) all of Tyche’s right, title and interest in the Membership Interest Purchase Agreement; (ii) all of Tyche’s right, title and interest in the preferred and common membership interest in FSH and the right to various equity interests in the affiliates of FSH; (iii) all of Tyche’s right, title and interest in the preferred and common membership interest in FSHA and the right to various equity interest in the affiliates of FSHA; and (iv) all of Tyche’s right, title and interest in any preferred or non-preferred ownership interest in any Foundation entities that have been acquired as a result of the Membership Interest Purchase Agreement.

Under the Tyche Agreement, TSH paid $11,102,372 in cash to Tyche and Tyche related entities and TSH issued promissory notes totaling $2,339,905 to Tyche and Tyche related entities for total consideration of $13,442,277. The promissory notes bear interest at annual rate of 11.5% and mature on August 1, 2013 with all principal and interest being due at that time. On August 1, 2013, we paid-off two of the promissory notes totaling $474,305. We are in the process of extending the terms on the remaining note in the amount of $1,865,600.

As further consideration for the Tyche Agreement, the Company issued Tyche and certain Tyche related entities warrants for the purchase of the Company’s common stock. The warrants issued included:

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