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Graymark calls second quarter inflection point

August 23, 2011 by · Leave a Comment 

CEO Stanton Nelson

After selling its pharmacy business at the end of 2010, Graymark Healthcare (NASDAQ:GRMH) has chalked up two quarters of cutting expenses this year while posting higher revenue in the second quarter, compared with the first quarter, in its ongoing sleep management services.

“Looking out at the rest of 2011, we feel the second quarter marks a key inflection point for Graymark,” CEO Stanton Nelson says in an exclusive interview with BioTuesdays.com, referring to the company’s efforts to cut costs without impacting revenue growth.

The sale of the pharmacy business to Walgreens (NYSE, NASDAQ:WAG) for about $33 million took Graymark from being a company with total annual revenue of about $100 million to one with about $8.6 million for the first half of 2011. “Our first priority after the sale was to make sure our SG&A was in line with our current sleep apnea business,” Mr. Nelson recalls, pointing to the appointment of Edward Carriero as CFO last November. “While he and I were working on cutting costs, we still had to stay focused on growing the business. I think we’ve been successful at doing that.”

Among other things, Graymark has centralized scheduling, verification of benefits, finance operations and billing this year. “We’ve taken out about $2 million of SG&A expenses compared with the first half last year,” he says. “And what you’ll see in the third quarter and the rest of 2011 is a year-over-year SG&A savings of about $3.5 million.”

Graymark hasn’t given guidance for 2011 revenue, but in 2010, sleep management services generated $22.8 million of revenue, up from $17.6 million in 2009. In the second quarter, revenue totaled $4.4 million, up from $4.2 million in the first quarter.

OSA

In 2009, Graymark launched the nation’s first comprehensive care model for the diagnosis, treatment and continued support of patients with obstructive sleep apnea (OSA), a sleep disorder characterized by abnormal pauses in breathing. Each pause or “apnea” can last from a few seconds to minutes and can occur five to more than 30 times per hour. OSA has been linked to obesity, hypertension, depression and Type 2 diabetes.

Graymark is now the largest public, pure-play sleep management company in the U.S. and the second largest overall, with 24 diagnostic and therapy clinics and 75 hospital/outreach locations in Oklahoma, Texas, Iowa, Kansas, Minnesota, Missouri, Nebraska, Nevada and South Dakota.

There is no cure for sleep apnea.  The most effective tool to treat the disease is a Continuous Positive Airway Pressure (CPAP) machine, which generates the required air pressure to keep a patient’s airway open during sleep.

CPAP

According to the National Sleep Foundation and the National Institutes of Health, there are 50 million Americans with a sleep disorder, of whom 18 million suffer from OSA. Moreover, 14 million or 80% of OSA sufferers are undiagnosed. A Frost and Sullivan report in 2010 predicted that the U.S. sleep apnea diagnostic and devices markets are expected to grow by 13% to $5.3 billion by 2014.

Mr. Nelson says the strategic decision to be a pure-play sleep apnea company was based largely on the fragmentation of the market and “our ability to go out and consolidate the space.” There are some 4,000 sleep labs in the U.S. dominated by small regional players and “mom-and-pop” shops. The seven largest companies in the sector own and operate only 15% of the total.

“Not only is there fragmentation of the market, but much of the competition is focused only on doing either the diagnosis or the therapy,” he points out. “Our approach is different, because we have a comprehensive model that allows us, to not only diagnose and treat people with sleep apnea, but also to resupply products for their treatment. Recurring revenue is a key differentiator.”

In addition to organic growth, Graymark is also “actively pursuing” tuck-in acquisitions in existing markets and geographic expansion through “multi-state opportunities outside the states we are currently in,” Mr. Nelson says. He adds, We believe we are still in the infancy stage of the marketplace.”

The company’s hospital outreach program operates almost like a joint venture. Graymark sets up the sleep lab, provides the equipment, and in most cases, sleep technicians to run the tests and a medical director interprets the test results.

“We run the facility for the hospital, which provides the space, and the hospital bills the patient. We get paid by the hospital, and our hope is that if the patient tests positive for sleep apnea, we can move them into our treatment and resupply programs,” Mr. Nelson states.

Graymark does not market directly to consumers. About 95% of its clients come from referring physicians who suggest a patient needs a sleep test. “We take over the patient at that point, since the referring physician can’t perform the test,” he says. “We make contact with the patient and can usually schedule an overnight sleep test on the same day as we get the referral.”

The company generates an average reimbursement of $800 per sleep study. Patients that test positive for sleep apnea then require a second overnight sleep test or titration study at a cost of $805, which involves the use of a CPAP device to determine the specific amount of pressure required to keep the airway open at all times.

Following the titration study, a technician spends time with a patient showing him or her how to use the $1,380 CPAP device and the problems to look out for. “Failure of compliance is usually the result of not being able to use the mask,” Mr. Nelson contends. “So we offer patients the opportunity to change masks at no cost during the first 90 days, and we’ve seen higher compliance rates based on our customer service, which involves six points of contact with a patient within the first 90 days.”

Compliance rates are critical for reimbursement. Compliance also drives patient retention and recurring revenue through Graymark’s program to resupply products to patients. Medicare, for example, reimburses only if mandated compliance rates are documented within the first 90 days of a patient getting set up with a CPAP device, and payments cease after three months if compliance is not demonstrated. Mr. Nelson says Graymark has achieved compliance rates of 80%, well above the national average of 50%.

The final step in the company’s business model is product resupply. Graymark ships components such as the mask, the hose, the filter and headgear, usually four times a year, and generates about $650 per patient per year. Shipments in the second quarter were 2,750, up from about 2,300 in the first quarter, and both were up more than 100% year-over-year. “All four ways that we make money in our model are reimbursed through insurance—either federal payors or third-party payors,” Mr. Nelson adds.

“What differentiates Graymark from many competitors is our customer service,” he says. “The quality aspect of patient treatment ultimately allows us to drive higher compliance rates and grow our resupply business.”

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